UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10K - ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (Mark One) [X] Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended December 31, 2000 [ ] Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to Commission file number (0-26663) IPSWICH BANCSHARES, INC. (Exact name of registrant as specified in its charter) Massachusetts 04-3459169 (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification No.) 23 Market Street Ipswich, Massachusetts 01938 (Address of principal executive offices) (Zip Code) Registrant's telephone number, including area code: (978) 356-7777 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: Name of each exchange on which registered: Common Stock, $0.10 par value NASDAQ National Market 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 of 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 [ ]. The aggregate market value of the voting stock held by nonaffiliates of the registrant, as of March 5, 2001, was $16,526,706. Although directors and executive officers of the registrant and its subsidiaries were assumed to be "affiliates" of the registrant for the purposes of this calculation, this classification is not to be interpreted as an admission of such status. The number of shares outstanding of the Company's common stock, as of March 5, 2001, was 2,038,902. DOCUMENTS INCORPORATED BY REFERENCE Information called for by Part III (Items 10, 11, 12 and 13) of this Form is incorporated by reference from the Company's definitive proxy statement (the "Proxy Statement") relating to the Annual Meeting of Stockholders of the Company to be held on April 25, 2001. FORWARD-LOOKING STATEMENTS This Financial Release contains certain statements that are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Although Ipswich Bancshares, Inc. believes that its expectations are based upon reasonable assumptions within the bounds of its knowledge of its business operations, there can be no assurance that actual results will not differ materially from those projected in the forward-looking statements. Certain factors that might cause such difference include, but are not limited to, the factors set forth in the Corporation's filings with the Securities and Exchange Commission, which include, among other factors, changes in general economic conditions, credit risk management, changes in interest rates, regulatory issues and changes in the assumptions used in making such forward-looking statements. Certain factors that may cause such differences include, but are not limited to the following: interest rates may increase, unemployment in the Company's market area may increase, property values may decline, and general economic and market conditions in the Company's market area may decline, all of which could adversely affect the ability of borrowers to re-pay loans; general economic and market conditions in the Company's market area may decline, the value of real estate securing payment of loans may decline and the Company's ability to make profitable loans may be impacted; adverse legislation or regulatory requirements may be adopted; and competitive pressure among depository institutions may increase. Any of the above may also result in lower interest income, increased loan losses, additional charge-offs and write-downs and higher operating expenses. The Company disclaims any intent or obligation to update publicly any of the forward looking statements herein, whether in response to new information, future events or otherwise. PART I - ------ ITEM 1 BUSINESS GENERAL Ipswich Bancshares, Inc. (the Company) is a Massachusetts corporation whose primary business is serving as the holding company for Ipswich Savings Bank (the Bank). On July 1, 1999, in connection with the formation of the Company as the holding company for the Bank, each share of the Bank's common stock previously outstanding was converted automatically into one share of common stock of the Company, and the Bank became a wholly owned subsidiary of the Company. The reorganization had no impact on the consolidated financial statements. The Company operates out of its main office located at 23 Market Street, Ipswich, Essex County, Massachusetts, and its seven full-service retail branch offices, located in Beverly, Essex, Marblehead, North Andover, Rowley, Reading and Salem, Massachusetts. The Company operates automatic teller machines at its main office and each of its full-service retail branch offices. As a bank holding company, the Company is subject to regulation, supervision and examination by the Board of Governors of the Federal Reserve (FRB) and the Bank is subject to regulation, supervision and examination by the Federal Deposit Insurance Corporation (the FDIC) and the Massachusetts Commissioner of Banks (the Commissioner). The Company's principal business is attracting deposits from the general public and using such deposits to fund its residential mortgage banking and commercial banking functions. The Company also performs residential mortgage loan servicing. The Bank is a member of the FDIC and deposits are insured by the Bank Insurance Fund to the fullest extent authorized by law (generally $100,000 per depositor). All deposits in excess of FDIC limits are insured by the Depositors Insurance Fund. At December 31, 2000, the Company had total assets of approximately $288 million, gross loans of $203 million, total deposits of $237 million, stockholders' equity of $15 million and a regulatory Tier 1 leverage capital ratio of 5.04%. Net income for 2000 was $2.7 million or $1.10 per fully diluted share. In 2000, the Company undertook a stock repurchase plan and repurchased 454,000 shares at a weighted average price of $8.93. Shares outstanding at December 31, 2000 were 2,071,552. 2 LENDING ACTIVITIES General. At December 31, 2000, the Company's loan portfolio, including net deferred costs and unearned discounts, totaled $203.1 million, representing 70.6% of its total assets. The Company's loan portfolio increased by $9.8 million or 5.1% primarily from originations of home equity lines of credit. The principal categories of loans in the Company's portfolio are residential real estate loans secured by 1-4 family residences; residential owner-occupied construction loans; home equity loans; commercial lines of credit; commercial real estate loans, which are primarily secured by multi-family residential, retail, office and industrial properties; and consumer loans. Substantially all of the mortgage loans in the Company's loan portfolio are secured by properties located in areas north and west of Boston, Massachusetts. See "Item 8 - Note 5 of Notes to Consolidated Financial Statements". Residential Mortgage Loans. Residential mortgage loans totaled $162.7 million representing 80.5% of the loan portfolio at December 31, 2000 substantially unchanged from December 31, 1999. The Company originates both long term fixed-rate and adjustable-rate residential real estate loans, secured by 1-4 family residences, through its mortgage lending function. The Company's mortgage operations are designed to provide consistent and ongoing earnings. These loans are offered on both a fixed and adjustable-rate basis, depending largely on the level of interest rates and consumer demand. In 2000, the Company originated approximately $55.2 million in residential mortgage loans, consisting of $21.1 million of fixed and $34.1 million of adjustable-rate mortgage loans. The Company sold approximately $25.3 million in fixed-rate loans in the secondary market. The mortgage division underwrites and originates loans for its own portfolio as well as for sale in the secondary market to the Federal National Mortgage Association (FNMA), the Federal Home Loan Mortgage Corporation (FHLMC) and institutional secondary market investors. The Company also originates "B" and "C" rated loans which may not be saleable in the secondary market due to the borrower's inability to meet certain underwriting criteria. The Company has established guidelines on the amount loaned to a single borrower and the percentage of the loan portfolio that these loans may comprise. The maximum loan-to-value is typically 80%. At December 31, 2000, the Company held $3.3 million of B and C rated loans. Residential Owner-Occupied Construction Loans. Residential owner-occupied construction loans totaled $1.4 million or 0.7% of total loans at December 31, 2000. The Company makes construction loans to prospective owner-occupants of single family homes. These loans require interest-only payments until completion of construction or the disbursement of the maximum allowed under the terms of the loan, whichever occurs first, at which time the loan automatically converts to a permanent, fully-amortizing, adjustable-rate loan that has a fixed-rate conversion feature. The Company's standard underwriting guidelines are used to evaluate loans that are made for amounts not exceeding 90% of the lesser of the projected appraised value of the property upon completion of construction or the cost of construction (including the purchase price of the land). Private mortgage insurance is required for all loans that exceed 80% of the lower of cost or appraised value. The Company requires borrowers to submit plans and specifications for the home, along with an executed contract with a licensed contractor. Scheduled progress payments are made only after inspections and periodic title updates are completed. Home Equity Loans. At December 31, 2000 home equity loans totaled $31.2 million or 15.4% of total loans. This was an increase of $7.8 million or 33.5% in 2000. A home equity loan may be made as a term loan or as a revolving line of credit and is typically secured by a second mortgage on the borrower's home. The Company will typically originate home equity loans in an amount up to 90% of the appraised value of the home, less any loans outstanding that are secured by the home. The Company originated $18.1 million in home equity loans in 2000, written at an introductory rate of 5.99% for the first six months, and repricing thereafter at the Prime Rate for the remaining term of the loan if the line is greater than $25,000 (Prime +1% for lines less than $25,000). These loans have a maximum life of twenty (20) years. 3 Commercial/Commercial Real Estate Loans. Commercial and commercial real estate loans totaled $5.7 million at December 31, 2000 or 2.8% of total loans. The Company offers commercial banking services to small businesses in its immediate market area. The Company has targeted small businesses with working capital needs and commercial real estate loans under $600,000 as potential customers. The Company has established underwriting criteria to limit its exposure to risk from one particular industry or borrower concentration. The current portfolio of commercial and commercial real estate loans are primarily secured by mixed-use commercial properties, multi-family residential properties, commercial and industrial buildings, land and several churches. The Company has a small portfolio of commercial lines of credit. These loans traditionally carry higher credit risk than residential loans. As a result, the Company assigns a higher allocation percentage of the allowance for loan losses to commercial real estate and industrial loans than to other types of loans in the portfolio. Consumer Loans. Consumer loans were $1.3 million or 0.6% of the loan portfolio at December 31, 2000. The Company makes loans for personal or consumer purposes. The Company's consumer loans consist of passbook, credit card, installment and overdraft protection loans. Loan and OREO Concentrations. There were no loans or OREO concentrations that exceeded 5% of capital, or $755,950, at December 31, 2000. Origination and Sale of Loans. Applications for residential mortgage loans are obtained through loan originators employed by the Company who solicit residential mortgage loan applications. There were five loan originators employed by the Company at December 31, 2000. These representatives, who are compensated primarily by commission, provide origination services during banking and non-banking hours at the Company or applicant's location. Residential mortgage loan applications come from referrals from real estate brokers and builders, existing customers, walk-in customers, and advertising. Commercial loans are obtained through solicitation made by a commercial officer employed by the Bank. Consumer loan applications are primarily obtained from existing and walk-in customers who have been made aware of the Company's programs by advertising and other means. All mortgage loans must be approved by an Officer Credit Committee and exceptions to policy as well as commercial loans by the Executive Committee of the Board of Directors. The Company's residential mortgage loans are generally originated on terms, conditions and documentation that permit their sale to the FHLMC, FNMA or other institutional investors in the secondary market. Loan sales in the secondary market provide additional funds for new residential lending. The Company's strategy involves originating both fixed and adjustable-rate residential mortgage loans. The decision to retain loans in portfolio or to sell them in the secondary market is dependent upon the Company's liquidity and market factors. Loan Fee Income. In addition to interest earned on loans, the Company receives income from fees in connection with late payments, prepayments or modifications and miscellaneous services related to its loans. Income from these activities varies from period to period with the volume and types of loans made, size of servicing portfolio, amounts of prepayments in the servicing portfolio and other factors. The Company recognizes on its balance sheet the estimated value of the rights to service mortgages it originates and sells in the secondary market on a servicing retained basis. The asset created is amortized on a level yield method over the estimated life of the underlying loans under which the asset was created. On a quarterly basis, the Company estimates the fair value of the unamortized asset and adjusts the recorded amount to the lower of unamortized cost or fair value through a valuation allowance charged to loan servicing fee income. The Company can recover any allowance amount if the fair value increases in subsequent periods. The servicing rights recognized in 2000 and 1999 were $229,000 and $1.2 million, respectively. The Company's mortgage servicing rights at December 31, 2000 was $225,000 for which the Company determined no valuation allowance was necessary. The Company carried no mortgage servicing rights at December 31, 1999. 