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SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
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For the fiscal year ended December 31, 2000
Commission file no. 0-22861
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FIRST INTERNATIONAL BANCORP, INC.
(Exact name of registrant as specified in its charter)
Delaware 06-1151731
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
280 Trumbull Street
Hartford, CT 06103
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (860) 727-0700
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Securities Registered Pursuant to Section 12(b) of the Act:
None
Securities Registered Pursuant to Section 12(g) of the Act:
(Title of each class)
Common Stock, par value $.10 per share
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No__
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
or Regulation S-K is not contained herein, and will not be contained, to the
best of Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. X
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As of March 1, 2001, the aggregate market value of the voting stock held by
non-affiliates of the Registrant, based on the closing price of the common stock
as reported by the NASDAQ National Market of $8.56 was approximately
$29,460,000.
As of March 1, 2001, the Registrant had 8,042,019 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
Part III, items 10, 11, 12 and 13 are incorporated by reference to First
International Bancorp, Inc.'s definitive proxy statement to stockholders which
is expected to be filed with the Securities and Exchange Commission no later
than 120 days after December 31, 2000.
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TABLE OF CONTENTS
PART 1 Page No.
ITEM 1. BUSINESS 1
ITEM 2. PROPERTIES 26
ITEM 3. LEGAL PROCEEDINGS 26
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY 26
HOLDERS
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND 27
RELATED STOCKHOLDER MATTERS
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA 28
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF 29
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES 61
ABOUT MARKET RISK
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 62
- Report of Independent Accountants
- Consolidated Balance Sheets as of December
31, 2000 and 1999
- Consolidated Statements of Income for the
years ended December 31, 2000, 1999 and
1998
- Consolidated Statements of Changes in
Stockholders' Equity for the years ended
December 31, 2000, 1999 and 1998
- Consolidated Statements of Cash Flows for
the years ended December 31, 2000, 1999
and 1998
- Notes to Consolidated Financial Statements
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS 107
ON ACCOUNTING AND FINANCIAL DISCLOSURE
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 107
ITEM 11. EXECUTIVE COMPENSATION 107
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS 107
AND MANAGEMENT
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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 107
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND 107
REPORTS ON FORM 8-K
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PART 1
ITEM 1: BUSINESS
GENERAL
Overview
First International Bancorp, Inc., a Delaware corporation, is a one bank holding
company incorporated in 1985 and regulated by the Board of Governors of the
Federal Reserve System. Its principal asset and subsidiary is First
International Bank (the "Bank"), a Connecticut state bank and trust company. The
Bank was established in 1955 as a national bank and converted to a state bank in
July 1999. The Bank is regulated by the State of Connecticut Department of
Banking ("CDB") and the Federal Deposit Insurance Corporation ("FDIC"). The Bank
changed its name from First National Bank of New England on February 1, 1999 to
more closely reflect the markets it serves. Since 1998, the Bank has established
various special purpose entities to facilitate loan securitizations and sales to
commercial paper conduits.
The Bank solicits commercial loans in New Jersey through its wholly-owned
subsidiary, First International Capital Corp. of New Jersey, and operates in
various other states under the trade name First International Capital.
The Company specializes in providing credit, trade and financial solutions to
small and medium size industrial companies located in the United States and in
international emerging markets. The Company serves its target market by offering
flexible and attractive loan terms to borrowers and manages its credit risk
through the combined utilization of commercial loan guarantee programs made
available by three U. S. federal agencies: the U. S. Small Business
Administration (the "SBA"), the U. S. Department of Agriculture (the "USDA"),
and the Export-Import Bank of the U. S. ("Ex-Im Bank"), as well as through the
use of private credit insurance policies.
For the federal fiscal year ending September 30, 2000, the Company was the
country's largest Ex-Im Bank lender measured by number of transactions; the
second largest USDA Business and Industry lender measured by dollar volume; and
the eleventh largest SBA 7(a) lender measured by dollar volume. The Company
maintains preferred status for government guaranteed lending programs in several
jurisdictions.
In September 1997, the Company completed an underwritten public offering whereby
1,955,000 shares of its common stock were issued for net proceeds of $23.8
million.
On March 26, 1999, the Company sold its last retail branch and its checking,
savings and money market accounts. The Company retained its certificates of
deposit and continues to offer certificates of deposit to retail and brokered
depositors. (See "Changes in Funding Sources" for further discussion of the
funding sources used by the Company.)
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Recent Events
On January 15, 2001, the Company entered into a definitive Agreement and Plan of
Merger with United Parcel Service, Inc. ("UPS"), pursuant to which at the
effective time of the transactions described in the merger agreement, a
wholly-owned subsidiary of UPS will be merged with and into the Company (the
"Merger"). The Company would be the surviving corporation of the Merger and a
wholly-owned subsidiary of UPS.
Under the terms of the merger agreement, the Company's stockholders will receive
shares of UPS Class B common stock in exchange for shares of the Company's
common stock, based on a conversion ratio described in the merger agreement,
subject to a number of potential adjustments. As of the date of this Annual
Report on Form 10-K, the Company estimates that the conversion ratio would be
approximately 0.1598 shares of UPS Class B common stock for each share of the
Company's common stock. Further, approximately 10% of the stock to be issued in
the Merger will be placed in escrow pending the performance of the Company's
loan portfolio during the 12 months following the closing and the resolution of
any indemnification claims with respect to the Company's representations,
warranties and covenants in the merger agreement. The conversion ratio and the
other terms of the Merger are described in the merger agreement which has been
filed by the Company as an exhibit to the Company's Current Report on Form 8-K,
filed with the Securities and Exchange Commission on January 19, 2001. In
addition, the terms of the Merger and the merger agreement will be described in
further detail in the Company's proxy statement for the Company's 2001 Annual
Meeting, which the Company anticipates will be filed with the Securities and
Exchange Commission in April 2001.
The Merger is subject to bank regulatory approvals, the approval of the
Company's stockholders, review under the Hart-Scott-Rodino Improvements Act and
other customary closing conditions. In connection with the execution of the
merger agreement, key Company stockholders, controlling approximately 52% of the
outstanding shares, have agreed to vote their shares of the Company stock in
favor of the transaction. The transaction is expected to close in the second
quarter of 2001.
As a condition to the completion of the Merger, prior to closing, the Bank will
seek one or more buyers of its deposit liabilities, approximately $280 million,
subject to regulatory approval. Upon the closing of such transaction, which is
intended to be immediately prior to the Merger closing, subject to the Bank's
receipt of approval, the Bank would cease to be a federally insured depository
institution regulated by the FDIC and the Company would cease to be a bank
holding company regulated by the Board of Governors of the Federal Reserve
System. Following the Merger, the Bank would operate as a non-depository bank
chartered by the Connecticut Department of Banking, and would continue to be
subject to Connecticut's state banking laws and regulations, as it is today.
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Changes In Funding Sources
Over the past three years, the Company and the Bank completed transactions that
effected changes in the manner in which the Company and the Bank obtain funding
for its lending business. These transactions included:
- - the sale of the Bank's last branch in March 1999, including checking,
savings and money market accounts, which requires the Bank to obtain
funding from alternative sources;
- - the establishment of a commercial paper conduit facility pursuant to
which up to $60 million is available to the Company (based upon the
contractual advance rates against the qualifying principal balance of
the loans pledged to secure the facility; the pledged loans consist of
the unguaranteed portion of loans guaranteed by the SBA);
- - establishment of and the increase in a second commercial paper conduit
facility from $65 million to $95 million and, in January 2001, to $120
million, pursuant to which the Company has the right to sell or finance
commercial revolving lines of credit and other qualifying loans during
the term of the facility;
- - loan securitization and sales transactions pursuant to which the
Company securitized and sold in the aggregate approximately $322
million of asset backed loans; and
- - the establishment of agreements with five national brokers which
provide a source for brokered certificates of deposit used for fundings
of one year or less.
The Company is currently finalizing companion facilities under its approved
commercial paper conduit credit lines and expects that transfers of loans under
the new facilities will be reflected as a financing on the Company's
consolidated balance sheet. Prior to the closing of the acquisition of the
Merger with UPS, the Company expects to continue to obtain funding for its
operations from retail and brokered certificates of deposit, the sale of loans
on a loan-by-loan basis, and from its commercial paper conduit facilities. The
Company does not plan to continue to securitize loans in 2001.
Loan Originations
Management believes that the specialized market knowledge and experience of the
Company's lending officers, combined with a broad range of commercial and
international financing products, enable the Company to satisfy the needs of its
small and medium size industrial clients. Brand recognition for the Company is
maintained by incorporating the servicemark Financing Industry Worldwide(sm) in
its logos. The Company's domestic and international lending relationships
generally range from $150,000 to $5.0 million.
The Company's Commercial business units underwrite lines of credit, term loans,
industrial mortgages and trade financing for businesses located throughout the
United States. Commercial lenders operate from the Company's Hartford,
Connecticut headquarters, as well as from regional representative offices
located in Boston and Springfield, Massachusetts; Providence, Rhode Island;
Morristown, New Jersey; Pittsburgh and Philadelphia, Pennsylvania; Rochester,
New York; Washington D.C.; Miami, Florida; Detroit, Michigan; St. Louis,
Missouri; Cleveland, Ohio; Los Angeles, California; and Richmond, Virginia. The
Company's domestic loan officers
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are trained to understand the specific financial needs of small and medium size
industrial companies, and to use government guaranteed and other commercial loan
products to respond to those needs. Domestic loan officers participate in
industrial trade organizations representing the Company's target market and
conduct other marketing activities to reach potential borrowers.
The Company's International business units underwrite Ex-Im Bank guaranteed and
insured and, to a lesser extent, private sector insured short and medium term
loans to small and medium size industrial companies located in various
international emerging markets. The International business units also underwrite
Ex-Im Bank guaranteed revolving lines of credit to U.S. manufacturers and offer
privately insured loans to U.S. importers of foreign-made goods. See
"International Lending Services and Products." International lending activities
support trade flows between the United States and emerging markets. The
Company's International business units operate from its Hartford, Connecticut
headquarters and are assisted in their efforts by contractual international
marketing representatives, or "master agents", many of whom are actively
involved in providing financial, accounting, consulting and/or engineering
services to industrial companies in their home countries. Marketing arrangements
have been established with professionals in Argentina, Brazil, Central America,
Egypt, India, Indonesia, Korea, Mexico, North Africa, Philippines, Poland, South
Africa, Turkey and West Africa. The Company has formally established
"representative offices" in certain countries in accordance with local
regulations.
Underwriting
The Company's underwriting activities are initiated from each of its lending
offices and supported and approved at the Hartford headquarters. Commercial
lending officers analyze the creditworthiness of proposed borrowers and evaluate
each borrower's financial statements, credit reports, business plans and other
data to determine if the credit and proposed collateral satisfy the Company's
specific lending standards and policies. All credit memoranda are reviewed by an
independent credit officer and may require additional approvals depending on the
particular circumstances of the financing package. Domestic and international
loans undergo a substantially identical approval process.
Loan Sales and Securitizations
The Company seeks to achieve high returns while meeting the growing credit needs
of its target market by selling a portion of its commercial and international
loans on a non-recourse, servicing-retained basis. A separate Capital Markets
business unit directs its resources toward identifying secondary loan markets to
sell loans originated by the Company to generate non-interest income and as a
further means of mitigating credit risk, leveraging capital and replenishing
liquidity.
In 1998, the Company began securitizing and selling certain whole loans and the
unguaranteed portions of certain government guaranteed loans that it originates,
and selling commercial revolving lines of credit, other commercial loans and the
unguaranteed portions of SBA loans to commercial paper conduits. In these
securitization and commercial paper transactions, the Company sells a pool of
loans to a trust, which either issues certificates representing beneficial
ownership interests in the trust or issues notes and sells these securities
through private placement transactions. In order to provide credit enhancement
for the certificates or notes, the
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Company has generally retained subordinated certificates or notes and
established a cash reserve account. The Company has also recorded an
interest-only strip in connection with each of these transactions. For all
securitizations and sales, the Company is the servicer of the underlying loans.
As more fully explained in "Regulation of the Bank - Capital Adequacy", due to
the possibility of increasing capital requirements for federally regulated
insured institutions such as the Bank, the Company does not plan to securitize
loans in 2001.
BUSINESS STRATEGY
The Company's strategy is to serve small and medium size industrial companies
through the following key activities:
Domestic Loan Origination Activities. Commercial business units currently
operate from the Hartford headquarters, as well as from regional loan production
or "representative" offices located in Boston and Springfield, Massachusetts;
Providence, Rhode Island; Pittsburgh and Philadelphia, Pennsylvania; Morristown,
New Jersey; Rochester, New York; Washington D.C.; Miami, Florida; Detroit,
Michigan; St. Louis, Missouri; Cleveland, Ohio; Los Angeles, California; and
Richmond, Virginia.
Financing Trade with International Emerging Markets. The International business
units operating from the Hartford headquarters are assisted in their efforts
abroad by relationships with international master agents in Argentina, Brazil,
Central America, Egypt, India, Indonesia, Korea, Mexico, North Africa,
Philippines, Poland, South Africa, Turkey and West Africa. The master agents are
actively involved in providing professional financial services to small and
medium size industrial companies in their home countries. The Company also
provides working capital to U.S. manufacturers who export to and import from
international emerging markets.
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LENDING ACTIVITIES AND POLICIES
The Company's distribution of domestic and international commercial loan
originations are detailed below:
For the Years Ended
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December 31, 2000 December 31, 1999
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Principal Percentage Principal Percentage
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(dollars in thousands)
Domestic:
SBA loans $148,608 29% $142,089 26%
USDA loans 47,300 9% 53,723 10%
Other commercial loans 161,431 32% 172,964 31%
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Total domestic banking 357,339 70% 368,776 67%
International:
Ex-Im working capital lines 52,340 10% 64,035 12%
Ex-Im medium term loans 66,569 13% 46,874 8%
Other international loans 33,492 7% 71,175 13%
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Total international banking 152,401 30% 182,084 33%
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Total commercial loan originations $509,740 100% $550,860 100%
======== === ======== ===
MARKETING
Domestic Lending
The Company originates domestic loans through approximately 70 commercial
lenders in fourteen offices who seek to establish long-term relationships with
their clients. The Company believes it is uniquely positioned to serve its
domestic market through an ability to provide clients with a flexible
combination of lines of credit, term loans and mortgages for industrial property
and trade financing. The Company generally utilizes the SBA, USDA, Ex-Im Bank
and/or privately insured loan guarantee and insurance programs as a part of a
financing package designed for an applicant's particular situation. The
Company's participation in these programs enables it to provide clients with
longer loan terms than are typically available to small and medium size
industrial companies.
Commercial loan officers are responsible for marketing, underwriting, servicing,
monitoring and collecting payments on their portfolio of loans. The Company
believes that this broad range of responsibilities enables the commercial loan
officers to establish strong working relationships with both existing and
prospective clients and promotes strong client service and prudent loan
portfolio management. Commercial loan officers are encouraged to keep apprised
of market conditions through frequent contact with clients and potential
borrowers, to develop specific knowledge of their clients' businesses, and to
offer flexible structuring of loan products. In consultation with the borrower,
a commercial loan officer will evaluate the financing needs of the business and
then recommend the best way to structure the lending transaction to fit the
client's unique needs.
The marketing efforts by commercial loan officers include participation in trade
associations serving the needs of small and medium size industrial companies;
contacting accountants, attorneys and other professionals known by the Company
to have relationships with businesses in need of financing; personal visits;
direct mail solicitations; and referrals from existing clients.
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Since the target client of both domestic and international loan officers is
often the same, an active cross-selling effort between these two areas is
encouraged.
Strategic Marketing Alliances
In addition to the marketing efforts of the Bank's domestic lending officers,
the Bank seeks to market its domestic loan products through marketing agreements
with various trade and cooperative associations. The Bank has such agreements
("Marketing Alliances") with the National Rural Utilities Cooperative Finance
Corporation and various regional chapters of the National Tooling & Machining
Association. The Marketing Alliances provide, among other things, for the
applicable trade or cooperative association to develop and implement a marketing
plan pursuant to which the Bank has implemented an expedited and streamlined
credit application and approval process for association members who desire
commercial term loans from the Bank. The Company has also entered into Marketing
Alliances with 20 industrially oriented e-business marketplaces and has
developed ThruCredit(sm), a proprietary integrative software that provides users
of the sites information on the Company's products and services and facilitates
on-line financing through applications, credit underwriting and processing
screens. The Bank retains sole discretion with respect to credit decisions made
on applications resulting from its Marketing Alliances. The Marketing Alliances
provide for the Bank to pay quarterly and annual compensation to such trade
associations and cooperative entities and e-business marketplaces based upon the
amount of loans made by the Bank to their members or users.
International Lending
The Company's international lenders in the Export Finance business unit target
U.S. exporters eligible for trade financing programs, including those supported
by Ex-Im Bank. These loan officers market pre-export working capital lines of
credit and SBA guaranteed and other commercial loans. This International
business unit also targets U. S. buyers of goods from certain international
emerging markets. As with the domestic lending relationships, the Export Finance
business unit is responsible for marketing, underwriting, servicing, monitoring
and collecting payments on its portfolio of loans.
The Company's international lenders in its International Buyer Finance business
unit target foreign purchasers of U. S. goods eligible for short and medium term
financing supported by Ex-Im Bank guarantees and insurance and by private sector
insurance. This International business unit is also responsible for marketing,
underwriting, servicing, monitoring and collecting payments on their portfolios
of loans.
Internationally, the Company has established marketing relationships with
professional firms in emerging markets who, in the course of conducting their
primary business, have frequent contact with local industrial companies who
require financing to purchase U.S. goods or are manufacturing or distributing
goods for export to the U. S. Prior to entering into relationships with these
"Master Agents," the Company conducts due diligence, including visiting the
prospective representative and conducting local diligence concerning their
business reputation and legal status. The Company also requires that each Master
Agent be trained about the Company's products and services at the Hartford
headquarters. Each Master Agent markets, on behalf of the Company, Ex-Im Bank
guaranteed and insured short and medium terms loans and privately insured export
loans in its respective market. The Master Agent will develop a lead
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with a potential borrower and may aid in the transaction by obtaining required
financial or operational data from borrowers and providing assistance in the
loan origination and closing process. The Master Agents work with the Company's
U.S.-based loan officer who completes the application underwriting and closing
process. The Master Agent receives a negotiated fee when a loan referred to the
Company has been underwritten and closed. The Master Agent assists the loan
officer in obtaining certain information from the applicant and in responding to
inquiries of the applicant, but does not have any direct underwriting
responsibilities. All decisions with respect to referrals of Master Agents are
made by the Company, which retains full control over international loan
originations.
The Company's Import Finance business unit lenders seek to finance goods
imported by U. S. industrial companies throughout the country under a private
sector insurance policy and to cross sell SBA guaranteed and other commercial
loans to the companies.
Marketing efforts of these International business units include visits to, and
direct mail solicitation of, U.S.-based exporters and importers of capital
goods, direct mail solicitation of foreign-based manufacturers and industrial
trade organizations, and in-country marketing by the Company's network of Master
Agents. The Company has also entered into contractual strategic marketing
alliances with Panalpina, Inc., a leading international freight forwarding
company, the Association for Manufacturing Technology, and the Korean Federation
of Small Business to provide access to additional trade finance opportunities.
DOMESTIC LENDING SERVICES AND PRODUCTS
Loan Products and the Origination Process
The commercial loans originated by the Company include industrial mortgage loans
(i.e., loans to businesses collateralized by industrial real property),
equipment term loans and revolving lines of credit to manufacturers, wholesalers
and distributors, many of which are exporters. The typical commercial borrower
is a privately owned and operated company with annual sales of $1 million to $50
million, employing 10-500 workers, and has been in business for at least three
years. A number of the Company's borrowers have a proprietary product line,
export their products and/or have a geographically diverse client base. The
Company is typically the borrower's primary lender and provides loans which are
collateralized by assets of the borrower.
The Company originates loans to a variety of industries; however, in the future
based upon its loss experience and economic forecasts, the Company may decide to
de-emphasize certain industries from time to time. In striving to meet the
credit needs of its clients, the Company utilizes government guarantee loan
programs which allow it to offer longer-term loans while mitigating the credit
risk to the Company through a government guarantee.
The interest rates accruing on the Company's commercial loans are typically U.S.
Prime-based, changing monthly or quarterly when the Prime Rate changes. The
Company also makes fixed rate loans from time to time. The Company originates
certain loans for sale through loan purchase programs pre-established with
investors. The term of a loan depends upon whether the loan is guaranteed or is
underwritten for a loan purchase program and the loans are generally fully
amortizing. Government guarantee programs give clients access to longer
financing terms
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and amortization schedules than are otherwise available. A government guaranteed
mortgage loan has a maximum term and amortization of up to 30 years, while the
term and amortization of a non-government guaranteed mortgage loan typically
does not exceed 15 years. Equipment loans are underwritten to correspond with
the useful life of the equipment and generally range from 5-15 years. SBA
guaranteed working capital term loans range from 7-10 years, while
non-government guaranteed working capital revolving lines of credit have
one-year terms.
The primary collateral sought by the Company for commercial loans consists of
liens which are generally first liens, on owner-occupied industrial real estate,
equipment, inventory and/or accounts receivable, although additional collateral
may include junior liens on residential properties. The Company generally
requests the personal guarantee of the principals of a business as an additional
repayment source because the Company believes doing so induces the guarantor to
facilitate repayment of the loan.
The two government guarantee loan programs utilized by the Company's business
units to provide financing to its niche market are discussed below.
SBA Guaranteed Loan Originations
The Company utilizes the SBA's 7(a) loan program for eligible borrowers. The
Company has Preferred and Certified Lender status in 23 SBA "districts."
Preferred Lender status allows the Bank to approve loans on behalf of the SBA,
with the national SBA processing center's concurrence that the applicant meets
the SBA eligibility requirements. The SBA generally completes its eligibility
review within 24 hours of submission. Certified Lender status entitles the Bank
to 72-hour turnaround from local SBA district offices for approval of loan
applications. In other districts where the Company does not have either
Preferred or Certified Lender Status, applications may be submitted with a 7-day
turnaround from the local SBA district office.
Until December 2000, the SBA's 7(a) loan program provided for a guarantee equal
to 75% of the principal balance, up to a maximum guarantee of $750,000 per
borrower. Effective in December 2000, the program was changed to allow for a
maximum guarantee of $1 million per borrower and a maximum loan size of $2
million.
The Company makes SBA loans to businesses which qualify under agency regulations
as a "small business." The primary operative SBA eligibility criterion for the
Bank's targeted market is that the borrower be a privately-owned manufacturer
with fewer than 500 employees. Loans may generally be used for the acquisition
or refinancing of plant and equipment, working capital and debt consolidation.
In the event of default, the SBA pays the guaranteed percentage of the loan to
the Company, and the SBA and Company share in any collections or collateral on a
pari passu basis. For example, if a loan carries a 75% guarantee, the SBA
receives 75% of all collections while the Company receives 25% of such amounts,
beginning with the initial recovery. The SBA also reimburses the Company's
collection costs on a similar basis.
If the SBA establishes that any resulting loss is attributable to a failure by
the Company to comply with SBA policies and procedures in connection with the
origination, documentation or
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funding of a loan, the SBA may decline to pay the guaranteed amount, or if the
guaranty has already been paid, may seek recovery of funds from the Company.
With respect to guaranteed SBA loan participations which have been sold, the SBA
will first honor its guarantee and then seek compensation from the Company in
the event that a loss is deemed to be attributable to a failure by the Company
to comply with SBA policies and procedures.
USDA Guaranteed Loan Originations
The Company utilizes the Business and Industry Program ("B&I Program") of the
USDA when available based on an applicant's geographical location and other
characteristics. The B&I Program generally provides for 80% guarantees on loans
with principal balances up to $5 million and 70% guarantees on loans with
principal balances between $5 million and $10 million and, therefore, enables
the Company to provide to eligible borrowers a greater amount of financing than
the Company would otherwise be able to provide under the SBA program or on an
unguaranteed basis due to legal lending limits. The stated purpose of this
program is to support industry, employment and general economic and
environmental conditions in rural communities, which are generally defined as
towns with fewer than 50,000 inhabitants. These loans may be utilized for the
acquisition, improvement or refinancing of plant and equipment or working
capital and debt consolidation purposes.
Loans to be guaranteed under the B&I Program are submitted to the USDA district
office and, depending on that office's loan authority, may be required to be
forwarded to the national USDA for approval. The USDA approved the Company as a
Certified Lender in 1997, making it one of the first USDA Certified Lenders
nationally. As a Certified Lender, the Company is recognized as a "Subject
Matter Expert" and is able to reserve funds, which facilitates the processing of
USDA loans.
The guarantee of the USDA also provides for pari passu recovery of collection
proceeds, and for recourse to the Company similar to that discussed above for
SBA loans in the event the Company is found to have been negligent in the
origination, documentation or funding of USDA loans.
DOMESTIC UNDERWRITING
For the Company's domestic underwriting process, the Company's staff seeks to:
(i) analyze borrowers' credit profiles; (ii) assess the collateral underlying a
loan; (iii) assure compliance with eligibility requirements for inclusion under
any applicable guarantee programs; and (iv) obtain or provide appropriate
documentation for the transaction.
Domestic lending officers receive and assemble initial applications, analyze the
creditworthiness of proposed borrowers, prepare credit memoranda and, aided by
staff, prepare any required government guarantee loan application forms and
conduct credit and trade reference checks. In the course of analyzing the
creditworthiness of prospective borrowers, commercial lending officers evaluate
each applicant's and any guarantors' financial statements, credit reports,
appraisals and other information regarding the value of collateral, the
experience, strength and continuity of the borrower's management, business plans
and other data to determine if the credit and collateral satisfy the Company's
standards and compliance with any applicable government guaranteed loan program
requirements. These standards may include debt service coverage or
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other financial ratios, reasonableness of the borrower's projections (when
submitted), the experience, strength and continuity of the borrower's
management, the financial condition of individual guarantors, the value of
collateral, and compliance with government guarantee loan program requirements.
The originating officer performs on-site inspections to determine the condition
of a borrower's facility, the manner in which business is being conducted, the
condition and maintenance of assets, the existence of environmental issues, and
other relevant conditions.
Originating lending officers have no authority to approve a loan on their own.
Subject to approval by the Credit Policy Officer, the business manager of each
Commercial business unit and the Company's Division Executives have lending
authority in accordance with their experience and tenure. Loans above specific
levels require the additional approval of the Chief Credit Officer and any loan
requests above $6 million must be further approved by the Company's Chief
Executive Officer. All loans to a borrower and its affiliates are aggregated to
determine whether the total is within an individual's lending authority.
Upon initial approval by a business manager, the credit memorandum must be
approved by the Credit Policy Officer, who reports to the Chief Credit Officer.
The Credit Policy Officer reviews the memorandum and supporting file for
compliance with internal Company policy as well as applicable government
guarantee requirements. If additional approvals are required, the credit
memorandum is forwarded to the appropriate parties as noted above. If the
financing package includes a government guaranteed loan, the application is
forwarded to the applicable government agency as required.
The Company performs a credit analysis on all applications, considering the type
and value of the assets collateralizing a loan, the characteristics of the
borrower, the borrower's industry, and the anticipated debt service ratio. The
Company generally requires that a borrower's most recently completed fiscal year
financial statements demonstrate an historical debt service coverage ratio of at
least 1.25 to 1. If requested funding is for plant or line of business
expansions, or there are other extenuating circumstances, consideration may also
be given to projected results and, therefore, certain loans may be granted when
historical debt service coverage is less than 1.25 to 1.
Real property taken as primary collateral for a loan is valued by an independent
appraiser in accordance with federal banking regulations, and the appraisal is
then subject to an internal review in accordance with these regulations.
Equipment serving as primary collateral for a loan is generally valued by an
independent equipment appraiser. The Company will generally obtain a Phase I
environmental report completed in accordance with the standards of the American
Society for Testing and Materials on any commercial real property to be
mortgaged. Additional environmental reporting and remediation are required prior
to closing if environmental issues either exist or are suspected.
The Company's standard underwriting criteria detail the maximum advance rates
which are utilized for each type of collateral. Commercial property is generally
given a collateral value for underwriting purposes equal to 80% of the appraised
value; finished goods and raw material are
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generally valued at 50% of book value; trade accounts receivable under 90 days
are generally valued at 75% of book value.
Although the minimum debt service coverage ratios and maximum prescribed
collateral values described above are generally utilized in the Company's
analyses, exceptions to these policy limits are approved based on management's
assessment of the borrower's particular situation. Proposed exceptions to the
Company's loan policy are reviewed by the approving officers. Decisions to
approve these loans are made on a case-by-case basis and depend upon the overall
creditworthiness of the applicant. The overall trends in underwriting exceptions
are monitored by the Chief Credit Officer and the Company's Management Asset
Quality and Board Loan Committee.
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INTERNATIONAL LENDING SERVICES AND PRODUCTS
The Company's International business units underwrite revolving lines of credit
to U.S. manufacturers, short and medium term loans to foreign buyers of U.S.
goods, short term loans to U.S. buyers of foreign goods, and letters of credit
issued in connection with such facilities.
The International lending business units include the following:
Business Units/Territory Products Used Description
- ------------------------ ------------- -----------
Export Finance (U.S.) Working capital line of credit; 90% One year revolving line of credit
Ex-Im guaranteed; indexed to U.S. to U.S. manufacturers
Prime, variable daily; U.S. dollar collateralized by export accounts
denomination receivable and inventory
Import Finance (U.S.) 90-360 day U.S. import term loan; Financing of accounts receivable
discount note; 95% privately insured; due from U.S. manufacturer
U.S. dollar denomination purchasing goods from international
emerging markets; unsecured
International Buyer Finance Short and medium term loan; 90-100% 1 to 5-year term loans to foreign
(principally Argentina, Brazil, guaranteed or insured by Ex-Im Bank or purchasers of qualified U.S. made
Central America, Mexico, Egypt, privately insured (generally 90%); inventory and equipment; unsecured
India, Indonesia, Korea, North indexed to 6-month LIBOR, variable or secured by inventory or equipment
Africa, Philippines, Poland, South semi-annually; U.S. dollar denominated
Africa, Turkey and West Africa)
Ex-Im Bank is an independent agency of the U.S. whose mission is to facilitate
export financing of U.S. goods and services by neutralizing the effect of export
credit subsidies from other governments and absorbing credit risks that the
private sector will not accept. The Company utilizes the Ex-Im Bank's loan
guarantee and insurance programs designed to support small and medium size U.S.
exporters. In 1997 the Company received Ex-Im Bank's annual "Small Business Bank
of the Year" Award.
International Lending - United States
Export Working Capital and U.S. Import Loan Products and the Origination Process
The typical U.S. client for the Company's international products is a U.S.-based
manufacturer with sales of $1 million to $50 million and export or import
financing needs. The Export Finance business unit handles clients who are
exporting while the Import Finance business unit handles U.S. importers. The
target profile of these clients is generally the same as for the Company's other
domestic clients.
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The one-year revolving Ex-Im Bank working capital lines of credit are indexed to
The Wall Street Journal Prime and adjust daily. The primary collateral for these
loans includes export-related accounts receivable and inventory. The accounts
receivable are generally insured under an Ex-Im Bank insurance policy, a private
export credit insurance policy or an acceptable letter of credit. Open accounts
receivable may qualify as collateral if approved in advance by the Company and
Ex-Im Bank. Borrowers must submit borrowing base certificates to the Company to
evidence the availability of acceptable collateral when an advance is requested,
and monthly thereafter.
The Company holds "Super Delegated Authority" status under Ex-Im Bank's working
capital loan guarantee program and, therefore, has authority to approve working
capital lines up to $10 million per borrower, up to an aggregate portfolio of
$150 million, without Ex-Im Bank approval. The Company also has the
responsibility to ensure that loans are underwritten, documented and funded in
accordance with Ex-Im Bank polices and procedures in order to avoid loss of the
guarantee. In the event of a loan default, the Company and Ex-Im Bank share in
all loan recovery proceeds on a pari passu basis in accordance with the 90%
guaranteed/10% unguaranteed ratio.
The loans made by the Company to finance the purchase by U.S. manufacturers of
goods from international emerging markets are unsecured loans which are
discounted at origination to yield a market rate. The Company has obtained a
credit risk policy from a private sector insurance company to insure loans made
under this program. In the event of a loan default, the insurance company will
pay the Company, subject to certain deductibles, 95% of the principal balance,
plus accrued interest. The Company has the responsibility to ensure that loans
are underwritten, documented and funded in accordance with the insurance policy
in order to avoid loss of the insurance.