4 Loan Servicing. Typically, the Company originates loans for sale in the secondary market, for which it may retain the servicing. Under its loan servicing agreements, the Company generally continues to collect payments on loans, to make certain insurance and tax advances on behalf of borrowers, and to provide other services related to the loans. The principal balance of the loans serviced by the Company for secondary market investors amounted to $11.1 million, and $0 at December 31, 2000 and 1999, respectively. The Company completed a sale of mortgage servicing rights in the fourth quarter of 1999. The Company sold the rights to service approximately $90 million in FNMA loans in 1999 as a method of managing the Company's exposure to future declines in interest rates. A gain of $63,000 was recognized as a result of the sales in 1999. Net loan servicing (expense) income amounted to $(2,000), $21,000 and $(341,000), for 2000, 1999 and 1998, respectively. The Company realizes the value of the servicing as a component of the sales of mortgage loans. The Company experienced a decline in net loan servicing income in 2000 as a result of the sale in 1999 of its servicing rights. In 1998, the Company recognized a total charge of $337,000 against servicing income as a result of the decline in the value of its servicing rights. The decrease in the value of its servicing rights in 1998 was due to the decline in interest rates during the year, which precipitated higher than normal prepayments. The value of servicing decreases as market interest rates decline which necessitates the Company recording the decline in value through a charge to the income statement and the establishment of a reserve. The Company booked an additional reserve of $141,000 in 1998 prior to completion of the servicing sale. The reserve was eliminated as a result of the servicing sale in the fourth quarter of 1998. Allowance for Loan Losses. The allowance for loan losses is established by management to absorb future charge-offs of loans deemed uncollectible. This allowance is increased by provisions charged to operating expense and by recoveries on loans previously charged off. The Company recorded provisions for loan losses of $60,000 in 2000, $100,000 in 1999 and $180,000 in 1998. In evaluating current information and events regarding borrowers' ability to repay their obligations, management considers commercial loans over $200,000 to be impaired when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the note agreement; other loans are evaluated collectively for impairment. When a loan is considered to be impaired, the amount of the impairment is measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or the fair value of collateral if the loan is collateral dependent. Impairment losses are included in the allowance for loan losses through a charge to the provision for loan losses. The Company sets the level of its allowance for loan losses based on a number of factors. Management uses available information (such as current economic conditions, levels of nonperforming loans, delinquency trends and collateral values) to assess the adequacy of the allowance and to determine future additions to the allowance. The process involves substantial uncertainties; ultimate losses may vary from current estimates. Management believes that the allowance for loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on judgments different from those of management. See "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Provision for Loan Losses," and "Item 8 - Note 6 of Notes to Consolidated Financial Statements". 5 The Company sets the level of its allowance for loan losses based on a number of factors. An individual analysis of all delinquent loans, as well as internally classified loans, is conducted and specific allowances are allocated for those loans that are determined to have certain weaknesses that make ultimate collectibility of both principal and interest questionable. In conjunction with its review, management considers external factors that may affect the adequacy of the allowance for loan losses. Such factors may include, but are not limited to, present real estate trends and regional economic conditions, past estimates of loan losses as compared to actual losses, potential problems with larger loans, loan concentrations and historical losses on loans. Management and the Executive Committee of the Board of Directors assess the amount of the allowance for loan losses monthly. The Board of Directors reviews a detailed assessment on at least a quarterly basis. INVESTMENT SECURITIES The Company invests in debt and equity securities, subject to restrictions imposed by federal and state law. The Company's securities portfolio is managed in accordance with a written investment policy adopted by the Board of Directors. The investment portfolio is a source of earnings in the form of interest and dividends; provides for diversification; and is a source of liquidity. Investments may be made by the President of the Company within specified limits and types. Transactions exceeding these limits must be approved in advance by the Executive Committee. All securities transactions are approved by the Board of Directors after execution of the transaction. At December 31, 2000, the Company maintained an investment portfolio comprised of adjustable-rate (ARM) and fixed-rate mortgage-backed securities (MBS), U.S. Government Agency callable debentures, trust preferred securities and equity securities totaling $64.5 million or 22.4% of assets. The Company has managed its investment portfolio with the intent of maintaining adequate liquidity and maximizing yields. The Company has categorized $10.7 million of MBS's, $16.4 million of U.S. Government Agency debentures and $3.2 million of trust preferred securities as held to maturity, carried at amortized cost, and $31.4 million of MBS's, $2.0 million U.S. Government Agency callable debentures and $822,000 of equity securities as available for sale, carried at market value. As of December 31, 2000, the Company has a net unrealized appreciation, net of taxes, of $473,000. This amount is reported as accumulated other comprehensive income within stockholders' equity. The aggregate market value of the investment portfolio at December 31, 2000 was $64.6 million. At December 31, 2000, the Company's portfolio of mortgage-backed securities was comprised of one-year adjustable-rate instruments and fixed rate mortgage-backed securities scheduled to mature after 2013. Due to amortization and prepayments of the underlying loans, the actual maturities of the ARM and fixed-rate mortgage-backed securities are typically less than the scheduled maturities. The rates on the ARM securities are indexed to the one year Constant Maturity Treasury (CMT) with annual period caps of 2% and life caps ranging from 9.03% to 13.96%. The margins over the one year CMT ranged from 1.95% to 2.63%. The portfolio of U.S. Government Agency callable debentures in both held to maturity and available for sale totaled $18.4 million with call dates ranging from a ten day notice to November 2002 and maturity dates scheduled after 2003. The portfolio of trust preferred debentures totaled $3.2 million with call dates between 2006 and 2007 and maturity dates scheduled after 2025. At December 31, 2000 and 1999, investments in the securities of any one issuer (excluding investments in securities of the U.S. government and federal agencies and stock in the Federal Home Loan Bank of Boston (the FHLB) did not exceed more than 5% of the Company's stockholders' equity. See "Item 8 - Notes 1 and 3 of Notes to Consolidated Financial Statements". 6 SOURCES OF FUNDS Deposits. Deposits obtained through retail banking offices have been the principal source of the Company's funds for use in lending and for other general business purposes. The Company's deposit products include passbook savings and club accounts, personal and commercial demand accounts, NOW accounts, money market deposit accounts and certificates of deposit ranging in term from three to 60 months. The Company also offers Individual Retirement Account deposits among these products. Total deposits amounted to $237.2 million at December 31, 2000. The Company's deposits are obtained primarily from residents of and businesses located in Ipswich, Rowley, North Andover, Beverly, Salem, Marblehead, Reading and Essex, Massachusetts. The Company attracts deposit accounts primarily by offering a wide variety of services and accounts, competitive interest rates, and convenient office locations and service hours. The Company prices its products competitively within its market area. The Company has no brokered deposits. In recent years, the Company has focused on providing customers with deposit products that meet their liquidity preferences. As a result, the Company has promoted certain deposit products, such as its checking account and money market account, which resulted in an increase in total deposits of $27.2 million or 12.9% during 2000. Total demand deposits, NOW accounts, money market deposit accounts and savings deposits totaled $163.3 million or 68.9% of total deposits at December 31, 2000, which represented a $20.1 million or 14.0% increase from 1999 levels of $143.3 million or 68.2% of total deposits. The ability of the Company to attract and retain deposits and the cost to the Company of these deposits have been, and will continue to be, significantly affected by economic and competitive conditions. See "Item 8 - Note 11 of Notes to Consolidated Financial Statements". Borrowings. The Company is a member of the FHLB of Boston, one of 12 regional Federal Home Loan Banks in the Federal Home Loan Bank System. The Federal Home Loan Banks provide a central credit facility primarily for member institutions. A member of the FHLB of Boston is required to hold shares of common stock in the FHLB of Boston. At December 31, 2000, the Company held $3.0 million of FHLB of Boston stock. At December 31, 2000, there were $32.1 million in borrowings outstanding at the FHLB of Boston and $45.0 million at December 31, 1999. The Company has a total borrowing capacity with the FHLB of Boston of $104.2 million at December 31, 2000, which would require the purchase of additional FHLB of Boston stock, if fully utilized. See "Item 8 - Note 12 of Notes to Consolidated Financial Statements". NON-DEPOSIT INVESTMENT SALES The Company has a contract with Linsco Private Ledger Financial Services (LPL) to offer non-deposit investment products. Through this arrangement, LPL and the Company employ an investment consultant to offer investment products to customers. LPL provides marketing support and retains compliance supervision of the program. 7 COMPETITION The Company's deposit gathering activities are concentrated in Ipswich, Rowley, North Andover, Beverly, Salem, Marblehead, Reading and Essex, Massachusetts. The Company's residential loan origination activities are concentrated in Essex and Middlesex Counties in Massachusetts and Southern New Hampshire. The Company faces strong competition for deposits from other savings banks, savings and loan associations, cooperative banks, credit unions and commercial banks located in its market area. The Company also competes for deposits with mutual funds and corporate and government securities. The Company competes for deposits principally by offering depositors a wide variety of deposit programs, automated teller machines, tax-deferred retirement programs and other services. It does not rely upon any individual, group or entity for a material portion of its deposits. Competition for residential real estate loans is strong and comes primarily from savings banks, mortgage banking companies, commercial banks, savings and loan associations, and other institutional lenders. The Company competes for loan originations primarily based on the interest rates and loan fees that it charges and the efficiency and quality of the services it provides. Competition for loans varies from time to time depending on general and local economic conditions, interest rate levels, and conditions in the mortgage market, among other factors. SUBSIDIARIES AND INVESTMENTS IN REAL ESTATE At December 31, 2000, Ipswich Bancshares, Inc. had one wholly-owned subsidiary, Ipswich Savings Bank. At December 31, 2000, the Bank had three subsidiaries; Ipswich Preferred Capital Corporation, Ipswich Securities Corporation, and North Shore Financial Services, Inc., all of which are Massachusetts corporations. Ipswich Preferred Capital Corporation (IPCC) was formed in 1999 as a Massachusetts business corporation which has elected to be taxed as a real estate investment trust for federal and Massachusetts tax purposes. IPCC is 99% owned by Ipswich Savings Bank. IPCC holds mortgage loans which were previously originated by the Bank. Ipswich Securities Corporation (ISC) was formed in 1995 to engage exclusively in the buying, selling and holding of securities on its own behalf as a subsidiary of the Bank. At December 31, 2000, ISC held a portfolio of fixed-rate and adjustable-rate mortgage-backed securities, U.S. Government Agency callable debentures and equity securities with total amortized cost of $38.2 million and an aggregate market value of $38.4 million. ISC also holds the title to a limited partnership interest in a mixed-income housing complex in Dorchester, Massachusetts. The book value of the partnership is $1. The investment qualifies for low income housing tax credits under the Internal Revenue Code. North Shore Financial Services, Inc. (NSFSI) (formerly known as North Shore Mortgage Company, Inc.) was formed in 1987 for the purpose of holding title to foreclosed properties. At December 31, 2000, NSFSI held title to two OREO properties with a carrying value totaling $2. The Company formed Ipswich Statutory Trust I in February 2001 for the exclusive purpose of issuing and selling Common Securities to the Company and Preferred Securities to the public. The proceeds were used to acquire 10.20% Junior Subordinated Deferrable Interest Debentures issued by the Company. See "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Capital Resources". The Company believes that its investments in the subsidiaries described above, and the activities and investments of those subsidiaries are permitted. 8 EMPLOYEES At December 31, 2000, the Company had 60 full-time employees and 38 part-time employees. The Company believes its employee relations are good. STOCKHOLDERS' EQUITY AND REGULATORY MATTERS General. The Company and the Bank are heavily regulated. As a bank holding company, Ipswich Bancshares, Inc. is supervised by the Board of Governors of the Federal Reserve Board System (the Federal Reserve Board) and it is also subject to the jurisdiction of the Massachusetts Board of Bank Incorporation. The activities of bank holding companies, such as the Company, that do not become financial holding companies under the recently enacted Gramm-Leach-Bliley Act (as discussed below) are limited to the business of banking and activities closely related or incidental to banking. Provided that it does not become a financial holding company, the Company may not directly or indirectly acquire the ownership or control of more than 5 percent of any class of voting shares or substantially all of the assets of any company that is not engaged in activities determined by the Federal Reserve Board prior to November 12, 1999 by order or regulation to be closely related to banking, and also generally must provide notice to or obtain the approval of the Federal Reserve Board in connection with any such acquisition. As a Massachusetts-chartered savings bank, the Bank is subject to regulation, examination and supervision by the FDIC and the Massachusetts Commissioner of Banks (the Commissioner). The Bank is also subject to certain requirements established by the Federal Reserve Board. Federal Deposit Insurance Corporation. The FDIC insures the Bank's deposit accounts up to the $100,000 maximum per separately insured account and is subject to reporting requirements of the FDIC. The FDIC has adopted requirements setting minimum standards for capital adequacy and imposing minimum leverage capital ratios. The Bank exceeded all applicable requirements at December 31, 2000. Furthermore, under the capital standards established pursuant to the FDIC Improvement Act of 1991, the Bank is currently well-capitalized. International bank supervisory organizations, principally the Basel Committee on Banking Supervision, currently are considering changes to the risk-based capital adequacy framework, which ultimately could affect the FDIC's guidelines regarding capital adequacy. For additional information on regulatory capital ratios, See "Note 14 to the Consolidated Financial Statements" and "Item 7 - Management's Discussion and Analysis - Financial Condition - Capital Resources". Massachusetts Commissioner of Banks and Board of Bank Incorporation. Massachusetts statutes and regulations govern, among other things, investment powers, lending powers, deposit activities, maintenance of surplus and reserve accounts, the distribution of earnings, the payment of dividends, issuance of capital stock, branching, acquisitions and mergers and consolidations. Any Massachusetts bank that does not operate in accordance with the regulations, policies and directives of the Commissioner may be subject to sanctions for noncompliance. The Commissioner may, under certain circumstances, suspend or remove officers or directors who have violated the law, conducted the Bank's business in a manner which is unsafe, unsound or contrary to the depositors' interest, or been negligent in their performance of their duties. In response to Massachusetts laws enacted in 1996, 1997 and 2000, the Commissioner finalized rules that generally give Massachusetts banks, and their subsidiaries, many powers equivalent to those of national banks. The Commissioner also has adopted regulations and procedures expediting the approval process for well-capitalized banks to establish branches or to engage in certain activities. 9 Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994. Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the Riegle-Neal), certain interstate transactions and activities are permitted. Interstate transactions and activities permitted for under the law include: (i) bank holding company acquisitions of separately held banks in a state other than a bank holding company's home state; (ii) mergers between banks with different home states, including consolidations of affiliated banks; (iii) establishment of interstate branches either de novo or by branch acquisition; and (iv) affiliate banks acting as agents for one another for certain banking functions without being considered a "branch". In general, subject to limitations, nationwide interstate acquisitions are now permissible, irrespective of related state law limitations other than limitations subject to deposit concentrations and bank age requirements. Interstate mergers are generally also permissible, and affiliated banks may act as agents for one another. Each of the transactions and activities must be approved by the appropriate federal bank regulator, with separate and specific criteria established for each category. In 1996, Massachusetts enacted interstate banking laws in response to the Riegle-Neal Act. The laws permit, subject to certain deposit and other limitations, interstate acquisitions, mergers and branching on a reciprocal basis. The Riegle-Neal Act has made it easier for out-of-state institutions to attempt to purchase or otherwise acquire a Massachusetts bank, or to compete with the Bank in Massachusetts, and similarly has made it easier for the Bank to compete outside the state. Gramm-Leach-Bliley Act of 1999. The general effect of the new law is to establish a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers by revising and expanding the Bank Holding Company Act framework to permit a holding company system, such as Ipswich Bancshares, Inc. to engage in a full range of financial activities through a new entity known as a "financial holding company." "Financial activities" is broadly defined to include not only banking, insurance, and securities activities, but also merchant banking and additional activities that the Federal Reserve Board, in consultation with the Secretary of the Treasury, determines to be financial in nature, incidental to such financial activities or complementary activities that do not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally. Generally, the Gramm-Leach-Bliley Act does the following: (i) repeals historical restrictions on, and eliminates many federal and state law barriers to, affiliations among banks, securities firms, insurance companies, and other financial service providers; (ii) provides a uniform framework for the functional regulation of the activities of banks, savings institutions, and their holding companies; (iii) broadens the activities that may be conducted by national banks (and derivatively, state banks), banking subsidiaries of bank holding companies, and their financial subsidiaries; (iv) provides an enhanced framework for protecting the privacy of consumer information; (v) adopts a number of provisions related to the capitalization, membership, corporate governance, and other measures designed to modernize the Federal Home Loan Bank system; (vi) modifies the laws governing the implementation of the Community Reinvestment Act of 1977; and (vii) addresses a variety of other legal and regulatory issues affecting both day-to-day operations and long-term activities of financial institutions. In order to engage in the new activities, a bank holding company, such as the Company, must meet certain tests and elect to become a financial holding company. Specifically, all of a bank holding company's banking subsidiaries must be well-capitalized and well-managed, as measured by regulatory guidelines, and all of the bank holding company's banks must have been rated "satisfactory" or better in their most recent CRA evaluation. Furthermore, a bank holding company that elects to be treated as a financial holding company may face significant consequences if its banks fail to maintain the required capital and management ratings, including entering into an agreement with the Federal Reserve Board that imposes limitations on its operations and may even require divestitures. Such possible ramifications may limit the ability of a bank subsidiary to significantly expand or acquire less than well-capitalized and well-managed institutions. At this time, the Company has not determined whether it will become a financial holding company. 