International Lending - Emerging Markets
Short and Medium Term Loan Products and the Origination Process
Emerging market-based clients of the Company's International Buyer Finance
business unit are typically small and medium size industrial companies requiring
financing to purchase equipment, components and raw materials from the U.S.
The Company primarily uses Ex-Im Bank guarantee and insurance programs to
mitigate its credit risk to the borrower. In 1998, as an alternative to the
Ex-Im Bank product, the Company obtained a credit risk insurance policy from a
private sector insurance company for short and medium term loans to industrial
companies in certain international emerging markets. The underwriting criteria
is substantially the same under both the Ex-Im Bank and privately insured
programs, although Ex-Im Bank imposes U.S. content measurements. Ex-Im Bank
guarantees or insurance programs provide 95-100% coverage on the medium term
loans and generally 90% coverage on short-term loans. The private sector
insurance policy generally insures 90% of the short and medium term loans. With
the private sector insurance policy, the Company has discretionary credit
approval authority for loans up to $750,000 which meet the underlying criteria
of the private sector insurance policy. The Company generally utilizes the
private sector insurance policy for smaller dollar requests and only in
connection with an Ex-Im Bank loan client.
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Short term loans may be up to one year in tenor while medium term loans are
generally 3-5 years. These loans finance the acquisition of qualified U.S.-made
inventory components and capital goods. The Ex-Im Bank program allows the
financing of up to the lower of 85% of purchase price or 100% of U.S. content.
Certain other U.S. content and product requirements must also be met. The loans
generally range in size from $150,000 to $5 million and are U.S.
dollar-denominated. Although the purchase of equipment is being financed, the
Ex-Im Bank loans are generally unsecured; the Company relies on the borrower's
cash flow and the Ex-Im Bank guarantee or Ex-Im Bank insurance. The Company does
obtain a security interest in the equipment being underwritten for loans made
pursuant to the private sector insurance policy.
International lending officers are responsible for marketing, underwriting,
servicing, monitoring and collecting their portfolios of loans. Because the
medium term loans are fully amortizing with semi-annual payments, there is less
post-closing analysis required for performing loans than for other types of
loans made by the Company.
In the event of default, the Company will work with Ex-Im Bank to handle the
workout and collection or restructure of Ex-Im Bank guaranteed medium and short
term loans and, in the event a claim is filed, Ex-Im Bank will pay the
guaranteed or insured principal balance, plus accrued interest. See "Delinquency
and Collection Activities."
INTERNATIONAL UNDERWRITING
International lending officers receive and assemble initial applications,
analyze the creditworthiness of proposed borrowers, prepare memoranda and, aided
by staff, prepare the required Ex-Im Bank and private sector insurance loan
application forms and conduct credit and trade reference checks. For short and
medium term loans, in-country Master Agents, where applicable, aid in the
transaction by obtaining required financial or operational data from borrowers
and by providing general assistance in the loan origination and closing process.
The Company's international lending officers will often visit a prospective U.S.
borrower's place of business and perform on-site inspections. The Company will
generally instruct its in-country Master Agents to make these inspections of
prospective foreign borrowers. Although certain of the international loans are
unsecured, site inspections are conducted in most cases because this information
is helpful in assessing a borrower's operations.
The approval process is substantially similar to that followed by the commercial
lending officers. The Credit Policy Officer reviews the memorandum and
supporting file for compliance with internal Company policies as well as
applicable Ex-Im Bank or private insurer program parameters. As with domestic
lending, exceptions to the Company's and Ex-Im Bank's loan policies are
entertained on a case-by-case basis by the approving loan officers, and
acceptance of exceptions depends upon the overall creditworthiness of the
applicant.
Working capital lines of credit are collateralized by export-related inventory
and accounts receivable less than 90 days old; this collateral has maximum
prescribed collateral values of 75% and 90%, respectively. As is the case with
respect to domestic loans, the collateral value
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required to support a loan is based on the borrower's individual circumstances,
and applications exceeding the Company's general standards may receive special
consideration.
For short and medium term loans, debt service coverage and operating history are
reviewed in the underwriting process. The lending officer also considers the
availability to the borrower of U.S. dollars and other "hard" currency revenue
sources from sales to the U.S. and other stable currency markets.
While most working capital lines of credit are within the Company's "Super
Delegated Authority", applications which do not comply with and/or are above the
Company's authority, and all Ex-Im Bank international buyer short and medium
term loans, require Ex-Im Bank approval. U.S. import loans in excess of
$500,000, and term loans in excess of $750,000, require approval from the
private sector insurance company if they are to carry that insurance.
CAPITAL MARKETS AND LOAN SERVICING
Capital Markets Activities
The Capital Markets business unit was established in July 1996 to assume
responsibility for the non-recourse, servicing-retained sale of SBA, USDA and
Ex-Im Bank government guaranteed loans and to identify markets for the sale of
non-guaranteed mortgage, term and revolving loans on a non-recourse,
servicing-retained basis. Since 1998, the Capital Markets business unit has
completed seven securitizations of the unguaranteed portions of SBA loans and
certain whole commercial loans, and has sold revolving lines of credit and other
loans to commercial paper conduits. These capital markets activities allow the
Company to leverage capital, replenish liquidity and mitigate the risk of
balance sheet exposure to any single borrower.
The guaranteed portions of SBA and USDA loans are generally sold during the
quarter of origination on a single loan basis to established brokers. Brokers
generally pool the SBA guaranteed portions. USDA loans are individually sold.
The guaranteed portions of Ex-Im Bank loans and lines of credit are generally
sold to the Private Funding Export Funding Corporation ("PEFCO"). PEFCO is a
private corporation established with the support of the United States Treasury
and Ex-Im Bank to assist in financing exports of U.S. goods and services by
making direct loans to foreign importers of U.S. made goods, and to provide
liquidity support for private sector lending utilizing Ex-Im Bank programs. The
Company holds a common stock investment of $987,000 at December 31, 2000 and is
a 1.9% shareholder. The Company is one of among approximately 38 PEFCO
shareholders.
SBA and USDA regulations permit the Company to sell or participate,
respectively, a portion of the unguaranteed amount of loans originated under
their respective programs. In accordance with SBA and USDA regulations, the
Company is generally required to retain an amount equal to 5% of the total loan
and such interest is to be held in the form of the unguaranteed portion of the
loan. Current SBA regulations require that the Company hold retained interests
in the unguaranteed portion of securitized loans equal to a minimum of 2% of the
securitization transaction. Upon the sale of any guaranteed portions, the
Company, if holding an unguaranteed portion, shares in the payment stream and
collateral on a pari passu basis with all (guaranteed and unguaranteed)
investors, beginning with the initial
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recovery. If the Company is holding an investment in a subordinated interest
following a securitization, the application of the cash flows is determined in
accordance with the applicable pooling and servicing agreement.
The Capital Markets business unit has developed a list of potential buyers of
non-guaranteed mortgage and term loans and devotes substantial resources to the
identification of these and other buyers. A primary objective in the negotiation
and sale of these loans is the Company's retention of sole responsibility for
borrower contact. Investors meet with borrowers only in rare circumstances, and
generally rely on the Company to prudently service and monitor lending
relationships. The Company believes that this is important to maintain client
relationships and also reflects investor confidence in its servicing ability and
reputation.
Loan Servicing Activities
At December 31, 2000, the total loan portfolio managed by the Company was $1.3
billion and comprised relationships with over 1,400 companies.
The Company services substantially all of the loans it originates, whether
securitized, sold individually to investors or held in portfolio. Servicing
includes collecting payments from borrowers and remitting applicable payments
and required reports to any investors; accounting for principal, interest and
any real estate taxes or other escrow receipts and payments; contacting
delinquent borrowers; supervising foreclosures; and liquidating collateral when
required. Other than tasks performed by the assigned lending officers, loan
servicing functions are centralized in the Hartford, Connecticut headquarters.
The Company receives servicing fees on loans serviced for others in varying
amounts, as determined under the particular terms of the sale. Management
believes that servicing loans originated generally enhances the Company's
relationship with borrowers. This contact allows the Company to continue to
offer its loan products to clients who may need additional financing. Further,
these servicing arrangements provide an additional and profitable revenue stream
that is less cyclical than the business of originating and selling loans
themselves.
After a loan is closed, the Loan Servicing business unit reviews the loan files
to confirm that loans were originated in accordance with any applicable
government guarantee program guidelines and Company policies. Thereafter, the
loan officers and the Loan Review business unit conduct periodic reviews of the
borrower's financial condition.
Delinquency and Collection Activities
The assigned loan officer retains responsibility for routine collection of loans
in his or her portfolio. The Company attempts to collect all loans on a 30-day
basis. An officer's initial collection efforts generally begin when an account
is 15 days past due. At 20 days past due, a reminder notice is sent to the
borrower and the officer again attempts to contact the borrower to determine the
reason for the delinquency and if the account will be brought current.
If a borrower is unable to make a payment within 30 days of the due date as of
month-end and has not made acceptable alternative arrangements with the Company,
the officer issues a past due letter requiring the borrower to make the required
payment within 10 business days by
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certified or cashiers check. If payment is not remitted on time, the account is
generally transferred to the Company's U.S. or International Asset Recovery
business unit for consideration of additional collection procedures, including
issuance of a demand letter and possible liquidation of collateral.
The Asset Recovery business units are responsible for contacting the borrower
and analyzing its current and projected financial condition, the reasons leading
to the delinquency and the value of the collateral available to the Company. The
Asset Recovery officers then propose a workout plan to the Chief Credit Officer
and other involved members of senior management. The Asset Recovery business
units will also provide any required notices and generally seek to comply with
applicable government guarantee program or investor requirements.
If a modification of loan terms or other acceptable workout cannot be achieved
within a reasonable time frame, the Company will liquidate the collateral
securing the loan. The Company prefers not to take title to real property or
equipment unless required to facilitate the collection process. The Company
solicits assistance from the principals of the delinquent borrower to effect the
liquidation of any property, with title remaining in the borrower's name,
thereby seeking to avoid a lengthy foreclosure or repossession process and
exposure to the Company regarding environmental or other liability issues. The
Company has generally found principals of borrowers to be cooperative in
assisting the Company in liquidating collateral efficiently. The Company follows
the same general workout procedures for substantially all of the loans it
services.
If a loan carries an SBA guarantee, the responsible SBA District Office will be
notified of the delinquency and will be presented with a liquidation plan within
60-90 days of such delinquency. Unless the SBA objects, the Company will carry
out the terms of the liquidation plan. As a Preferred Lender, the Bank has
responsibility and authority over liquidation procedures on all SBA guaranteed
loans serviced. Any loss after liquidation of collateral is allocated pro rata
between the guaranteed and unguaranteed portions of an SBA Loan. After an SBA
loan becomes 60-90 days past due, the SBA, at the Company's request, will
repurchase the guaranteed portion of the principal balance of the loan at par
from the secondary market investor, together with accrued interest covering a
period of up to 120 days.
USDA procedures require that the Company file a liquidation plan when it is
believed action should be taken on a delinquent loan, which is generally when
the loan is 60-90 days delinquent. The USDA has 30 days to review the plan. The
Company will then execute the approved plan or work with the USDA to arrive at a
mutually acceptable plan. Any loss after liquidation of collateral is allocated
pro rata between the guaranteed and unguaranteed portions of the USDA loan. The
holder of the guaranteed portion may request that the USDA repurchase the
guaranteed portion at any time, or the Company will request repayment on that
holder's behalf when liquidation is complete. The USDA does not impose any
restrictions on the number of days for which interest will be paid on the
guaranteed portions.
The liquidation of delinquent working capital and medium and short term Ex-Im
Bank loans is handled in conjunction with Ex-Im Bank. If deemed appropriate, the
Company may submit a plan to Ex-Im Bank to approve a workout plan to provide
additional time for the borrower to
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repay the loan. The Company may submit a claim for repurchase at any time
between 30 and 120 days after a delinquency occurs, but at no time may such
claim be made more than 150 days after the delinquency unless properly extended
in the event of a workout plan. Ex-Im Bank will make payment under its guarantee
within 30 days after acceptance of the Company's request.
In the event of default on a private sector insured loan, the Company handles
the liquidation of the loan during a 150-day waiting period. At the end of the
waiting period, subject to certain deductibles being satisfied, the private
sector insurance company pays the Company an amount equal to the insured portion
of the principal balance, plus accrued interest and may ask the Company to
continue to handle the liquidation of the loan. The Company may also seek
approval of a workout plan from the insurance company if deemed appropriate.
The Company retains responsibility for the proper documentation and servicing of
all loans serviced for others, and may incur losses related to these loans if it
is found to be negligent by a guaranteeing agency, insurer or investor in
carrying out these duties.
Unguaranteed and uninsured loans or unguaranteed and uninsured portions of loans
held by investors are subject to negotiated servicing agreements, which in some
cases provide investors with the option of assuming responsibility for all
collection efforts after a loan becomes 60-90 days delinquent. If the Company is
contractually responsible for collection efforts, the servicing agreements
generally require that the investor pre-approve liquidation actions.
CREDIT RISK MANAGEMENT
The Company has developed a proprietary credit screening and risk analysis
model, RISCOPE(sm), used in the initial underwriting, post-closing loan
monitoring and on-going rating process by lending officers and the Loan Review
business unit. RISCOPE(sm) assists the Company in quantifying the credit risk of
commercial clients. The model takes into account quantitative and qualitative
factors and is designed to analyze the Company's primary client base: small and
medium size industrial companies. Additionally, the model facilitates an
efficient completion of the underwriting process and, once loans are originated,
helps management identify weaknesses in loans earlier than might otherwise be
done if payment default were their only manifestation.
The Chief Credit Officer has primary responsibility for credit risk management,
ensuring the appropriateness of underwriting criteria and application thereof,
the implementation of RISCOPE(sm), and the independent analyses of loans by the
Loan Review business unit.
The Credit Policy Officer, who reports to the Chief Credit Officer, reviews all
credit memoranda for compliance with the requirements of government guarantee
programs and Company credit policies. If, based on particular facts and
circumstances, policy exceptions are proposed by lending officers, the Credit
Policy Officer will ensure that all appropriate policy exceptions are documented
and approved by the authorized party. The Company's management Asset Quality
Committee evaluates the nature and trends of these exceptions monthly. The Chief
Credit Officer reports these exceptions quarterly to the Board of Directors'
Loan Committee.
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The Bank "risk rates" its loan portfolio by monitoring changes in the financial
condition of borrowers, assessing overall economic trends, and assigning
numerical ratings to individual loans. The Company applies a nine tiered risk
rating system. The rating system, in conjunction with other available
quantitative and qualitative data, is utilized to assist management in its
quarterly evaluation of the adequacy of the Allowance for Loan Losses.
The assigned lending officer has primary responsibility for risk ratings, and
that officer's decisions are periodically reviewed by the Loan Review business
unit. Risk ratings are based on the borrower's operating cash flow, industry,
product line, earnings, assets, liability, management experience, debt capacity,
and prior credit history with the Company.
The Loan Review business unit reviews the loan portfolio to evaluate the
appropriateness of officer risk ratings and overall trends in the portfolio.
Loan Review results are reported quarterly to the Loan Committee of the Board.
COMPETITION
The Company competes for clients with other commercial and savings banks,
finance companies, mutual funds, insurance companies, brokerage and investment
banking firms and certain other nonfinancial institutions, many of whom are able
to devote far greater resources than the Company to market, underwrite and
service loans to the same client base. The Company competes by emphasizing its
expertise and knowledge of its clients' businesses, commitment to service, and
flexibility in structuring financial transactions. Through the combined
utilization of government guaranteed loan programs, the Company is able to
provide flexible longer-term financing than would otherwise be available to
borrowers.
REGULATION AND SUPERVISION
Financial Services Modernization
On November 12, 1999, President Clinton signed into law The Gramm-Leach-Bliley
Act ("Gramm-Leach") which significantly altered banking laws in the United
States. Gramm-Leach enabled combinations among banks, securities firms and
insurance companies beginning March 11, 2000. As a result of Gramm-Leach, many
of the depression-era laws which restricted these combinations and other
activities which may be engaged in by banks and bank holding companies, were
repealed. Under Gramm-Leach, bank holding companies are permitted to offer their
customers virtually any type of financial service that is financial in nature or
incidental thereto, including banking, securities underwriting, insurance (both
underwriting and agency) and merchant banking.
In order to engage in these new financial activities, a bank holding company
must qualify and register with the Federal Reserve Board as a "financial holding
company" by demonstrating that each of its bank subsidiaries is "well
capitalized," "well managed," and has at least a "satisfactory" rating under the
CRA.
These new financial activities authorized by Gramm-Leach may also be engaged in
by a "financial subsidiary" of a national or state bank, except for insurance or
annuity underwriting, insurance company portfolio investments, real estate
investment and development and merchant
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banking, which must be conducted in a financial holding company. In order for
the new financial activities to be engaged in by a financial subsidiary of a
national or state bank, Gramm-Leach requires each of the parent bank (and its
sister-bank affiliates) to be well capitalized and well managed; the aggregate
consolidated assets of all of that bank's financial subsidiaries may not exceed
the lesser of 45% of its consolidated total assets or $50 billion; the bank must
have at least a satisfactory CRA rating; and, if that bank is one of the 100
largest national banks, it must meet certain financial rating or other
comparable requirements.
Gramm-Leach establishes a system of functional regulation, under which the
federal banking agencies will regulate the banking activities of financial
holding companies and banks' financial subsidiaries, the U.S. Securities and
Exchange Commission will regulate their securities activities and state
insurance regulators will regulate their insurance activities. Gramm-Leach also
provides new protections against the transfer and use by financial institutions
of consumers' nonpublic, personal information.
Holding Company Regulation
The Company is registered as a bank holding company and regulated and subject to
periodic examination, by the Board of Governors of the Federal Reserve System
("FRB") under the Bank Holding Company Act ("BHCA").
Although the Company may meet the qualifications for electing to become a
financial holding company under Gramm-Leach, the Company is retaining its
pre-Gramm-Leach status for the present time under the BHCA.
The Company is currently limited to the business of owning, managing or
controlling the Bank and engaging in certain other bank-related activities,
including those activities that the FRB determines from time to time to be
closely related to banking. The BHCA requires, among other things, the prior
approval of the FRB if a bank holding company proposes to (i) acquire all or
substantially all of the assets of a bank, (ii) acquire direct or indirect
ownership or control of more than 5% of the outstanding voting stock of any bank
(unless it already owns a majority of such bank's voting shares) or (iii) merge
or consolidate with any other bank holding company.
As a bank holding company, the Company is required by the FRB to act as a source
of financial strength and to take measures to preserve and protect the Bank. As
a result, the Company may be required to inject capital in the Bank if that need
arises. The FRB may charge a bank holding company such as the Company with
unsafe and unsound practices for failure to commit resources to a subsidiary
bank when required.
To be considered regulatory capital, loans from the Company to the Bank must be
on terms subordinate in right of payment to deposits and to most other
indebtedness of the Bank.
The FRB, FDIC and, in the case of a Connecticut state bank and trust company,
the CDB, collectively have extensive enforcement authority over bank holding
companies and Connecticut state banks. This enforcement authority, initiated
generally for violations of law and unsafe and unsound practices, includes,
among other things, the ability to assess civil money penalties, to initiate
injunctive actions and to terminate deposit insurance in extreme cases.
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Interstate Banking
The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, as
amended (the "Interstate Banking Act") generally permits bank holding companies
to acquire banks in any state, and preempts all state laws restricting the
ownership by a bank holding company of banks in more than one state. The
Interstate Banking Act also permits a bank to merge with an out-of-state bank
and convert any offices into branches of the resulting bank if both states have
not opted out of interstate branching; permits a bank to acquire branches from
an out-of-state bank if the law of the state where the branches are located
permits the interstate branch acquisition; and permits banks to establish and
operate de novo interstate branches whenever the host state opts-in to de novo
branching. Bank holding companies and banks seeking to engage in transactions
authorized by the Interstate Banking Act must be adequately capitalized and
managed.
Connecticut has allowed interstate mergers and acquisitions, the establishment
of Connecticut-chartered banks by foreign bank holding companies and interstate
de novo branching since 1995, subject to certain reciprocity requirements.
Connecticut law also places a minimum permissible age of five years on the
target bank and a 30% limit on concentration of deposits in both interstate and
intrastate acquisitions. Legislation was enacted in 1996 which expressly permits
an out-of-state bank to merge or consolidate with or acquire a branch of another
out-of-state bank which has a branch in Connecticut.
REGULATION OF THE BANK
General
As a Connecticut-chartered bank and trust company, the deposits of which are
insured by the FDIC, the Bank is subject to regulation and supervision by both
the CDB and the FDIC. This regulation and supervision is intended primarily to
protect depositors and the FDIC's Bank Insurance Fund, not stockholders.
The CDB regulates the Bank's internal organization as well as its deposit,
lending and investment activities. The approval of the Connecticut Banking
Commissioner (the "Commissioner") is required for the establishment of branch
offices and business combination transactions. The CDB, through its Bank
Examination Division, conducts periodic examinations of the Bank. The FDIC also
regulates many of the areas regulated by the Department.
Under Connecticut banking law, no person may acquire beneficial ownership of
more than 10% of any class of voting securities of a Connecticut-chartered bank,
or any bank holding company of such a bank, without prior notification of, and
lack of disapproval by, the Commissioner. Similar restrictions apply to any
person who holds in excess of 10% of any such class and desires to increase
these holdings to 25% or more of such class.
Connecticut banking laws grant banks broad lending authority. Subject to certain
limited exceptions, however, total secured and unsecured loans made to any one
obligor pursuant to this statutory authority may not exceed 25% of the Bank's
equity capital and the allowance for loan losses.
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Federal law also imposes additional restrictions on the Bank with respect to
loans and credit to certain related parties and transactions with the Company's
principal stockholders, officers, directors and affiliates. Extensions of credit
to such persons (i) must be made on substantially the same terms (including
interest rates and collateral) as, and follow credit underwriting procedures not
less stringent than, those prevailing for comparable transactions with members
of the general public, and (ii) must not involve more than the normal risk of
repayment or present other unfavorable features.
Capital Adequacy
The federal bank regulatory authorities have adopted risk-based capital
guidelines to which the Bank is subject. The guidelines establish a systematic
framework that makes regulatory capital requirements more sensitive to
differences in risk profile among banking organizations, takes off-balance sheet
exposures into explicit account in assessing capital adequacy, and minimizes
disincentives to holding liquid, low-risk assets. These risk-based capital
ratios are determined by allocating assets and specified off-balance sheet
financial instruments into four weighting categories, with higher levels of
capital required for the categories perceived as representing greater risk.
Under these guidelines, a banking organization's capital is divided into two
tiers. The first tier ("Tier 1") includes common equity, perpetual preferred
stock (excluding auction rate, money market or remarketable issues) and minority
interests held by others in a consolidated subsidiary, less goodwill and any
disallowed intangibles. Supplementary ("Tier 2") capital includes, among other
items, cumulative and limited-life preferred stock, mandatory convertible
securities, subordinated debt and the allowance for loan and lease losses,
subject to certain limitations and less required deductions as provided by
regulation.
Banking organizations are required to maintain a risk-based capital ratio of
total capital (Tier 1 plus Tier 2) to risk-weighted assets of 8%, of which at
least 4% must be Tier 1 capital. Federal bank regulatory authorities may,
however, set higher capital requirements when a banking organization's
particular circumstances warrant. As a general matter, banking organizations are
expected to maintain capital ratios well above the regulatory minimums.
In addition, federal bank regulatory authorities have established guidelines for
a minimum leverage ratio (Tier 1 capital to average total assets). These
guidelines provide for a minimum leverage ratio of 3% for banking organizations
that meet certain specified criteria, including excellent asset quality, high
liquidity, low interest rate exposure and the highest regulatory rating. Banking
organizations not meeting these criteria or which are experiencing or
anticipating significant growth are required to maintain a leverage ratio which
exceeds the 3% minimum by at least 100 to 200 basis points. The risk based
capital and leverage ratios of the Bank as of December 31, 2000 and December 31,
1999 are set forth in Note 10 to the Company's Consolidated Financial
Statements.
Federal banking agencies must take "prompt corrective action" with respect to
depository institutions that do not meet minimum capital requirements. Federal
bank regulatory authorities have adopted regulations setting forth a five-tiered
system for measuring the capital adequacy of the depository institutions they
supervise. Under these regulations, a depository institution is
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classified in one of the following capital categories: "well capitalized,"
"adequately capitalized," "undercapitalized," "significantly undercapitalized",
and "critically undercapitalized." Based on the Bank's current regulatory
capital position, management believes that the Bank is "well capitalized."
The Bank is generally prohibited from making any capital distribution (including
payment of a cash dividend) or paying any management fees to the Company if the
Bank would thereafter be undercapitalized. Undercapitalized depository
institutions are subject to growth limitations and are required to submit a
capital restoration plan acceptable to federal banking agencies. If a depository
institution fails to submit an acceptable plan, it is treated as if it is
"significantly undercapitalized."
Failure to meet applicable capital guidelines could subject a bank or bank
holding company to a variety of enforcement remedies available to the federal
bank regulatory authorities, including limitation on the ability to pay
dividends, the issuance of a capital directive to increase capital and, in the
case of a bank, the termination of deposit insurance by the FDIC or (in severe
cases) the appointment of a conservator or receiver.
Federal bank regulatory authorities proposed regulatory amendments to the
risk-based capital rules in September 2000 which would require FDIC-insured
banks to hold additional capital for "retained interests" that are associated
with loans sold or securitized. The regulations, if passed in their current or a
substantially similar form, would likely require the Bank to (i) significantly
reduce the level of such retained interests relative to capital by selling these
assets or raising a significant amount of additional capital to support the
Bank's lending activities, and (ii) structure certain future loan sales or
securitization transactions in a manner which may be less economically favorable
to the Bank, or refrain completely from loan securitizations.
The comment period on the proposed capital regulations closed December 26, 2000.
These regulations would not apply to the Bank or the Company following the
proposed Merger with UPS since the Bank would not have FDIC-insured deposits. In
light of this regulatory proposal, the Company has determined that it is prudent
to suspend its securitization activities prior to the closing of the proposed
Merger with UPS.
It is possible that, due to the high level of securitization-related retained
interests or other factors, the FDIC would no longer classify the Bank as "well
capitalized". Such an action would require the Bank to request approval from the
FDIC to continue to access the brokered CD market unless, and until, well
capitalized status is again achieved.
In addition, SBA regulations require that in order to fund the unguaranteed
portions of SBA loans under the Company's commercial paper facility, the Bank
must be well capitalized and must maintain a minimum currency rate (i.e. loans
paying in accordance with their terms). If the Bank is not able to meet these
requirements or if the Bank were to receive a regulatory enforcement action from
the FDIC, funding under the commercial paper facilities may not be available for
the Company's loans and alternative funding would have to be obtained.
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Any of these actions may reduce future earnings. Further, if the Company or the
Bank were not able to obtain additional capital on acceptable terms, the
Company's business strategy may have to be altered.
Dividends
The Bank is subject to legal limitations on the frequency and amount of
dividends that can be paid to the Company. The FDIC and CDB, in general, also
have the power to prohibit the payment of dividends by the Bank which would
otherwise be permitted under applicable regulations if the agencies determine
that these dividends would constitute an unsafe or unsound practice.
CDB approval is required for the payment of dividends by the Bank in any
calendar year if the total of all dividends declared by the Bank in that year
exceeds the current year's net income combined with the retained net income of
the two preceding years. "Retained net income" means the net income of a
specified period less any common or preferred stock dividends declared for that
period. Moreover, no dividends may be paid by a state bank in excess of its
undivided profits account. In addition, the FRB and the FDIC have issued policy
statements which provide that, as a general matter, insured banks and bank
holding companies may pay dividends only out of current operating earnings.
There are also statutory limits on other transfers of funds to the Company and
any other future non-banking subsidiaries of the Company by the Bank, whether in
the form of loans or other extensions of credit, investments or asset purchases.
These transfers by the Bank generally are limited in amount to 10% of the Bank's
capital and surplus to the Company and any such future subsidiary of the
Company, or 20% in the aggregate to the Company and all such subsidiaries.
Furthermore, these loans and extensions of credit are required to be fully
collateralized in specified amounts depending on the nature of the collateral
involved.
Community Reinvestment Act
The Federal and State of Connecticut Community Reinvestment Acts require the
FDIC and CDB to evaluate the Bank's performance in helping to meet the credit
needs of the community. The Bank defines its CRA marketplace as Hartford County.
This definition is not intended to restrict the availability of credit services
throughout the Bank's general service area, but represents a special commitment
the Bank has made to provide lending and depository services to the community.
As a part of the CRA program, the Bank is subject to periodic examinations by
the FDIC and CDB and maintains comprehensive records of its CRA activities for
this purpose. Following its most recent examination in March 1998 by its former
primary regulator, the Comptroller of the Currency, the Bank received a rating
of "Satisfactory." The Bank filed a CRA Strategic Plan with the FDIC and CDB and
is currently operating under this approved Plan. The Plan details the manner and
level of performance to be achieved to obtain a satisfactory or an outstanding
rating in each of the lending, investment and service categories as specified in
the CRA. Based on its internal analysis of performance under the Plan for the
year ended December 31, 2000, the Bank had met the "satisfactory" goals.
The Bank is specifically interested in making financing available to small and
medium size businesses in its defined lending area. The Bank evaluates credit
applications without regard to
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race, color, religion, national origin, gender, marital status or age, and does
not discriminate against any loan applicant whose income may come entirely or in
part from any public assistance program, or against any applicant who has
exercised in good faith any right under the Consumer Protection Act. The Company
maintains preferred status with the SBA, USDA and Ex-Im Bank, which enables it
to provide access to credit products that might otherwise be unavailable.
ITEM 2. PROPERTIES
The Company leases approximately 50,000 square feet in Hartford, Connecticut to
house its headquarters and lending and support staff. The Company maintains
leased space for representative offices in Boston and Springfield,
Massachusetts; Providence, Rhode Island; Morristown, New Jersey; Philadelphia
and Pittsburgh, Pennsylvania; Rochester, New York; Washington, D.C.; Miami,
Florida; Detroit, Michigan; St. Louis, Missouri; Cleveland, Ohio; Los Angeles,
California; and Richmond, Virginia. The Company's leases generally provide for
two five-year renewal options and options on additional space. Management
believes that its existing facilities are adequate for their present and
proposed uses and that suitable facilities will be available on reasonable terms
for any additional space required.
ITEM 3. LEGAL PROCEEDINGS
Because the nature of the business of the Company involves the collection of
numerous accounts, the validity of liens and compliance with state and federal
laws, the Company is subject to claims and legal actions in the ordinary course
of its business. While it is impossible to estimate with certainty the ultimate
legal and financial liability with respect to these claims and actions, the
Company believes that the ultimate resolution of these actions is unlikely to
have a material adverse effect on the financial position, results of operations
or cash flows of the Company.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the fourth quarter of 2000 to a vote of
security holders through solicitation of proxies or otherwise.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The following table reflects the range of the reported high and low sales prices
of shares of the Company's common stock on The NASDAQ National Market(SM):
1998 HIGH LOW
First Quarter $17-3/4 $12-7/8
Second Quarter $17-5/16 $14-3/8
Third Quarter $14-1/2 $9-1/2
Fourth Quarter $11-1/2 $6-7/8
1999 HIGH LOW
First Quarter $11-7/8 $8-7/8
Second Quarter $13 $8-1/8
Third Quarter $13-3/4 $9
Fourth Quarter $10-1/4 $7
2000 HIGH LOW
First Quarter $9-1/8 $6-3/4
Second Quarter $8-7/8 $6-1/2
Third Quarter $8-1/16 $7
Fourth Quarter $8-5/8 $6-9/16
On March 1, 2001, The Company had approximately 169 stockholders of record. This
number does not include beneficial owners holding shares through nominee or
"street" names. The Company believes the number of beneficial stockholders is in
excess of 1,300.
Holders of the Company's common stock are entitled to receive dividends when,
as, and if declared by the Board of Directors, out of funds legally available
for such purpose. The Company has paid quarterly cash dividends to its
stockholders since October 1995 equal to $.03 per share.
The Company currently plans to continue to declare and pay quarterly cash
dividends on approximately the same basis to the holders of the common stock
until the closing of the proposed Merger with UPS. However, there can be no
assurance that dividends will be declared and paid in the future. In determining
whether and to what extent the Company should declare and pay dividends, the
Company's Board of Directors will consider, among other factors, the Company's
consolidated financial condition and results of operations, tax considerations,
general economic conditions and capital requirements. Additionally, the
Company's ability to declare and pay dividends may depend upon the receipt of
dividends from its wholly owned subsidiary, First International Bank, which is
restricted by the requirements of federal and state banking laws. See Note 10 of
the Consolidated Financial Statements.