10 Further, the Gramm-Leach-Bliley Act includes a new section of the Federal Deposit Insurance Act governing subsidiaries of state banks that engage in "activities as principal that would only be permissible" for a national bank to conduct in the financial subsidiary. The provision will permit state banks, to the extent permitted under state law, to engage in certain new activities which are permissible for subsidiaries of a financial holding company. Further, it expressly preserves the ability of a state bank to retain all existing subsidiaries. Massachusetts permits Massachusetts-chartered banks to engage in activities which are permissible for national banks and that are approved by the Commissioner. Thus, the Bank would only be permitted to engage in the activities authorized by the Gramm-Leach-Bliley Act that are also approved by the Commissioner or otherwise authorized by Massachusetts law. In order to form a financial subsidiary, a state bank must be well-capitalized, and the state bank would be subject to certain capital deduction, risk management and affiliate transaction rules which are applicable to national banks. ITEM 2 PROPERTIES At December 31, 2000, the Company conducted its business from its headquarters and main office at 21-23 Market Street, Ipswich, Massachusetts and seven branch offices. The Company owns its main office facilities on Market Street, and its branch office in Essex, Massachusetts, and leases branch office space in Rowley, North Andover, Salem, Marblehead, Reading and Beverly, Massachusetts. The Rowley lease runs through the year 2005, with two five-year renewal options thereafter. The Salem lease runs through the year 2005, with three five-year renewal options thereafter. The North Andover lease runs through the year 2004, with two five-year renewal options thereafter. The Beverly lease runs through the year 2001, with 5 five-year renewal options thereafter. The Marblehead lease runs through the Year 2003 with three five-year renewal options thereafter. The Reading lease runs through the Year 2003 with three five-year renewal options thereafter. The Company's properties that are not leased are owned free and clear of any mortgages. The Company also owns property at 25 Market Street, Ipswich, Massachusetts, which it leases to unrelated third parties. ITEM 3 LEGAL PROCEEDINGS The Company is not involved in any material legal proceedings other than ordinary routine litigation incidental to its business. ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS None. PART II - ------- ITEM 5 MARKET FOR THE BANK'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS Ipswich Bancshares, Inc. Common Stock is traded in the over-the-counter market and quoted on the NASDAQ National Market under the symbol "IPSW". On March 5, 2001, there were approximately 249 holders of record of the 2,038,902 shares of the Ipswich Bancshares, Inc. Common Stock outstanding. 11 The following table presents the quarterly high and low sales prices for the Company's Common Stock during the periods in 2000, and 1999, as reported by NASDAQ. The quotations represent high and low sales prices for the stock as reported by NASDAQ. SALES PRICE ------------------ DIVIDENDS Quarter-ending HIGH LOW DECLARED -------------- ---- --- -------- December 31, 2000 $9.625 $8.00 $.11 September 30, 2000 9.875 7.75 .10 June 30, 2000 10.00 7.50 .10 March 31, 2000 10.00 5.875 .10 December 31, 1999 12.875 8.25 .10 September 30, 1999 10.375 8.50 .05 June 30, 1999 11.00 9.75 .05 March 31, 1999 12.25 9.625 .05 Future dividends, if any, will be at the discretion of the Board of Directors based upon a variety of factors including earnings, financial condition, capital adequacy, general economic conditions and regulatory and legal restrictions. 12 ITEM 6 SELECTED FINANCIAL DATA IPSWICH BANCSHARES, INC. AND SUBSIDIARY At or for the Year Ended December 31, ------------------------------------------------------------ 2000 1999 1998 1997 1996 ---------- ---------- --------- --------- --------- (Dollars in thousands except for per share data) Balance Sheet Data: - ------------------ Total assets $ 287,834 $ 276,298 $ 271,328 $ 227,244 $ 158,942 Loans 203,137 193,327 188,991 165,453 121,025 Deposits 237,237 210,082 199,757 171,241 129,343 Stockholders' equity 15,119 16,975 14,223 11,833 9,851 Income Statement Data: - --------------------- Net interest income $ 8,935 $ 8,698 $ 7,461 $ 6,435 $ 5,073 Provision for loan losses 60 100 180 120 120 ---------- ---------- --------- --------- --------- Net interest income after provision for loan losses 8,875 8,598 7,281 6,315 4,953 Total non-interest income 1,736 2,925 2,437 1,700 1,520 Total non-interest expenses 6,819 6,910 5,596 4,476 4,049 ---------- ---------- --------- --------- --------- Pretax income 3,792 4,613 4,122 3,539 2,424 Income tax expense 1,137 1,324 1,484 1,327 632 ---------- ---------- --------- --------- --------- Net income $ 2,655 $ 3,289 $ 2,638 $ 2,212 $ 1,792 ========== ========== ========== ========= ========= Per Share Data: - -------------- Book value per share (1) $ 7.30 $ 6.72 $ 5.95 $ 4.96 $ 4.15 Basic earnings per share (1) 1.12 1.33 1.10 .93 .76 Diluted earnings per share (1) 1.10 1.29 1.03 .88 .73 Dividends per share (1) .41 .25 .17 .125 .10 Selected Operating Ratios: - ------------------------- Return on average stockholders' equity 15.79% 21.04% 20.09 20.38% 20.07% % Return on average assets .93 1.22 1.09 1.18 1.22 Gross interest margin 3.24 3.36 3.23 3.60 3.63 Operating expense to average assets 2.38 2.56 2.32 2.39 2.75 Dividends/net income 35.97 19.12 15.43 13.43 13.17 Shares outstanding (1) 2,071,552 2,525,427 2,392,286 2,385,076 1,187,811 Capital Ratios: - -------------- Average equity to average assets 5.99% 5.74% 5.37% 5.71% 6.04% Total risk-based capital ratio 11.53 14.38 11.70 10.81 12.01 Other Data: - ---------- Non-performing assets $ 229 $ 142 $ 1,186 $ 2,164 $ 3,213 Non-performing assets as a percent of .08% .05% .44% .95% 2.02% total assets Number of checking accounts 16,314 13,959 12,622 10,599 8,417 Number of employees 98 95 96 80 64 (1) Adjusted for 2 for 1 stock split effective August 27, 1997 13 ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS GENERAL The following discussion and analysis of financial condition and results of operations should be read in conjunction with the Consolidated Financial Statements and Notes thereto included in Item 8 of this Report. Certain Guide 3 information is included in Item 1 of this Report. FINANCIAL CONDITION General. Total assets increased by $11.5 million, or 4.2% to $287.8 million at December 31, 2000. The growth in total assets was primarily due to an increase of $9.8 million in total loans. Total assets at December 31, 1999 amounted to $276.3 million, an increase of $5.0 million, or 1.8%, from $271.3 million at December 31, 1998, resulting primarily from an increase in total loans of $4.3 million. Cash and Cash Equivalents. Cash and cash equivalents increased by $577,000 to $8.8 million at December 31, 2000, from the year end 1999 balance of $8.3 million. This was primarily a result of a decline in Federal funds sold of $1.7 million offset by required reserve balances kept at the Federal Reserve Bank of Boston and cash reserves held at the branches, which in total increased by $2.3 million in 2000. Investment Securities. Total investment securities decreased by $3.1 million or 4.5% during 2000, primarily from the sale of $5 million of U.S. Treasury bills and amortization of mortgage-backed securities offset by the purchase of $3.2 million of trust preferred securities. At December 31, 2000, the Company had identified $31.4 million in mortgage-backed securities as available for sale. The Company has also identified $2.0 million of callable debentures and $822,000 of equity securities as available for sale. The Company included net unrealized gains on investment securities available for sale, net of taxes, of $473,000 in accumulated other comprehensive income within stockholders' equity at December 31, 2000. The Company's portfolio of held to maturity securities consisted of $10.7 million of fixed-rate mortgage-backed securities, $16.4 million of callable securities and $3.2 million of trust preferred securities. See "Item 8 - Note 3 of Notes to Consolidated Financial Statements". The maturity distribution and weighted average coupon of investments in debt obligations at December 31, 2000 follows: One Five Over Within to Five to Ten Ten One Year Years Years Years Total -------- ------- ----- ----- ----- (Dollars in Thousands) Available for Sale (at market value) - ------------------------------------ Mortgage-backed securities: FNMA participation certificates $ - $ - $ - $ 27,804 $ 27,804 FHLMC participation certificates - - - 3,603 3,603 U.S. Government Agency obligations - - 1,999 - 1,999 ------ ----- ----- ------- ------- $ - $ - $1,999 $ 31,407 $ 33,406 ====== ===== ===== ======= ======= Weighted average coupon - % - % 7.17% 7.60% 7.57% 14 One Five Over Within to Five to Ten Ten One Year Years Years Years Total -------- ------- ----- ----- ----- (Dollars in Thousands) Held to Maturity (at amortized cost) - ------------------------------------ Mortgage-backed securities: FNMA participation certificates $ - $ - $ - $ 2,940 $ 2,940 FHLMC participation certificates - - - 4,377 4,377 GNMA participation certificates - - - 3,393 3,393 U.S. Government Agency obligations - 2,000 12,383 1,998 16,381 Trust preferred securities - - - 3,191 3,191 ----- ------ ------- -------- -------- $ - $2,000 $12,383 $ 15,899 $ 30,282 ===== ====== ======= ======== ======== Weighted average coupon - % 6.13% 7.04% 6.90% 6.93% The carrying value of investments in debt and equity obligations at December 31, follows: 2000 1999 1998 ---- ---- ---- (Dollars in Thousands) Available for Sale (at market value) - ------------------------------------ Mortgage-backed securities: FNMA participation certificates $27,804 $ 25,631 $ 12,990 FHLMC participation certificates 3,603 5,112 11,883 U.S. Treasury bills - 4,865 - U.S. Government Agency obligations 1,999 3,894 4,101 Marketable equity securities 822 - - ------ ------- ------- $34,228 $ 39,502 $ 28,974 ====== ======= ======= Held to Maturity (at amortized cost) - ------------------------------------ Mortgage-backed securities: FNMA participation certificates $ 2,940 $ 3,077 $ 1,980 FHLMC participation certificates 4,377 4,868 741 GNMA participation certificates 3,393 3,731 3,975 U.S. Government Agency obligations 16,381 16,393 3,500 Trust preferred securities 3,191 - - ------ ------- ------- $30,282 $ 28,069 $ 10,196 ====== ======= ======= Loans. Total gross loans increased by $9.4 million or 4.9% to $202.2 million at December 31, 2000. The growth was principally in home equity balances. Total residential real estate loans, which represent the largest component of the loan portfolio, increased by only $510,000 in 2000. Origination volume, which is sensitive to market rates, declined in 2000 resulting in limited growth opportunities. The Company's focus in 2000 was on originating variable rate home equity loans. As a result, outstanding home equity balances increased by $7.8 million or 33.5% in 2000. 15 Loan Portfolio and Maturity. The following table sets forth information concerning the Company's loan portfolio by type of loan at the dates indicated. At December 31, ------------------------------------------------------------------------------------------------- 2000 1999 1998 1997 1996 ----------------- ---------------- ----------------- ---------------- --------------- Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- (Dollars in Thousands) Mortgage Loans: Residential $162,680 80.5% $162,633 84.4% $160,153 84.9% $136,345 82.6% $ 94,384 78.2% Residential owner- occupied construction 1,353 0.7 890 0.5 1,412 0.7 2,638 1.6 4,568 3.8 Home equity 31,212 15.4 23,385 12.1 19,772 10.5 18,035 10.9 14,545 12.0 -------- ---- -------- ---- -------- ---- -------- ---- -------- ---- Subtotal 195,245 96.6 186,908 97.0 181,337 96.1 157,018 95.1 113,497 94.0 Commercial/commercial real estate 5,698 2.8 4,873 2.5 6,191 3.3 6,717 4.1 6,618 5.5 -------- ---- -------- ---- -------- ---- -------- ---- -------- ---- Commercial/mortgage loans, gross 200,943 99.4 191,781 99.5 187,528 99.4 163,735 99.2 120,115 99.5 Consumer loans 1,302 0.6 1,060 0.5 1,188 0.6 1,255 0.8 630 0.5 -------- ---- -------- ---- -------- ---- -------- ---- -------- ---- Gross loans 202,245 100.0% 192,841 100.0% 188,716 100.0% 164,990 100.0% 120,745 100.0% Plus deferred loan origination costs 987 586 378 606 427 Less unearned discount (95) (100) (103) (143) (147) -------- -------- -------- -------- -------- Loans, net of deferred cost and unearned discount 203,137 193,327 188,991 165,453 121,025 Less allowance for loan losses (1,803) (1,798) (1,742) (1,673) (1,548) -------- -------- -------- -------- -------- Loans, net $201,334 $191,529 $187,249 $163,780 $119,477 ======== ======== ======== ======== ======== The following table sets forth residential owner-occupied construction and commercial and commercial real estate loans by maturity date as of December 31, 2000: Residential Owner-Occupied Commercial/ Construction Loans Commercial Real Estate Loans ------------------ ---------------------------- Amount Percentage Amount Percentage ------ ---------- ------ ---------- (Dollars in Thousands) Within one year $1,353 100.0% $ 799 14.0% One to five years - - 1,478 25.9 Over five years - - 3,421 60.1 ------ ----- ------ ----- Total $1,353 100.0% $5,698 100.0% ====== ===== ====== ===== 16 Commercial real estate loans with maturity dates over one year: Amount ------ (Dollars in thousands) Fixed interest rate $2,191 Adjustable interest rate 2,203 ------ Total $4,354 ====== The following table sets forth information concerning mortgage and commercial loans originated, sold, repaid, charged-off and transferred during the periods indicated. Year Ended December 31, ----------------------------------- 2000 1999 1998 -------- -------- --------- (Dollars in Thousands) Beginning balance $191,781 $187,528 $ 163,735 Mortgage and commercial loan originations: Residential 54,450 94,954 192,195 Residential owner-occupied construction 772 1,394 1,673 Commercial 1,526 - - Home equity 18,086 15,339 17,311 ------- ------- -------- Total mortgage and commercial loan originations 74,834 111,687 211,179 Loans held for sale at January 1 - 24,000 8,031 Conventional loan sales: Servicing retained 9,787 67,101 84,216 Servicing released 15,477 16,444 26,700 Amortization, payoffs, charge-offs, unadvanced funds 34,821 38,831 60,501 Securitized and transferred to investment portfolio 584 8,996 - Transfers to OREO - 62 - Transfers to loans held for sale 5,003 - 24,000 ------- ------- -------- Total loan sales, amortization, payoffs, charge-offs, transfers, and unadvanced funds 65,672 131,434 195,417 ------- ------- -------- Ending balance $200,943 $191,781 $ 187,528 ======= ======= ======== Residential loan originations totaled $55.2 million in 2000, $96.3 million in 1999 and $193.9 million in 1998. It should be noted that these originations are not fully reflected in loan balances outstanding due to the securitization, regular amortization and prepayments of residential real estate loans as well as refinancings and the sale of a portion of new loan production. As mentioned above, the originations of residential loans are sensitive to market interest rates and 1998 experienced extremely high levels of refinancings. The majority of the Company's residential loans are underwritten to be eligible for sale in the secondary market. The Company sells most of the eligible 30-year fixed rate loans it originates. A loan which the Company intends to sell may be sold directly or converted into mortgage-backed securities and sold in that form. Residential loans sold directly amounted to $15.5 million in 2000, $16.4 million in 1999 and $26.7 million in 1998. Those sold in the form of mortgage-backed securities held for sale or available for sale totaled $9.8 million, $67.1 million and $84.2 million, respectively, in 2000, 1999 and 1998. The portfolio of residential mortgage loans serviced for others totaled $11.1 million at December 31, 2000, compared to $0 at December 31, 1999 and $18.8 million at December 31, 1998. 17 Allowance for Loan Losses. The following table summarizes changes in the allowance for loan losses and certain ratios for the periods indicated. At December 31, ----------------------------------------------------------- 2000 1999 1998 1997 1996 --------- --------- -------- -------- -------- (Dollars in Thousands) Average loans (1) $ 201,011 $ 200,265 $190,072 $142,512 $108,805 ========= ========= ======== ======== ======== Period-end loans (2) $ 203,137 $ 193,327 $188,991 $165,453 $121,025 ========= ========= ======== ======== ======== Allowance for loan losses at beginning of period $ 1,798 $ 1,742 $ 1,673 $ 1,548 $ 2,154 Loans charged-off: Commercial - - - - 736 Residential real estate - 4 42 7 8 Home equity and other consumer 86 77 89 24 1 --------- --------- -------- -------- -------- 86 81 131 31 745 Loan recoveries: Commercial - - - - 14 Residential real estate - 3 3 33 5 Home equity and other consumer 31 34 17 3 - --------- --------- -------- -------- -------- 31 37 20 36 19 --------- --------- -------- -------- -------- Net charge-offs/(recoveries) 55 44 111 (5) 726 Provision charged to operations 60 100 180 120 120 --------- --------- -------- -------- -------- Allowance for loan losses at end of period $ 1,803 $ 1,798 $ 1,742 $ 1,673 $ 1,548 ========= ========= ======== ======== ======== Selected Ratios: - --------------- Allowance for loan losses to period-end loans, 0.89% 0.93% 0.92% 1.01% 1.28% net Net charge-offs/(recoveries) to average loans 0.03% 0.02% 0.06% - % 0.67% Net charge-offs/(recoveries) to allowance for loan losses 3.05% 2.45% 6.37% (0.30)% 46.90% Allowance as a percentage of non-performing loans 787.34% 5800.00% 372.22% 176.11% 92.14% (1) Includes loans held for sale (2) Represents net loans, excluding loans held for sale 18 The allowance for loan losses as a percentage of total loans remained stable at .89% at December 31, 2000 down marginally from .93% at December 31, 1999 and .92% at December 31, 1998. Management analyzes the adequacy of the allowance for loan losses on a quarterly basis. See "Item 7 - Results of Operations - Provision for Loan Losses". Management measures the adequacy of its allowance for loan losses by assigning loans into risk categories based on a loan classification system modeled after the bank regulatory classification system. While management believes that its allowance for loan losses is adequate to cover possible losses, there are uncertainties regarding future events. Deterioration in the real estate market or economy may result in additions to nonaccruing loans, charge-offs or provisions for loan losses to maintain an adequate allowance. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses. Such agencies may require the Company to provide additions to the allowance based on their judgments about information available to them at the time of their examination. Allocation of the allowance for loan losses to the various categories of the portfolio is also made periodically, based on management's judgment in weighing various factors, including the quality of specified loans, the level of nonaccruing loans in the various categories, current economic conditions, trends in delinquencies and prior charge-offs, and the collateral value of the underlying security. Because the allowance for loan losses is based on various estimates, including loan collectibility and real estate values, and includes a high degree of judgment, subsequent changes in the general economic prospects of the borrowers may require changes in those estimates. Allocation of the Allowance for Loan Losses. The allocation of the allowance for loan losses at December 31, and the percent of loans in each category to total loans, follows: At December 31, ------------------------------------------------------------------------------------------ 2000 1999 1998 1997 1996 ---------------- ---------------- --------------- --------------- --------------- Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent ------ ----- ------ ----- ------ ----- ------ ----- ------ ------ (Dollars in Thousands) Commercial/commercial real estate $ 158 2.8% $ 151 2.5% $ 215 3.3% $ 217 4.1% $ 291 5.5% Residential real estate 976 81.2 1,065 84.9 1,030 85.6 1,014 84.2 929 82.0 Home equity and other consumer 669 16.0 582 12.6 497 11.1 442 11.7 328 12.5 ------ ----- ------ ----- ------ ----- ------ ----- ------ ------ $1,803 100.0% $1,798 100.0% $1,742 100.0% $1,673 100.0% $1,548 100.00% ====== ===== ====== ===== ====== ===== ====== ===== ====== ====== Notwithstanding the foregoing allocations, the entire allowance for loan losses is available to absorb charge-offs in any category of loans. Deposits. Deposits ended the year at $237.2 million, an increase of $27.2 million or 12.9% over the year-end 1999 balance of $210.1 million. The increase was most pronounced in demand deposit accounts and NOW accounts which increased by $15.0 million in 2000. In addition, certificates of deposit increased by $7.1 million and money markets by $3.2 million. The increase in checking account balances resulted from customers acquired from institutions affected by mergers in the Company's market area. 19 The following table shows the distribution of the Company's deposits at December 31, 2000 1999 1998 ------------------------------ ----------------------------- ------------------------------- Weighted Weighted Weighted % of Average % of Average % of Average ---- ------- ---- ------- ---- ------- Amounts Deposits Rate Amounts Deposits Rate Amounts Deposits Rate ------- -------- ------ ------- -------- ------ ------- -------- ------ (Dollars in Thousands) Demand deposits $ 22,855 9.6% .00% $ 15,209 7.2% .00% $ 18,656 9.3% .00% Savings: Savings 39,531 16.7 2.26 37,704 17.9 2.31 37,768 18.9 2.38 NOW accounts 34,871 14.7 .83 27,481 13.1 .76 22,954 11.5 .92 Money markets 66,083 27.9 5.04 62,859 30.0 4.49 55,418 27.8 4.63 -------- ----- ---- -------- ----- ---- -------- ----- ---- Total demand and savings 163,340 68.9 2.76 143,253 68.2 2.75 134,796 67.5 2.73 Certificates of deposit 73,897 31.1 5.93 66,829 31.8 5.09 64,961 32.5 5.34 -------- ----- ---- -------- ----- ---- -------- ----- ---- Total deposits $237,237 100.0% 3.75% $210,082 100.0% 3.40% $199,757 100.0% 3.58% ======== ===== ==== ======== ===== ==== ======== ===== ==== Deposits of $100,000 or more totaled approximately $77.6 and $72.6 million at December 31, 2000 and 1999, respectively. The following table presents, by various rate categories, the amount of certificate of deposit accounts and the periods to maturity of the certificate accounts outstanding at the dates indicated: At December 31, 2000 At December 31, ------------------------------------ ----------------------------- Maturing Maturing Maturing 2000 1999 1998 Within 1 Year 1-3 Years Thereafter Total Total Total ------------- --------- ---------- ----- ----- ----- (Dollars In Thousands) Certificate accounts: 4.00% to 4.99% $ 1,994 $ 502 $- $ 2,496 $26,993 $ 19,381 5.00% to 5.99% 32,213 2,953 23 35,189 30,677 39,891 6.00% to 6.99% 16,968 7,310 409 24,687 8,178 5,189 7.00% to 7.99% 7,441 2,576 1,508 11,525 981 500 ------- ------ ----- ------ ------ ------- Total $ 58,616 $13,341 $1,940 $73,897 $66,829 $ 64,961 ======= ====== ===== ====== ====== ======= Certificates at or over $100,000 totaled $16.9 million in 108 certificates at December 31, 2000 and $11.2 million in 86 certificates at December 31, 1999. The maturity distribution of certificates of deposit in amounts of $100,000 or more at December 31, 2000 follows: Amount ------ (Dollars in Thousands) Within 3 months $ 3,264 3 to 6 months 4,679 6 to 12 months 5,742 After one year 3,200 ------- $16,885 ======= 20 Borrowings. The Company borrows from the FHLB of Boston to support liquidity and manage its asset/liability position. Borrowings decreased to $32.1 million, a decrease of $12.9 million in 2000 from the year-end 1999 balance of $45 million. The Company relies on borrowed funds as an alternative funding source in order to support earning assets. The weighted average rate on borrowings was 6.60% at December 31, 2000 versus 5.75% at December 31, 1999. The weighted average maturity of the borrowings at December 31, 2000 was twenty months versus five months at December 31, 1999. Short term market interest rates increased substantially in 2000 which significantly impacted the Company's borrowings. In response, the Company paid off a portion of its borrowings and extended the maturities on its remaining funding. This resulted in an increase of 85 basis points in the cost of its borrowed funds in 2000. NON-PERFORMING ASSETS General. Non-performing assets stood at $229,000 at December 31, 2000 and $142,000 at the end of 1999. Non-performing Loans. When a loan is originated, interest on the loan is accrued (i.e., recognized as income) on a regular periodic basis even if the loan payment has not yet been received. The recording of interest income on problem loan accounts generally ceases when the loans become 90 days past due and the loans are not in the process of collection. It is also the policy of the Company to classify as non-accrual, loans less than 90 days delinquent and loans performing in accordance with their terms, if in management's judgment such loans are likely to present future principal or interest repayment problems and could ultimately be classified as non-performing. There were no loans on non-performing status at December 31, 2000 and 1999 that were considered troubled debt restructurings. The following table sets forth information regarding delinquent loans and other non-performing assets held by the Company at the dates indicated. The Company had $170,000 in loans greater than 90 days past due and still accruing at December 31, 2000. These loans were not classified as non-performing loans. At December 31, -------------------------------------------- 2000 1999 1998 1997 1996 ---- ---- ---- ---- ---- (Dollars in Thousands) Delinquent loans 30-89 days past due (not included in non-performing loans) $ 575 $ 250 $ 194 $1,218 $ 827 Delinquent loans 90+ days past due (not included in non-performing loans) 170 650 442 3 292 ----- ---- ----- ----- ----- $ 745 $ 900 $ 636 $1,221 $1,119 ===== ==== ===== ===== ===== Delinquent loans as a percent of gross loans .37% .47% .34% .74% .92% ===== ===== ====== ====== ====== 21 At December 31, -------------------------------------------- 2000 1999 1998 1997 1996 ---- ---- ---- ---- ---- (Dollars in Thousands) Non-performing loans: Loans accounted for on a non-accrual basis $ 229 $ 31 $ 468 $ 358 $ 337 Restructured loans - - - 592 1,343 ----- ---- ----- ----- ----- Total non-performing loans 229 31 468 950 1,680 OREO, net of allowance for OREO losses - 111 718 1,214 