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ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
YEARS ENDED DECEMBER 31,
---------------------------------------------------------------------------
2000 1999 1998 1997 1996
----------- ----------- ----------- ----------- -----------
(Amounts in thousands, except per share data)
SELECTED INCOME STATEMENT DATA:
Interest income .................................. $ 24,303 $ 18,372 $ 18,192 $ 14,625 $ 13,305
Interest expense ................................. (16,038) (11,581) (7,924) (6,371) (5,741)
----------- ----------- ----------- ----------- -----------
Net interest income ....................... 8,265 6,791 10,268 8,254 7,564
Provision for possible loan losses ............... (3,595) (3,019) (3,071) (2,239) (3,487)
----------- ----------- ----------- ----------- -----------
Net interest income after provision for
possible losses .......................... 4,670 3,772 7,197 6,015 4,077
Non-interest income .............................. 32,134 35,212 22,008 15,110 9,945
Non-interest expense ............................. (26,084) (28,283) (17,700) (13,801) (8,425)
----------- ----------- ----------- ----------- -----------
Income before income taxes ................ 10,720 10,701 11,505 7,324 5,597
Income taxes ..................................... (3,263) (4,692) (4,472) (2,895) (2,353)
----------- ----------- ----------- ----------- -----------
Income before effect of accounting change .. $ 7,457 $ 6,009 $ 7,033 $ 4,429 $ 3,244
Cumulative effect of change in accounting
principle, net of taxes ...................... (1,695) -- -- -- --
----------- ----------- ----------- ----------- -----------
Net income ....................................... $ 5,762 $ 6,009 $ 7,033 $ 4,429 $ 3,244
=========== =========== =========== =========== ===========
PER COMMON SHARE AMOUNTS:
INCOME BEFORE EFFECT OF ACCOUNTING CHANGE:
Basic ............................................ $ 0.90 $ 0.74 $ 0.89 $ 0.70 $ 0.56
Diluted .......................................... $ 0.89 $ 0.72 $ 0.86 $ 0.67 $ 0.56
NET INCOME:
Basic ............................................ $ 0.70 $ 0.74 $ 0.89 $ 0.70 $ 0.56
Diluted .......................................... $ 0.69 $ 0.72 $ 0.86 $ 0.67 $ 0.56
Weighted average basic shares outstanding ........ 8,266 8,151 7,909 6,330 5,763
Weighted average diluted shares outstanding ...... 8,385 8,322 8,200 6,567 5,835
Book value ....................................... $ 7.43 $ 6.90 $ 6.29 $ 5.47 $ 2.63
Cash dividends declared .......................... $ 0.12 $ 0.12 $ 0.12 $ 0.12 $ 0.12
Dividend payout ratio ............................ 17.2% 16.3% 13.5% 16.5% 20.3%
CONSOLIDATED BALANCE SHEET -
AVERAGE BALANCES:
Total assets ..................................... $ 322,447 $ 276,555 $ 235,991 $ 177,891 $ 157,593
Securities held to maturity ...................... $ 959 $ 1,529 $ 2,851 $ 3,068 $ 3,033
Securities available for sale .................... $ 56,265 $ 45,589 $ 16,941 $ 13,911 $ 7,462
Loans, net of unearned income .................... $ 162,840 $ 152,842 $ 158,741 $ 125,113 $ 117,484
Interest-bearing deposit liabilities ............. $ 246,293 $ 204,298 $ 154,938 $ 124,016 $ 117,651
Short-term borrowings ............................ $ 695 $ 3,602 $ 605 $ 133 $ 57
Stockholders' equity ............................. $ 58,033 $ 51,750 $ 44,270 $ 21,649 $ 12,603
CONSOLIDATED RATIOS:
Net interest margin .............................. 3.2% 2.8% 4.8% 5.1% 5.2%
Non-interest income to net revenue ............... 79.5% 83.8% 68.2% 64.7% 56.8%
Return on average assets ......................... 1.8% 2.1% 3.0% 2.5% 2.1%
Return on average stockholders' equity ........... 10.0% 11.6% 15.9% 20.5% 25.5%
Average stockholders' equity to average assets ... 18.0% 17.3% 18.8% 12.2% 8.1%
Leverage capital ratio ........................... 12.7% 15.5% 18.6% 14.7% 8.4%
Total risk-based capital ratio ................... 10.8% 11.3% 16.4% 17.6% 11.6%
Year-end allowance for possible loan losses to
year-end loans, net of unearned income ......... 3.7% 3.0% 3.3% 2.3% 2.6%
Net charge-offs to average loans, net of
unearned income ................................ 1.6% 1.6% 1.4% 1.7% 2.1%
Year-end nonperforming loans to year-end
loans, net of unearned income and other real
estate owned ................................... 2.7% 3.3% 2.5% 1.8% 2.0%
OTHER OPERATING DATA:
Total loans originated ........................... $ 509,740 $ 550,860 $ 391,677 $ 306,960 $ 172,920
Total loans managed at year-end .................. $ 1,264,683 $ 1,076,092 $ 779,055 $ 573,545 $ 380,432
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ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion and analysis of the consolidated financial condition
and results of operations of First International Bancorp, Inc. (the "Company")
should be read in conjunction with the Company's consolidated financial
statements, including the related notes thereto, and other information.
GENERAL
First International Bancorp, Inc., a Delaware corporation, is a one-bank holding
company incorporated in 1985 and regulated by the Board of Governors of the
Federal Reserve System. Its principal asset and subsidiary is First
International Bank (the "Bank"), a Connecticut state chartered bank and trust
company which is regulated by the State of Connecticut Banking Department and
the Federal Deposit Insurance Corporation ("FDIC"). The Bank was established in
1955 as a national bank and changed its name from First National Bank of New
England on February 1, 1999 to more closely reflect the markets it serves. The
Bank converted from a national bank to its state charter effective July 1, 1999.
The Company specializes in providing credit, trade and financial solutions to
small and medium size industrial companies located in the United States and
international emerging markets. The Company serves its target market by offering
flexible and attractive terms to borrowers and manages its credit risk through
the combined utilization of commercial loan guarantee programs made available by
three U. S. federal agencies, the U. S. Small Business Administration (the
"SBA"), the U. S. Department of Agriculture (the "USDA") and the Export-Import
Bank of the U. S. ("Ex-Im Bank"), as well as through the use of private credit
insurance policies.
For the federal fiscal year ending September 30, 2000, the Company was the
country's largest Ex-Im Bank lender measured by number of transactions; the
second largest USDA Business and Industry lender measured by dollar volume; and
the eleventh largest SBA 7(a) lender measured by dollar volume. The Company
maintains preferred and certified status for government guaranteed lending
programs in several jurisdictions.
In September 1997, the Company completed an underwritten public offering whereby
1,955,000 shares of its common stock were issued for net proceeds of $23.8
million.
On March 26, 1999, the Company sold its last retail branch and its checking,
savings and money market accounts. The Company retained its certificates of
deposit and continues to offer certificates of deposit to retail and brokered
depositors. (See "Changes in Funding Sources" for further discussion of the
funding sources used by the Company.)
On January 15, 2001, the Company entered into a definitive Agreement and Plan of
Merger with United Parcel Service, Inc. ("UPS"), pursuant to which at the
effective time of the transactions described in the merger agreement, a
wholly-owned subsidiary of UPS will be merged with and
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into the Company (the "Merger"). The Company would be the surviving corporation
of the Merger and a wholly-owned subsidiary of UPS.
Under the terms of the merger agreement, the Company's stockholders will receive
shares of UPS Class B common stock in exchange for shares of the Company's
common stock, based on a conversion ratio described in the merger agreement,
subject to a number of potential adjustments. Further, approximately 10% of the
stock to be issued in the Merger will be placed in escrow pending the
performance of the Company's loan portfolio during the 12 months following the
closing and the resolution of any indemnification claims with respect to the
Company's representations, warranties and covenants in the merger agreement. The
conversion ratio and the other terms of the Merger are described in the merger
agreement which has been filed by the Company as an exhibit to the Company's
Current Report on Form 8-K, filed with the Securities and Exchange Commission on
January 19, 2001. In addition, the terms of the Merger and the merger agreement
will be described in further detail in the Company's proxy statement for the
Company's 2001 Annual Meeting, which the Company anticipates will be filed with
the Securities and Exchange Commission in April 2001.
The Merger is subject to bank regulatory approvals, the approval of the
Company's stockholders, review under the Hart-Scott-Rodino Improvements Act and
other customary closing conditions. In connection with the execution of the
merger agreement, key Company stockholders, controlling approximately 52% of the
outstanding shares, have agreed to vote their shares of the Company stock in
favor of the transaction. The transaction is expected to close in the second
quarter of 2001.
As a condition to the completion of the Merger, the Bank, prior to closing the
Merger, will seek one or more buyers of its deposit liabilities, approximately
$280 million, subject to regulatory approval. Upon the closing of such
transaction, which is intended to be immediately prior to the Merger closing,
subject to the Bank's receipt of approval, the Bank would cease to be a
federally insured depository institution regulated by the FDIC and the Company
would cease to be a bank holding company regulated by the Board of Governors of
the Federal Reserve System. Following the Merger, the Bank would operate as a
non-depository bank chartered by the Connecticut Department of Banking, and
would continue to be subject to Connecticut's state banking laws and
regulations, as it is today.
Except for historical information contained herein, certain matters discussed in
this annual report are "forward-looking statements" as defined in the Private
Securities Litigation Reform Act ("PSLRA") of 1995, which involve risk and
uncertainties that exist in the Company's operations and business environment,
and are subject to change based on various factors. The Company wishes to take
advantage of the "safe harbor" provisions of the PSLRA by cautioning readers
that numerous important factors discussed below, among others, in some cases
have caused and in the future could cause the Company's actual results to differ
materially from those expressed in any forward-looking statements made by, or on
behalf of, the Company. In addition to the risks and uncertainties of ordinary
business operations, the following include some other, but not all, of the
factors or uncertainties that could cause actual results to differ from
projections:
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- - A general economic slowdown.
- - Inability of the Company to continue to manage its growth strategy
either domestically or internationally.
- - Disruption in the U. S. capital markets, delaying or preventing the
Company from receiving funding under commercial paper credit facilities
or completing loan sales or inability of the Company to continue to
accept brokered certificates of deposit since the Company depends on a
mix of these fundings for its operations.
- - Unpredictable delays or difficulties in the development and
introduction of new products and programs.
- - Inability of the Company to realize the recorded values of servicing
assets and other retained interests associated with its portfolio of
loans managed for others.
- - Regulatory, accounting and legislative changes that may occur in the
future that impact the Company's marketplace through changing banking
regulations or changes in the interpretation and application of these
regulations or accounting pronouncements or other matters, including
the ability of the Company to continue to meet leverage and risk based
capital requirements, based on recently proposed regulatory capital
amendments relative to retained interests in securitizations and loan
sales. (See "Liquidity and Capital Resources.")
- - Fluctuations in the quarterly operating results due to a number of
factors, including among others, variations in the volume of loans
originated and changes in the capital markets expectations on yields on
loan sales which may cause variations in the effective interest rates
yielded on loans and retained interests.
- - Unexpectedly high levels of, or large fluctuations in interest rates,
which could result in decreased net interest income, a reduction of
gains on loan sales, an increase in loan losses, an impairment of
retained interests, or other negative effects.
- - Risks associated with government guarantee loan programs, since a
substantial portion of the Company's business still depends upon the
continuation of the various government guarantee loan programs as
discussed below.
The Company believes that it has the product offerings, facilities, personnel
and financial resources for continued business success in competitive markets.
However, future revenues, costs, margins and profits, and the timing of these,
are all influenced by a number of factors, some of which may be beyond the
Company's control, including those discussed above.
In addition, with respect to the proposed Merger of the Company and UPS, readers
should be aware of the following factors, among others: the possibility that the
proposed Merger will not be consummated as a result of failure of the Company to
satisfy certain conditions; the possibility that the proposed Merger will be
delayed substantially; the inability to obtain, or meet
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conditions imposed for governmental approvals of the proposed Merger and other
transactions described in the merger agreement; the possibility that the
announcement of the proposed Merger will have an adverse impact on the Company's
business; and that there may be significant costs incurred relating to the
proposed Merger.
BUSINESS STRATEGY
In contrast to many other banks, the Company derives a majority of its revenues
from non-interest income, principally gains on the service-retained sale of
commercial and international loans and related loan servicing income. During the
past five years of operations, the Company has achieved the majority of its
revenue growth from the sale and the securitization of government guaranteed and
other commercial loans and fee income on loans managed for others. The Company
has expanded its U.S. loan origination activities and its international presence
in emerging markets. The Company's growth is evidenced by the 18% increase in
its loans under management to $1.3 billion at December 31, 2000 from $1.1
billion as of December 31, 1999. The mix of loans originated continues to
reflect increased reliance on government guaranteed loan programs.
The following chart illustrates the composition of loan originations since 1998:
Years Ended December 31,
------------------------------------
2000 1999 1998
--------- --------- ---------
(dollars in thousands)
Guaranteed loans $ 314,817 $ 306,721 $ 252,864
Unguaranteed loans 194,923 244,139 138,813
--------- --------- ---------
Total loans originated $ 509,740 $ 550,860 $ 391,677
========= ========= =========
CHANGES IN FUNDING SOURCES
Over the past three years, the Company completed transactions that effected
changes in the manner in which the Company obtains funding for its lending
business. These transactions included:
- - the sale of the Company's last branch in March 1999, including
checking, savings and money market accounts which requires the Company
to obtain funding from alternative sources;
- - establishment of a commercial paper conduit facility pursuant to which
up to $60 million is available to the Company (based upon the
contractual advance rates against the qualifying principal balance of
the loans pledged to secure the facility; the pledged loans consist of
the unguaranteed portion of loans guaranteed by the SBA);
- - establishment of and the increase in a second commercial paper conduit
facility from $65 million to $95 million and, in January 2001, to $120
million pursuant to which the
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Company has the right to sell or finance commercial revolving lines of
credit and other qualifying loans during the term of the facility;
- - loan securitization and sales transactions pursuant to which the
Company securitized and sold in the aggregate approximately $322
million of asset-backed loans, and
- - establishment of agreements with five national brokers which provide a
source for brokered certificates of deposits used for fundings of one
year or less.
ANTICIPATED FUTURE FUNDING SOURCES
The Company does not plan to continue to securitize loans or sell loans to its
commercial paper conduit facilities in 2001 due to proposed bank regulations
that would significantly increase the Bank's capital requirements, as more fully
described in "Liquidity and Capital Resources." Approximately 33% of the
Company's annual loan originations were funded from these sources in 2000 and
approximately 21% of the Company's operating income came from these
transactions.
The Company is currently finalizing companion facilities under its approved
commercial paper conduit credit lines and expects to continue to transfer loans
to such conduits, but expects that these transfers will be reflected as
financings on the Company's balance sheet.
Since January 1, 2000 the Company has de-emphasized non-government guaranteed
commercial lending and has successfully increased the percentage of government
guaranteed lending by nearly 11%. In 2001, the Company will seek to continue to
increase the use of the SBA, USDA and Ex-Im Bank government guaranteed loan
programs which offer an established "whole loan" secondary market. The Company
will also continue to increase the origination and sale of commercial mortgages
and term loans under other established whole loan purchase programs.
The Company also expects to continue to obtain funding for its operations while
an independent entity from retail and brokered certificates of deposits. See
"Liquidity and Capital Resources" for further discussion of the Company's
current strategies.
ACCOUNTING FOR LOAN SALES
Gains from loan sales, securitizations and servicing income represented a
majority of the Company's revenues. Detailed below is a discussion of the
relevant accounting principles governing loan sales and securitizations and the
Company's servicing activities.
SBA and USDA Loan Sales
The majority of the Company's SBA and USDA guaranteed loans are variable rate,
indexed to the Prime Rate as quoted in The Wall Street Journal ("Prime"). The
Company generally sells the guaranteed portions of these loans shortly after
origination. If the Company sells a 20-year SBA or USDA guaranteed mortgage loan
with an interest rate of Prime plus 1.50%, the Company may receive a premium and
a specified amount of excess servicing because the market demands a
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yield of less than Prime plus 1.50% for a like tenor government instrument.
Investors in the guaranteed portions demand yields above a conventional U.S.
Treasury bill because of the prepayment risks and other factors inherent in the
guaranteed loans. After the loan sale, an investor will receive the pro rata
principal and pro rata interest at the note rate less any ongoing guarantee and
Company servicing fees. When the Company sells an SBA loan for a cash premium,
it must retain a minimum required servicing fee of 1%. The Company does elect
from time to time to retain a higher servicing fee and sell a loan for a lesser
premium or at par.
The Company may sell the unguaranteed portions of the SBA and USDA loans on a
loan-by-loan basis at or above the carrying value. In accordance with SBA and
USDA regulations, the Company has generally been required to retain a 5%
interest in the unguaranteed portion of the loan when some of the unguaranteed
portion is sold on a loan-by-loan basis.
When the Company sells part of a loan, the gain recognized is based on the
relative fair values of the loan sold, the portion of the loan retained and any
other assets created in the transaction. The Company creates a servicing asset
when it sells loans on a servicing-retained basis with a servicing fee in excess
of "adequate compensation." This servicing asset is equal to the net present
value of the estimated cash flows in excess of such compensation. The original
principal balance of a loan must be allocated between the guaranteed portion
sold, the unguaranteed portion retained and the servicing asset, resulting in a
discount being recognized on the unguaranteed retained portion of the loan.
In connection with calculating a gain on sale, the Company must make certain
assumptions which include (i) the amount of adequate compensation used to
determine the amount of the servicing asset that the Company will recognize at
the date of the sale, (ii) the estimated life of the underlying loan used in
projecting the time period over which the Company will receive the servicing fee
(the "constant prepayment rate" or CPR), and (iii) the discount rate used in the
present value calculation of the servicing asset.
Based on estimates from potential sub-servicers, the Company defines adequate
compensation as 20 basis points. The Company estimates its cost to service loans
plus a normal profit to be less than 20 basis points. The constant prepayment
rates utilized by the Company in estimating the lives of the loans are based on
the Company's experience in its target market and consideration of current
market conditions. Such constant prepayment rates are currently estimated at 8%
for most asset classes with a rate of 30% used for certain Ex-Im Bank backed
loans which loans have had earlier prepayments due to claims on defaults. The
estimated cash flows are then discounted to derive a fair value.
Actual prepayment rates may be affected by a variety of economic and other
factors, including prevailing interest rates, loss rates, and the availability
of alternative financing. The effect of these factors varies depending on the
types of loans. Estimated prepayment rates are based on management's
expectations of future prepayments, and, while management believes that the term
of amortization and market interest rate on the variable rate loans somewhat
reduce the prepayment risk, there can be no assurance that management's
prepayment estimates are accurate. If the actual prepayment rate for loans sold
is higher than projected at the time such loans were sold, the carrying value of
the servicing asset may be considered impaired and be
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reduced by a charge to earnings. If the actual prepayment rate for loans sold is
lower than estimated, the carrying value of the servicing asset is not increased
through income although the total future cash flows would exceed previously
estimated amounts.
The servicing asset is amortized against the servicing fee income received
monthly, on an effective interest method, and the discount on the retained loan
is accreted to interest income on an effective interest method. The servicing
asset is carried at the lower of amortized cost or market value.
Ex-Im Bank and Other Commercial Loan Sales
Sales of the Ex-Im Bank guaranteed short and medium term loans and working
capital lines of credit are generally made at the carrying value, although the
Company receives a servicing fee above the 20 basis points defined as adequate
compensation resulting in the recognition of a gain at the time of the sale
equal to the calculated servicing asset and any net loan origination fees. Due
to the revolving nature of the Ex-Im Bank working capital loans sold, the
Company recognizes the servicing income as collected.
The Company also sells 100% of certain other unguaranteed commercial loans on a
loan-by-loan basis where no portion of the loan is retained on the Company's
balance sheet.
Securitization and Sale of Loans
Since mid 1998, the Company has either securitized or sold certain whole loans
and the unguaranteed portions of certain government guaranteed loans that it
originated. In such transactions the Company sells a pool of loans to a trust,
which in turn issues certificates representing beneficial ownership interests in
the trust or which issues notes and sells such securities through private
placement transactions. For all securitizations, the Company is the servicer of
the underlying loans. The Company will generally retain one or more of the
following "retained interests" in the securitized assets: interest-only strips,
subordinated certificates and interests, servicing assets and cash reserve
accounts. The Company has established special purpose entities to facilitate
the individual securitizations and sale transactions. Generally, the Company
retains risks in the form of default, prepayment and, in the case of certain
loan securitizations and the sales of revolving lines of credit and other loans
to the commercial paper conduit, interest rate and/or basis risk.
The estimates of gain on loan sales and securitizations and the value of
retained interests are based on assumed lives, loss rates and discount rates
and, in certain cases, expected interest rate risk. Accordingly, the ultimate
realization of such assets involves risks. Management analyzes each pool sold or
securitized at the time of the transaction and as of each quarterly reporting
period. Original assumptions are based on past performance of similar loan types
originated by the Company and, to the extent available, market data and data on
performance of similar loans originated by others and management's estimate of
future performance. Such retained interests are recorded at estimated fair value
and classified as investments available-for-sale. Management compares the
original assumptions to actual pool performance quarterly.
As contrasted to the secondary markets for residential mortgage loans and
certain other consumer loans, the Company has observed that commercial loans
have been securitized for a
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shorter time period and generally in strong economic cycles. Accordingly, market
data on the performance of commercial loans sold is much less detailed and is
more aggregated than that available for consumer loans. Management believes that
certain market data available on SBA commercial loan performance reflects a
lower quality borrower than the typical Company borrower since the Company
generally lends to industrial companies, which are required to be better
capitalized than service companies or start-ups. Generally, the Company's
securitized pools carry a lower average rate or coupon and are expected to have
lower prepayment and loss ratios than SBA commercial pools sold by other
issuers.
The loss and prepayment assumptions used by the Company (as detailed in Note 3
to the Company's consolidated financial statements) indicate lower expected loss
and prepayment rates than indicated by certain published data for SBA loan pools
originated by others. Management believes that such assumptions are warranted
given management's assessment of the Company's loan pool characteristics, the
nature of the collateral supporting the loans, the quality of the individual
borrowers and the Company's experience in lending to its customers, including
actual historical performance.
It is possible that actual performance on the unguaranteed SBA loan or
commercial loan-backed transactions could vary from that assumed due to
unforeseen changes in customer behavior and economic conditions resulting in
additional losses.
The Company as servicer, by contract, generally receives annual servicing fees
ranging from 40-100 basis points of the outstanding principal balance of the
loans and the rights to any additional cash flows arising after the investors in
the securitization trust have received the contracted return. The Company's
retained interests are subordinate to the investor's interests. SBA regulations
require that the Company hold a subordinated note in the unguaranteed portion of
securitized loans equal to a minimum of 2% of the aggregate amount of the
transaction.
Management elected early adoption of EITF 99-20 "Recognition of Interest Income
and Impairment on Purchased and Retained Beneficial Interests in Securitized
Financial Assets." In accordance with this standard, estimated cash flows are
discounted at market rates to derive a fair value. The impact of this accounting
change, which is reflected as a cumulative effect, net of taxes, as of October
1, 2000 is $1.7 million. Because of continuing market concerns over the ultimate
recoverability of securitization-related retained interests, a further pre-tax
impairment on securitization - related retained interests of $754,000 was
recorded against non-interest income in the fourth quarter of 2000.
RESULTS OF OPERATIONS
The following discussions make reference to average balances of certain assets
and liabilities as well as volume and rate changes. These tables are included at
the end of this section.
COMPARISON OF THE YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
Net Income. Net income totaled $5.8 million in 2000, a decrease of $200,000 or
3% from 1999 net income of $6.0 million, which had decreased $1.0 million or 14%
from 1998 income of $7.0 million. Net income for the year ended December 31,
2000 includes a charge of $1.7 million,
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40
net of taxes, to reflect the cumulative effect of a change in accounting
principle following the Company's adoption of EITF 99-20 in valuation of
securitization-related retained interests as of October 1, 2000.
The 2000 net income reflects a $2.5 million or 13% increase in the gain on loan
sales to $21.6 million, including gains of $7.7 million on securitizations and
sales to commercial paper conduit facilities, which increased 21%. Gain on the
sale of guaranteed loans of $12.9 million was 4% higher than the prior year.
Loan servicing income and fees of $9.7 million increased 58% over the prior
year. Non-interest income also reflects a reduction of $754,000 due to a further
change in the estimate of the valuation of securitization-related retained
interests for the fourth quarter. Net interest income increased $1.5 million due
to increased interest earnings from loans and investments partially offset by an
increase in the funding cost of brokered certificates of deposits. The results
for 1999 also include an $8.9 million gain from the sale of the Company's last
branch and associated deposit accounts.
Income from unconsolidated subsidiaries of $1.2 million for 2000 and $335,000
for 1999 net of taxes, reflects the net earnings from these subsidiaries
recorded on the equity method which approximates a level yield method for
recognizing income on the investment.
Operating expenses decreased $2.2 million or 8% as the additions to lending and
staff personnel and domestic expansion were more than offset by the reduction in
non-recurring items associated with the prior year branch sale, conversion to a
state bank charter and other costs associated with various regulatory matters.
The Company's effective tax rate, including the effect of taxes on
unconsolidated subsidiaries and the cumulative effect adjustment referred to
above, decreased to 37.5% for the year ended December 31, 2000 from the year
ended December 31, 1999 of 45%. The 1999 effective tax rate reflected the
non-deductibility of a portion of the Chief Executive Officer's compensation
over $1 million.
The 1999 net income reflects a $2.2 million or 13% increase in the gain on loan
sales to $19.2 million for 1999 including gains of $6.3 million on the
securitization of loans, an increase of 54%. Gain on the sale of guaranteed
loans was level with the prior year at $12.3 million. Loan servicing income
increased $1.9 million or 45% relating to the continued growth in loans sold and
managed for investors. Included in income is an $8.9 million gain from the sale
of the Company's last remaining branch and related checking, savings and money
market deposit accounts. These increases were offset by a reduction in net
interest income of $3.5 million or 34% due in part to higher funding costs after
the sale of the branch.
Operating expenses increased $10.6 million or 60% in 1999 reflecting marketing
cost increases, additions to lending personnel, domestic and international
expansion, as well as certain non-recurring expenses incurred in connection with
the branch sale and conversion to a state charter, as well as other regulatory
matters and the expense associated with the repair of a government guaranteed
loan. Expenses include $1.7 million related to a bonus paid to the Chief
Executive Officer in connection with the re-negotiation of his employment
agreement. This bonus was used by the Chief Executive Officer to retire a
$980,000 note receivable held by the Company and to
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pay income taxes associated with the bonus. Also included in expenses is
$940,000 related to cash bonuses paid to seven members of senior management in
conjunction with the completion of the sale of the Company's last retail branch.
The Company's effective tax rate, including the effect of taxes on
unconsolidated subsidiaries, increased to 45% for the year ended December 31,
1999 from 38.9% for the year ended December 31, 1998 due to the
non-deductibility of the portion of the Chief Executive Officer's compensation
over $1 million.
Net Interest Income. Net interest income increased $1.5 million or 22% to $8.3
million in 2000 due to a $18 million or 7% increase in average interest-earning
assets as well as a 178 basis point increase in the yield on earning assets. The
increase in the earnings yield was a result of Prime rate increases totaling 150
basis points late in 1999 and through mid-year 2000, improved pricing on certain
loan types and a reflection of the increase in assets held in liquid investment
securities. The increased yield on assets was partially offset by a 92 basis
points higher cost of funds. Average interest-bearing liabilities increased
$39.1 million or 19%.
Net interest income for the year ended December 31, 1999 decreased $3.5 million
or 34% to $6.8 million from 1998 due to a $25.4 million or 12% increase in
average interest-earning assets offset by an 82 basis point decrease in the
yield on earning assets. The increase in investment securities income relates to
yields on I/O and other investment securities associated with Company-sponsored
securitizations. The average yield on loans decreased 63 basis points reflecting
the Prime rate reductions in the last four months of 1998. Average
interest-bearing liabilities increased $52.4 million or 33.7% while the cost of
funds increased 48 basis points as greater reliance was placed on brokered
certificates of deposits after the sale of the branch. The brokered certificates
of deposits have a higher cost than the average cost of the branch checking,
savings and money-market deposits they replaced.
Interest Income. Interest income increased $5.9 million or 32% to $24.3 million
in 2000 from $18.4 million in 1999 due to a $12.2 million or 7% increase in
average loans outstanding and a $5.4 million or 7% increase in average
investments. The yield on loans and investments increased by 169 basis points
and 193 basis points, respectively, reflecting the Prime rate increases
experienced in late 1999 through mid-2000.
Interest income of $18.4 million reported for 1999 was relatively unchanged from
the $18.2 million for 1998, due to the increase in average investments of $31.4
million, less a $6.1 million reduction in average loans on hand. The average
yield on loans decreased 63 basis points reflecting the 1998 Prime rate
reductions, which began to be reversed in the last quarter of 1999. The average
yield on investments decreased by 6 basis points due to lower yields on federal
funds sold.
Interest Expense. Interest expense increased $4.5 million or 38% to $16.0
million from $11.6 million in 1999 due to a $42.0 million or 21% increase in
interest bearing deposits. Additionally, an increase in the cost of funds for
interest bearing liabilities of 112 basis points further increased interest
costs. The average balance of brokered certificates of deposit increased $82.1
million or 61% to $216.0 million from $133.6 million in 1999. The brokered
certificates of deposits have been a primary source of funding by the Bank after
the sale of the last branch in March 1999. Interest expense increased $6.8
million on these deposits to $14.1 million in 2000 from $7.3
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42
million in 1999. Additionally, the cost of funds increased 107 basis points with
the rising interest rate environment during late 1999 and through 2000. A $39.5
million or 56% decrease in other interest bearing demand deposits contributed to
an overall cost of liabilities of 6.49%, a total increase of 92 basis points
from 1999.
Interest expense increased $3.7 million or 47% to $11.6 million in 1999 from
$7.9 million in 1998 with a $49 million or 32% increase in interest bearing
deposits including replacement of $21 million of non-interest bearing accounts
that were transferred with the sale of the branch in March 1999. The overall 48
basis points higher cost of funds resulted primarily from the shift to the use
of newer sources of funding including warehouse lines of credit and brokered
certificates of deposit which accounted for 71 basis points increase in interest
costs.
Provision for Possible Loan Losses. The provision for possible loan losses
totaled $3.6 million in 2000, $3.0 million in 1999 and $3.1 million in 1998. The
provision is affected by net loan charge-offs, changes in the level and mix of
loans, changes in asset quality, and general economic conditions. See Allowance
for Loan Losses for further discussion.
Non-Interest Income. The components of non-interest income are detailed below:
Years Ended December 31,
-------------------------------
2000 1999 1998
-------- -------- --------
NON-INTEREST INCOME: (dollars in thousands)
Gain on loan sales:
SBA sales ................................. $ 5,764 $ 5,813 $ 6,101
USDA sales ................................ 3,520 4,292 3,390
Ex-Im working capital sales ............... 435 531 474
Ex-Im short and medium term sales ......... 3,166 1,716 2,274
Unguaranteed portions of SBA and USDA sales -- -- 436
Other commercial sales .................... 1,009 521 190
Securitizations and sales to conduits ..... 7,662 6,314 4,094
-------- -------- --------
Gain on loan sales ................... 21,556 19,187 16,959
Loan servicing income and fees ............... 9,703 6,161 4,249
Other non-interest income .................... -- 75 704
Income on stockholder note receivable ........ 211 123 63
Gain on securities sales ..................... 204 416 33
Income from unconsolidated subsidiaries ...... 1,214 335 --
Impairment on retained interests ............. (754) -- --
Gain on branch sale .......................... -- 8,915 --
-------- -------- --------
Total non-interest income ............ $ 32,134 $ 35,212 $ 22,008
======== ======== ========
Non-interest income of $32.1 million in 2000 represents a decrease of $3.1
million or 9%; however, after excluding the $8.9 million 1999 gain from the sale
of the branch, non-interest income increased $5.8 million. Loan servicing income
and fees increased $3.5 million or 58% due to higher average balances of loans
serviced.
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The gain on guaranteed loans increased by $533,000 or 4% to $12.9 million from
$12.4 million in 1999. Gains on the guaranteed portions of SBA and USDA loan
sales decreased $821,000 or 8% in 2000 on a flat volume of SBA and USDA loans
sold, which totaled approximately $196 million for each year. The decrease in
the return reflects a slight reduction in USDA guaranteed loans but is primarily
attributable to a widening of investor spreads. Gains on the sale of Ex-Im Bank
short and medium term loans increased 85% or $1.5 million in 2000 as compared to
1999 owing primarily to an increase in originations. The volume of Ex-Im Bank
term loans sold increased 42% or $19.7 million as the Company de-emphasized use
of its privately-insured loan product in favor of the higher yielding Ex-Im Bank
alternative. The average rate of return on Ex-Im Bank term loans increased to
4.5% in 2000 from 3.6% in 1999 due to improved pricing on these loans.