1,533 ----- ---- ----- ----- ----- Total non-performing assets $ 229 $ 142 $1,186 $2,164 $3,213 ===== ==== ===== ===== ===== Non-performing assets as a percent of total assets .08% .05% .44% .95% 2.02% ===== ===== ====== ====== ====== See "Item 8 - Notes 1 and 5 of Notes to Consolidated Financial Statements". Potential Non-performing Loans. In addition to non-performing loans, at December 31, 2000, the Company had classified an additional $889,074 of performing loans as "substandard" based on an internal rating system used by the Company. These substandard loans evidence one or more weaknesses or potential weaknesses related to repayment history, the borrower's financial condition, adequacy of collateral, or other factors. Depending on the local economy and other factors, these loans, as well as other performing loans not so classified, may become non-performing in the future. These loans were primarily commercial real estate loans. OREO. The following table sets forth the types of properties which comprised the Company's OREO portfolio at the dates shown. The Company held two properties on December 31, 2000 located in Essex County, Massachusetts currently carried at $1 each. At December 31, --------------------------------- 2000 1999 1998 ----- ---- ---- (Dollars in Thousands) Land $- $ - $669 Commercial - 49 49 Residential 1-4 family - 62 - ----- ---- ---- OREO $ - $111 $718 ===== ==== ==== RESULTS OF OPERATIONS General. The Company's results of operations depend primarily on its net interest income and the efficiency of the Company's operations. The Company's net income is affected by its costs of operations, including non-interest expenses such as salaries and employee benefits, occupancy costs, non-performing loans and other classified assets. For the year ended December 31, 2000, the Company reported net income of $2.7 million, or $1.10 per fully diluted share ($1.12 basic), compared to $3.3 million or $1.29 per fully diluted share ($1.33 basic) for 1999 and $2.6 million or $1.03 per fully diluted share ($1.10 basic) for 1998. The Company's return on average stockholders' equity decreased from 21.04% in 1999 to 15.79% in 2000. The Company's financial performance in 2000 was significantly impacted by the rise in market interest rates which substantially impacted the Company's net interest margin and revenues from mortgage banking. 22 The Company's financial performance in 1999 and 1998 was positively impacted by favorable interest rates and mortgage originations which translates into mortgage banking revenues. Net Interest and Dividend Income. Net interest and dividend income was $8.9 million in 2000, $8.7 million in 1999 and $7.5 million in 1998. Net interest income increased $237,000 in 2000, $1.2 million during 1999 and $1.0 million during 1998, primarily due to higher average earning asset volumes in each of the years. Market interest rates have been fairly volatile over the past several years. During 2000, market interest rates rose throughout the year. The Company was substantially impacted by the rates paid on deposits and borrowings during 2000, the effect of which narrowed the interest rate spread to 2.77% and the gross interest margin to 3.24% in 2000. Average earning assets increased 6.6% in 2000 to $275.7 million and increased 12.1% during 1999 to $258.7 million over the previous year, respectively. The increase in each of the two years was primarily due to higher investment portfolio growth. The volatility in the interest rates has also impacted the yields earned on the investment portfolio. The yields earned on investment securities increased 51 basis points in 2000 to 6.75% as compared to 6.24% in 1999 and 6.29% in 1998. Total average loans increased $746,000 during 2000 primarily due to reduced originations and increased by $10.2 million in 1999 principally from residential loan originations. The yield on real estate loans increased 26 basis points in 2000 to 7.41% while decreasing 17 basis points during 1999 to 7.15%. The largest component of the yield on real estate loans was residential loans. The rate paid on interest-bearing deposits increased 42 basis points in 2000 to 4.04% and decreased 40 basis points during 1999 to 3.62%. Core deposits, which include NOW, savings and money market accounts, typically have rates lower than those paid on certificates of deposit. However, to grow the core deposit balances, the Company has offered promotional rates on certain products. While the Company reduced the rates in 1998 in connection with a decline in market interest rates, the impact of the rate reduction was felt in 1999. The balances maintained in NOW accounts have increased in both 2000 and 1999 while the rates on this product have remained fairly stable during that same time period. Certificate of deposit average balances increased $5.8 million and $1.3 million, respectively, during 2000 and 1999. The Company has decreased its reliance on borrowed funds as an alternative source of funds to deposits. During 2000, the average balance of borrowed funds declined $3.6 million while the rate paid increased 95 basis points. In 1999, the average balance of borrowed funds increased $6.9 million while the rate paid decreased 31 basis points. The combination of the factors mentioned above contributed to a 19 basis point decrease to 2.77% in the interest rate spread in 2000 and a 17 basis point increase in the interest rate spread to 2.96% during 1999. The gross interest margin on earnings assets was 3.24% for the year ended December 31, 2000 and 3.36% and 3.23%, respectively, for 1999 and 1998. Interest Income and Interest Expense. The following table sets forth, for the periods indicated, information based on average monthly balances during the periods indicated regarding (i) the total dollar amount of interest income from interest-earning assets and the resultant average yields; (ii) the total dollar amount of interest expense on interest-bearing liabilities and the resultant average costs; (iii) net interest income; (iv) interest rate spread; and (v) gross interest margin. Non-accrual loan balances have been included in the appropriate category; however, only interest actually paid on such loans has been included in interest income. 23 Year Ended December 31, ----------------------------------------------------------------------------------------- 2000 1999 1998 ------------------------------ --------------------------- -------------------------- Interest Interest Interest Average Earned/ Average Average Earned/ Average Average Earned/ Average Balance Paid Yield Balance Paid Yield Balance Paid Yield ------- ---- ----- ------- ---- ----- ------- ---- ----- (Dollars in Thousands) Interest-earning assets: Loans: Residential (1) $168,804 $12,036 7.13% $172,407 $12,170 7.06% $163,660 $11,784 7.20% Commercial 5,106 444 8.70 5,490 477 8.69 6,487 557 8.59 Home equity 26,098 2,299 8.81 21,251 1,561 7.35 18,807 1,464 7.78 Consumer 1,003 109 10.87 1,117 105 9.40 1,118 102 9.12 -------- ------- -------- ------- -------- ------- Total loans 201,011 14,888 7.41 200,265 14,313 7.15 190,072 13,907 7.32 Investments (2) 74,710 5,041 6.75 58,397 3,642 6.24 40,577 2,551 6.29 -------- ------- -------- ------- -------- ------- Total interest- Earning assets 275,721 19,929 7.23 258,662 17,955 6.94 230,649 16,458 7.14 Cash and due from banks 6,483 6,247 6,447 Other assets 2,963 4,248 4,303 -------- -------- -------- Total assets $285,167 $269,157 $241,399 ======== ======== ======== Interest-bearing liabilities: Savings deposits NOW accounts $37,936 879 2.32% $35,987 868 2.41% $37,005 937 2.53% Money market 28,399 233 .82 23,787 176 .74 19,343 203 1.05 deposit accounts 63,477 3,055 4.81 58,115 2,441 4.20 44,165 2,030 4.60 Certificates of deposit 69,436 3,885 5.60 63,608 3,091 4.86 62,346 3,372 5.41 -------- ------- -------- ------- -------- ------- Total interest- bearing deposits 99,248 8,052 4.04 181,497 6,576 3.62 162,859 6,542 4.02 Borrowed funds 47,413 2,942 6.21 50,995 2,681 5.26 44,100 2,455 5.57 ------- ------- ------- ------ ------- ------- Total interest- bearing liabilities 246,661 10,994 4.46 232,492 9,257 3.98 206,959 8,997 4.35 Demand deposits 18,624 18,048 18,207 Other liabilities 2,808 3,154 3,263 ------- ------- ------- Total liabilities 268,093 253,694 228,429 Stockholders' equity 17,074 15,463 12,970 ------ ------ ------ Total liabilities and Stockholders' equity $285,167 $269,157 $241,399 ======== ======== ======== Net interest income $ 8,935 $ 8,698 $ 7,461 ======= ======= ======= Interest rate spread 2.77% 2.96% 2.79% Gross interest margin 3.24% 3.36% 3.23% (1) Residential loans include portfolio loans and loans held for sale. (2) Includes Federal funds sold. 24 The following table presents the changes in interest and dividend income and the changes in interest expense attributable to changes in interest rates or changes in the volume of interest-earning assets and interest-bearing liabilities for the periods indicated. Changes which are attributable to both rate and volume have been allocated to changes due to volume. 2000 vs. 1999 1999 vs. 1998 Changes Due to Changes Due to Increased (Decreased) Increased (Decreased) ------------------------ ------------------------- Rate Volume Total Rate Volume Total ---- ------ ----- ---- ------ ----- (Dollars in Thousands) Interest income: Loans $ 520 $ 55 $ 575 $(322) $ 728 $ 406 Mortgage-backed securities 263 463 726 46 803 849 Short-term investments 8 134 142 (22) 73 51 Investment securities 27 504 531 (31) 222 191 ----- ----- ----- ---- ----- ------ Total 818 1,156 1,974 (329) 1,826 1,497 Interest expense: Deposits 759 717 1,476 (641) 675 34 Borrowed funds 483 (222) 261 (136) 362 226 ----- ----- ----- ---- ----- ------ Total 1,242 495 1,737 (777) 1,037 260 ----- ----- ----- ---- ----- ------ Net interest and dividend income $ (424) $ 661 $ 237 $ 448 $ 789 $ 1,237 ===== ===== ===== ==== ===== ====== Provision for Loan Losses. The provision for loan losses in 2000 was $60,000, a decrease of $40,000 or 40.0% from 1999 as growth of the loan portfolio slowed and asset quality improved in 2000. The ratio of the allowance for loan losses to non-performing loans was 787.3% at December 31, 2000, and 5,800.0% at December 31, 1999. For 2000, net loan charge-offs against the allowance for loan losses amounted to $55,000. See "Item 7 - Financial Condition - Allowance for Loan Losses". The provision for loan losses in 1999 was $100,000, a decrease of $80,000 or 44.4% from 1998 principally as a result of a moderation of growth in the loan portfolio. The ratio of the allowance for loan losses to non-performing loans was 5,800.0% at December 31, 1999, and 372.2% at December 31, 1998. For 1999, net loan charge-offs against the allowance for loan losses amounted to $44,000. See "Item 7 - Financial Condition - Allowance for Loan Losses". The amount of provision for loan losses that the Company records is predicated on several factors including asset quality, growth in the loan portfolio and market and economic conditions. The level of provisions recorded in 1999 through 2000 reflect the fact that the composition of the portfolio is primarily residential mortgages which carry a lower risk than commercial and commercial real estate. Levels of non-performing loans have also decreased. The decrease in the provision in 2000 is reflective of slower growth in the loan portfolio and continued strong asset quality. Future provisions will be dictated by the ongoing quality of the portfolio and economic conditions that may impact the loan portfolio. Loan loss provisions may be substantially increased if conditions dictate. Increases in the allowance for loan losses or reductions in the carrying values of non-performing assets could be required by regulatory agencies as a result of their examinations. The Bank was most recently examined by the Massachusetts Commissioner of Banks in the first quarter of 2000. The Company was most recently examined by the Federal Reserve Bank in the third quarter of 2000. 