The gain on loan-backed securitizations increased $1.4 million or 21% to $7.7
million in 2000 from $6.3 million in 1999. This increase related to one
additional loan securitization completed in 2000 compared to 1999. The gain on
sale of commercial loans increased $488,000 or 94% due to an increased volume of
whole loan sales in 2000 as the market continued to develop. Income from
unconsolidated subsidiaries increased $879,000 or 262% due to larger average
loan balances outstanding in the subsidiaries in 2000 compared to 1999 and a
lower average ratio of line facility advances.
In 2000, the Company completed three securitizations and several sales to the
commercial paper conduit and other facilities; gains on these transactions
totaled $7.7 million on loans sold totaling $233 million. (See "Loan
Securitizations.")
Management elected early adoption of EITF 99-20 "Recognition of Interest Income
and Impairment on Purchased and Retained Beneficial Interests in Securitized
Financial Assets." In accordance with this standard, estimated cash flows are
discounted at market rates to derive a fair value. The impact of this accounting
change, which is reflected as a cumulative effect, net of taxes, as of October
1, 2000 is $1.7 million. Because of continuing market concerns over the ultimate
recoverability of securitization-related retained interests, a further pre-tax
impairment on securitization-related retained interests of $754,000 was
recorded against non-interest income in the fourth quarter of 2000.
Non-interest income increased $13.2 million or 60% to $35.2 million in 1999 from
$22 million in 1998 due to a $2.2 million increase in gain on loan sales and
securitizations, a $1.9 million increase in loan servicing income and the $8.9
million gain on the sale of the branch and related checking, savings and money
market deposit accounts.
Loan servicing income comprises the servicing fees received on loans sold on a
servicing retained basis, net of amortization of the servicing asset. The
increases in loan servicing income reflects the growth in loans under
management.
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Years Ended December 31,
-----------------------------------------
2000 1999 1998
----------- ----------- -----------
LOAN SERVICING INCOME AND FEES (dollars in thousands)
Loan Servicing Income:
SBA guaranteed loans .................. $ 4,014 $ 2,801 $ 1,612
USDA guaranteed loans ................. 1,761 1,102 348
Ex-Im working capital loans ........... 385 218 225
Ex-Im short and medium term loans ..... 779 193 448
Other commercial loans ................ 132 359 176
Securitized and sales facilities' loans 993 527 53
Residential and consumer loans ........ 14 8 51
----------- ----------- -----------
Loan servicing income ......... 8,078 5,208 2,913
Servicing asset impairment ............ (163) (265) --
----------- ----------- -----------
Net loan servicing income ..... 7,915 4,943 2,913
Other loan fees ......................... 1,788 1,218 1,336
----------- ----------- -----------
Total loan servicing income
and fees ................. $ 9,703 $ 6,161 $ 4,249
=========== =========== ===========
LOANS SERVICED FOR OTHERS (AT END OF YEAR)
Outstanding balance ................... $ 1,113,124 $ 926,752 $ 656,532
=========== =========== ===========
The increases in total loan servicing income reflect the continuing growth of
the servicing portfolios and the fact that in certain cases, actual cash flows
were greater than those assumed for certain of the loans serviced. The $2.9
million or 55% increase in loan servicing income to $8.1 million in 2000
reflects the $208.4 million or 26% increase in the average balance of commercial
loans serviced for others to $1.0 billion in 2000 from $791.6 million in 1999
and the mix of the loans.
The $2.3 million or 79% increase in loan servicing income to $5.2 million in
1999 reflects the $248.8 million or 62% increase in the average balance of
commercial loans serviced for others to $791.6 million in 1999 from $542.8
million in 1998.
The Company recognized impairments in the carrying value of the servicing asset
related to certain Ex-Im Bank medium term loans following payment defaults on
the underlying loans of $163,000 and $265,000 in the years ended December 31,
2000 and 1999, respectively. The majority of these charges relate to loans made
to borrowers in Brazil, a country which, at the time, was suffering from
macroeconomic pressures. Ex-Im Bank has paid the claims in full to the investors
under the Ex-Im Bank guarantee.
Other loan fees are comprised of fees earned on letters of credit, fees
forfeited by borrowers choosing not to complete a transaction and late fees
collected on loans under management. Letters of credit fees totaled $558,000 in
2000 compared to $552,000 in 1999. Such letter of credit fees in 1999 increased
$90,000 or 20% from $462,000 in 1998. The continued level of fees relates to
demand from the Company's exporting borrowers who have the need for letters of
credit to support their trade activities. Late fees on loans under management
increased $300,000
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or 84% to $658,000 in 2000 over 1999, reflecting management's focus on
collecting such fees. Late fees on loans increased $125,000 or 54% in 1999 over
1998.
NON-INTEREST EXPENSE.
YEARS ENDED DECEMBER 31,
------------------------------------
2000 1999 1998
---------- ---------- ----------
NON-INTEREST EXPENSE: (dollars in thousands)
Salaries and benefits ....... $ 17,118 $ 18,124 $ 11,235
Occupancy ................... 1,937 1,787 1,523
Furniture and equipment ..... 1,384 1,252 1,007
Outside services ............ 2,055 2,598 773
Office expenses ............. 985 989 834
Marketing ................... 1,772 1,991 1,453
Other ....................... 833 1,542 875
---------- ---------- ----------
Total non-interest expense .. $ 26,084 $ 28,283 $ 17,700
========== ========== ==========
SELECTED DATA AT YEAR END
Total servicing portfolio ... $1,264,640 $1,076,092 $ 779,055
========== ========== ==========
Number of loans serviced .... 3,314 2,859 2,050
========== ========== ==========
Number of total personnel ... 222 190 182
========== ========== ==========
Number of lenders ........... 95 79 69
========== ========== ==========
Non-interest expense decreased $2.2 million or 8% in 2000 from 1999 primarily
attributable to a $1.0 million or 6% decrease in salaries and benefits. The
decrease reflects the payment of certain special bonuses in 1999. In connection
with the re-negotiation of the employment agreement between the Company and its
Chief Executive Officer and in consideration of his overall contributions, the
Company paid him a $1.7 million bonus in March 1999. This bonus was used by the
Chief Executive Officer to retire the $980,000 note receivable held by the
Company and to pay the income taxes associated with the bonus. In conjunction
with the completion of the sale of the Company's last retail branch and
deposits, seven members of senior management received cash bonuses totaling
$940,000 in the aggregate in March 1999.
The Company increased its year end workforce to 222 or 17% above the December
31, 1999 staffing level. The increases were primarily in the representative
offices and Hartford lending force as well as in the Loan Servicing business
unit.
Marketing expense decreased $219,000 or 11% in 2000 primarily reflecting reduced
expenses compared to the prior year which included $183,000 associated with
advertising related to a retail certificate of deposit solicitation in early
1999 and a loan origination campaign in September 1999. The $543,000 decrease in
outside services in 2000 reflects the reduction in legal fees associated with
various regulatory matters.
Other expenses decreased $709,000 in 2000 as there was no comparable expenses to
the $340,000 expense incurred in March 1999 for the loss of a government
guarantee on a single
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SBA loan managed for investors and certain expenses associated with operating
the branch sold in the first quarter of 1999.
Non-interest expenses increased $10.6 million or 60% in 1999 from 1998 primarily
attributable to a $6.9 million or 61% increase in salaries and benefits.
Approximately $2.68 million of this increase is attributable to the March 1999
bonuses paid to the Chief Executive Officer and other members of senior
management as discussed above. The remainder of the increase in expenses is due
to an average 6-7% increase in salaries effective January 1999 and headcount
increases of 13 people bringing the 1999 year-end total to 190 from 182 as of
the end of the previous year, net of five branch personnel who were hired by the
bank which purchased the branch. The staffing increases were primarily in the
international lending areas, but also in the support areas of loan servicing,
credit, capital markets, and finance due to the added complexity associated with
the Company's business model.
Marketing expense increased $538,000 or 37% in 1999 primarily reflecting
increased expenses associated with the marketing and referral activities of the
Company's International Master Agents, as well as $183,000 associated with
advertising related to a retail certificate of deposit solicitation in early
1999 and a loan origination campaign in September of 1999. Domestic and
international travel expenses also increased $133,000, reflecting the Company's
continued geographic expansion. The $1.8 million increase in outside services in
1999 reflects the increase in legal fees associated with various regulatory
matters, establishment of agent relationships and/or representative office
status in several of the Company's international markets, the Company's name
change and conversion from a national bank to a Connecticut bank, required legal
diligence in conjunction with this conversion, and the establishment of
strategic alliance agreements for barter financing, energy financing and
investments.
Other expenses increased $667,000 in 1999, primarily made up of a $340,000
expense incurred in March 1999 for the loss of a government guarantee on a
single SBA loan managed for investors.
The Company's efficiency ratios, calculated as the ratio of non-interest
expenses to the sum of net interest income and non-interest income, were 65%,
67% and 55% for the years ended December 31, 2000, 1999 and 1998, respectively.
Income Taxes. The effective income tax rates, including the impact of
unconsolidated subsidiaries and the cumulative effect adjustment of the
Company's adoption of EITF 99-20, for the years ended December 31, 2000, 1999
and 1998 were 37.5%, 45.0% and 38.9%, respectively. The unusually high 1999
effective income tax rate reflects the non-deductibility of the portion of the
Chief Executive Officer's compensation over $1 million.
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The following table sets forth the components of the Company's net interest
income and yield on average interest earning assets and rate on interest bearing
liabilities.
FOR THE YEARS ENDED
--------------------------------------------------------------------------------------
DECEMBER 31, 2000 DECEMBER 31, 1999 DECEMBER 31, 1998
---------------------------- --------------------------- ---------------------------
INTEREST AVERAGE INTEREST AVERAGE INTEREST AVERAGE
AVERAGE EARNED/ YIELD/ AVERAGE EARNED/ YIELD/ AVERAGE EARNED/ YIELD/
BALANCE PAID RATE BALANCE PAID RATE BALANCE PAID RATE
-------- --------- ------- -------- -------- ------- -------- -------- -------
(DOLLARS IN THOUSANDS)
ASSETS
Loans (1)
Commercial ........................ $172,766 $ 17,730 10.26% $159,911 $13,704 8.57% $162,776 $ 15,016 9.22%
Residential ....................... 1,721 163 9.47% 2,257 171 7.58% 4,847 392 8.09%
Other consumer .................... 535 54 10.09% 652 58 8.90% 1,247 114 9.15%
-------- --------- ------- -------- ------- ------- -------- -------- -------
Total loans .......................... 175,022 17,947 10.25% 162,820 13,933 8.56% 168,870 15,522 9.19%
Investment securities (2) ............ 57,224 4,742 8.29% 47,118 2,953 6.27% 19,792 1,258 6.36%
Federal funds sold ................... 25,726 1,614 6.27% 30,388 1,486 4.89% 26,310 1,412 5.37%
-------- --------- ------- -------- ------- ------- -------- -------- -------
Total investment securities and
federal funds sold ................ 82,950 6,356 7.66% 77,506 4,439 5.73% 46,102 2,670 5.79%
-------- --------- ------- -------- ------- ------- -------- -------- -------
Total earning assets ................. 257,972 24,303 9.42% 240,326 18,372 7.64% 214,972 18,192 8.46%
Total non-earning assets ............. 64,475 36,229 21,019
-------- -------- --------
Total assets .............................. $322,447 $276,555 $235,991
======== ======== ========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits
Interest bearing demand deposits .. $ 2,988 $ 32 1.07% $ 3,807 $ 86 2.26% $ 8,964 $ 212 2.37%
Premier money market .............. 0 0 -- 24,989 1,203 4.81% 92,591 4,928 5.32%
Other savings ..................... 0 0 -- 2,565 98 3.82% 9,889 295 2.98%
Retail certificates of deposit .... 23,320 1,330 5.70% 32,762 1,624 4.96% 19,728 1,141 5.78%
Brokered certificates of deposit .. 215,676 14,118 6.55% 133,552 7,325 5.48% 14,456 793 5.49%
IRA certificates of deposit ....... 4,309 237 5.50% 6,623 403 6.08% 9,310 527 5.66%
-------- --------- ------- -------- ------- ------- -------- -------- -------
Total deposits ....................... 246,293 15,717 6.38% 204,298 10,739 5.26% 154,938 7,896 5.10%
Other borrowings ..................... 695 321 46.19% 3,602 842 23.38% 605 28 4.63%
-------- --------- ------- -------- ------- ------- -------- -------- -------
Total interest bearing liabilities ... 246,988 16,038 6.49% 207,900 11,581 5.57% 155,543 7,924 5.09%
-------- --------- ------- -------- ------- ------- -------- -------- -------
Non-interest bearing liabilities:
Demand deposits ...................... 11,377 13,069 34,136
Other liabilities .................... 6,049 3,836 2,042
-------- -------- --------
Total non interest bearing liabilities 17,426 16,905 36,178
Stockholders' equity ................. 58,033 51,750 44,270
-------- -------- --------
Total liabilities and stockholders' equity $322,447 $276,555 $235,991
======== ======== ========
Net interest income/net interest spread ... $ 8,265 2.93% $ 6,791 2.07% $ 10,268 3.37%
========= ======= ======= ======= ======== =======
Net interest margin ....................... 3.20% 2.83% 4.78%
======= ======= =======
Average interest earning assets/average
interest bearing liabilities ......... 104.45% 115.60% 138.21%
======= ======= =======
(1) For purposes of these computations, non-accruing loans are included in
the average balance.
(2) The yield does not give effect to changes in fair value that are
reflected as a component of stockholders' equity or the impairment
recognized on retained interests.
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The following rate/volume analysis shows the portions of the net change in
interest income due to changes in volume or rate. The changes in net interest
income due to both volume and rate have been allocated proportionally to changes
due to volume and changes due to rate.
YEAR ENDED DECEMBER 31, YEAR ENDED DECEMBER 31,
2000 COMPARED TO 1999 1999 COMPARED TO 1998
CHANGES DUE TO: CHANGES DUE TO:
------------------------------- -------------------------------
VOLUME RATE TOTAL VOLUME RATE TOTAL
------- ------- ------- ------- ------- -------
(DOLLARS IN THOUSANDS)
ASSETS:
Loans:
Commercial .................................... $ 1,165 $ 2,861 $ 4,026 $ (260) $(1,052) $(1,312)
Residential ................................... (46) 38 (8) (197) (24) (221)
Other consumer ................................ (11) 7 (4) (53) (3) (56)
------- ------- ------- ------- ------- -------
Total loans ................................ 1,108 2,906 4,014 (510) (1,079) (1,589)
------- ------- ------- ------- ------- -------
Investment securities ............................ 714 1,075 1,789 1,713 (18) 1,695
Federal funds sold ............................... (251) 379 128 206 (132) 74
------- ------- ------- ------- ------- -------
Total investments and funds sold ........... 463 1,454 1,917 1,919 (150) 1,769
------- ------- ------- ------- ------- -------
Total earning assets ....................... 1,571 4,360 5,931 1,409 (1,229) 180
------- ------- ------- ------- ------- -------
LIABILITIES:
Deposits:
Interest-bearing demand deposits .............. $ (16) $ (38) $ (54) $ (116) $ (10) $ (126)
Premier money market savings .................. (1,203) 0 (1,203) (3,254) (471) (3,725)
Other savings ................................. (98) 0 (98) (280) 83 (197)
Retail certificates of deposit ................ (515) 221 (294) 665 (182) 483
Brokered certificates of deposit .............. 5,167 1,626 6,793 6,532 0 6,532
IRA certificates of deposit ................... (130) (36) (166) (161) 37 (124)
------- ------- ------- ------- ------- -------
Total deposits ............................. 3,205 1,773 4,978 3,386 (543) 2,843
Other borrowings ................................. (980) 459 (521) 449 365 814
------- ------- ------- ------- ------- -------
Total interest-bearing liabilities ......... 2,225 2,232 4,457 3,835 (178) 3,657
------- ------- ------- ------- ------- -------
Change in net interest income .............. $ (654) $ 2,128 $ 1,474 $(2,426) $(1,051) $(3,477)
======= ======= ======= ======= ======= =======
FINANCIAL CONDITION
General. Total assets increased $34.2 million or 10% to $362.2 million at
December 31, 2000 from $328.0 million at December 31, 1999 which had increased
$54.3 million or 20% from the December 31, 1998 balance of $273.7 million. These
increases reflect increases in the receivables from loans sold, servicing assets
and other retained interests following the securitization or sale of loans
originated. In 2000 the Company originated loans totaling $509.7 million and
completed sales and securitizations of loans totaling $530.0 million. In 1999
loans originated and loans sold or securitized totaled $550.9 million and $426.0
million, respectively. The growth in the balance sheet has generally been funded
by increases in deposits and retained earnings.
Cash and Cash Equivalents. Cash and cash equivalents decreased by $7.8 million
or 21% to $29.4 million at December 31, 2000, reflecting the use of cash to fund
loan originations. The cash balances decreased to $37.1 million at December 31,
1999.
Investment Securities. The investment securities portfolio increased to $59.2
million at December 31, 2000 from $44.0 million at December 31, 1999 which was
an increase of $15.2
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million or 34%. As a result of the Company's securitizations, the portfolio at
December 31, 2000 includes $7.8 million of rated and unrated junior bonds and
$32.7 million of interest-only strips, with comparable amounts for 1999 of $8.9
million and $21.9 million, respectively. Refer to Note 3 of the Company's
consolidated financial statements for additional information.
Securities classified as available for sale (carried at fair value) and as held
to maturity (carried at amortized cost) are as follows:
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
-------- -------- -------- --------
DECEMBER 31, 2000 (dollars in thousands)
- ------------------------------------------
AVAILABLE FOR SALE
U.S. Treasury and agency obligations ..... $ 13,361 $ 21 $ (11) $ 13,371
State and municipal obligations .......... 682 -- (10) 672
Mutual funds ............................. 41 -- -- 41
Bank certificates of deposit ............. 2,000 -- -- 2,000
Commercial loan-backed securities ........ 7,483 541 (201) 7,823
Retained interests ....................... 33,250 130 (676) 32,704
-------- -------- -------- --------
$ 56,817 $ 692 $ (898) $ 56,611
======== ======== ======== ========
HELD TO MATURITY
U.S. government mortgage-backed securities $ 156 $ 4 $ -- $ 160
Debt securities of foreign governments ... 625 -- -- 625
-------- -------- -------- --------
$ 781 $ 4 $ -- $ 785
======== ======== ======== ========
DECEMBER 31, 1999
- ------------------------------------------
AVAILABLE FOR SALE
U.S. Treasury obligations ................ $ 10,453 $ -- $ (79) $ 10,374
State and municipal obligations .......... 237 -- (25) 212
Mutual funds ............................. 29 -- -- 29
Commercial loan-backed securities ........ 8,515 737 (371) 8,881
Retained interests ....................... 21,588 -- (72) 21,516
-------- -------- -------- --------
$ 40,822 $ 737 $ (547) $ 41,012
======== ======== ======== ========
HELD TO MATURITY
U.S. government mortgage-backed securities $ 540 $ -- $ (4) $ 536
Debt securities of foreign governments ... 625 -- -- 625
-------- -------- -------- --------
$ 1,165 $ -- $ (4) $ 1,161
======== ======== ======== ========
DECEMBER 31, 1998
- ------------------------------------------
AVAILABLE FOR SALE
U.S. Treasury obligations ................ $ 11,579 $ 15 $ (1) $ 11,593
State and municipal obligations .......... 88 3 -- 91
Mutual funds ............................. 19 -- -- 19
Commercial loan-backed securities ........ 14,930 696 -- 15,626
Retained interests ....................... 4,127 -- -- 4,127
-------- -------- -------- --------
$ 30,743 $ 714 $ (1) $ 31,456
======== ======== ======== ========
HELD TO MATURITY
U.S. government mortgage-backed securities $ 1,361 $ 4 $ (1) $ 1,364
Debt securities of foreign governments ... 625 -- -- 625
-------- -------- -------- --------
$ 1,986 $ 4 $ (1) $ 1,989
======== ======== ======== ========
Investment in Unconsolidated Subsidiaries. The investment in unconsolidated
subsidiaries has increased $4.5 million to $19.8 million at December 31, 2000
from the December 31, 1999 balance of $15.3 million due to increased levels of
sales activity to these entities. The Company
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completed its first sales to these facilities in December 1998 and the balance
at December 31, 1998 totaled $3.3 million. See Note 4 of the Company's
consolidated financial statements for additional information.
Loans. Loans of $142.2 million at December 31, 2000 were comparable to the
$141.4 million at December 31, 1999. The balance as of December 31, 1999
reflected an increase of $23.9 million or 20% from $117.5 million at December
31, 1998. The size of the loan portfolios is affected by the timing of loan
sales and securitizations.
December 31,
---------------------------------------------------------------------------------
2000 1999 1998 1997 1996
--------- --------- --------- --------- ---------
(dollars in thousands)
PORTFOLIO LOANS
- -----------------------------------------
Other commercial ........................ $ 59,845 $ 27,205 $ 55,000 $ 67,235 $ 55,948
Commercial real estate .................. 3,581 35,998 31,650 55,192 39,095
Ex-Im Bank .............................. 9,943 15,558 4,859 4,581 5,486
Privately insured term and import ....... 20,635 23,537 18,891 20 --
Residential real estate ................. 1,720 1,827 3,013 6,515 12,843
Consumer loans and lines of credit ...... 413 629 533 1,855 1,254
--------- --------- --------- --------- ---------
Total portfolio loans .......... $ 96,137 $ 104,754 $ 113,946 $ 135,398 $ 114,626
--------- --------- --------- --------- ---------
LOANS HELD FOR SALE
- -----------------------------------------
Other commercial ........................ $ 46,525 $ 37,813 $ 6,526 $ 6,901 $ --
Commercial real estate .................. 8,421 6,068 2,051 2,169 --
Privately insured term and import ....... 134 393 -- -- --
Consumer loans and lines of credit ...... 299 312 -- -- --
--------- --------- --------- --------- ---------
Total held for sale loans ......... $ 55,379 $ 44,586 $ 8,577 $ 9,070 $ --
--------- --------- --------- --------- ---------
Less: Allowance for loan losses ......... $ 5,550 $ 4,550 $ 4,000 $ 3,100 $ 3,000
Discount on retained loans ........ 3,897 3,371 1,419 1,782 2,241
Net deferred loan origination costs (156) (16) (431) (109) (67)
--------- --------- --------- --------- ---------
Loans, net ........................ $ 142,225 $ 141,435 $ 117,535 $ 139,695 $ 109,452
========= ========= ========= ========= =========
Loan Sales and Securitizations. Gains from loan sales, securitizations and
servicing income represented a majority of the Company's revenues. See
Accounting for Loan Sales above for a discussion of the relevant accounting
principles governing loan sales and securitizations and the Company's servicing
activities.
During 2000 the Company completed three commercial loan securitization
transactions involving the issuance of $130.0 million of senior and subordinated
securities, and a total of $76.3 million in sales to commercial paper conduit
facilities.
In connection with the "SBA Loan Backed Series 2000-1" completed in March 2000,
a $32.3 million Class A certificate rated AAA by Duff and Phelps Credit Rating
Co. and Aaa by Moody's Investor Services, Inc. and a $2.8 million Class M
certificate rated A2 by Duff and Phelps Credit Rating Co. and A by Moody's
Investor Services, Inc. were sold in a private
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placement. A $725,000 Class B unrated certificate is retained by the Company as
required under SBA regulations.
Related to the "Business Loan Trust 2000-A" backed by commercial term loans and
completed in June 2000, a $56.6 million senior note rated AAA by Duff and Phelps
Credit Rating Co. and Aaa by Moody's Investor Services, Inc. as well as a $2.6
million note rated A2 and A, a $2.6 million note rated BBB and Baa2 and a $3.2
million note rated BB and Ba2 were sold in a private placement.
In connection with the "SBA Loan Backed Series 2000-2" completed in November
2000, a $27 million Class A certificate rated AAA by Duff and Phelps Credit
Rating Co. and Aaa by Moody's Investor Services, Inc. and a $2.3 million Class M
certificate rated A2 by Duff and Phelps Credit Rating Co. and A by Moody's
Investor Services, Inc. were sold in a private placement. A $660,000 Class B
unrated security is retained by the Company as required under SBA regulations.
In connection with the "SBA Loan Backed Series 1999-1", completed in June 1999,
a $33.7 million Class A certificate rated Aaa by Moody's Investor Services, Inc.
was sold in a private placement. A $3.0 million Class B certificate rated A2 by
Moody's Investor Services, Inc. initially held by the Company, was sold later in
1999 for a gain of $265,000. A $750,000 Class B unrated security is held by the
Company.
Related to "Business Loan Trust 1999-A" backed by commercial term loans and
completed in September 1999, a $56.6 million senior note rated AAA by Duff and
Phelps Credit Rating Co. and Aaa by Moody's Investor Services, Inc. as well as a
$2.6 million A2 rated note and a $2.6 million BBB rated note were sold in a
private placement. A $3.2 million unrated note is held by the Company from this
securitization.
Allowance for Loan Losses. The Company reviews the adequacy of the allowance for
loan losses quarterly. The allowance totaled $5.55 million at December 31, 2000,
an increase of $1.0 million or 22% from the $4.55 million balance at December
31, 1999, which was increased $550,000 from the $4.0 million balance at December
31, 1998.
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ACTIVITY IN THE ALLOWANCE FOR LOAN LOSSES
For the Years Ended December 31,
----------------------------------------------------------------------------
2000 1999 1998 1997 1996
-------- -------- -------- -------- --------
(dollars in thousands)
Balance of allowance for loan losses
at the beginning of the period .. $ 4,550 $ 4,000 $ 3,100 $ 3,000 $ 2,000
Charge-offs:
SBA ............................. 253 166 775 262 478
USDA ............................ 415 126 -- 68 --
Ex-Im working capital ........... 202 260 -- -- --
Privately insured term and import 1,366 793 83 46 27
Investor mortgage ............... -- 3 582 1,395 1,730
Other commercial ................ 604 1,199 876 279 168
Residential and other consumer .. -- 2 8 195 124
-------- -------- -------- -------- --------
Total charge-offs ............. 2,840 2,549 2,324 2,245 2,527
Recoveries:
SBA ............................. 1 3 -- 13 --
Other commercial ................ 244 75 30 77 26
Investor mortgage ............... -- 2 123 6 14
Residential and other consumer .. -- -- -- 10 --
-------- -------- -------- -------- --------
Total recoveries .............. 245 80 153 106 40
-------- -------- -------- -------- --------
Net charge-offs ...................... 2,595 2,469 2,171 2,139 2,487
Provision for loan losses ............ 3,595 3,019 3,071 2,239 3,487
-------- -------- -------- -------- --------
Balance of allowance for loan
losses at end of period ......... $ 5,550 $ 4,550 $ 4,000 $ 3,100 $ 3,000
======== ======== ======== ======== ========
Total loans .......................... $151,516 $149,340 $122,523 $135,398 $114,627
======== ======== ======== ======== ========
Allowance to total loans ............. 3.7% 3.0% 3.3% 2.3% 2.6%
======== ======== ======== ======== ========
Included in charge-offs are losses on the unguaranteed portions of SBA, USDA and
Ex-Im Bank loans which represent losses realized on the retained loans after
deduction of the Company's share of proceeds from collection and liquidation of
collateral.
The privately insured term and inventory loan charge-offs are substantially
attributable to the privately insured inventory buyer loans made under three
separate fiscal year insurance policies, each covering loans originated during a
specific policy year. Individual loans, and any related losses are attributable
to a specific policy, each of which carries a separate deductible. The Company's
cumulative loss through December 31, 2000 divided by total loans originated and
covered under the annual policies totaled 303 and 177 basis points for the 1998
and 1999 policies, respectively. The majority of such losses are from the policy
deductibles. The policies also provide for a 10% co-payment. At December 31,
2000, the remaining balance of privately insured inventory buyer loans totaled
$6.4 million under the 1998 and 1999 policies. Since the deductibles under these
policies have been met, the Company is at risk only for the 10% co-payment,
which is borne on a pari-passu basis with the insurer. Effective with the 2000
policy the Company takes security interest in the underlying inventory.
Outstandings under the 2000
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policy total $1.1 million at December 31, 2000. See Note 5 to the Company's
consolidated financial statements.
The privately insured term and import loan charge-offs for the year ended
December 31, 1999 include charge-offs of $264,000 associated with import loans
that did not carry private insurance. Shortly after introducing the import loan
product, which are loans to U. S. importers, the Company obtained a credit
insurance policy for this line of business.
The Company monitors the performance of the portfolios by use of Static Loss
Pool Analysis. For purposes of this analysis, seasoned portfolios are defined as
having been originated at least 8 quarters prior to the analysis. Using a
30-quarter time period, the SBA portfolio has generated an average annual loss
of 48 basis points. During the same time period, the commercial loan portfolios
have generated average annual losses ranging from 41-57 basis points. No losses
have been realized on the Company's owner-occupied commercial mortgage
portfolio.
Investor mortgage lending, which was comprised of multi-family urban residential
loans on properties located in various Connecticut inner cities, is no longer
conducted.
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54
The following table sets forth the breakdown of the allowance for loan losses by
loan category at the dates indicated. Management believes that the allowance can
be allocated by category only on an approximate basis, and therefore allocation
of the allowance to each category is not necessarily indicative of future losses
and does not restrict use of the allowance to absorb losses in any category. The
unallocated portion of the allowance represents an amount that is not
specifically allocated to one of the loan portfolios.
DECEMBER 31,
------------------------------------------------------------------
2000 1999 1998 1997 1996
------ ------ ------ ------ ------
ALLOCATION OF THE ALLOWANCE BY CATEGORY OF LOANS (dollars in thousands)
Unguaranteed portions of:
SBA and USDA loans ........................... $ 559 $ 820 $1,050 $ 853 $ 491
Ex-Im Bank working capital loans ............. 170 202 245 145 44
Privately insured term and import loans ........ 495 763 483 -- --
Commercial mortgage loans ...................... 125 139 128 250 271
Other commercial loans ......................... 3,431 1,759 1,367 1,052 475
Investor mortgage loans ........................ 20 26 63 269 1,061
Residential and other consumer loans ........... 13 35 43 67 113
Loans held for sale ............................ 277 223 43 -- --
Unallocated .................................... 460 583 578 464 545
------ ------ ------ ------ ------
Total allowance for loan losses .............. $5,550 $4,550 $4,000 $3,100 $3,000
====== ====== ====== ====== ======
PERCENT OF LOANS IN EACH CATEGORY TO TOTAL LOANS
Unguaranteed portions of:
SBA and USDA loans ........................... 10.4% 11.0% 30.0% 26.9% 30.5%
Ex-Im Bank working capital loans ............. 5.5 5.9 3.9 2.8 3.0
Privately insured term and import loans ........ 14.7 20.1 15.4 -- --
Ex-Im Bank medium term loans ................... -- 0.1 -- 0.5 1.8
Commercial mortgage loans ...................... 1.6 5.4 8.5 14.7 16.4
Other commercial loans ......................... 29.2 25.1 29.7 44.8 29.4
Investor mortgage loans ........................ 0.7 0.9 2.6 4.1 6.6
Residential and other consumer loans ........... 1.4 29.9 2.9 6.2 12.3
Loans held for sale ............................ 36.5 1.6 7.0 -- --
------ ------ ------ ------ ------
Total ........................................ 100% 100% 100% 100% 100%
====== ====== ====== ====== ======
The increased allocation of the allowance for other commercial loans reflects
management's estimate of the effects of the softening economy and other trends
on its line of credit portfolio. Such loans are revolving lines generally
secured by accounts receivable, inventory and junior liens on other assets.
Management is seeking to reduce the exposure in this portfolio by working with
borrowers to structure amortizing loans or otherwise reduce the balance.
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The following table sets forth information regarding the Company's
non-performing loans at the dates indicated:
December 31,
------------------------------------------------------------------
2000 1999 1998 1997 1996
------ ------ ------ ------ ------
(dollars in thousands)
Non-Performing Loans
Commercial:
Unguaranteed portions:
SBA and USDA loans ........................ $1,257 $1,264 $1,533 $1,226 $ 188
Ex-Im Bank working capital loans .......... -- 397 418 -- --
Privately insured term and import loans....... 1,112 1,759 112 -- --
Commercial mortgage loans .................... -- 49 6 39 --
Other commercial loans ....................... 1,793 1,358 890 535 132
Investor mortgage loans ...................... -- -- -- 415 1,853
Consumer .......................................... -- 131 145 149 79
------ ------ ------ ------ ------
Total non-performing loans ........................ $4,162 $4,958 $3,104 $2,364 $2,252
====== ====== ====== ====== ======
Total non-performing loans to total loans ......... 2.7% 3.3% 2.5% 1.8% 2.0%
====== ====== ====== ====== ======
Total non-performing loans to total assets ........ 1.1% 1.5% 1.1% 1.1% 1.4%
====== ====== ====== ====== ======
Allowance to total non-performing loans ........... 133% 92% 129% 131% 133%
====== ====== ====== ====== ======
The Company manages the non-performing assets actively, including a quarterly
review of the net realizable value of collateral securing these loans. Any
deterioration in the relationship between the loan amount and the net realizable
value of the collateral will be considered in the evaluation of the allocation
of the allowance attributed to the subject loan and/or a partial charge-off.
The Company had one loan past due 90 days and accruing interest at the end of
1999 but not for any other period end presented in the above table.
Other Real Estate Owned. It is the Company's policy, whenever possible, not to
take title to real property collateralizing loans, thereby avoiding management
time and any environmental liabilities associated with holding such properties.
From the year end 1998 to 2000 reporting periods discussed herein, the highest
balance of other real estate owned totaled $265,000 and there were no such
balances outstanding at any year end.
Receivable From Loans Sold. Receivable from loans sold represents the balance of
loans sold for which funding has not yet been received. Government guaranteed
loans are generally sold within 30 days of origination, usually at a time when a
group of loans are aggregated to attract interested bidders. The sales are
generally settled within 30 days of the trade date. During this thirty day
period, the Company reviews and delivers closing documents to the investor. The
receivable balance fluctuates with the month's loan sale activity and tends to
be higher at any
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quarter end due to increased loan closing activity. The Company actively
monitors the settlement of loans to ensure that this source of liquidity is
effectively managed.
Servicing Assets. (See "Accounting for Loan Sales" and "Non Interest Income").
The servicing asset for loans sold is as follows:
AT DECEMBER 31,
-------------------------------------
2000 1999 1998
------- ------- -------
SERVICING ASSET (dollars in thousands)
SBA .................................. $18,978 $13,408 $ 7,836
USDA ................................. 10,643 6,835 2,271
Ex-Im short and medium term .......... 3,708 2,858 2,749
Commercial loan securitizations ...... 855 419 378
Commercial paper sales facilities..... 1,705 1,240 407
Other commercial ..................... 73 63 82
------- ------- -------
Total servicing asset ............ $35,962 $24,823 $13,723
======= ======= =======
Prepaid Expenses and Other Assets. At December 31, 2000 prepaid expenses and
other assets include $1.6 million of accrued servicing fees; $3.4 million from
interest and costs advanced on behalf of investors, guarantee agencies and other
loan-related items; and $6.2 million relating to a receivable for insurance
claims relating to the privately-insured loan product.
Deposits. Deposits have historically been the Company's primary funding source
and have increased to sustain the Company's balance sheet growth. See "Liquidity
and Capital Resources."
Federal Home Loan Bank of Boston Advances. Periodically, the Company utilizes
Federal Home Loan Bank ("FHLB") advances to provide short-term liquidity. As of
December 31, 2000, the Bank had a $10.2 million unused line of credit from the
FHLB.
Commercial Paper Credit Facility Availability. As detailed in Note 9 to the
Company's consolidated financial statements, the Company has approved commercial
paper credit facilities totaling $155 million of which $82 million was utilized
as of December 31, 2000 by the unconsolidated subsidiaries. Subsequent to
year-end, the Company obtained its lender's approval for a $25 million increase
to one of these facilities.
Stockholders' Equity. Stockholders' equity increased $4.6 million to $59.6
million at December 31, 2000 from $55.0 million at December 31, 1999 and
increased $5.9 million in 1999 from $49.1 million at December 31, 1998 primarily
due to the retention of earnings. The Company has paid quarterly dividends of
$.03 per share since the fourth quarter of 1995. As explained in Note 10 to the
Company's consolidated financial statements, a note receivable from the
Company's Chief Executive Officer was repaid in 1999 with proceeds from a bonus
award by the Company, as part of an amended employment contract. At December 31,
2000, the Company held a note receivable from the Company's Chief Executive
Officer related to the sale of 200,000 shares of common stock in March 1999,
which is reflected as a separate component of stockholders' equity. On January
24, 2001, the Company repurchased 241,600 shares from
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57
the Chief Executive Officer and his wife and applied the proceeds to the full
repayment of the note and the interest accrued thereon (see Note 10 to the
Company's consolidated financial statements).
LIQUIDITY AND CAPITAL RESOURCES
Management considers scheduled cash flows from existing borrowers, projected
deposit levels, estimated liquidity needs from maturing and disintermediating
deposits, approved extensions of credit, and unadvanced commitments to existing
borrowers in determining the level and maturity of funding necessary to support
operations. Historically, the Company has increased the level of deposits to
support its planned loan growth. The Company also has supported its growth by
regularly selling loans on a servicing retained basis.
Over the past three years, the Company completed transactions that effected
changes in the manner in which the Company obtains funding for its lending
business. These transactions included:
- - the sale of the Company's last branch in March 1999, including
checking, savings and money market accounts which requires the Company
to obtain funding from alternative sources;
- - establishment of a commercial paper conduit facility pursuant to which
up to $60 million is available to the Company (based upon the
contractual advance rates against the qualifying principal balance of
the loans pledged to secure the facility; the pledged loans consist of
the unguaranteed portion of loans guaranteed by the SBA). The Company
sold loans totaling approximately $9.3 million during 2000 under this
facility;
- - establishment of and the increase in a second commercial paper conduit
facility from $65 million to $95 million and, in January 2001, to $120
million pursuant to which the Company has the right to sell commercial
revolving lines of credit and other qualifying loans during the term of
the facility. The Company sold loans totaling approximately $67 million
during 2000 under this facility;
- - loan securitization and sales transactions pursuant to which the
Company securitized and sold in the aggregate approximately $322
million of asset-backed loans; (See "Securitization and Sale of Loans")
and
- - establishment of agreements with five national brokers which provide a
source for brokered certificates of deposits used for fundings of one
year or less.
The Company does not plan to continue to securitize loans or sell loans to its
existing commercial paper conduit facilities in 2001 due to proposed bank
regulations that would significantly increase the Bank's capital requirements,
as more fully described below. Approximately 33% of the Company's annual loan
originations were funded from these sources
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in 2000 and approximately 21% of the Company's operating income came from these
transactions.
The Company is currently finalizing companion facilities under its approved
commercial paper conduit credit lines and expects to continue to transfer loans
to such conduits, but expects that these transfers will be reflected as
financings on the Company's balance sheet.
Since January 1, 2000 the Company has de-emphasized non-government guaranteed
commercial lending and has successfully increased the percentage of government
guaranteed lending by nearly 11%. In 2001, the Company will seek to continue to
increase the use of the SBA, USDA and Ex-Im Bank government guaranteed loan
programs which offer an established "whole loan" secondary market. The Company
will also continue to increase the origination and sales of commercial mortgages
and term loans under other established whole loan purchase programs.
Management of the Company believes that the funding provided by the access to
such capital markets and commercial paper conduits, will also be sufficient when
combined with the amounts available to the Company from issuance of brokered and
retail certificates of deposit and other sources of revenues, for the Company's
current liquidity requirements.
The Bank is subject to various regulatory capital requirements administered by
federal banking agencies. Failure to meet minimum capital requirements can
result in certain mandatory and discretionary actions by regulators that, if
undertaken, could have a direct material effect on the Company's financial
condition. The regulations require that the Bank meet specific capital adequacy
guidelines as calculated under regulatory accounting practices. The Bank's
capital classification is also subject to qualitative judgments by the
regulators about interest rate risk, concentration of credit risk, asset quality
and other factors.
Quantitative measures established by regulations to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios of Tier I capital to
total average assets, and minimum ratios of Tier I and total capital to risk
weighted assets. As of December 31, 2000, the Bank's capital ratios are in
excess of regulatory minimum requirements. See Note 10 to the consolidated
financial statements for a table of minimum required and actual capital ratios.
Federal bank regulatory authorities proposed regulatory amendments to the risk
based capital rules in September 2000 which would require FDIC-insured banks to
hold additional capital for "retained interests" that are associated with loans
sold or securitized. The regulations, if passed in their current or a
substantially similar form, would likely require the Bank to (i) significantly
reduce the level of such retained interests relative to capital by selling these
assets or raising a significant amount of additional capital to support the
Bank's lending activities, and (ii) structure certain future loan sales or
securitization transactions in a manner which may be less economically favorable
to the Bank, or refrain completely from loan securitizations.
The comment period on these regulations closed December 26, 2000. These
regulations would not apply to the Bank or the Company following the proposed
merger with UPS since the Bank will not have FDIC-insured deposits.
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59
It is possible that, due to the high level of securitization - related retained
interests or other factors, the FDIC would no longer classify the Bank as "well
capitalized." Such an action would require the Bank to request approval from the
FDIC to continue to access the brokered CD market unless, and until, well
capitalized status is again achieved.
In addition, SBA regulations require that in order to fund the unguaranteed
portions of SBA loans under the Company's commercial paper facility, the Bank
must be well capitalized and must maintain a minimum currency rate (i.e. loans
paying in accordance with their terms). If the Bank is not able to meet these
requirements, or if the Bank were to receive a regulatory enforcement action
from the FDIC, funding under the commercial paper facilities may not be
available for these loans and alternative financing would have to be obtained.
Any of these actions may reduce future earnings. Further, if the Company or the
Bank were not able to obtain additional capital on acceptable terms, its
business strategy may have to be altered.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK AND ASSET/LIABILITY
MANAGEMENT
Reliance on Capital Markets
In 2000, the Company securitized and sold to sale facilities $168 million of
loans which is 33% of the dollar volume of loans originated in 2000.
Approximately 36% of the Company's $21.6 million gain on loan sales in 2000 were
attributable to such securitizations and sales. In 1999, the Company securitized
and sold to sales facilities $201 million of loans or 36% of loans originated.
Gains from such transactions accounted for 33% of the $19.2 million gain on loan
sales for the year. 1998 volume of $117 million of loans securitized and sold to
sales facilities represented 29% of the $391.7 million of loans originated in
1998. In 1998, approximately 24% of the Company's $16.9 million gain on loan
sales were attributed to securitizations of commercial loans and the sale of
loans to a commercial paper conduit. The above noted volume reflects the
Company's increasing reliance on securitizations.
As discussed in "Liquidity and Capital Resources", the Company does not expect
to continue to account for future transfers of loans to the commercial paper
conduits as sales or to complete asset-backed private placements of the
unguaranteed portions of SBA loans and commercial loans. The Company will seek
to continue to sell the guaranteed portions of SBA, USDA, Ex-Im Bank loans and
to sell commercial loans on a "whole loan" or loan-by-loan basis. The Company
has striven to increase the relative percentage of government guaranteed loans
to total loan originations as reflected by the fact that such government
guaranteed loans represented approximately 62% of the total loans originated in
2000 up from 56% in 1999. The Company expects to continue to focus on government
guaranteed loan products which are generally sold shortly after origination on a
whole loan basis.
Although reliance on the capital markets for the sale of such loans presents the
Company with risks related to liquidity and earnings volatility, the Company
believes that its expertise and experience as a government guaranteed lender
provides it with the ability to manage such risks. The Company believes that its
overall strategy of blending whole loan sales of government guaranteed loans
with smaller balances of non-guaranteed commercial loans and its on-going
56
60
ability to fund loans through its commercial paper conduits provide adequate
alternatives. As far as other sources of funds, after the sale of the March 1999
branch discussed earlier, the Company has continued to receive funding from
retail and brokered certificates of deposit.
As discussed above, the Company does not plan to securitize any loans in the
near future. The Company will seek to fund the unguaranteed portions of SBA
loans through a companion commercial paper conduit financing vehicle under the
Company's existing $60 million credit facility for such loans. The documentation
on this additional facility is currently being finalized. The Company expects
that these transfers will be reflected as financings on the balance sheet. The
Company's ability to continue to fund the unguaranteed portion of SBA loans
requires approval of the SBA. The SBA's approval is dependent on maintenance of
certain minimum regulatory capital levels, and a minimum currency rate (i.e.
loans paying in accordance with terms). An inability of the Company to meet
these requirements would adversely affect funding available under the commercial
paper facilities and require the Company to seek alternative sources of funding.
Other factors will also affect the Company's ability to access commercial paper
facilities, including conditions in the securities markets generally, and in the
asset-backed securities market specifically, the credit quality of the Company's
loan portfolio, compliance of the Company's loans with the eligibility
requirements established in connection with the facilities, receipt of a
regulatory enforcement action, the Company's ability to adequately service its
loan portfolio, and the material downgrading or withdrawal of ratings given to
securities previously issued in the Company's securitizations.
In recent years, the capital markets have periodically experienced rapid and
extreme changes evidenced by a decline of investor demand for certain
asset-backed securities and a widening of the spreads between the interest rates
on treasury securities and interest rates on asset-backed securities. The
uncertainties were exacerbated in late 1999 with concerns over Year 2000 market
preparedness. The Company is currently dependent on a single financial
institution for its two commercial paper credit facilities and, therefore, bears
a significant risk that this lender may decide to exit this market due to
general market conditions, or changes in its own strategic initiatives, or may
impose unacceptable terms on the facilities offered to the Company, making
continued use of the facilities uneconomical.
Any substantial reduction in the accessibility of the commercial paper conduit
facilities or any adverse change in the terms of the facilities or in the
capital markets generally, could have an adverse effect on the Company's
financial condition or results of operations.
Interest Rate Risk
An earnings at risk model is one tool utilized by the Company to measure
interest rate risk. Such a model computes the estimated effect on net income
from changes in interest earned on assets and expenses paid on liabilities, as
well as the impact of off-balance sheet items in the event of a range of assumed
changes in market interest rates. This analysis estimates the risk of loss in
market risk sensitive instruments in the event of a sudden and sustained one
hundred to two hundred basis point increase or decrease in the market interest
rates. The Company's Board of Directors has adopted an interest rate risk policy
which is designed to limit the maximum
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61
decreases in net income and capital in the event of a sudden and sustained
change in market interest rates. The estimated change in the Company's net
income based on the fourth quarter calculation of a hypothetical immediate 2%
increase in interest rates was a decrease of 6%, while the estimated change in
net income of a 2% decrease in interest rates was a decrease of 4%. Such amounts
were within the limits established by the Board of Directors.
Such an earnings at risk calculation is based on the estimated change in
interest income and interest expense utilizing numerous assumptions, including
historical relationships between various indices utilized by the Company in
setting interest rates and management's judgment as to the expected relationship
of such rates in the current environment. This calculation utilizes such
relative levels of market interest rates as well as assumptions regarding loan
prepayments and deposit decays and should not be relied upon as indicative of
actual results. Importantly, the computations do not contemplate any actions the
Company could undertake in response to changes in interest rates.
Certain shortcomings are inherent in the method of analysis presented in the
computation of earnings at risk. Actual results may differ from those presented
should market conditions vary from assumptions used in the calculation. In the
event of a change in interest rates, prepayment and early withdrawal levels
could deviate significantly from those assumed in the earnings at risk
calculation. Finally, the ability of many borrowers to repay their adjustable
rate loans and the value of the underlying collateral may decrease in the event
of interest rate decreases.
The Company seeks to manage its assets and liabilities to reduce the potential
adverse impact on net interest income that might result from changes in interest
rates. Control of interest rate risk is conducted through systematic monitoring
of maturity mismatches. The Company's investment decision-making takes into
account not only the rates of return and their underlying degree of risk, but
also liquidity requirements, including minimum cash reserves, withdrawal and
maturity of deposits and additional demand for funds. For any given period, the
pricing structure is matched when an equal amount of assets and liabilities
reprice. An excess of assets or liabilities over these matched items results in
a gap or mismatch, as shown in the table presented on the following page. A
negative gap denotes liability sensitivity and normally means that a decline in
interest rates would have a positive effect on net interest income, while an
increase in interest rates would have a negative effect on net interest income.
However, significant variations may exist in the degree of interest rate
sensitivity between individual asset and liability types within the repricing
periods presented due to differences in their repricing elasticity relative to
the change in the general level of interest rates. All of the Company's assets
and liabilities are U.S. dollar-denominated and, therefore, the Company bears no
direct foreign exchange risk.
The majority of the Company's assets reprice according to contractual
arrangements although the Company historically had fairly broad discretion over
the frequency and magnitude of interest rate changes on its liabilities which
enabled the Company to minimize the impact of any general changes in the
interest rate environment. The discretion is now limited due to the sources of
funds utilized as discussed above and in "Liquidity and Capital Resources."
The Company utilizes the analysis detailed below to generally monitor the
composition of assets and liabilities and focuses on the one-year mismatch. The
Company's cumulative one-year gap
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reflects a fairly well-matched position. The table below includes receivables
from loans sold of $56.1 million and investments in unconsolidated subsidiaries
of $19.8 million, both of which are supported by underlying loans which will be
collected or reprice within three months.
DECEMBER 31, 2000
---------------------------------------------------------------------------------------
0 TO 90 91 TO 180 181 TO 366 1 TO 5 OVER 5
DAYS DAYS DAYS YEARS YEARS TOTAL
--------- --------- --------- --------- --------- ---------
Commercial loans .................. $ 130,196 $ 7,188 $ 897 $ 4,577 $ 6,525 $ 149,383
Other loans ....................... 367 686 264 289 527 2,133
Investments ....................... 48,375 125 3,801 -- 6,900 59,201
Federal funds sold ................ 24,750 -- -- -- -- 24,750
Accounts receivable from loans sold 56,097 -- -- -- -- 56,097
Investment in unconsolidated
subsidiaries....................... 19,758 -- -- -- -- 19,758
--------- --------- --------- --------- --------- ---------
Total interest earning assets $ 279,543 $ 7,999 $ 4,962 $ 4,866 $ 13,952 $ 311,322
========= ========= ========= ========= ========= =========
Checking .......................... $ 2,263 $ 2,263 $ 3,394 $ 3,395 $ -- $ 11,315
Savings ........................... 812 812 1,218 1,219 -- 4,061
Time deposits ..................... 99,857 163,335 16,858 1,761 -- 281,811
--------- --------- --------- --------- --------- ---------
Total interest bearing
liabilities........................ $ 102,932 $ 166,410 $ 21,470 $ 6,375 $ -- $ 297,187
========= ========= ========= ========= ========= =========
Interest sensitivity gap .......... $ 176,611 $(158,411) $ (16,508) $ (1,509) $ 13,952 $ 14,135
========= ========= ========= ========= ========= =========
Cumulative gap .................... $ 176,611 $ 18,200 $ 1,692 $ 183 $ 14,135
========= ========= ========= ========= =========
Cumulative gap as a percentage of
Total interest earning assets 57% 6% 1% 0% 5%
========= ========= ========= ========= =========
SEASONALITY
The Company's business has been somewhat seasonal, as the level of domestic loan
originations tends to be lower during the first quarter when many U.S. companies
have not yet produced their fiscal financial statements and during the third
quarter when many U.S. manufacturers reduce operations for a limited time for
summer vacation. The Company's historical reliance on securitizations for the
sale of loans has made the Company's earnings lower in the quarters when loans
originated were held in portfolio for a future securitization or because the
timing of loan closings within the quarter did not afford a loan buyer
appropriate time to make the decision to purchase the loans. The seasonality and
timing factors have been somewhat mitigated by the conduits and sales facilities
put in place in the prior two years and the general increase in volume and
contribution of new loan origination officers and the international lending
expansion.
IMPACT OF INFLATION
The consolidated financial statements and related data presented elsewhere have
been prepared in accordance with generally accepted accounting principles which
require the measurement of financial position and operating results in terms of
historical dollars without considering changes in the relative purchasing power
of money over time due to inflation. The primary impact of inflation on the
operations of the Company is reflected in increased operating costs. Interest
rates have a significant impact on the Company's performance. Increases in
interest rates affect the ability of the Company's borrowers to service their
variable rate debt and decrease the spread between the interest collected on
fixed rate loans and variable rate bond interest paid for certain of the
Company's term securitizations, which could impact the realizability of the
associated
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retained interests. Furthermore, inflation can directly affect the value of loan
collateral in general, and real estate collateral in particular. These factors
are taken into account in the initial underwriting process and over the life of
the loans. The Company believes that it has the systems in place to continue to
manage the rates, liquidity and interest rate sensitivity of the Company's
assets and liabilities.
RECENT ACCOUNTING PRONOUNCEMENTS
SFAS No. 133/137/138
In June 1998, the FASB issued No. 133 "Accounting for Derivative Instruments and
Hedging Activities," for which the implementation date was extended by SFAS No.
137 and details clarified by SFAS No. 138 and is effective for the Company's
financial statements beginning in the first quarter 2001. These statements
establish accounting and reporting standards for derivative instruments and for
hedging activities, and require that all derivatives be recognized as either
assets or liabilities in the entity's balance sheet and be measured at fair
value. Changes in the fair value of the derivative instruments are to be
recognized depending on the intended use of the derivative and whether or not it
has been designated as a hedge. The future implementation is not expected to
have a significant impact upon the Company's financial position, results of
operations or cash flows.
SFAS No. 140
In September 2000 the FASB issued No. 140, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities" which replaces
SFAS No. 125. The guidance in SFAS No. 140, while not changing most of the
guidance originally issued in SFAS No. 125, revises the standards for accounting
for securitizations and other transfers of financial assets and collateral and
requires certain additional disclosures related to transferred assets.
Certain provisions of the statement related to the disclosure of collateral and
securitization transactions, became effective for the Company's December 31,
2000 year end reporting. Other provisions related to the transfer and servicing
of financial assets and extinguishments of liabilities are effective for
transactions occurring after March 31, 2001.
Based on current circumstances and after consideration of planned revisions to
existing commercial facility agreements to conform them to the requirements of
SFAS No. 140, management believes the application of the new rules will not have
a material impact on the Company's results of operations, financial position or
cash flows. The new rules do not impact the existing securitizations which were
all completed prior to March 31, 2001.
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information set forth beginning page 56 in Item 7 of this report is
incorporated by reference herein.
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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Report of Independent Accountants
The Board of Directors and Stockholders of First International Bancorp, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of income, changes in stockholders' equity and cash
flows present fairly, in all material respects, the financial position of First
International Bancorp, Inc. and its Subsidiary (the "Company") at December 31,
2000 and 1999 and the results of its operations and its cash flows for each of
the three years in the period ended December 31, 2000, in conformity with
accounting principles generally accepted in the United States of America. These
financial statements are the responsibility of the Company's management; our
responsibility is to express an opinion on these financial statements based on
our audits. We conducted our audits of these statements in accordance with
auditing standards generally accepted in the United States of America which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
As discussed in Notes 2 and 3 to the consolidated financial statements, the
Company changed its method of accounting for certain securitization-related
retained interests in 2000.
/s/ PricewaterhouseCoopers LLP
March 23, 2001
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FIRST INTERNATIONAL BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 2000 AND 1999
(dollars in thousands)
2000 1999
--------- ---------
ASSETS
Cash and due from banks ............................ $ 4,615 $ 1,357
Federal funds sold ................................. 24,750 35,780
--------- ---------
Cash and cash equivalents ................ 29,365 37,137
Investment securities (Note 3):
Available for sale at fair value .............. 56,611 41,012
Held to maturity at amortized cost
(fair value $785 and $1,161) ............. 781 1,165
U.S. Agency stocks at cost .................... 1,809 1,809
Loans, net (Note 5) ................................ 142,225 141,435
Receivable from loans sold (Note 2) ................ 56,097 50,980
Investment in unconsolidated subsidiaries (Note 4).. 19,758 15,277
Accrued interest receivable ........................ 2,522 2,278
Premises and equipment, net (Note 6) ............... 4,548 4,326
Servicing asset (Note 7) ........................... 35,962 24,823
Prepaid expenses and other assets .................. 12,550 7,802
--------- ---------
TOTAL ASSETS .................................. $ 362,228 $ 328,044
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits (Note 8) .................................. $ 297,187 $ 266,300
Accrued interest payable ........................... 3,441 3,341
Other liabilities .................................. 2,043 3,416
--------- ---------
TOTAL LIABILITIES ............................. 302,671 273,057
Commitments and Contingencies (Notes 5, 6 and 10)
Stockholders' equity (Notes 1, 2, 10, 11 and 16):
Common stock, $.10 par value, 12,000,000 shares
authorized 8,279,574 and 8,259,818 shares issued
and outstanding .............................. 828 826
Preferred stock, $.10 par value, 2,000,000
shares authorized: no shares issued and
outstanding .................................. -- --
Paid-in capital in excess of par value ........ 34,826 34,788
Stockholder note receivable ................... (1,980) (1,980)
Unrealized holding gain (loss) on
investments available-for-sale, net .......... (145) 94
Retained earnings .................................. 26,028 21,259
--------- ---------
Total stockholders' equity ................... 59,557 54,987
--------- ---------
Total liabilities and stockholders' equity ... $ 362,228 $ 328,044
========= =========
The accompanying notes are an integral part of the consolidated financial
statements.
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FIRST INTERNATIONAL BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(dollars in thousands, except per share amounts)
2000 1999 1998
-------- -------- --------
INTEREST INCOME:
Loans, including net fees ................... $ 17,947 $ 13,933 $ 15,522
Investment securities ....................... 4,742 2,953 1,258
Federal funds sold .......................... 1,614 1,486 1,412
-------- -------- --------
Total interest income .................... 24,303 18,372 18,192
-------- -------- --------
INTEREST EXPENSE:
Deposits .................................... 15,717 10,739 7,896
Warehouse lines and short term advances ..... 321 842 28
-------- -------- --------
Total interest expense ................... 16,038 11,581 7,924
-------- -------- --------
Net interest income ...................... 8,265 6,791 10,268
PROVISION FOR POSSIBLE LOAN LOSSES .............. 3,595 3,019 3,071
-------- -------- --------
Net interest income after
provision for possible loan losses .... 4,670 3,772 7,197
NON-INTEREST INCOME:
Gain on sale of guaranteed commercial loans . 12,885 12,352 12,239
Loan servicing income and fees .............. 9,703 6,161 4,249
Gain on securitizations and sales to conduits 7,662 6,314 4,094
Gain on sale of commercial loans ............ 1,009 521 626
Gain on sale of securities .................. 204 416 33
Other income ................................ 211 123 267
Income from unconsolidated subsidiaries ..... 1,214 335 --
Impairment on retained interests ............ (754) -- --
Service charges and other deposit fees ...... -- 75 500
Gain on branch sale ......................... -- 8,915 --
-------- -------- --------
Total non-interest income ................ 32,134 35,212 22,008
-------- -------- --------
Total operating income ................... 36,804 38,984 29,205
-------- -------- --------
NON-INTEREST EXPENSE:
Salaries and benefits ....................... 17,118 18,124 11,235
Occupancy ................................... 1,937 1,787 1,523
Furniture and equipment ..................... 1,384 1,252 1,007
Outside services ............................ 2,055 2,598 773
Office expenses ............................. 985 989 834
Marketing ................................... 1,772 1,991 1,453
Other ....................................... 833 1,542 875
-------- -------- --------
Total non-interest expense ............... 26,084 28,283 17,700
-------- -------- --------
Income before income taxes and
cumulative effect of accounting change .. 10,720 10,701 11,505
PROVISION FOR INCOME TAXES ...................... 3,263 4,692 4,472
-------- -------- --------
Income before cumulative effect of
accounting change ...................... $ 7,457 $ 6,009 $ 7,033
Cumulative effect of change in
accounting principle, net of taxes ..... (1,695) -- --
-------- -------- --------
Net income ............................... $ 5,762 $ 6,009 $ 7,033
======== ======== ========
BASIC EARNINGS PER SHARE (NOTES 2 AND 10)
Income before cumulative effect of
accounting change ...................... $ 0.90 $ 0.74 $ 0.89
Cumulative effect of change in
accounting principle, net of taxes ..... (0.20) -- --
-------- -------- --------
$ 0.70 $ 0.74 $ 0.89
======== ======== ========
DILUTED EARNINGS PER SHARE (NOTES 2 AND 10)
Income before cumulative effect of
accounting change ...................... $ 0.89 $ 0.72 $ 0.86
Cumulative effect of change in
accounting principle, net of taxes ..... (0.20) -- --
-------- -------- --------
$ 0.69 $ 0.72 $ 0.86
======== ======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
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FIRST INTERNATIONAL BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(dollars in thousands)
COMPREHENSIVE
INCOME
-----------------
PAID IN UNREALIZED
CAPITAL IN STOCKHOLDER HOLDING GAIN (LOSS)
COMMON EXCESS OF NOTE ON INVESTMENTS
STOCK PAR VALUE RECEIVABLE AVAILABLE-FOR-SALE
- ------------------------------------------------- ----------- ----------- ----------- ------------------
BALANCE AT JANUARY 1, 1998 ..................... $ 787 $ 32,083 $ (877) $ 12
Issuance of 85,902 shares of common stock under
option plan (Note 11) ....................... 8 478 -- --
Dividends on common stock ($.12/share) ........... -- -- -- --
Accretion on stockholder note receivable
(Note 10) .................................... -- -- (64) --
Other comprehensive income, increase in
unrealized holding gain, net of income
taxes ....................................... -- -- -- 416
Net income ....................................... -- -- -- --
Comprehensive income ............................. -- -- -- --
-------- -------- -------- --------
BALANCE AT DECEMBER 31, 1998 ................ $ 795 $ 32,561 $ (941) $ 428
Issuance of 107,181 shares of common
stock under option plan (Note 11) ........... 11 247 -- --
Dividends on common stock ($.12/share) ........... -- -- -- --
Repayment of stockholder note receivable (Note 10) -- -- 941 --
Sale of common stock (Note 10) ................... 20 1,980 (1,980)
Other comprehensive income, decrease in
unrealized holding gain, net of income
taxes ....................................... -- -- -- (334)
Net income ....................................... -- -- -- --
Comprehensive income ............................. -- -- -- --
-------- -------- -------- --------
BALANCE AT DECEMBER 31, 1999 ................ $ 826 $ 34,788 $ (1,980) $ 94
Issuance of 19,756 shares of common
stock under option plan (Note 11) ........... 2 38 -- --
Dividends on common stock ($.12/share) ........... -- -- -- --
Other comprehensive income, decrease in
unrealized holding gain, net of income
taxes ....................................... -- -- -- (239)
Net income ....................................... -- -- -- --
Comprehensive income ............................. -- -- -- --
-------- -------- -------- --------
BALANCE AT DECEMBER 31, 2000 ................ $ 828 $ 34,826 $ (1,980) $ (145)
======== ======== ======== ========
Retained
Earnings Total
- ------------------------------------------------- ---------- --------
BALANCE AT JANUARY 1, 1998 ..................... $ 10,143 $ 42,148
Issuance of 85,902 shares of common stock under
option plan (Note 11) ....................... -- 486
Dividends on common stock ($.12/share) ........... (948) (948)
Accretion on stockholder note receivable
(Note 10) .................................... -- (64)
Other comprehensive income, increase in
unrealized holding gain, net of
income taxes ................................ -- 416
Net income ....................................... 7,033 7,033
--------
Comprehensive income ............................. -- 7,449
-------- --------
BALANCE AT DECEMBER 31, 1998 ................ $ 16,228 $ 49,071
Issuance of 107,181 shares of common
stock under option plan (Note 11) ........... -- 258
Dividends on common stock ($.12/share) ........... (978) (978)
Repayment of stockholder note receivable (Note 10) -- 941
Sale of common stock (Note 10) ................... 20
Other comprehensive income, decrease in
unrealized holding gain,
net of income taxes ......................... -- (334)
Net income ....................................... 6,009 6,009
--------
Comprehensive income ............................. -- 5,675
-------- --------
BALANCE AT DECEMBER 31, 1999 ................ $ 21,259 $ 54,987
Issuance of 19,756 shares of common
stock under option plan (Note 11) ........... -- 40
Dividends on common stock ($.12/share) ........... (993) (993)
Other comprehensive income, decrease in
unrealized holding gain, net of income
taxes ....................................... -- (239)
Net income ....................................... 5,762 5,762
--------
Comprehensive income ............................. -- 5,523
-------- --------
BALANCE AT DECEMBER 31, 2000 ................ $ 26,028 $ 59,557
======== ========
The accompanying notes are an integral part of the consolidated financial
statements.