25 Non-interest Income. The company recorded income from non-interest sources of $1.7 million in 2000, $2.9 million in 1999 and $2.4 million in 1998. The decrease of $1.2 million in 2000 resulted from a decline of $1.2 million in mortgage banking gains. The increase in 1999 was primarily due to $308,000 in added deposit account fees. Deposit account fees totaled $1.7 million, $1.5 million and $1.2 million in 2000, 1999 and 1998, respectively, and was derived primarily from customer service charges and fees. Loan late charges and other fees decreased during 2000 by $90,000 to $127,000, while increasing by $13,000 in 1999 to $217,000. The majority of the increase in deposit fee income in each of the two years is due to increased debit card income and overdraft income. As customers increasingly use debit cards or non-customers use the Company's multiple ATM's, overall fee income has increased. Non-interest Expense. Non-interest expenses decreased $91,000 or 1.3% to $6.8 million in 2000 while increasing $1.3 million or 23.5% to $6.9 million in 1999. The decrease in 2000 was primarily due to the decline in professional fees. The increase in 1999 reflects the opening of two branches in mid-1998, which fully impacted expenses in 1999. Salaries and employee benefits, the largest component of non-interest expense, decreased $20,000 to $3.2 million in 2000 and increased $673,000 in 1999 to $3.2 million. The increase in 1999 was primarily due to increased costs from the branch openings. Office occupancy and equipment decreased $2,000 to $914,000 in 2000 and increased $219,000 in 1999 to $916,000. The increase in 1999 was primarily due to increased costs to operate branch locations. Data processing expenses totaled $924,000 in 2000, $798,000 in 1999 and $691,000 in 1998. Data processing expenses increased $126,000 in 2000 and $107,000 in 1999 due to a higher loan and deposit base, as well as the addition of internet banking. Professional fees, including corporate legal and accounting and auditing expenses, totaled $337,000 in 2000, $778,000 in 1999 and $248,000 in 1998. Professional fees decreased $441,000 in 2000 due to the one time expense in 1999 to form the holding company and REIT. Marketing expenses totaled $524,000 in 2000, $537,000 in 1999 and $632,000 in 1998. The Company expends considerable expense to generate loan and deposit customers. Other operating expenses totaled $859,000 in 2000, $921,000 in 1999 and $890,000 in 1998. Some of the cost savings in 2000 result from the continued focus on cost containment. The Company has experienced some savings in the area of corporate insurance. Federal and State Income Tax Expense. The Company recorded tax expenses of $1.1 million, $1.3 million and $1.5 million in 2000, 1999 and 1998, respectively, and realized effective tax rates of 30.0%, 28.7% and 36.0%, respectively. The income tax expense decrease of $187,000 in 2000 resulted from a reduction in the valuation allowance of $190,000 in 2000. Recognition of deferred tax assets and liabilities is based on the expected future tax consequences of temporary differences between the financial reporting and tax basis of the Company's assets and liabilities. Measurement of deferred tax assets and liabilities is based upon the provision of enacted tax laws and the effects of future changes in tax laws or rates. 26 ASSET AND LIABILITY MANAGEMENT The Company does not use static GAP analysis to manage its interest rate risk. It believes that simulation modeling more accurately encompasses the impact of changes in interest rates on the earnings of the Company over time. However, the Company prepares a GAP schedule to measure its static position. Our assumption is that NOW and DDA accounts, which generally are subject to immediate withdrawal, have effective maturities over five years. Premium savings accounts are assumed to have maturities of six to twelve months, while base rate savings accounts are assumed to have maturities over five years. Savings accounts are generally subject to immediate withdrawal. Money market accounts have an effective maturity up to five years. At December 31, 2000, the Company's cumulative gap with respect to assets and liabilities maturing or repricing within one year was a negative $9.5 million or 3.3% of total assets. During a period of rising interest rates, a negative gap would tend to adversely affect income while a positive gap would tend to result in an increase in income. During a period of falling interest rates, a negative gap would tend to result in an increase in net income while a positive gap would tend to adversely affect income. A principal focus has been the origination of prime interest rate-based home equity loans and the sale in the secondary market of the majority of fixed-rate loans originated. The home equity loans reprice to market rates as the prime rate, as published by the Wall Street Journal, fluctuates. These loans mature or reprice more quickly and are, therefore, more interest rate sensitive than long-term, fixed-rate, single family residential loans. The Company also maintains a significant portfolio of adjustable-rate mortgage-backed securities in its investment portfolio. 27 The following table summarizes the contractual maturities or assumed repricing of the Company's assets, liabilities and equity at December 31, 2000: Assets/Liabilities Maturing or Repricing at December 31, 2000 in: --------------------------------------------------------------------------------- 0-6 6-12 1-2 3-5 Over 5 Months Months Years Years Years Total --------- --------- --------- --------- ------ --------- (Dollars in Thousands) Assets: Residential ARM loans $ 16,841 $ 18,273 $ 21,364 $ 45,740 $ - $ 102,218 Residential fixed rate mortgage loans 4,335 4,208 7,583 17,845 28,736 62,707 Loans held for sale 5,003 - - - - 5,003 Home equity loans 30,968 8 11 57 168 31,212 Commercial loans 1,572 518 828 1,539 1,241 5,698 Consumer loans 382 121 21 35 743 1,302 Fixed MBS held-to-maturity 720 732 1,370 3,186 4,702 10,710 Callable debentures held-to-maturity 2,010 2,253 6,120 2,000 3,998 16,381 Corporate debt securities held-to-maturity - - - - 3,191 3,191 Fixed MBS available-for-sale 125 117 211 480 599 1,532 ARM MBS available-for-sale 17,975 11,116 - - 784 29,875 Callables debentures available-for-sale - - 1,999 - - 1,999 Equity securities 3,000 - - - 1,075 4,075 Cash and due from banks - - - - 8,836 8,836 Non-earnings assets - - - - 3,095 3,095 --------- --------- --------- --------- --------- --------- Total 82,931 37,346 39,507 70,882 57,168 287,834 Liabilities and equity capital: Interest bearing NOW accounts - - - - 34,871 34,871 Demand deposits - - - - 22,855 22,855 Savings - 8,559 - - 30,972 39,531 Money market deposits 35,413 9,087 10,790 10,793 - 66,083 Certificates of deposit 38,907 19,709 12,003 3,278 - 73,897 Borrowings 108 18,000 7,000 7,000 - 32,108 Other liabilities - - - - 3,370 3,370 Equity capital - - - - 15,119 15,119 --------- --------- --------- --------- --------- --------- Total 74,428 55,355 29,793 21,071 107,187 287,834 --------- --------- --------- --------- --------- --------- Excess (deficiency) of assets over liabilities and equity capital $ 8,503 $ (18,009) $ 9,714 $ 49,811 $ (50,019) $ - ========= ========= ========= ========= ========= ========= Cumulative Gap $ 8,503 $ (9,506) $ 208 $ 50,019 $ - $ - Cumulative assets as a % of cumulative liabilities and equity capital 111.42% 92.68% 100.13% 127.69% 100.00% Cumulative excess (deficiency) of assets over liabilities and equity capital as a % of total assets 2.95% (3.30)% 0.07% 17.38% 0.00% 28 LIQUIDITY The primary sources of funds for the Company are deposits, borrowings from the FHLB of Boston, the sale of loans, loan amortization, prepayments and maturities, and the sale of investments and mortgage-backed securities available for sale. Total deposits and FHLB borrowings increased by $14.3 million, or 5.6%, during 2000, and increased by $2.3 million, or 0.9%, during 1999. During 2000 and 1999, the Company used its sources of funds primarily to meet commitments to pay maturing certificates of deposit and savings withdrawals, to fund loan commitments and to purchase investment securities. At December 31, 2000 and 1999, approved loan commitments outstanding amounted to $3.4 million and $6.8 million, respectively. At the same dates, commitments of the Company to borrowers under unused lines of credit and home equity credit lines amounted to $36.9 million and $31.9 million, respectively, and the unadvanced portions of residential owner-occupied construction loans amounted to $484,000 and $573,000, respectively. The Company monitors its liquidity in accordance with guidelines established by its Asset/Liability and Investment Policies. Management believes that the Company currently has adequate liquidity available to meet operating needs. To meet unexpected demands, the Company has borrowing capabilities with the FHLB of Boston. At December 31, 2000, the total borrowing capacity was $104.2 million. See "Item 1 - Business - Source of Funds - Borrowings". CAPITAL RESOURCES The following table summarizes the Company's and Bank's required and actual regulatory capital ratios and amounts at December 31, 2000. The required ratios included in the table are the capital minimums for December 31, 2000, as required by FRB and FDIC regulations: Required Actual Excess ------------------- ------------------- -------------------- Amount Percent Amount Percent Amount Percent ------ ------- ------ ------- ------ ------- (Dollars in Thousands) Regulatory Tier 1 leverage capital ratio Company $11,614 4.0% $ 14,623 5.04% (1) $ 3,009 1.04% Bank 11,560 4.0 14,863 5.14 (1) 3,303 1.14 Risk-based: Tier 1 Company $ 5,688 4.0% $ 14,623 10.28%(2) $ 8,935 6.28% Bank 5,679 4.0 14,863 10.47 (2) 9,184 6.47 Total risk-based Company $11,377 8.0% $ 16,398 11.53% (2) $ 5,021 3.53% Bank 11,358 8.0 16,638 11.72 (2) 5,280 3.72 (1) Regulatory Tier 1 leverage capital differs from the ratio of stockholders' equity to total assets calculated in accordance with generally accepted accounting principles. Additionally, the Regulatory Tier 1 leverage capital calculation utilizes average assets for the fourth quarter of 2000, which were $290,356 and $289,011 for the Company and Bank, respectively. (2) Based upon total risk-based assets of $142,211 and $141,970 for the Company and Bank, respectively. In the first quarter of 2000, the Company announced a 10% stock repurchase plan and, subsequently, upon completion of the plan announced a second one in the third quarter of 2000. In total, the Company repurchased 454,000 shares in 2000 at a weighted average price of $8.93 per share. The stock repurchase plan was implemented in order to enhance shareholder value. 29 Ipswich Statutory Trust I (the Trust), a Connecticut statutory trust, was created in February 2001. The Trust exists for the exclusive purpose of (i) issuing and selling Common Securities to the Company and Preferred Securities to the public (together the "Trust Securities"), (ii) using the proceeds of the sale of Trust Securities to acquire 10.20% Junior Subordinated Deferrable Interest Debentures ("Junior Subordinated Debentures") issued by the Company, and (iii) engaging only in those other activities necessary, convenient or incidental thereto (such as registering the transfer of the Trust Securities). Accordingly, the Junior Subordinated Debentures will be the sole assets of the Trust. The preferred securities accrue and pay distributions semi-annually at an annual rate of 10.20% of the stated liquidation amount of $1,000 per preferred security. The Company has fully and unconditionally guaranteed all of the obligations of the Trust. The guaranty covers the semi-annual distributions and payments on liquidation or redemption of the trust preferred securities, but only to the extent of funds held by the Trust. In the first quarter of fiscal 2001, the Trust sold $3.5 million of its trust preferred securities to the public and $109,000 of its common securities to the Company. The trust preferred securities are mandatory redeemable upon the maturity of the Junior Subordinated Debentures on February 22, 2031 or upon earlier redemption as provided in the Indenture. The Company has the right to redeem the Junior Subordinated Debentures, in whole or in part on or after February 22, 2011 at a redemption price specified in the Indenture plus any accrued but unpaid interest to the redemption date. The costs will be amortized into operating expense over the life of the securities. The Company owns all of the common securities of the Trust, the only voting security, and as a result, the Trust is a subsidiary of the Company. For further information regarding the Company's capital resources, see "Item 1 - Business - Stockholders' Equity and Regulatory Matters". DIVIDENDS During 1995, the Company established a policy whereby the Board of Directors declares quarterly cash dividends, after a review of earnings, capital and asset quality trends. Dividends were initiated in the third quarter of 1995 by the declaration of a post-split $.005 dividend per common share. In total, the Company declared dividends of $955,000, $629,000 and $407,000 or $.41, $.25 and $.17 per share in 2000, 1999 and 1998, respectively. The declaration of future cash dividends will be subject to operating results, financial conditions, regulatory, tax considerations and other factors. In the third quarter of 1997, the common stock was split 2-for-1, effected by means of a stock dividend. This dividend was paid as a result of the Company's desire to increase the number of shares outstanding, in order to improve the trading liquidity of its shares. The number of shares outstanding at December 31, 2000 and 1999 was approximately 2.1 million and 2.5 million, respectively. IMPACT OF INFLATION AND CHANGING PRICES The Consolidated Financial Statements and related notes thereto presented in Item 8 of this Report 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. Unlike many industrial companies, most of the assets and virtually all of the liabilities of the Company are monetary in nature. As a result, interest rates have a more significant impact on the Company's performance than the general level of inflation. Over short periods of time, interest rates may not necessarily move in the same direction or in the same magnitude as the price of goods and services. 