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FIRST INTERNATIONAL BANCORP, INC. AND SUBSIDIARY
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 2000, 1999 AND 1998
(dollars in thousands)
2000 1999 1998
--------- --------- ---------
Cash flows from operating activities:
Net income ............................................................... $ 5,762 $ 6,009 $ 7,033
--------- --------- ---------
Adjustments to reconcile net income to net cash
provided by operating activities:
Depreciation and amortization ....................................... 1,175 996 678
Amortization of investment premiums, net ............................ 563 60 16
Accretion of loan discount, net ..................................... (210) (187) (1,930)
Impairment on retained interests .................................... 754 -- --
Cumulative effect of accounting change, net ......................... 1,695 -- --
Provision for possible loan losses .................................. 3,595 3,019 3,071
Income from unconsolidated subsidiaries ............................. (1,214) (335) --
Gain on sale of bank branch ......................................... -- (8,915) --
Provision for loss on other real estate owned ....................... -- -- 35
Increase (decrease) in other liabilities ............................ (473) 450 399
(Increase) decrease in deferred loan costs .......................... (140) 416 (322)
Increase in accrued interest receivable ............................. (244) (895) (183)
Increase in accrued interest payable ............................... 100 2,573 22
Deferred income tax (benefit) provision ............................. (863) 318 173
Gain on sale of investment securities ............................... (204) (416) (33)
Gain on sale of loans ............................................... (21,556) (19,187) (16,959)
Loss on sale of other real estate owned ............................. -- 17 3
(Increase) decrease in receivable from loans sold ................... (5,117) (12,078) (10,128)
Increase in servicing assets ........................................ (11,139) (10,681) (3,336)
Increase in prepaid expenses and other assets ....................... (3,613) (3,388) (8,158)
Accretion on stockholder note receivable ............................ -- (16) (64)
Loans originated for sale ................................................ (509,740) (550,860) (391,677)
Proceeds from sale of loans originated for sale .......................... 530,702 567,245 415,871
--------- --------- ---------
Total adjustments .............................................. (15,929) (31,864) (12,522)
--------- --------- ---------
Net cash used in operating activities .......................... (10,167) (25,855) (5,489)
Cash flows from investing activities:
Net decrease (increase) in loans ......................................... (3,441) (23,900) 14,009
Increase in investment in unconsolidated subsidiaries .................... (3,267) (12,312) (3,300)
Purchase of investment securities available for sale ..................... (40,929) (77,157) (36,734)
Purchase of equity securities ............................................ -- (566) (709)
Proceeds from sales of investment securities available for sale .......... 1,175 57,455 4,537
Proceeds from maturities and principal repayments of investment
securities available for sale ....................................... 19,635 11,767 11,876
Proceeds from maturities of mortgage-backed securities available for sale 301 41 60
Proceeds from maturities and principal repayments of investment
securities held to maturity ......................................... -- -- 4,525
Proceeds from maturities of mortgage-backed securities held to maturity .. 384 820 925
Proceeds from sales of equity securities ................................. -- 934 602
Proceeds from sale of other real estate owned ............................ -- 80 51
Capital expenditures, net ................................................ (1,397) (1,507) (1,799)
--------- --------- ---------
Net cash used in investing activities .............................. (27,539) (44,345) (5,957)
--------- --------- ---------
Cash flows from financing activities:
Net increase in deposits ................................................. 30,887 55,341 47,553
Net decrease in other borrowings ......................................... -- (1,048) (37)
Proceeds from issuance of common stock ................................... 40 278 271
Principal repayment of stockholder note receivable ....................... -- 957 --
Dividends paid ........................................................... (993) (978) (948)
--------- --------- ---------
Net cash provided by financing activities ........................... 29,934 54,550 46,839
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents ................ (7,772) (15,650) 35,393
Cash and cash equivalents at beginning of period ............................. 37,137 52,787 17,394
--------- --------- ---------
Cash and cash equivalents at end of year ..................................... $ 29,365 $ 37,137 $ 52,787
========= ========= =========
Cash paid during the year for:
Interest ................................................................. $ 15,938 $ 9,008 $ 7,902
Income taxes ............................................................. $ 5,024 $ 5,719 $ 3,182
Non-cash items:
Real estate acquired in settlement of loans ............................. $ -- $ 265 $ 186
The accompanying notes are an integral part of the consolidated financial
statements.
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FIRST INTERNATIONAL BANCORP, INC. AND SUBSIDIARY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. DEFINITIVE MERGER AGREEMENT
On January 15, 2001, First International Bancorp, Inc. (the "Company") entered
into a definitive Agreement and Plan of Merger with United Parcel Service, Inc.
("UPS"), pursuant to which at the effective time of the transactions described
in the merger agreement, a wholly-owned subsidiary of UPS will be merged with
and into the Company (the "Merger"). The Company will be the surviving
corporation of the Merger and be a wholly-owned subsidiary of UPS.
Under the terms of the merger agreement, the Company's stockholders will receive
shares of UPS Class B common stock in exchange for shares of the Company's
common stock, based on a conversion ratio described in the merger agreement,
subject to a number of potential adjustments. Further, approximately 10% of the
stock to be issued in the Merger will be placed in escrow pending the
performance of the Company's loan portfolio during the 12 months following the
closing and the resolution of any indemnification claims with respect to the
Company's representations, warranties and covenants in the merger agreement. The
conversion ratio and the other terms of the Merger are described in the merger
agreement which has been filed by the Company as an exhibit to the Company's
Current Report on Form 8-K, filed with the Securities and Exchange Commission on
January 19, 2001. In addition, the terms of the Merger and the merger agreement
will be described in further detail in the Company's proxy statement for the
Company's 2001 Annual Meeting, which the Company anticipates will be filed with
the Securities and Exchange Commission in April 2001.
The Merger is subject to bank regulatory approvals, the approval of the
Company's stockholders, review under the Hart-Scott-Rodino Improvements Act and
other customary closing conditions. In connection with the execution of the
merger agreement, key Company stockholders, controlling approximately 52% of the
outstanding shares, have agreed to vote their shares of the Company stock in
favor of the transaction. The transaction is expected to close in the second
quarter of 2001.
As a condition to the completion of the Merger, First International Bank (the
"Bank"), the Company's wholly-owned subsidiary, prior to closing the Merger,
will seek one or more buyers of its deposit liabilities, approximately $280
million, subject to regulatory approval. Upon the closing of such transaction,
which is intended to be immediately prior to the Merger closing, subject to the
Bank's receipt of approval, the Bank would cease to be a federally insured
depository institution regulated by the FDIC and the Company would cease to be a
bank holding company regulated by the Board of Governors of the Federal Reserve
System. Following the Merger, the Bank would operate as a non-depository bank
chartered by the Connecticut Department of Banking, and would continue to be
subject to Connecticut's state banking laws and regulations, as it is today.
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2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of First
International Bancorp, Inc. and the consolidated accounts of its wholly-owned
subsidiary, First International Bank, formerly known as First National Bank of
New England. The Bank converted from a national bank to a Connecticut state
chartered bank and trust company in July 1999. Since 1998, the Bank established
various special purpose wholly-owned entities to facilitate loan securitizations
and sales to commercial paper conduits. Certain of these entities are not
consolidated but are accounted for under the equity method of accounting (Note
4). The Bank has also established a wholly-owned subsidiary, First International
Capital Corp. of New Jersey, through which all loan solicitation activities to
borrowers located in New Jersey are conducted. Intercompany accounts and
transactions relating to the consolidated subsidiaries have been eliminated in
consolidation.
The Company operates from its headquarters in Hartford, Connecticut and
representative offices, which are responsible for marketing and regional loan
origination efforts, in Boston and Springfield, Massachusetts; Providence, Rhode
Island; Rochester, New York; Morristown, New Jersey; Philadelphia and
Pittsburgh, Pennsylvania; St. Louis, Missouri; Washington D.C.; Cleveland, Ohio;
Detroit, Michigan; Miami, Florida; Los Angeles, California and Richmond,
Virginia. The Company also has international representatives in Argentina,
Brazil, Central America, Egypt, India, Indonesia, Korea, Mexico, North Africa,
the Philippines, Poland, South Africa, Turkey and West Africa.
The Company operated a full service branch and its only branch at its
headquarters in Hartford until March 31, 1999 at which time the Company
consummated the sale of its main branch premises and all of its checking,
savings and money market accounts. The Company currently obtains funding from
retail and brokered certificate of deposit accounts, commercial paper conduits
and loan securitizations and sales. The Company's primary revenues are derived
from net interest income and the origination and sale, on a servicing retained
basis, of commercial loans. The Company began securitizing and selling
commercial loans and portions thereof in 1998 and has completed seven loan
securitizations through December 31, 2000.
The Bank is a national leader in the use of loan guarantee programs offered by
the U.S. Small Business Administration ("SBA"), the U.S. Department of
Agriculture ("USDA") and the Export-Import Bank of the United States ("Ex-Im
Bank"). Continued availability of such loan guarantees are dependent upon timely
and adequate federal budget appropriations. Each of these federal programs is
funded through September 2001, but there can be no assurance of sufficient
budgetary allocations to allow a continuation of such programs in substantially
their current form.
In preparing the consolidated financial statements, management makes estimates
and assumptions that affect the reported amounts of assets and liabilities as of
the date of the balance sheet and the results of operations for the period.
Notwithstanding this diligence, such estimates are particularly sensitive to the
economic environment and can be significantly affected by changing economic
conditions affecting the value of the collateral, interest rates, borrowers'
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financial position, market conditions and other factors. Material estimates in
these consolidated financial statements relate to the estimated lives, market
rates for discounting of expected cash flows and expected losses of loans sold
or securitized where servicing has been retained and, in certain cases, interest
rate mismatches, as well as the allowance and provision for possible loan losses
and the valuation of other real estate owned ("OREO"). Assumptions utilized in
accounting for the loan sales and securitizations are periodically compared to
actual and projected results and adjustments made as appropriate. Market
conditions are evaluated and independent appraisals of collateral are obtained
by management as needed in the process of setting the estimates. Accordingly,
actual cash flows or the timing of the cash flows could differ significantly
from the expected cash flows projected using these estimates, including the
estimates of servicing assets and other retained interests, loan losses and OREO
valuation.
INVESTMENT SECURITIES
Securities that may be sold as part of the Company's asset/liability or
liquidity management, or in response to or in anticipation of changes in
interest rates and resulting prepayment risk, or for other similar factors, are
classified as available-for-sale and carried at fair market value. Unrealized
holding gains and losses on such securities are reported net of related taxes as
a separate component of stockholders' equity. Debt securities that the Company
has the ability and positive intent to hold to maturity are classified as
held-to-maturity and carried at amortized cost. Realized gains and losses on the
sales of all investment securities are reported in earnings and computed using
the specific identification cost basis. Declines in the market value of
investment securities that are deemed to be other than temporary are charged to
income. See also Securitizations and Loan Sales.
INVESTMENT IN UNCONSOLIDATED SUBSIDIARIES
The Company is the sole investor in certain "Special Purpose Entities" ("SPE's")
that meet certain specific criteria under Statement of Financial Accounting
Standards ("SFAS") No. 125 and therefore are not consolidated with the Company's
financial statements. A qualifying special purpose entity is a corporation whose
activities are permanently restricted to holding title to the assets
transferred, issuing beneficial interests in the assets transferred and
collecting and distributing proceeds from the transferred assets to the
beneficial interest holders. It also must have a standing at law distinct from
the transferor. The Company has accounted for these entities under the equity
method. See Note 4. The Company has sold loans to these SPE's since 1998 which
qualify for gain treatment under the accounting literature. The Company is
carrying as investments available for sale, Interest-Only ("I/O") securities
arising from the sale of loans to these entities totaling $3.7 million and $3.5
million as of December 31, 2000 and 1999, respectively.
LOANS
Loans are stated at their principal amount outstanding. Interest income on loans
is recognized on the simple interest method based upon the principal amount
outstanding.
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Receivable from loans sold and gain on commercial loan sales are attributable to
the sale of commercial loans which have been at least partially guaranteed by
the SBA, the USDA or Ex-Im Bank as well as the sale of unguaranteed commercial
loans. Transactions are generally settled within 30 days of the sale. The gain
on the sale of a portion of a loan is based on the relative fair market values
of the loan sold and the loan retained.
The discount on retained loans, which relates to the retained portion of the
unguaranteed portion of SBA and USDA loans, is reflected as a reduction of loans
in the consolidated balance sheet. The discount is amortized into interest
income over the estimated life of the retained loan on an effective interest
method.
LOANS HELD FOR SALE
The Company classifies loans for which it intends to sell as loans held for sale
and carries them at the lower of cost or market based on the aggregate value of
the portfolio.
LOAN ORIGINATION FEES (COSTS)
Fees received for loan originations and commitments, and related origination
costs, are deferred and recognized as a yield adjustment utilizing the effective
interest method over the contractual life of the related loan, adjusted for
prepayment and sales.
PROVISION/ALLOWANCE FOR POSSIBLE LOAN LOSSES
The Company evaluates the collectibility of collateral-dependent impaired loans
based on the estimated net realizable value of the collateral. If the Company
were to have non-collateral impaired loans, the collectibility would be based on
the present value of expected future cash flows discounted at the historical
effective interest rate. Smaller-balance homogeneous loans consisting of
residential mortgages and consumer loans are evaluated for collectibility by the
Company based on historical loss experience rather than on an individual
loan-by-loan basis. The Company evaluates all other impaired loans on an
individual loan-by-loan basis; it does not aggregate impaired loans into major
risk classifications. The Company considers a loan to be impaired when, based on
current information and events, it is probable that it will be unable to collect
all amounts of contractual interest and principal as scheduled in the loan
agreement. An insignificant delay of under 60 days or a 10% shortfall in the
amount of the payment is not an event that, when considered in isolation, would
automatically cause the Company to consider a loan to be impaired. The Company
places a loan on nonaccrual status when it is 90 days or more past due or when,
in management's assessment, the full collectibility of principal and interest is
uncertain. Except for certain restructured loans, impaired loans are loans that
are on nonaccrual status.
When an impaired loan or a portion of an impaired loan is deemed uncollectible,
the portion deemed uncollectible is charged against the allowance for loan
losses and subsequent recoveries, if any, are credited to the allowance. The
Company either recognizes interest income on impaired loans on a cash basis or
reflects a recapture of principal for all payments received. The Company
reverses any accrued interest income at the date of determination.
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Management determines the adequacy of its allowance for possible loan losses
primarily through periodic reviews of the loan portfolio, loan delinquencies,
collateral on loans and past payment history adjusted for such factors as known
changes in the character of the loan portfolio and current economic conditions.
Consideration is also given to anticipated economic conditions, as well as other
relevant factors in establishing the allowance. The allowance is increased by
provisions for loan losses charged to income and decreased by charge-offs, net
of recoveries.
SECURITIZATIONS AND LOAN SALES
The Company securitizes and sells certain unguaranteed commercial loans and the
unguaranteed portion of certain guaranteed commercial loans. In connection with
these transactions, the Company records a gain which is based on the fair market
value of the assets securitized, including retained interests. The Company will
generally retain one or more of the following "retained interests" in the
securitized assets: interest-only strips, subordinated certificates and
interests, servicing assets and cash reserve accounts. Initial estimates of fair
values of such retained interests are derived from cash flow models, using
assumptions such as expected losses, prepayment speeds, discount rates, the
excess spreads and earnings on principal cash accounts, all based on the
cash-out method.
A portion of the gain on loans securitized and commercial loan sales is due to a
servicing asset which represents the present value of the differential between
the contractual servicing fee received by the Company and adequate compensation,
defined as the fee a sub-servicer would require to assume the role of servicer,
after considering the estimated effects of prepayments. The discounted future
cash flows received in excess of the contractual servicing fee are classified as
an "Interest-Only (I/O) security." For certain of its securitizations, the
Company is required to make an initial deposit to a cash spread account which,
along with excess cash flows from the underlying loans, serve as credit
enhancements to the bondholders.
Effective October 1, 2000, the Company adopted EITF 99-20 "Recognition of
Interest Income and Impairment on Purchased and Retained Beneficial Interests in
Securitized Financial Assets," which requires that estimated cash flows be
discounted at a market rate to determine impairment.
The servicing assets are amortized as a charge to non-interest income over the
estimated lives of the underlying loans on an effective interest method. The I/O
and any initial deposit to the cash spread accounts accrete earnings based on
the yield of the effective interest rate and are reduced as excess cash is
returned to the Bank. Subsequent to the securitization, the retained interests
are carried at fair value. To obtain fair values, quoted market prices are used
if available. If fair value quotes are unavailable, the Company estimates fair
value based on the present value of future cash flows expected based on key
assumptions (i.e., credit loss, prepayment speed, interest rates) and compares
actual performance to the expected performance of the related loan
securitization pool. Estimated cash flows are discounted at a market rate.
Subordinated certificates, interest-only strips and cash spread account deposits
are classified as investments available-for-sale.
Actual prepayment rates may be affected by a variety of economic and other
factors, including prevailing interest rates and the availability of alternative
financing. The effect of these factors
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varies depending on the types of loans and structure of the securitization.
Estimated prepayment rates are based on historical rates, prepayment and
management's expectations of future prepayments as supported by market studies,
and, while management believes that the term of amortization and market interest
rate on the variable rate loans somewhat reduce the prepayment risk, there can
be no assurance that management's prepayment estimates are accurate. If the
actual prepayment rate, actual losses for loans sold, interest rate
differentials between the underlying loans and the bonds, or the estimated
market discount rates are unfavorably different than projected at the time such
loans were sold, the carrying value of the retained interests may be considered
impaired and be reduced by a charge to earnings. If the actual prepayment rate,
loan losses and other variables for loan portfolios sold on a servicing retained
basis are more favorable than estimated, the carrying value of the retained
interests is not increased through earnings, although the total future cash flow
income and resultant yields would exceed previously estimated amounts.
Retained interests are categorized and analyzed by pools of related loans with
the aggregate of each of the guaranteed portion of SBA, USDA and Ex-Im loans
sold considered as individual pools. Each of the securitizations is considered a
separate pool and loan sales to sales facilities are pooled by type such as
revolver, term or SBA unguaranteed loans.
OTHER REAL ESTATE OWNED
Other real estate owned, representing property acquired by foreclosure or
acceptance of a deed in lieu of foreclosure, is carried at the lower of the
unpaid loan balance at the date of acquisition or fair value less estimated
disposal costs. Improvements are capitalized to the extent realizable. Holding
and selling costs are expensed as incurred.
PREMISES AND EQUIPMENT
Premises and equipment are stated at cost less accumulated depreciation and
amortization. Depreciation and amortization are computed on the straight-line
method over the estimated useful lives of the assets. Leasehold improvements are
amortized over the period of the related lease and renewal options as deemed
appropriate. Costs of maintenance and repairs are expensed, while major
improvements are capitalized. Software development costs for internal use
programs for operations are capitalized and depreciated over the useful lives.
Costs of staff training and data conversion are expensed as incurred.
INCOME TAXES
Income taxes are provided based on the asset/liability method of accounting.
Deferred income taxes and tax benefits are recognized for the future income tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. A valuation allowance is
established when it is more likely than not that some portion of the deferred
tax asset will not be realized.
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EARNINGS PER SHARE
Earnings per share for all periods presented have been calculated in accordance
with SFAS No. 128, "Earnings Per Share" which requires the presentation of basic
and diluted earnings per share. Basic earnings per share is determined based on
the weighted average shares outstanding, while diluted earnings per share
reflects the potential dilution that could occur if in-the-money options to
issue common stock were exercised.
STOCK OPTION PLANS
The Company has chosen not to adopt fair value accounting for stock based
compensation and continues to employ intrinsic value accounting for its option
plans as detailed in Note 11. Certain disclosures as if fair value accounting
had been adopted, including pro forma net income and earnings per share, have
been made in these financial statements.
CASH AND CASH EQUIVALENTS
For purposes of reporting cash flows, cash and cash equivalents include cash on
hand and amounts due from banks and federal funds sold. Generally, federal funds
are sold for one-day periods or terms of less than 30 days.
COMPREHENSIVE INCOME
The Company has adopted SFAS No. 130, "Reporting Comprehensive Income" which
established standards for reporting comprehensive income, defined as the change
in equity of a business enterprise during a period from nonowner sources. The
Company's comprehensive income is comprised of net income and the unrealized
holding gain (loss) on investments classified as available-for-sale (see Note
16).
SEGMENT INFORMATION
The Company adopted in 1999 SFAS No. 131, "Disclosures about Segments of an
Enterprise and Related Information." SFAS No. 131 supersedes SFAS No. 14
"Financial Reporting for Segments of a Business Enterprise," replacing the
"industry segment" approach with the "management" approach. The management
approach designates the internal organization that is used by management for
making operating decisions and assessing performance as the source of the
Company's reportable segments. SFAS No. 131 also requires disclosures about
products and services, geographic areas and major customers. (See Note 15.)
RECLASSIFICATIONS
Certain amounts from 1999 and 1998 have been reclassified to conform to the 2000
presentation.
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RECENT ACCOUNTING PRONOUNCEMENTS
SFAS No. 133/137/138
In June 1998, the FASB issued No. 133 "Accounting for Derivative Instruments and
Hedging Activities," which implementation date was extended by SFAS No. 137 and
details clarified by SFAS No. 138 and is effective for the Company's financial
statements beginning in the first quarter 2001. These statements establish
accounting and reporting standards for derivative instruments and for hedging
activities, and require that all derivatives be recognized as either assets or
liabilities in the entity's balance sheet and be measured at fair value. Changes
in the fair value of the derivative instruments are to be recognized depending
on the intended use of the derivative and whether or not it has been designated
as a hedge. The future implementation is not expected to have a significant
impact upon the Company's financial position, results of operations or cash
flows.
SFAS No. 140
In September 2000, the FASB issued No. 140, "Accounting for Transfers and
Servicing of Financial Assets and Extinguishments of Liabilities" and replaces
SFAS No. 125. The guidance in SFAS No. 140, while not changing most of the
guidance originally issued in SFAS No. 125, revises the standards for accounting
for securitizations and other transfers of financial assets and collateral and
requires certain additional disclosures related to transferred assets.
Certain provisions of the statement related to disclosure of collateral and
securitization transactions became effective for the Company's December 31, 2000
year end reporting and had no impact on the financial statements. Other
provisions related to the transfer and servicing of financial assets and
extinguishments of liabilities are effective for transactions occurring after
March 31, 2001.
Based on current circumstances and after consideration of planned revisions to
existing commercial paper facility agreements to conform them to the
requirements of SFAS No. 140, management believes the application of the new
rules will not have a material impact on the Company's results of operations,
financial position or cash flows. The new rules do not impact the existing
securitizations which were all completed prior to March 31, 2001.
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3. INVESTMENT SECURITIES
Securities classified as available-for-sale (carried at fair value) and as held
to maturity (carried at amortized cost) as of December 31, 2000 and 1999 are as
follows:
GROSS GROSS ESTIMATED
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
---- ----- ------ -----
(dollars in
thousands)
DECEMBER 31, 2000
AVAILABLE FOR SALE
U.S. Treasury and agency obligations ..................... $ 13,361 $ 21 $ (11) $ 13,371
State and municipal obligations .......................... 682 -- (10) 672
Mutual funds ............................................. 41 -- -- 41
Bank certificates of deposit ............................. 2,000 -- -- 2,000
Commercial loan-backed securities ........................ 7,483 541 (201) 7,823
Retained interests ....................................... 33,250 130 (676) 32,704
-------- -------- -------- --------
$ 56,817 $ 692 $ (898) $ 56,611
======== ======== ======== ========
HELD TO MATURITY
U.S. government mortgage-backed securities ............... $ 156 $ 4 $ -- $ 160
Debt securities of foreign governments ................... 625 -- -- 625
-------- -------- -------- --------
$ 781 $ 4 $ -- $ 785
======== ======== ======== ========
DECEMBER 31, 1999
AVAILABLE FOR SALE
U.S. Treasury obligations ................................ $ 10,453 $ -- $ (79) $ 10,374
State and municipal obligations .......................... 237 -- (25) 212
Mutual funds ............................................. 29 -- -- 29
Commercial loan-backed securities ........................ 8,515 737 (371) 8,881
Retained interests ....................................... 21,588 -- (72) 21,516
-------- -------- -------- --------
$ 40,822 $ 737 $ (547) $ 41,012
======== ======== ======== ========
HELD TO MATURITY
U.S. government mortgage-backed securities ............... $ 540 $ -- $ (4) $ 536
Debt securities of foreign governments ................... 625 -- -- 625
-------- -------- -------- --------
$ 1,165 $ -- $ (4) $ 1,161
======== ======== ======== ========
DECEMBER 31,
-------------------------
2000 1999
----------- -----------
(dollars in thousands)
STOCK SECURITIES
Federal Home Loan Bank of Boston (FHLBB) at cost $ 822 $ 822
Private Export Funding Corporation (PEFCO) at cost 987 987
------- -------
$ 1,809 $ 1,809
======= =======
The Company is required to hold a common stock investment in the FHLBB based on
borrowings from the FHLBB (Note 9). The Company sells Ex-Im Bank guaranteed
loans to PEFCO on a servicing-retained basis and holds common stock in PEFCO, a
portion of which is pledged to PEFCO to support the Company's servicing duties.
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At December 31, 2000 and 1999, investments with a carrying value of $16.1
million and $11.8 million, respectively, were pledged to collateralize public
and government deposits, as required by law, and certain of the Bank's lines of
credit. In 2000 the Bank sold a junior bond from a 1998 securitization
transaction with a carrying value of $1.2 million and recorded a gain of
$204,000. During 1999 the Bank sold three debt securities with a carrying value
of $8.3 million recording gains aggregating $416,000.
The contractual maturities of debt securities at December 31, 2000 and 1999 are
as follows:
DECEMBER 31, 2000 DECEMBER 31, 1999
----------------------------------------- -------------------------------------
WEIGHTED WEIGHTED
AMORTIZED FAIR AVERAGE AMORTIZED FAIR AVERAGE
COST VALUE YIELD COST VALUE YIELD
---- ----- ----- ---- ----- -----
AVAILABLE FOR SALE (dollars in thousands) (dollars in thousands)
Due in one year or less ............. $ 6,034 $ 6,036 5.52% $ 6,529 $ 6,516 5.64%
Due after five years
through ten years .............. 4,000 4,007 8.10% -- -- 0.00%
Due after ten years ................. 2,332 2,334 7.51% 237 212 6.24%
Retained interests .................. 33,250 32,704 12.94% 21,588 21,516 9.74%
Mortgage-backed securities .......... 11,201 11,530 10.50% 12,468 12,768 8.12%
------- ------- ------- ------- ------- -------
$56,817 $56,611 9.93% $40,822 $41,012 8.61%
======= ======= ======= ======= ======= =======
HELD TO MATURITY
Due after one year
through five years ............. $ 100 $ 100 8.25% $ 100 $ 100 7.00%
Due after five years
through ten years .............. 525 525 7.46% 525 525 7.45%
Mortgage-backed securities .......... 156 160 7.30% 540 536 6.43%
------- ------- ------- ------- ------- -------
$ 781 $ 785 7.53% $ 1,165 $ 1,161 6.94%
======= ======= ======= ======= ======= =======
RETAINED INTERESTS
Retained interests include cash spread accounts and interest-only strips
associated with the securitizations completed to date and are included in the
Company's available-for-sale investment portfolio.
The Bank has completed seven commercial loan securitization transactions and
various other sales to commercial paper conduits and to other sales facilities
since 1998.
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Certain information as of December 31, 2000 related to the Company's loan
securitizations is as follows:
SECURITIZATIONS
-------------------------
UNGUARANTEED
SBA TERM
LOANS LOANS
----- -----
(dollars in thousands)
Aggregate loan balances securitized sold to date.. $129,322 $195,000
Loan balances outstanding at year end ............ $107,695 $157,427
Investment in subordinated notes at year end ..... $ 2,419 $ 5,404
Retained interests at year end ................... $ 10,547 $ 18,437
90+ day delinquencies at year end ................ 3.20% 2.06%
Cumulative loan losses, net of recoveries ........ 1.09% 0.59%
Delinquencies and loss ratios are calculated as a weighted average percentage of
the original securitized loans. Delinquencies were reviewed and any expected
losses were considered in the modeled cash flows for the securitizations.
Certain cash flows received from securitization trusts and other related data
for the year ended December 31, 2000 are as follows:
SECURITIZATIONS
--------------------------
UNGUARANTEED
SBA TERM
LOANS LOANS
----- -----
(dollars in thousands)
Proceeds from new securitizations ............ $59,570 $65,000
Gain on securitizations ...................... $ 4,350 $ 637
Servicing fees received ...................... $ 312 $ 625
The Company completed two securitizations of Unguaranteed SBA Loans and a
securitization of Term Loans in 2000. The initial fair value of the retained
interests and gains for these loan securitizations assumed a constant prepayment
rate of 8%. Average cumulative losses utilized on the Unguaranteed SBA and Term
Loan securitizations were 6.83% and 4.25%, respectively, while the effective
discount rates averaged 13.13% and 8.68%, respectively.
The Company tests for impairment of retained interests quarterly. Prior to
October 1, 2000, in accordance with EITF 89-4 "Accounting for a Purchased
Investment in a Collateralized Mortgage" and EITF 93-18 "Recognition of
Impairment for an Investment in a Collateralized Mortgage Obligation Instrument
or in a Mortgage-Backed Interest-Only Certificate," the Company's historical
quarterly impairment test included the application of a risk free rate to
estimated cash flows.
Effective October 1, 2000, the Company adopted EITF 99-20, "Recognition of
Interest Income and Impairment on Purchased and Retained Beneficial Interests in
Securitized Financial Assets,"
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which requires the discounting of estimated cash flows at a market rate. The
cumulative effect of the accounting change was $2.7 million, net of a tax
benefit of $1.0 million. The early adoption of EITF 99-20 was made to reflect
the impact of the softer market for such retained interests in 2000.
During the fourth quarter of 2000, the market perception of the value of
retained interests continued to decline, due in part to increased concerns over
the effect of our economic slowdown on asset quality. Therefore, in order to
reflect the current market rates on the I/O's, the estimated discount rate was
set on a prospective basis to provide a margin of 50 or 100 basis points above
the most junior bond in the securitization, depending on the credit enhancement
available to the junior-most bondholder.
The weighted average discount rates used for securitization-related retained
interests was 12.79%, following the changes in accounting. These changes, absent
any future impairment in projected cash flows, will serve in future reporting
periods to increase the yield on the remaining $29.0 million of such retained
interests.
These changes in the estimate of the fair value of such retained interests,
effected by the change in the discount rate, resulted in a charge to
non-interest income of $754,000 which reduced net income before the cumulative
effect by $471,000, and the cumulative effect of the accounting change as of
October 1, 2000 of $1.7 million, net of taxes. Combined, the overall decline in
fair value of retained interests reduced the Company's net income by $2.2
million and basic and diluted earnings per share each by $.26 for the year ended
December 31, 2000.
Key assumptions used to test for impairment of securitization-related retained
interests at December 31, 2000 are as follows:
SECURITIZATIONS
-------------------------
UNGUARANTEED TERM
SBA LOANS LOANS
--------- -----
Annual prepayment speeds, earlier
to later years ranging from ................. 9-5.5% 8-5.5%
Aggregate expected credit losses ............... 6.85% 3.93%
Effective discount rate for cash flows ......... 13.13% 12.56%
At December 31, 2000, key economic assumptions and the sensitivity of the
current carrying values of residual cash flows on retained interests on
securitizations to immediate adverse changes in those assumptions follow:
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SECURITIZATIONS
-------------------------
UNGUARANTEED TERM
SBA LOANS LOANS
--------- -----
(dollars in thousands)
Fair value of retained interests .................. $ 10,547 $ 18,437
Weighted-average life (in months) ................. 160 138
PREPAYMENT SPEED ASSUMPTION (RANGE OF ANNUAL RATES) 9-5.5% 8-5.5%
Decline in fair value of 10% increase ......... $ (306) $ (225)
Decline in fair value of 20% increase ......... $ (612) $ (460)
EXPECTED CREDIT LOSSES (AGGREGATE RATE) ........... 6.85% 3.93%
Decline in fair value of 10% increase ......... $ (538) $ (523)
Decline in fair value of 20% increase ......... $ (1,056) $ (1,018)
RESIDUAL CASH FLOWS DISCOUNT RATE (ANNUAL RATE) ... 13.13% 12.56%
Decline in fair value of 1.00% increase ....... $ (264) $ (638)
Decline in fair value of 2.00% increase ....... $ (441) $ (1,294)
Changes in the base interest rates on the securitized unguaranteed SBA loans
give rise to minimal impact to the fair value as these loans are predominantly
variable and the bonds also bear interest at a variable rate. The term loan
securitizations have variable rate bonds but are collateralized by some fixed
rate loans.
These sensitivities are hypothetical and should be used with caution. As the
figures indicate, changes in fair value based on a 10% variation in assumptions
generally cannot be extrapolated because the relationship of the change in the
assumption to the change in fair value may not be linear. Also, the effect of a
variation in a particular assumption on the fair value of the retained interest
is generally calculated without changing any other assumption; in reality,
changes in one factor may result in changes in another (for example, increases
in market interest rates may result in lower prepayments and increased credit
losses), which might magnify or counteract the sensitivities.
The Company, through two SPE's, has commercial paper conduit facilities to fund
the purchase of revolving lines of credit and certain other international and
commercial term loans. As discussed in Notes 2 and 4, these subsidiaries are not
consolidated with the accounts of the Company. The Company's investment in such
consolidated subsidiaries totals $19.8 million at December 31, 2000 and
servicing income recognized during 2000 aggregated $268,000. Since 1998, loans
totaling $259.9 million have been sold to such SPE's, and at December 31, 2000
the outstanding balances of such loans totaled $98.5 million. Loans delinquent
90 days or more at December 31, 2000 totaled $639,000 or less than 0.7% of total
loans outstanding. The subsidiaries recognized net credit losses of $1.3 million
or 1.25% of the average outstanding balance for the year ended December 31,
2000. The subsidiaries have an allowance for loan losses of $2.6 million at
December 31, 2000.
During the year ended December 31, 2000 the weighted average key assumptions
used to determine the initial fair value of retained interests and gains on loan
sales to the commercial
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paper facilities include annual prepayments ranging between 7.5 to 12%, expected
aggregate credit losses ranging from 1.4 to 5.4% and a weighted average
effective discount rate of 14.67%.
At December 31, 2000, key economic assumptions and the sensitivity of the
current fair value of residual cash flows on retained interests in the
commercial paper facilities to immediate adverse changes in those assumptions
follow:
COMMERCIAL
PAPER FACILITIES
----------------
(dollars in thousands)
FAIR VALUE OF INTEREST-ONLY STRIP ............................ $ 3,720
PREPAYMENT SPEED ASSUMPTION (AVERAGE ANNUAL RATE) ............ 8%
Decline in fair value using 10% .......................... $ (226)
Decline in fair value using 12% .......................... $ (437)
EXPECTED CREDIT LOSSES (AGGREGATE RATE) ...................... 2.60%
Decline in fair value using 3.60% ........................ $ (986)
Decline in fair value using 4.60% ........................ $(1,972)
RESIDUAL CASH FLOWS DISCOUNT RATE (ANNUAL RATE) .............. 14.15%
Decline in fair value using 16.15% ....................... $ (276)
Decline in fair value using 18.15% ....................... $ (470)
As noted previously, these sensitivities are hypothetical and should be used
with caution.
4. INVESTMENTS IN UNCONSOLIDATED SUBSIDIARIES
Summarized combined balance sheets for these entities as of December 31, 2000
and 1999 and statements of operations for the years ended December 31, 2000 and
1999 are presented below and are reflected net of applicable federal and state
income taxes. There was no operating activity in these subsidiaries for 1998
since the initial sale to these facilities was consummated in late December
1998.
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CONDENSED BALANCE SHEETS
As of December 31,
2000 1999
-------- --------
(dollars in thousands)
ASSETS
Cash ............................................... $ 5,892 $ 2,011
Loans, net ......................................... 95,966 109,178
Accrued interest receivable ........................ 876 503
-------- --------
Total assets .................................. $102,734 $111,692
======== ========
LIABILITIES AND STOCKHOLDER'S EQUITY
Borrowings ......................................... $ 81,889 $ 95,754
Accrued interest payable ........................... 1,087 661
-------- --------
Total liabilities ........................... 82,976 96,415
Stockholder's equity:
Common stock and paid in capital ................... 18,580 14,942
Retained earnings .................................. 1,178 335
-------- --------
Total stockholder's equity .................... $ 19,758 $ 15,277
-------- --------
-------- --------
Total liabilities and stockholder's equity .... $102,734 $111,692
======== ========
CONDENSED STATEMENTS OF OPERATIONS
For the Years Ended December 31,
2000 1999
-------- --------
(dollars in thousands)
INTEREST INCOME:
Loans, including net fees .......................... $ 7,871 $ 2,741
Investments ........................................ 335 --
-------- --------
Total interest income ............. 8,206 2,741
INTEREST EXPENSE:
Interest on borrowings ............................. 6,124 2,094
Expense from interest rate swap, net ............... 49 40
-------- --------
Total interest expense ............ 6,173 2,134
-------- --------
Net interest income ............... 2,033 607
Non interest operating expenses .................... 90 48
-------- --------
Income before taxes .................. 1,943 559
Provision for income taxes ............... 729 224
-------- --------
Net income .................................... $ 1,214 $ 335
======== ========
In connection with the sales of revolving commercial loans, one of these Bank
subsidiaries entered into a Prime/Libor basis swap with notional balances of
$57,000,000 as of December 31, 2000 and $28,000,000 as of December 31, 1999 to
mitigate the basis risk inherent in the transaction. The swap provides for net
settlement on a monthly basis, which is recorded as an adjustment to net
interest income. The net cost of the swap for the years ended December 31, 2000
and 1999 was $49,000 and $40,000, respectively, and is included in the expenses
of the related unconsolidated subsidiary.
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5. LOANS
The outstanding balances of loans originated and held by the Company as of
December 31 are as follows:
2000 1999
---- ----
(dollars in thousands)
PORTFOLIO LOANS
Other commercial ........................... $ 59,845 $ 27,205
Commercial real estate ..................... 3,581 35,998
Ex-Im Bank ................................. 9,943 15,558
Privately insured term and import .......... 20,635 23,537
Residential real estate .................... 1,720 1,827
Consumer loans and lines of credit ......... 413 629
--------- ---------
Total portfolio loans ................ $ 96,137 $ 104,754
--------- ---------
LOANS HELD FOR SALE
Other commercial ........................... $ 46,525 $ 37,813
Commercial real estate ..................... 8,421 6,068
Privately insured term and import .......... 134 393
Consumer loans and lines of credit ......... 299 312
--------- ---------
Total held for sale loans ............ $ 55,379 $ 44,586
--------- ---------
Less: Allowance for loan losses ............ $ 5,550 $ 4,550
Discount on retained loans ........... 3,897 3,371
Net deferred loan origination cost ... (156) (16)
--------- ---------
Loans, net ........................... $ 142,225 $ 141,435
========= =========
At December 31, 2000, the Company had fixed and variable rate loans with
maturities greater than one year totaling $7,619,000 and $78,295,000,
respectively.
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The scheduled maturities of the Company's loan portfolio as of December 31, 2000
are as follows:
AFTER ONE
WITHIN ONE YEAR THROUGH AFTER FIVE
YEAR FIVE YEARS YEARS TOTAL
---- ---------- ----- -----
(dollars in thousands)
Other commercial ................... $ 43,690 $ 2,560 $ 60,120 $106,370
Commercial real estate ............. 1,041 457 10,504 12,002
Ex-Im Bank ......................... 6,851 3,092 -- 9,943
Privately insured term and import .. 13,924 6,845 -- 20,769
Residential real estate ............ 20 250 1,450 1,720
Consumer loans and lines of credit . 76 10 626 712
-------- -------- -------- --------
$ 65,602 $ 13,214 $ 72,700 $151,516
======== ======== ======== ========
Changes in the allowance for possible loan losses were as follows:
DECEMBER 31,
-----------------------------------
2000 1999 1998
------- ------- -------
(dollars in thousands)
Balance at beginning of period ....... $ 4,550 $ 4,000 $ 3,100
Provision charged to income ..... 3,595 3,019 3,071
Recoveries on loans
previously charged off ..... 245 80 153
Loans charged off ............... (2,840) (2,549) (2,324)
------- ------- -------
Balance at end of period ... $ 5,550 $ 4,550 $ 4,000
======= ======= =======
Certain information with regard to impaired loans is detailed below:
DECEMBER 31,
----------------------
2000 1999
------ ------
(dollars in thousands)
Impaired loans with a valuation allowance ...... $4,162 $3,168
Allocated allowance ............................ $ 700 $ 658
Average recorded investment .................... $3,190 $3,064
Interest income recognized ..................... $ 110 $ 228
Commitment to lend additional funds ............ $ -- $ --
The carrying value of the impaired loans has been calculated based on the
estimated fair value of the underlying collateral.
Nonaccrual loans totaled $4,162,000 and $4,958,000 at December 31, 2000 and
1999, respectively. The gross interest income that would have been recorded if
the non-accrual loans had been current in accordance with their original terms
would have been $545,000, $312,000 and $176,000 for the years ended December 31,
2000, 1999 and 1998, respectively. The actual amount of
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interest income recognized on those loans was $110,000, $243,000 and
$160,000 for the years ended December 31, 2000, 1999 and 1998, respectively.
Loans to principal stockholders, directors, companies of which directors are
principal owners, individuals directly related to or affiliated with directors,
and executive officers aggregated $188,000 and $194,000 at December 31, 2000 and
1999, respectively. During 2000, repayments totaled $6,000 and no advances were
made.
In the normal course of business, the Bank enters into agreements to extend
credit which are not reflected in the accompanying consolidated financial
statements.
Such outstanding credit commitments are detailed below:
DECEMBER 31,
--------------------------
2000 1999
---- ----
(dollars in thousands)
Commercial lines of credit ................. $108,515 $100,788
Consumer lines of credit ................... 602 1,007
Performance letters of credit .............. 7,639 9,615
Financial letters of credit ................ 13,671 13,453
Commercial letters of credit ............... 7,100 16,199
-------- --------
Total commitments .......................... $137,527 141,062
-------- --------
At December 31, 2000 and 1999, letters of credit totaling $20,088,000 and
$26,951,000, respectively, carry the guarantee of Ex-Im Bank.
Commitments to extend such credit are agreements to lend to a client as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require the payment of a fee. Since some of the agreements may expire without
being drawn upon or may be terminated by the Bank, these amounts do not
necessarily represent a future cash requirement of the Bank. Prior to entering
into any agreement to extend credit, the Bank evaluates the client's
creditworthiness in accordance with loan underwriting standards as approved by
the Board of Directors. The amount of collateral obtained, if deemed necessary,
is based on management's credit evaluation of the client. Collateral for
commercial loan commitments varies but may include accounts receivable,
inventory, property, plant and equipment and commercial real estate.
Although the Bank's maximum exposure to credit loss is the total contract amount
of the commitments and letters of credit noted above, management does not
anticipate any material losses as a result of these agreements and does not
consider them to represent an undue level of credit, interest or liquidity risk
for the Bank.
The Bank specializes in lending to small and medium size industrial enterprises
and professional firms throughout the U.S. and in international emerging
markets. Approximately 22% of the loans outstanding have been made to borrowers
located in Connecticut. Such loans and loan commitments are generally
collateralized by real estate or other assets.
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The Bank's loans to companies in various international emerging markets are U.
S. dollar denominated loans and are either (i) 100% or 90% guaranteed by Ex-Im
Bank and sold at origination on a non-recourse, servicing retained basis or,
(ii) insured by a privately issued credit insurance policy which provides
coverage of up to 90% of the commercial risk of the transaction.
Gains on the sale of these loans and the related servicing income in aggregate,
and by significant country, is detailed below.
FOR THE YEARS ENDED DECEMBER 31,
----------------------------------------------------------------
GAINS FROM LOAN SALES SERVICING INCOME
---------------------------- ----------------------------
2000 1999 1998 2000 1999 1998
---- ---- ---- ---- ---- ----
(dollars in thousands)
All International .... $3,166 $1,716 $2,274 $ 779 $ 193 $ 448
Argentina ............ -- 277 -- 49 11 --
Brazil ............... 450 324 873 261 80 284
Dominican Republic ... -- -- 320 -- -- 9
Ghana ................ 1,111 314 -- 124 3 --
Mexico ............... 311 208 -- 91 21 --
Philippines .......... 357 -- 275 58 -- 7
Turkey ............... -- 224 -- 48 11 --
No other countries account for a significant portion of gain on loan sales or
servicing income.
Loans held by the Bank to borrowers located outside the U.S. totaled $21,044,000
and $30,649,000 at December 31, 2000 and 1999, respectively.
The Company reported total revenues from the gain on loan sales, interest income
and loan servicing income from loans made to companies located outside the U.S.
in the aggregate amounts of $7,034,000, $4,439,000 and $4,242,000 for the years
ended December 31, 2000, 1999 and 1998, respectively. The Company does not have
any assets or employees located outside of the U. S.
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LOANS SERVICED FOR OTHERS
The outstanding balances of loans originated by the Company and sold to others
on a servicing retained basis are as follows:
DECEMBER 31,
2000 1999
---- ----
(dollars in thousands)
GUARANTEED LOANS:
SBA ........................................ $ 344,867 $ 292,204
USDA ....................................... 137,197 114,775
Ex-Im Bank ................................. 147,866 129,518
FHLMC ...................................... 428 443
---------- ----------
630,358 536,940
---------- ----------
UNGUARANTEED PORTIONS
AND UNGUARANTEED LOANS:
SBA ........................................ 30,154 38,024
USDA ....................................... 5,219 5,310
Securitized unguaranteed SBA and term ...... 265,122 210,764
Commercial paper conduit facilities ........ 98,599 70,374
Other commercial ........................... 82,671 63,836
Home equity lines .......................... 1,001 1,504
---------- ----------
482,766 389,812
---------- ----------
---------- ----------
Total loans serviced for others ............ $1,113,124 $ 926,752
---------- ----------
6. PREMISES, EQUIPMENT AND LEASES
DECEMBER 31,
----------------------
2000 1999
---- ----
(dollars in thousands)
Buildings and leasehold improvements ........... $3,065 $2,824
Furniture, fixtures, and equipment ............. 6,228 5,480
------ ------
9,293 8,304
Less: Accumulated depreciation
and amortization ......................... 4,745 3,978
------ ------
$4,548 $4,326
====== ======
The Company leases its corporate offices in Hartford, Connecticut and other
facilities for its U.S. representative offices. Each of the leases provides for
minimum and contingent rentals and include renewal options. Total rental expense
for the years ended December 31, 2000, 1999 and 1998 was $1,684,000, $1,494,000
and $1,279,000, respectively.
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Minimum future obligations for premises under noncancelable leases are as
follows:
YEAR END OPERATING LEASES
- ----------- -----------------
(dollars in thousands)
2001 $ 1,711
2002 1,779
2003 1,854
2004 1,935
2005 1,973
Thereafter 2,034
--------
$ 11,286
========
7. SERVICING ASSETS
AT DECEMBER 31,
----------------------
2000 1999
------- -------
(dollars in thousands)
SERVICING ASSET
SBA ................................ $18,978 $13,408
USDA ............................... 10,643 6,835
Ex-Im short and medium term ........ 3,708 2,858
Commercial loan securitizations .... 855 419
Commercial paper sales facilities .. 1,705 1,240
Other commercial ................... 73 63
------- -------
Total servicing asset ......... $35,962 $24,823
======= =======
Servicing assets recognized on all loans sold and servicing assets amortized
during the year ended December 31, 2000 were $14.8 million and $3.7 million,
respectively. Servicing assets recognized on securitized loans and sales
facilities' loans and servicing assets amortized during the year ended December
31, 2000 aggregated $1.5 million and $600,000, respectively. The Company has no
servicing liabilities.
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8. DEPOSITS
DECEMBER 31,
----------------------------------------------------
2000 1999
------------------------ -----------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
AMOUNT RATE AMOUNT RATE
------ ---- ------ ----
(dollars in thousands)
Non-interest bearing checking .......... $ 11,315 -- $ 10,627 --
Savings accounts ....................... 4,061 1.06% 3,340 2.30%
Time deposits under $100,000 ........... 11,664 6.06% 21,751 4.97%
Time deposits $100,000 or more ......... 12,230 6.13% 17,380 5.28%
Brokered certificates of deposit........ 257,917 6.81% 213,202 6.04%
-------- ---- -------- ----
Total deposits .............. $297,187 6.41% $266,300 5.62%
======== ==== ======== ====
DECEMBER 31,
--------------------------
TIME DEPOSIT MATURITIES 2000 1999
-------- --------
(dollars in thousands)
TIME DEPOSITS MATURING WITHIN:
1 year ..................................... $280,050 $250,143
2 years .................................... 738 1,189
3 years .................................... 454 297
4 years .................................... 254 278
5 years .................................... 315 426
-------- --------
Total time deposits ................. $281,811 $252,333
======== ========
MATURITY PERIOD OF TIME
DEPOSITS OVER $100,000
DECEMBER 31, 2000
-----------------
(dollars in thousands)
Three months or less ..................................... $ 94,855
Over three though six months ............................. 160,420
Over six through twelve months ........................... 14,088
Over one year ............................................ 784
--------
Total time deposits over $100,000 ........................ $270,147
========
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9. FUNDING SOURCES
WAREHOUSE CREDIT LINE AND SALE FACILITY
The Bank previously had a combined $75 million warehouse line of credit and sale
facility with Prudential Securities Credit Corporation ("Prudential") to fund or
purchase commercial (non-government guaranteed) loan originations that also
permitted the Bank to sell loans to a qualified Special Purpose Entity ("SPE").
Prudential has exited this line of business and the Bank allowed the facility to
expire without extension in December 2000. $17.8 million of loans that
collateralized this facility were put back to the SPE and the outstanding
borrowings of $14.3 million were repaid by December 31, 2000.
COMMERCIAL LOAN CONDUITS
The Company, through an SPE, has a $95 million commercial paper conduit facility
with First Union Securities, Inc. ("First Union") to fund the purchase of
revolving lines of credit and certain other international and commercial loans.
During 2000, $67 million of loans were sold under this facility. Advances under
the facility are at an interest rate of one-month LIBOR plus 75 basis points and
the advance rates are generally 85% of the principal balance outstanding on the
loans sold to the facility. The facility is a three year committed facility that
is extendable annually; the current facility matures on November 23, 2003. Upon
maturity of the facility, the Company may not transfer new loans into the
facility and all cash collected from borrowers is used to repay outstanding
amounts. The Company is not, however, required to repurchase or otherwise remove
loans previously transferred. At December 31, 2000 an aggregate $80.3 million
was outstanding under this facility and is reflected on the books of the
unconsolidated SPE. As of December 31, 2000 First Union has agreed to increase
the facility to $120 million and to provide a companion facility under the
approved credit line to permit any availability to be used for on-balance sheet
financing of loans.
The Bank has a $60 million commercial loan conduit facility with First Union
Securities, Inc. to fund the purchase of the unguaranteed portion of SBA loans.
Advances under the facility are at an interest rate of one-month LIBOR plus 75
basis points and the advance rates are 93% of the principal balance outstanding
on the loans sold to the facility. The facility matures on December 12, 2002. At
December 31, 2000 $1.5 million was outstanding under the facility and is
reflected on the books of the unconsolidated SPE. As of December 31, 2000 First
Union has agreed to provide a companion facility under the approved credit line
to permit any availability to be used for on-balance sheet financing of loans.
In addition to the expiration of the facilities that could result in the
occurrence of a termination of each facility, there will be an acceleration of
the termination date, and therefore no further advances would be permitted under
these facilities if there is an early amortization event or event of default
under the facilities. These events include, without limitation, solvency events
with respect to the Bank or the SPEs; the receipt of a regulatory enforcement
action by the Bank; various actions by the Bank in its capacity as the servicer
of the loans; failure of the Bank or the SPEs to make certain payments when due;
failure of the aggregate pool of loans to satisfy certain
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concentration and mix requirements; or failure of the loans to satisfy certain
yield, default or loss ratios. None of these events had been triggered at
December 31, 2000.
BROKERED CERTIFICATES OF DEPOSIT
The Bank has the ability to solicit wholesale certificates of deposit through
established brokers. At December 31, 2000, the Bank had written agreements with
five national brokers for the issuance of such deposits. As a well-capitalized
institution the Bank may utilize brokered certificates of deposit to the extent
deemed appropriate by the Company. At December 31, 2000, the Bank had $257.9
million of such deposits outstanding, which mature over the next twelve months.
See Note 10 for a discussion of proposed regulatory capital rules which may
affect the Bank's ability to remain well-capitalized.
FEDERAL HOME LOAN BANK OF BOSTON ADVANCES
The Bank has the ability to borrow from the FHLBB under a line of credit. Any
outstanding advances from the FHLBB are collateralized by certain U.S. Treasury
and Agency-issued securities and mortgage loans on residential properties. As of
December 31, 2000, approximately $10.2 million was available to the Bank under
this line.
OTHER BORROWINGS
The Bank also maintains lines of credit at various correspondent banks, which
are primarily used for the issuance or confirmation of letters of credit. At
December 31, 2000, these lines aggregated $30.5 million of which $25.5 million
is required to be collateralized upon usage. Letters of credit totaling $17.9
million were outstanding for the Bank's clients at December 31, 2000 under such
lines.
10. STOCKHOLDERS' EQUITY
EARNINGS PER SHARE CALCULATION
The table detailed below reconciles the weighted average number of shares used
in the basic earnings per share ("EPS") calculation to the number of shares used
in the diluted EPS calculation. There were no changes to net income available to
common stockholders between the basic and diluted EPS calculations.
December 31,
------------
2000 1999 1998
---- ---- ----
(shares in thousands)
Common shares for basic EPS ............... 8,266 8,151 7,909
Dilutive shares from option plans ......... 119 171 291
----- ----- -----
Common shares for diluted EPS. .... 8,385 8,322 8,200
===== ===== =====
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Options to purchase 767,547 shares of common stock at a weighted average price
of $10.38 per share were outstanding at December 31, 2000, but were not included
in the computation of diluted EPS because the exercise price of the options
exceeded the average market price of the common shares.
STOCKHOLDER NOTES RECEIVABLE
In June 1994 the Board of Directors approved the sale of 614,600 shares of the
Company's common stock to the Company's Chief Executive Officer at a price of
$1.69 per share. The terms of the transaction provided for a cash down payment
of $17,560 and a promissory note in the amount of $1,020,000 for the balance.
The note was collateralized by the stock issued with principal due at maturity
on December 31, 2000. Interest was to accrue at the rate of 7% and was due at
maturity; however, upon completion of the public offering in September 1997, the
accrued interest was forgiven and the indebtedness was converted to a
non-interest bearing note. On January 27, 1999, the Company agreed to forgive
the remaining principal balance of the stockholder note receivable and agreed to
pay a bonus to the Company's Chief Executive Officer equal to the amount of his
resulting tax liability. This transaction was reflected in the results for the
quarter ended March 31, 1999 through an increase in salaries expense of $1.7
million.
On January 27, 1999, the Company agreed to sell 200,000 shares of the Company's
common stock to the Company's Chief Executive Officer at a price of $10.00 per
share. This per share price represented the closing price of the common stock on
the Nasdaq National Market on January 27, 1999, the date on which the Company's
Board approved the terms of the sale although the sale of the shares did not
actually occur until March 31, 1999, at which time the closing price of the
common stock was $9.50 per share. No adjustment was made to the purchase price
of the shares. As payment of the aggregate purchase price for the shares the
Company received $20,000 in cash and a promissory note for the balance of the
purchase price. The promissory note was collateralized by a recourse pledge of
these shares. No principal or interest was payable under the promissory note
prior to April 1, 2002 and the interest and principal may have been forgiven in
certain circumstances involving a "change in control" of the Company. In
addition to any possible future forgiveness, the Company agreed to provide a
reimbursement for the tax liabilities associated with such forgiveness.
On January 24, 2001, the Company purchased 241,600 shares of common stock held
by the Chief Executive Officer and his wife (this included the 200,000 pledged
shares discussed above) at $9.1875 per share, the closing price of the Company's
stock on January 23, 2001. The proceeds of this transaction were applied to the
repayment of the promissory note and the interest accrued thereon. The repayment
of this promissory note was a condition of closing the merger with UPS.
PREFERRED STOCK
The Company has established a class of 2,000,000 shares of preferred stock. The
Board of Directors was granted the power to establish and designate the
different series and voting powers, designations, preferences and other rights,
qualifications, limitations or restrictions to be placed upon any shares of
preferred stock to be issued by the Company.
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DIVIDENDS
Dividends payable by First International Bancorp, Inc. are generally
unrestricted, although the ability of the Company to pay dividends may, from
time to time, be dependent upon the dividends paid to it by the Bank. A
Connecticut state chartered bank and trust company must obtain the approval of
the State Banking Commissioner if the total of all dividends declared in any
calendar year exceeds the bank's net profits, as defined, for that year combined
with its retained net profits for the preceding two calendar years.
REGULATORY CAPITAL REQUIREMENTS
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios of total and Tier I
capital to risk-weighted assets (as defined in regulations). Management believes
that, as of December 31, 2000 and 1999, the Bank meets all capital adequacy
requirements to which it is subject.
As of December 31, 2000 and 1999, based on the most recent regulatory filings
with the Federal Deposit Insurance Corporation, the Bank is well capitalized
under the regulatory framework for prompt corrective action. To be categorized
as well-capitalized, the Bank must maintain minimum total and Tier I risk-based
and Tier I leverage ratios as set forth in the table below.
Federal bank regulatory authorities proposed regulatory amendments to the
capital rules in September 2000 which would require FDIC-insured banks to hold
additional capital for retained interests associated with loans sold or
securitized. The regulations, if passed in their current or a substantially
similar form, would likely require the Bank to (i) significantly reduce the
level of such retained interests relative to capital by selling these assets or
raising a significant amount of additional capital to support the Bank's lending
activities, and (ii) structure certain future loan sales or securitization
transactions in a manner which may be less economically favorable to the Bank,
or refrain completely from loan securitizations.
The comment period on the proposed capital regulations closed December 26, 2000.
These regulations would not apply to the Bank or the Company following the
proposed merger with UPS since the Bank would not have FDIC-insured deposits. In
light of this regulatory proposal, the Company has determined that it is prudent
to suspend its securitization activities prior to the closing of the proposed
merger with UPS. The Company is currently finalizing companion facilities under
its approved commercial paper conduit credit lines but expects that future
transfers to such facilities will be reflected as financings on the Company's
balance sheet.
It is possible that, due to the high level of securitization - related retained
interests or other factors, the FDIC would no longer classify the Bank as "well
capitalized." Such an action would require the Bank to request approval from the
FDIC to continue to access the brokered CD market unless, and until, well
capitalized status is again achieved.
In addition, SBA regulations require that in order to fund the unguaranteed
portions of SBA loans under the Company's commercial paper facility, the Bank
must be well capitalized and must maintain a minimum currency rate (i.e. loans
paying in accordance with their terms). If the
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Bank is not able to meet these requirements, or if the Bank were to receive a
regulatory enforcement action from the FDIC, funding under the commercial paper
facilities may not be available for these loans and alternative financing would
have to be obtained.
Any of these actions may reduce future earnings. Further, if the Company or the
Bank were not able to obtain additional capital on acceptable terms, the
Company's business strategy may have to be altered.
Current risk-based capital regulations require the Company to treat the loans
securitized or sold to a commercial paper conduit as a financing for risk-based
capital purposes unless the total retained interests for a particular
transaction represent less than 8% of the outstanding principal balance of the
loans securitized or sold. This manner of calculation has been used for all
periods presented below.
REGULATORY REGULATORY
MINIMUM FOR MINIMUM TO BE
CAPITAL ADEQUACY WELL CAPITALIZED
ACTUAL PURPOSES UNDER PCA PROVISIONS
------ -------- --------------------
DOLLAR DOLLAR DOLLAR DOLLAR
AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO
------ ----- ------ ----- ------ -----
(DOLLARS IN THOUSANDS)
AS OF DECEMBER 31, 2000:
Total capital (to risk weighted
assets) ................................. $61,574 10.80% $45,625 8.00% $57,031 10.00%
Tier 1 capital (to risk weighted
assets) ................................. $54,433 9.54% $22,813 4.00% $34,219 6.00%
Tier 1 capital (to average assets) ...... $54,433 12.72% $17,122 4.00% $21,403 5.00%
AS OF DECEMBER 31, 1999:
Total capital (to risk weighted
assets) ................................. $58,020 11.32% $41,003 8.00% $51,251 10.00%
Tier 1 capital (to risk weighted
assets) ................................. $53,470 10.43% $20,506 4.00% $30,750 6.00%
Tier 1 capital (to average assets) ...... $53,470 15.53% $11,042 4.00% $13,802 5.00%
AS OF DECEMBER 31, 1998:
Total capital (to risk weighted
assets) ................................. $37,511 16.36% $18,343 8.00% $22,929 10.00%
Tier 1 capital (to risk weighted
assets) ................................. $34,643 15.11% $9,171 4.00% $13,757 6.00%
Tier 1 capital (to average assets) ...... $47,181 18.59% $10,151 4.00% $12,689 5.00%
11. STOCK OPTION PLANS
The Company's 1994 Incentive Stock Option Plan allows for the award of options
to officers which vest immediately. As of December 31, 2000, 264 shares were
available for issuance out of the 393,403 options authorized under the plan.
The Company's Amended and Restated 1996 Stock Option Plans and 2000 Stock Option
Plan provide for the issuance of options that may be granted to officers and
directors. These options generally vest ratably over a four-year period
beginning one year after the grant date. A total of 970,106 shares were
authorized for issuance under the 1996 Stock Option Plans and at December 31,
2000 there were 27,868 shares available for issuance under this plan. A total of
150,000
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shares were authorized for issuance under the 2000 Stock Option Plan and 141,750
shares were available for issuance thereunder.
The plans provide that the options may be granted to purchase common stock at a
price not less than the fair market price of the Company's stock at the date for
the granting of such options, and unless otherwise provided, the options have a
ten year term. The plans also provide that options granted and the related
option price are adjusted to reflect changes in the shares outstanding due to
stock splits and dividends, or other adjustments.
The following tables detail the activity under the 1994 Incentive Stock Option
Plan and 1996 Stock Option Plans:
AVERAGE
OPTION OPTION
1994 INCENTIVE STOCK OPTION PLAN SHARES PRICE
Outstanding at January 1, 1998 ................. 179,777 $1.875
Exercised ................................. (57,013) 1.758
Canceled .................................. (263) 2.191
------- ------
Outstanding at December 31, 1998 ............... 122,501 1.929
Exercised ................................. (36,425) 1.960
------- ------
Outstanding at December 31, 1999 ............... 86,076 1.917
Granted ................................... 44,800 8.000
Exercised ................................. (14,425) 1.814
------- ------
Outstanding at December 31, 2000. .............. 116,451 $4.270
======= ======
AVERAGE
OPTION OPTION
1996 STOCK OPTION PLANS SHARES PRICE
Outstanding at January 1, 1998 ................. 452,855 $5.313
Granted ................................... 225,500 14.969
Exercised ................................. (13,889) 3.121
Canceled .................................. (37,783) 5.704
------- ------
Outstanding at December 31, 1998 ............... 626,683 8.813
Granted ................................... 219,406 9.924
Exercised ................................. (70,756) 2.630
Canceled .................................. (76,323) 10.433
------- ------
Outstanding at December 31, 1999 ............... 699,010 9.610
Granted ................................... 184,046 8.000
Exercised ................................. (5,331) 2.631
Canceled .................................. (26,488) 10.415
------- ------
Outstanding at December 31, 2000 ............... 851,237 $9.281
======= ======
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During 2000, 8,250 options were granted under the 2000 Stock Option Plan at an
$8.00 option price, all of which are outstanding at December 31, 2000.
In July 1997, the Company's Board of Directors approved the grant of options to
purchase 5,000 shares of common stock to each non-employee director at the price
of $8.50 per share. A total of 40,000 options, which vested 180 days from the
date of grant were awarded at that date. There are 25,000 options outstanding
from these director grants with a remaining contractual life of 6.70 years at
December 31, 2000. In April 1999, the Company's Board of Directors approved the
grant of options to purchase 2,000 shares of common stock to two non-employee
directors which vested ratably over four years, had a contractual life of ten
years and an exercise price of $8.313. In May 2000, the Company's Board of
Directors approved the grant of options to purchase 1,000 shares of common stock
to a non-employee director which vested ratably over four years, had a
contractual life of ten years and an exercise price of $8.00. Such options as
granted in 1999 and 2000 are outstanding at December 31, 2000.
Certain information as of December 31, 2000 with regard to options outstanding
is detailed below:
Weighted-
Number of Average Weighted- Weighted-
Options Remaining Average Number
Range of Outstanding at Contractual Life Exercise Exercisable at
Exercise Price December 31, 2000 (years) Price December 31, 2000
-------------- ----------------- ------- ----- -----------------
1994 INCENTIVE STOCK
OPTION PLAN: $1.689 to 2.191 71,651 4.40 $1.937 71,651
$8.00 44,800 9.20 $8.000 44,800
1996 STOCK OPTION PLAN: $2.191 to 2.631 135,740 6.00 $2.568 133,745
$6.88 1,000 7.80 $6.875 1,000
$8.000 to 8.50 318,533 8.10 $8.219 276,356
$9.875 to 10.00 200,364 8.10 $9.997 189,232
$13.50 to 14.375 78,000 7.40 $14.207 77,750
$15.375 to 16.3125 117,600 7.10 $15.439 109,600
2000 STOCK OPTION PLAN: $8.00 8,250 9.60 $8.000 4,000
DIRECTORS' OPTIONS $8.00-8.50 28,000 6.80 $8.47 25,500
------- ------ -------
TOTAL, ALL OPTIONS 1,003,938 $8.672 933,634
======= ====== =======
In estimating the compensation which would be attributable to each option grant
since July 15, 1997 if fair value accounting were to be utilized, the Company
has used the Black Scholes option pricing model with the following weighted
average assumptions for options granted in 2000, 1999 and 1998: dividend yield
of 1.6%, 1.2% and 1.0%; expected volatility of 68.2%, 64.8% and 37.5%; risk free
interest rate of 6.16%, 5.50% and 5.08%; and an expected life of 5 years.
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Had compensation been determined in accordance with the fair value provisions of
SFAS No. 123, the Company's net income, basic earnings per share and diluted
earnings per share would have been reduced to the pro forma amounts indicated
below:
December 31,
------------
2000 1999 1998
---- ---- ----
Net Income (in thousands)
As reported $5,762 $6,009 $7,033
Pro forma $4,604 $4,769 $6,577
Basis earnings per share
As reported $0.70 $0.74 $0.89
Pro forma $0.56 $0.59 $0.83
Diluted earnings per share
As reported $0.69 $0.72 $0.86
Pro forma $0.55 $0.57 $0.80
12. INCOME TAXES
The components of the income tax provision for the years ended December 31 are
as follows:
2000 1999 1998
---- ---- ----
(dollars in thousands)
Current Provision:
Federal ................................... $3,552 $3,441 $3,346
State ..................................... 574 933 953
------ ------ ------
............................................... 4,126 4,374 4,299
------ ------ ------
Deferred Provision (Benefit):
Federal ................................... (728) 258 135
State ..................................... (135) 60 38
------ ------ ------
............................................... (863) 318 173
------ ------ ------
Total provision for income taxes...... $3,263 $4,692 $4,472
====== ====== ======
The effective tax rates differ from the federal statutory rate primarily due to
state taxes, net of the federal benefit and a dividend received deduction. In
1999, compensation expense of $1.4 million associated with total salary and
bonus paid to the Company's Chief Executive Officer was deemed non-deductible
for tax purposes which accounted for 4.3% of the tax rate increase over
statutory rates. The State of Connecticut statutory tax rate has decreased in
each of the last three years.
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A reconciliation of the statutory rate to the effective rate follows:
2000 1999 1998
---- ---- ----
% % %
Tax at statutory rate,
including unconsolidated subsidiaries ...... 34.0 34.0 34.0
Taxes on unconsolidated subsidiaries ................. (4.6) (1.1) --
State tax, net of federal benefit .................... 0.6 7.0 5.2
Dividends received deduction ......................... (0.1) (0.1) (0.1)
Nondeductible compensation ........................... -- 4.3 --
Other, net ........................................... 0.5 (0.2) (0.2)
---- ---- ----
Total tax provision .................... 30.4 43.9 38.9
==== ==== ====
The components of the net deferred tax asset (liability) at December 31 are as
follows:
2000 1999
---- ----
Federal State Federal State
------- ----- ------- -----
Deferred tax assets: (dollars in thousands)
Allowance for possible loan losses ............ $ 1,128 $ 175 $ 819 $ 195
Investments mark-to-market .................... 49 12 -- --
Other ......................................... 112 17 146 36
------- ------- ------- -------
Total deferred tax assets ................ 1,289 204 965 231
Deferred tax liabilities:
Investments mark-to-market .................... -- -- 74 20
Depreciation .................................. 82 13 53 13
Deferred loan costs ........................... 50 8 4 1
Deferred gain on sale of loans ................ 594 92 1,222 291
Other ......................................... 6 -- 4 1
------- ------- ------- -------
Total deferred tax liabilities ........... 732 113 1,357 326
------- ------- ------- -------
Net deferred tax assets/(liabilities) .... $ 557 $ 91 $ (392) $ (95)
======= ======= ======= =======
The allocation of the deferred tax provision involving items charged to current
year income and items charged directly to stockholders' equity for the years
ended December 31, are as follows:
2000 1999
---- ----
Federal State Federal State
------- ----- ------- -----
(dollars in thousands)
Deferred tax benefit allocated to shareholders' equity .... $(123) $ (32) $(148) $ (41)
Deferred tax provision allocated to cumulative effect...... (98) (19) -- --
Deferred tax provision (benefit) allocated to income ...... (728) (135) 258 60
----- ----- ----- -----
Total deferred tax provision (benefit) .......... $(949) $(186) $ 110 $ 19
===== ===== ===== =====
13. EMPLOYEE BENEFIT PLAN
The Company maintains a contributory savings plan, which qualifies under Section
401(k) of the Internal Revenue Code for employees meeting certain service
requirements. Eligible employees may make contributions to the Plan based on
specified percentages of their compensation. Beginning July 1, 1998, the Company
matched 100% of employees' contribution, up to 6% of compensation. The matching
contribution was 85% in prior periods. The Company's matching
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contributions totaled $507,000, $475,000 and $290,000 for the years ended
December 31, 2000, 1999 and 1998, respectively.
14. ESTIMATED FAIR VALUES OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107 "Disclosures About Fair
Value of Financial Instruments" (SFAS No. 107) requires the Company to disclose
fair value information for certain of its financial instruments, including
loans, securities, deposits, borrowings and other such instruments. Quoted
market prices are not available for a significant portion of the Company's
financial instruments and, as a result, the fair values presented may not be
indicative of net realizable or liquidation values. Fair values are estimates
derived using present value or other valuation techniques and are based on
judgments regarding future expected loss experience, current economic
conditions, risk characteristics and other factors. In addition, fair value
estimates are based on market conditions and information about the financial
instrument at a specific point in time. Fair value estimates are based on
existing on- and off-balance sheet financial instruments without attempting to
estimate the value of anticipated future business and the value of assets and
liabilities that are not considered financial instruments. Such items include
loan servicing rights on loans on balance sheet, core deposit intangibles and
other customer relationships, premises and equipment, foreclosed real estate and
income taxes. In addition, the tax ramifications relating to the realization of
the unrealized gains and losses may have a significant effect on fair value
estimates, and have not been considered in the estimates.
The following is a summary of the methodologies and assumptions used to estimate
the fair value of the Company's financial instruments pursuant to SFAS No. 107:
CASH, CASH EQUIVALENTS AND OTHER: The fair value of cash and due from banks,
federal funds sold, accrued interest receivable, receivable for loans sold and
accrued interest payable, is considered to approximate the book value due to
their short-term nature.
SECURITIES: Securities classified as available-for-sale are carried at fair
value and include I/O strips associated with securitizations and sales of loans.
Fair value for securities available for sale and held to maturity was determined
by secondary market and independent broker quotations where available, or by the
Company's estimate of market value.
LOANS: The fair values for loans are estimated using discounted cash flow
analyses and interest rates currently being offered for loans with similar terms
to borrowers of similar credit quality. The fair values for loans held for sale
are based on estimated sales prices derived from the current market conditions.
SERVICING ASSETS: The fair values of servicing assets associated with loans
serviced for others is derived based on an estimate of the projected cash flows
due the Bank over the estimated life of the underlying portfolio.
DEPOSIT LIABILITIES: The fair value for demand and savings deposits is equal to
the amount payable on demand at the balance sheet date which is equal to the
carrying value. The fair value
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of certificates of deposit was estimated by discounting cash flows using rates
currently offered by the Bank for consumer deposits of similar remaining
maturities or rates currently offered by brokers for brokered certificates of
deposit of similar remaining maturities, as applicable.
The fair value information of the Company's financial instruments required to be
valued by SFAS No. 107 are as follows:
DECEMBER 31, 2000 DECEMBER 31, 1999
----------------- -----------------
CARRYING ESTIMATED CARRYING ESTIMATED
VALUE FAIR VALUE VALUE FAIR VALUE
----- ---------- ----- ----------
(dollars in thousands)
FINANCIAL ASSETS
Cash and due from banks .......... $ 4,615 $ 4,615 $ 1,357 $ 1,357
Federal funds sold ............... 24,750 24,750 35,780 35,780
Securities available for sale .... 56,611 56,611 29,811 29,811
Securities held to maturity ...... 781 785 1,165 1,161
Stock securities ................. 1,809 1,809 1,809 1,809
Loans ............................ 142,225 142,041 141,435 141,625
Receivable from loans sold ....... 56,097 56,097 50,980 50,980
Accrued interest receivable ...... 2,522 2,522 2,278 2,278
Servicing assets ................. 35,962 36,829 24,404 24,992
FINANCIAL LIABILITIES
Deposits
Checking .................... $ 11,315 $ 11,315 $ 10,627 $ 10,627
Savings ..................... 4,061 4,061 3,340 3,340
Time deposits ............... 281,811 282,111 252,333 250,079
Accrued interest payable ......... 3,441 3,441 3,341 3,341
15. SEGMENT INFORMATION
The Company has determined that its reportable segments are its domestic
Commercial Banking divisions, its International Banking division and its Loan
Servicing business unit.
The domestic Commercial Banking divisions are an aggregation of the Commercial
Banking-East, Commercial Banking-Central and Commercial Banking-West divisions,
which included eight, five and six business units, respectively, at December 31,
2000. The Commercial Banking divisions offer SBA, USDA and other commercial
loans to small and medium size industrial companies in the U.S. Each Commercial
division is headed by an Executive Vice President and the divisions offer the
same products and services and have the same marketing approach.
The International Banking division is comprised of four business units: the
International Buyer Finance business unit which markets Ex-Im Bank guaranteed
and insured loans and privately insured loans to small and medium size
industrial companies located in international emerging markets, the Export
Finance business unit which provides Ex-Im Bank guaranteed export working
capital lines of credit and SBA loans to U.S. companies, the Import Finance
business unit which provides privately-insured import financing and SBA loans to
U. S. companies, and
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one domestic business unit which offers SBA and other commercial loans to small
and medium size industrial companies located in the U. S.
The Loan Servicing business unit is responsible for all loan operations
functions, which include the preparation of loan documents, the maintenance of
loans and the servicing of loans managed for others.
The segment information prepared internally and utilized for decision-making
includes only revenues from gain on loan sales and certain fees and only certain
expenses. Gains on the sale of loans and loan related fee income are allocated
to business units and aggregated for each division. Direct expenses, principally
personnel costs, and a limited amount of certain other expenses, such as
supplies and indirect marketing are allocated to the business units. Interest
income but not interest expense is allocated to business units. There is no
allocation of the loan loss provision, corporate overhead expense or income
taxes. Likewise, assets are generally not allocated among business units and,
therefore, are not disclosed below. The Company periodically evaluates the costs
and benefits of making certain additional income, expense and asset allocations.
The accounting policies of the segments are the same as those described in Note
2. There are no intersegment revenues.
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Financial information for the Company's business segments is as follows:
For the Years Ended December 31,
--------------------------------
COMMERCIAL BANKING DIVISIONS 2000 1999 1998
---- ---- ----
(dollars in thousands)
Gains on the sale of loans .............. $17,055 $16,663 $11,560
Other loan-related income ............... 960 218 198
------- ------- -------
Total allocated revenues .... $18,015 $16,881 $11,758
Allocated non-interest expense .......... 9,538 8,817 5,800
------- ------- -------
Direct net contribution .... $ 8,477 $ 8,064 $ 5,958
======= ======= =======
Number of business units at year end .... 19 16 14
======= ======= =======
Number of lenders ....................... 74 58 53
======= ======= =======
For the Years Ended December 31,
--------------------------------
INTERNATIONAL BANKING DIVISION 2000 1999 1998
---- ---- ----
(dollars in thousands)
Gains on the sale of loans .............. $ 4,501 $ 2,524 $ 2,814
Other loan-related income ............... 1,230 645 603
------- ------- -------
Total allocated revenues ... $ 5,731 $ 3,169 $ 3,417
Allocated non-interest expense .......... 4,181 3,218 2,239
------- ------- -------
Direct net contribution .... $ 1,550 $ (49) $ 1,178
======= ======= =======
Number of business units at year end .... 4 4 3
======= ======= =======
Number of lenders ....................... 21 21 16
======= ======= =======
For the Years Ended December 31,
--------------------------------
LOAN SERVICING BUSINESS UNIT 2000 1999 1998
---- ---- ----
(dollars in thousands)
Loan servicing income ................... $7,513 $5,298 $2,913
Allocated non-interest expense .......... 1,648 1,802 1,265
------ ------ ------
Direct net contribution .... $5,865 $3,496 $1,648
====== ====== ======
Loans under management at year end ...... $1,265 $1,076 $ 779
====== ====== ======
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Detailed below are reconciliations of the amounts reported for each business
segment to the amounts reported in the consolidated income statement:
Commercial International Loan Unallocated Consolidated
FOR THE YEAR ENDED DECEMBER 31, 2000 Banking Banking Servicing Amounts Totals
------- ------- --------- ------- ------
(dollars in thousands)
Total allocated revenues ........................ $ 18,015 $ 5,731 $ 7,513 -- $ 31,259
Interest income ................................. 12,604 4,880 -- 6,819 24,303
Other fees and income ........................... -- -- -- 875 875
-------- -------- -------- -------- --------
Total revenues ......................... $ 30,619 $ 10,611 $ 7,513 $ 7,694 $ 56,437
-------- -------- -------- -------- --------
Non-interest expense ............................ 9,538 4,181 1,648 10,717 26,084
Interest expense ................................ -- -- -- 16,038 16,038
Provision for possible loan losses .............. -- -- -- 3,595 3,595
-------- -------- -------- -------- --------
Total expenses ......................... 9,538 4,181 1,648 30,350 45,717
-------- -------- -------- -------- --------
Income before income taxes and
cumulative effect change in
accounting principle ............. $ 21,081 $ 6,430 $ 5,865 $(22,656) $ 10,720
======== ======== ======== ======== ========
Commercial International Loan Unallocated Consolidated
FOR THE YEAR ENDED DECEMBER 31, 1999 Banking Banking Servicing Amounts Totals
------- ------- --------- ------- ------
(dollars in thousands)
Total allocated revenues ....................... $ 16,881 $ 3,169 $ 5,298 -- $ 25,348
Interest income ................................ 10,803 3,606 -- 3,963 18,372
Gain on sale of branch ......................... -- -- -- 8,915 8,915
Other fees and income .......................... -- -- -- 949 949
-------- -------- -------- -------- --------
Total revenues ........................ $ 27,684 $ 6,775 $ 5,298 $ 13,827 $ 53,584
-------- -------- -------- -------- --------
Non-interest expense ........................... 8,817 3,218 1,802 14,446 28,283
Interest expense ............................... -- -- -- 11,581 11,581
Provision for possible loan losses ............. -- -- -- 3,019 3,019
-------- -------- -------- -------- --------
Total expenses ........................ 8,817 3,218 1,802 29,046 42,883
-------- -------- -------- -------- --------
Income before income taxes ... $ 18,867 $ 3,557 $ 3,496 $(15,219) $ 10,701
======== ======== ======== ======== ========
Commercial International Loan Unallocated Consolidated
FOR THE YEAR ENDED DECEMBER 31, 1998 Banking Banking Servicing Amounts Totals
------- ------- --------- ------- ------
(dollars in thousands)
Total allocated revenues ........................... $ 11,758 $ 3,417 $ 2,913 $ -- $ 18,088
Interest income .................................... 13,341 1,675 -- 3,176 18,192
Unallocated gain on the sale of commercial loan-
backed securitizations ..................... -- -- -- 2,598 2,598
Other fees and income .............................. -- -- -- 1,322 1,322
-------- -------- -------- -------- --------
Total revenues ............................ 25,099 5,092 2,913 7,096 40,200
-------- -------- -------- -------- --------
Non-interest expense ............................... 5,800 2,239 1,265 8,396 17,700
Interest expense ................................... -- -- -- 7,924 7,924
Provision for possible loan losses ................. -- -- -- 3,071 3,071
-------- -------- -------- -------- --------
Total expenses ............................ 5,800 2,239 1,265 19,391 28,695
-------- -------- -------- -------- --------
Income before income taxes ....... $ 19,299 $ 2,853 $ 1,648 $(12,295) $ 11,505
======== ======== ======== ======== ========
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16. OTHER COMPREHENSIVE INCOME
The components of other comprehensive income, and related tax effects are as
follows:
Before Tax Tax (Benefit) Net of
Amount Expense Tax Amount
------ ------- ----------
YEAR ENDED DECEMBER 31, 2000
Net unrealized losses on securities arising during
the period ........................................ $(190) $ (65) $(125)
Less: reclassification adjustment for gains
realized in net income ............................ (204) (90) (114)
----- ----- -----
Net unrealized losses on securities ................. $(394) $(155) $(239)
===== ===== =====
YEAR ENDED DECEMBER 31, 1999
Net unrealized losses on securities arising during
the period ........................................ $(107) $ (40) $ (67)
Less: reclassification adjustment for gains
realized in net income ............................ $(416) $(149) $(267)
----- ----- -----
Net unrealized losses on securities ................. $(523) $(189) $(334)
===== ===== =====
YEAR ENDED DECEMBER 31, 1998
Net unrealized losses on securities arising during
the period ........................................ $ 710 282 $ 428
Less: reclassification adjustment for gains
realized in net income ............................ (20) (8) (12)
----- ----- -----
Net unrealized gains on securities .................. $ 690 $ 274 $ 416
===== ===== =====
103
107
17. PARENT COMPANY FINANCIAL INFORMATION
First International Bancorp, Inc. is the parent company of First International
Bank. There have been no loans extended from the Bank to First International
Bancorp, Inc. since inception of the holding company.
FIRST INTERNATIONAL BANCORP, INC.
CONDENSED BALANCE SHEETS
For the Years Ended December 31,
--------------------------------
2000 1999
---- ----
(dollars in thousands)
ASSETS
Cash on deposit with Bank subsidiary .............. $ 161 $ 58
Investment securities:
Available for sale, at fair value ............ 21 19
Investment in the Bank ............................ 58,840 54,479
Other assets ...................................... 572 431
------- -------
Total assets ................................. $59,594 $54,987
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Other liabilities ................................. $ 37 $ --
Stockholders' equity .............................. 59,557 54,987
------- -------
Total liabilities and stockholders' equity ... $59,594 $54,987
======= =======
FIRST INTERNATIONAL BANCORP, INC.
CONDENSED STATEMENTS OF INCOME
For the Years Ended December 31,
--------------------------------
2000 1999 1998
---- ---- ----
(dollars in thousands)
Dividends from Bank subsidiary ..................... $ 1,120 $ 650 $ 650
Net interest income from investments ............... 140 122 116
Equity in undistributed net income of the Bank ..... 4,600 6,309 6,366
Non-interest expenses, net ......................... (73) (1,813) (87)
------- ------- -------
Income before income taxes .................... 5,787 5,268 7,045
Provision (benefit) for income taxes ..... 25 (741) 12
------- ------- -------
Net income .................................... $ 5,762 $ 6,009 $ 7,033
======= ======= =======
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108
FIRST INTERNATIONAL BANCORP, INC.
CONDENSED STATEMENT OF CASH FLOWS
For the Years Ended December 31,
--------------------------------
2000 1999 1998
---- ---- ----
(dollars in thousands)
Cash from operating activities
Net income .............................................................. $ 5,762 $ 6,009 $ 7,033
Adjustments to reconcile net income to net cash provided
by operating activities:
Equity in undistributed net income of subsidiary ................... (4,600) (6,309) (6,366)
Decrease (increase) in other assets ................................ (141) (149) 40
Increase in other liabilities assets ............................... 37 -- --
Stockholder note receivable accretion .............................. -- -- (64)
-------- -------- --------
Net cash provided by operations ............................... 1,058 (449) 643
-------- -------- --------
Cash flows from investing activities:
Purchase of investment securities available for sale, net .......... (2) -- (4,068)
Proceeds from maturities and sale of securities held to maturity ... -- -- 8,135
Additional investment in Bank subsidiary ........................... -- -- (11,100)
-------- -------- --------
Net cash used in investing activities ......................... (2) -- (7,033)
-------- -------- --------
Cash flows from financing activities:
Proceeds from sale of common stock under option plan ............... 40 278 271
Payment of stockholder note receivable ............................. -- 941 --
Dividends paid ..................................................... (993) (978) (948)
-------- -------- --------
Net cash provided by (used in) financing activities ........... (953) 241 (677)
-------- -------- --------
Net increase (decrease) in cash and cash equivalents .......... 103 (208) (7,067)
Cash and cash equivalents beginning of year ............................. 58 266 7,333
-------- -------- --------
Cash and cash equivalents end of year ................................... $ 161 $ 58 $ 266
======== ======== ========
105
109
18. SELECTED QUARTERLY CONSOLIDATED FINANCIAL INFORMATION (UNAUDITED)
2000 Quarter Ended March 31 June 30 September 30 December 31
- ------------------ -------- ------- ------------ -----------
(dollars in thousands)
Net interest income .......................................... $ 2,184 $ 1,920 $ 2,117 $ 2,044
Provision for possible loan losses ........................... 558 874 1,160 1,003
-------- -------- -------- --------
Net interest income after provision for possible loan
loss................................................... 1,626 1,046 957 1,041
Gain on sale of loans ........................................ 5,021 4,718 4,729 7,088
Other non-interest income .................................... 2,312 3,231 2,452 2,583
-------- -------- -------- --------
Total operating income .................................. 8,959 8,995 8,138 10,712
Non-interest expense .................................... 5,673 5,761 5,924 8,726
-------- -------- -------- --------
Income before income taxes and cumulative effect of
accounting change...................................... 3,286 3,234 2,214 1,986
Provision for income taxes ................................... 1,144 1,077 804 238
-------- -------- -------- --------
Income before cumulative effect of accounting change .... 2,142 2,157 1,410 1,748
-------- -------- -------- --------
Cumulative effect of change in accounting principle,
net of taxes ............................................... -- -- -- (1,695)
-------- -------- -------- --------
Net income ................................................... $ 2,142 $ 2,157 $ 1,410 $ 53
======== ======== ======== ========
Basic earnings per share:
Income before cumulative effect of accounting change ..... $ 0.26 $ 0.26 $ 0.17 $ 0.21
Cumulative effect of change in accounting principle,
net of taxes............................................ -- -- -- (0.20)
-------- -------- -------- --------
$ 0.26 $ 0.26 $ 0.17 $ 0.01
======== ======== ======== ========
Diluted earnings per share:
Income before cumulative effect of accounting change ..... $ 0.26 $ 0.25 $ 0.17 $ 0.21
Cumulative effect of change in accounting principle,
net of taxes............................................ -- -- -- (0.20)
-------- -------- -------- --------
$ 0.26 $ 0.25 $ 0.17 $ 0.01
======== ======== ======== ========
1999 Quarter Ended March 31 June 30 September 30 December 31
- ------------------ -------- ------- ------------ -----------
(dollars in thousands)
Net interest income .......................................... $ 1,467 $ 1,552 $ 1,825 $ 1,947
Provision for possible loan losses ........................... 1,539 449 413 618
-------- -------- -------- --------
Net interest income after provision for possible loan
loss .................................................. (72) 1,103 1,412 1,329
Gain on sale of loans ........................................ 3,050 6,189 3,531 6,417
Other non-interest income .................................... 10,157 1,645 1,600 2,623
-------- -------- -------- --------
Total operating income .................................. 13,135 8,937 6,543 10,369
Non-interest expense .................................... 9,352 5,531 6,356 7,044
-------- -------- -------- --------
Income before income taxes .............................. 3,783 3,406 187 3,325
Provision for income taxes ................................... 1,566 1,349 44 1,733
-------- -------- -------- --------
Net income .............................................. $ 2,217 $ 2,057 $ 143 $ 1,592
======== ======== ======== ========
Basic earnings per share ..................................... $ 0.28 $ 0.25 $ 0.02 $ 0.19
======== ======== ======== ========
Diluted earnings per share ................................... $ 0.27 $ 0.24 $ 0.02 $ 0.19
======== ======== ======== ========
106
110
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
ITEMS 10 - 13
Information required by these items may be found in the Company's proxy
statement for its Annual Meeting of Shareholders, which is expected to be filed
by the Company within 120 days of the end of its most recent fiscal year.
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON FORM 8-K
A. The following documents are filed as a part of this report:
1. Financial Statements:
None.
2. Financial Schedules:
None.
3. Exhibits:
Exhibit
Number Description
------ -----------
2.1 Agreement and Plan of Merger, dated as of January 15,
2001, by and among the Registrant, United Parcel
Service, Inc. and Stag Merger Company, Inc., and
certain related exhibits as included in the
Registrant's Current Report on Form 8-K filed January
19, 2001.
3.1 Amended and Restated Certificate of Incorporation of
the Registrant.*
3.2 Amended and Restated By-laws of the Registrant.*
10.1 Employment Agreement among Registrant, First National
Bank of New England and Brett N. Silvers dated April
15, 1994; as amended by Letter Agreement dated July
3, 1997.*
107
111
10.1.1 Letter dated March 31, 1999, to amend the Employment
Agreement among the Registrant, First International
Bank, N.A. and Brett N. Silvers.***
10.1.2 Letter dated March 15, 2000, to amend the Employment
Agreement among the Registrant, First International
Bank and Brett N. Silvers.****
10.1.3 Registration Rights Agreement by and among First
International Bancorp, Inc. and Nancy W. Silvers and
The Silvers Family Trust, dated March 31, 1999.***
10.1.4 Letter Agreement between Brett N. Silvers and Nancy
W. Silvers and the Registrant for the purchase of
241,600 shares of Registrant's stock in satisfaction
of a Promissory Note, dated as of January 24, 2001.
10.4 Amended and Restated 1996 Stock Option Plans.****
10.4.1 2000 Stock Option Plan****
10.5 1994 Incentive Stock Option Plan, as amended.*
10.6 401(k) Plan.****
10.7 Lease between Cambridge One Commercial Plaza, LLC and
the Bank dated June 1, 1997.*
10.8 First Amendment of Lease between Cambridge One
Commercial Plaza, LLC and the Bank dated November 30,
1998.****
10.9 Second Amendment of Lease between Cambridge One
Commercial Plaza, LLC and the Bank dated as of March
26, 1999.****
10.9.1 Third Amendment of Lease between Cambridge One
Commercial Plaza, LLC and the Bank dated as of
October 29, 1999.
10.9.2 Fourth Amendment of Lease between Cambridge One
Commercial Plaza, LLC and the Bank dated as of April
1, 2000.
10.10 Employment Agreement between the Bank and Leslie A.
Galbraith dated March 15, 2000.****
10.11 Employment Agreement between the Bank and Shaun P.
Williams dated March 6, 2000.****
10.13 Amended and Restated Loan Purchase and Servicing
Agreement among FNBNE Funding Corp., First
International Bank, Variable Funding Capital
Corporation, First Union Capital Markets Corp., First
Union National Bank and HSBC Bank USA, dated
September 24, 1999.****
10.13.1 Amendment No. 1 to Amended and Restated Loan Purchase
and Servicing Agreement among FNBNE Funding Corp.,
First International Bank, Variable Funding Capital
Corporation, First Union Securities, Inc., First
Union National Bank and HSBC Bank USA, dated November
23, 1999.****
10.13.2 Amendment No. 2 to Amended and Restated Loan Purchase
and Servicing Agreement among FNBNE Funding Corp.,
First International Bank, Variable Funding Capital
Corporation, First Union Securities, Inc., First
Union National Bank and HSBC Bank USA, dated
May 15, 2000.
108
112
10.13.3 Amendment No. 3 to Amended and Restated Loan Purchase
and Servicing Agreement among FNBNE Funding Corp.,
First International Bank, Variable Funding Capital
Corporation, First Union Securities, Inc., First
Union National Bank and HSBC Bank USA, dated December
31, 2000.
10.14 Pooling and Servicing Agreement between Marine
Midland Bank and First National Bank of New England,
dated as of May 31, 1998.****
10.15 Sale and Servicing Agreement between FNBNE Business
Loan Trust 1998-A and First National Bank of New
England, dated as of December 1, 1998.****
10.15.1 Pooling and Servicing Agreement between HSBC Bank USA
and First International Bank, National Association
for the SBA Loan-Backed Series 1999-1 dated as of May
31, 1999.****
10.15.2 Sale and Servicing Agreement between FIB Business
Loan Trust 1999-A and First International Bank, dated
as of September 1, 1999.****
10.15.3 Pooling and Servicing Agreement among HSBC Bank USA,
First International Bank and FIB Funding Trust for
the SBA Loan-Backed Series 2000-1 dated as of March
3, 2000.
10.15.4 Sale and Servicing Agreement among First
International Bank SBA Loan Trust 2000-2, First
International Bank and FIB Funding Trust dated as of
November 1, 2000.
10.15.5 Sale and Servicing Agreement among FIB Business Loan
Trust 2000-A, First International Bank and FIB
Holdings, Inc. dated as of June 1, 2000.
10.17 Commercial Loan Sale Agreement between First
International Bank and FIB Holdings, Inc., dated as
of December 1, 1999.****
10.19 Sale and Servicing Agreement between FIB Funding
Trust and First International Bank dated as of
October 1, 1999.****
10.19.1 Amendment No. 1 to Sale and Servicing Agreement
between FIB Funding Trust and First International
Bank dated as of June 1, 2000.
10.19.2 Amendment No. 2 to Sale and Servicing Agreement
between FIB Funding Trust and First International
Bank dated as of October 1, 2000.
10.20 Note Purchase Agreement among FIB Funding Trust,
First International Bank, Variable Funding Capital
Corporation, First Union Securities, Inc. and First
Union National Bank dated as of October 1, 1999.****
10.20.1 Amendment No. 1 to Note Purchase Agreement among FIB
Funding Trust, First International Bank, Variable
Funding Capital Corporation, First Union Securities,
Inc. and First Union National Bank dated as of June
1, 2000.
109
113
10.21 Guaranty from First International Bank in favor of
First Union Securities, Inc. dated as of October 1,
1999.****
21.1 Subsidiaries of Registrant.
23.1 Consent of PricewaterhouseCoopers LLP.
* Denotes an exhibit which has previously been filed as an exhibit to the
Company's Registration Statement on Form S-1, Commission File No.
333-31339.
** Denotes an exhibit which has previously been filed as an exhibit to the
Company's Report on Form 8-K, Commission File No. 0-22861.
*** Denotes an exhibit which has previously been filed as an exhibit to the
Company's Report on Form 10-Q, Commission File No. 0-22861.
**** Denotes an exhibit which has previously been filed as an exhibit to the
Company's Report on Form 10-K, Commission File No. 0-22861.
B. Reports on Form 8-K.
The Company did not file any Current Reports on Form 8-K during the quarter
ended December 31, 2000. The Company did file a Current Report on Form 8-K on
January 16, 2001 to disclose the press release and other communication materials
regarding the Registrant's signing of a definitive merger agreement with United
Parcel Service, Inc., and a Current Report on Form 8-K on January 19, 2001 to
file such definitive merger agreement.
110
114
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized.
Date: March 26, 2001
First International Bancorp, Inc.
By: /s/ Brett N. Silvers
--------------------------------
Brett N. Silvers
Chief Executive Officer
Pursuant to the requirements of the Securities Act of 1934, this report has been
signed below by the following persons on behalf of the registrant and in the
capacities and on the dates indicated:
Signature Title Date
--------- ----- ----
/s/ Brett N. Silvers
- ---------------------------------
Brett N. Silvers Director and March 26, 2001
Chief Executive Officer
/s/ Michael R. Carter
- ---------------------------------
Michael R. Carter Director March 26, 2001
/s/ Arnold L. Chase
- ---------------------------------
Arnold L. Chase Director March 26, 2001
/s/ Cheryl A. Chase
- ---------------------------------
Cheryl A. Chase Director March 26, 2001
/s/ Frank P. Longobardi
- ---------------------------------
Frank P. Longobardi Director March 26, 2001
/s/ Leslie A. Galbraith
- ---------------------------------
Leslie A. Galbraith Executive Vice President and
Secretary March 26, 2001
/s/ Shaun P. Williams
- ---------------------------------
Shaun P. Williams Executive Vice President, Chief March 26, 2001
Financial Officer and Treasurer
111