30 RECENT ACCOUNTING DEVELOPMENTS In September 2000, the FASB issued SFAS No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a replacement of FASB Statement 125. It revises the standards for accounting for securitizations and other transfers of financial assets and collateral and requires certain disclosures, but it carries over most of SFAS No. 125's provisions without reconsideration. This Statement provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. This Statement is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001. This Statement is effective for recognition and reclassification of collateral and for disclosures relating to securitization and collateral accepted need not be reported for periods ending on or before December 15, 2000. Disclosures about securitization and collateral accepted need not be reported for periods ending on or before December 15, 2000, for which financial statements are presented for comparative purposes. This Statement is to be applied prospectively with certain exceptions. Other than those exceptions, earlier or retroactive application of its accounting provisions is not permitted. The adoption of this statement did not have a significant effect on the Company's financial condition, liquidity or results of operation. ITEM 7A QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK The Company's success is dependent upon its ability to manage interest rate risk. Interest rate risk can be defined as the exposure of the Company's net interest income to adverse movements in interest rates. Although the Company manages other risks, such as credit and liquidity risk, in the normal course of its business, management considers interest rate risk to be its most significant market risk and could potentially have the largest material effect on the Company's financial condition and results of operations. Because the Company does not maintain a trading portfolio it is not exposed to significant market risk from trading activities. The Company's interest rate risk management is the responsibility of the Asset/Liability Management Committee (ALCO). ALCO establishes policies that monitor and coordinate the Company's sources, uses and pricing of funds. The committee is also involved in formulating the economic projections for the Company's budget and strategic plan. The Company continues to reduce the volatility of its net interest income by managing the relationship of interest-rate sensitive assets to interest-rate sensitive liabilities. In recent years, the focus has been to originate adjustable-rate residential loans for portfolio, which reprice or mature more quickly than fixed-rate residential loans. The Company's adjustable-rate loans are primarily tied to published indices, such as the one- year Constant Maturity Treasury (CMT). The Company utilizes a simulation model to analyze net interest income sensitivity to movements in interest rates. The simulation model projects net interest income based on both a rise or fall in interest rates (rate shock) over a twelve and twenty-four month period. The model is based on the actual maturity and repricing characteristics of interest-rate sensitive assets and liabilities. The model incorporates assumptions regarding the impact of changing interest rates on the prepayment rate of certain assets and liabilities. The assumptions are based on nationally published prepayment speeds on assets and liabilities when interest rates increase or decrease by 200 basis points or greater. The model factors in projections for anticipated activity levels by product lines offered by the Company. The simulation model also takes into account the Company's increased ability to control the rates on deposit products more so than adjustable-rate loans tied to published indices. Interest rate risk represents the sensitivity of earnings to changes in market interest rates. As interest rates change the interest income and expense streams associated with the Company's financial instruments also change, thereby impacting net interest income (NII), the primary component of the Company's earnings. ALCO utilizes the results of the simulation model and static GAP reports to quantify the estimated exposure of NII to sustained interest rate changes. 31 The following reflects the Company's NII sensitivity analysis as of December 31: Estimated Rate Change NII Sensitivity ----------- --------------- 2000 1999 ---- ---- +200bp (3.10)% (5.29)% -200bp (0.24)% 6.04% The preceding sensitivity analysis does not represent the Company's forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions including: the nature and timing of interest rate levels including yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment/replacement of asset and liability cash flows, and others. While assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances as to the predictive nature of these assumptions including how customer preferences or competitor influences might change. Also, as market conditions vary from those assumed in the sensitivity analysis, actual results will also differ due to: prepayment/refinancing levels likely deviating from those assumed, the varying impact of interest rate change caps or floors on adjustable-rate assets, the potential effect of changing debt service levels on customers with adjustable-rate loans, depositor early withdrawals and product preference changes, and other internal/external variables. Furthermore, the sensitivity analysis does not reflect actions that ALCO might take in responding to or anticipating changes in interest rates. 32 ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Independent Auditors' Report 34 Consolidated Balance Sheets 35 Consolidated Statements of Income 37 Consolidated Statements of Changes in Stockholders' Equity 39 Consolidated Statements of Cash Flows 41 Notes to Consolidated Financial Statements 44 33 INDEPENDENT AUDITORS' REPORT The Board of Directors Ipswich Bancshares, Inc. We have audited the accompanying consolidated balance sheets of Ipswich Bancshares, Inc. and Subsidiary (the Company) as of December 31, 2000 and 1999, and the related consolidated statements of income, changes in stockholders' equity and cash flows for each of the three years in the period ended December 31, 2000. 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 in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of Ipswich Bancshares, Inc. and Subsidiary at December 31, 2000 and 1999, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2000 in conformity with generally accepted accounting principles. Portland, Maine Limited Liability Company January 19, 2001 34 IPSWICH BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS December 31, 2000 and 1999 (Dollars in Thousands Except Per Share Data) ASSETS 2000 1999 --------- --------- Cash and due from banks (note 2) $ 8,836 $ 6,552 Interest-bearing deposits - 2 Federal funds sold (note 2) - 1,705 --------- --------- Total cash and cash equivalents 8,836 8,259 Investment securities available for sale, at market value; amortized cost of $33,452 and $39,485 (notes 3 and 12) 34,228 39,502 Investment securities held to maturity, at cost; market value of $30,374 and $27,061 (notes 3 and 12) 30,282 28,069 Loans held for sale (note 4) 5,003 - Loans (notes 5 and 12) 203,137 193,327 Allowance for loan losses (note 6) (1,803) (1,798) --------- --------- Net loans 201,334 191,529 Stock in Savings Bank Life Insurance Company 253 253 Stock in FHLB of Boston (notes 9 and 12) 3,000 3,977 Banking premises and equipment, net (note 7) 2,983 3,168 Other real estate owned (note 8) - 111 Accrued interest receivable 1,435 1,248 Mortgage servicing rights (note 10) 225 - Other assets 255 182 --------- --------- Total assets $ 287,834 $ 276,298 ========= ========= 35 LIABILITIES AND STOCKHOLDERS' EQUITY ------------------------------------ 2000 1999 --------- --------- Liabilities: Deposits (note 11) $ 237,237 $ 210,082 Borrowed funds (note 12) 32,108 45,000 Mortgagors' escrow accounts 972 993 Accrued expenses and other liabilities 1,726 2,731 Deferred income tax liability (note 13) 672 517 --------- --------- Total liabilities 272,715 259,323 Commitments and contingencies (notes 4, 7, 13 and 17) Stockholders' equity (notes 14 and 15): Serial preferred stock, $.10 par value per share; 1,000,000 shares authorized, none issued - - Common stock, $0.10 par value per share; 12,000,000 shares authorized, 2,525,552 and 2,525,427 shares issued 253 253 Additional paid-in capital 2,297 2,262 Retained earnings 16,150 14,450 Treasury stock at cost (454,000 shares) (4,054) - Accumulated other comprehensive income (note 3) 473 10 --------- --------- Total stockholders' equity 15,119 16,975 Total liabilities and stockholders' equity $ 287,834 $ 276,298 ========= ========= See accompanying notes. 36 IPSWICH BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 2000, 1999 and 1998 (Dollars in Thousands, Except Per Share Data) 2000 1999 1998 -------- -------- -------- Interest and dividend income: Loans $ 14,888 $ 14,313 $ 13,907 Federal funds sold and interest bearing deposits 328 187 136 Investment securities available for sale 2,822 2,233 1,108 Investment securities held to maturity 1,891 1,222 1,307 -------- -------- -------- Total interest and dividend income 19,929 17,955 16,458 Interest expense: Deposits (note 11) 8,052 6,576 6,542 Borrowed funds 2,942 2,681 2,455 -------- -------- -------- Total interest expense 10,994 9,257 8,997 -------- -------- -------- Net interest and dividend income 8,935 8,698 7,461 Provision for loan losses (note 6) 60 100 180 -------- -------- -------- Net interest and dividend income after provision for loan losses 8,875 8,598 7,281 Non-interest income: Net mortgage banking gains (losses) (note 4) (147) 1,030 1,466 Net gain (loss) on sale of mortgage servicing rights (note 10) 15 63 (196) Loan servicing (expenses) income, net (note 10) (2) 21 (341) Deposit account fees 1,701 1,504 1,196 Other loan fees 127 217 204 Gains on sales of securities available for sale, net (note 3) 33 78 93 Other 9 12 15 -------- -------- -------- Total non-interest income 1,736 2,925 2,437 -------- -------- -------- Net interest, dividend and non-interest income 10,611 11,523 9,718 37 IPSWICH BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME (CONTINUED) Years Ended December 31, 2000, 1999 and 1998 (Dollars in Thousands, Except Per Share Data) 2000 1999 1998 ------- ------- ------- Non-interest expenses: Salaries and employee benefits (note 15) $ 3,212 $ 3,232 $ 2,559 Occupancy and equipment expenses (note 7) 914 916 697 Data processing expenses 924 798 691 Professional fees 337 778 248 Advertising and marketing expenses 524 537 632 FDIC and DIF deposit insurance 52 36 27 OREO income, net (note 8) (3) (308) (148) Other 859 921 890 ------- ------- ------- Total non-interest expenses 6,819 6,910 5,596 ------- ------- ------- Income before income taxes 3,792 4,613 4,122 Income tax expense (note 13) 1,137 1,324 1,484 ------- ------- ------- Net income $ 2,655 $ 3,289 $ 2,638 ======= ======= ======= Basic earnings per share (notes 1 and 16) $ 1.12 $ 1.33 $ 1.10 Diluted earnings per share (notes 1 and 16) 1.10 1.29 1.03 Dividends per share .41 .25 .17 See accompanying notes. 38 IPSWICH BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Years Ended December 31, 2000, 1999 and 1998 (Dollars in Thousands Except Per Share Data) Accumulated Other Total Additional Compre- Stock- Shares Common Paid-in Retained Treasury hensive holders' Issued Stock Capital Earnings Stock Income Equity --------- --- ----- ------ --- --------- --------- Balance at December 31, 1997 2,385,076 $ 239 $ 1,969 $ 9,559 $- $ 66 $ 11,833 Stock options exercised 7,210 - 18 - - - 18 Issuance of stock rights - - 22 - - - 22 Cash dividends - - - (407) - - (407) Comprehensive income: Net income - - - 2,638 - - 2,638 Other comprehensive income: Unrealized holding gains on securities, net of taxes of $63 - - - - - - 93 Reclassification adjustment for amounts included in net income, net of taxes of $17 - - - - - - 26 --------- Other comprehensive income - - - - - 119 119 Total comprehensive income - - - - - - 2,757 --------- --- ----- ------ --- --------- --------- Balance at December 31, 1998 2,392,286 239 2,009 11,790 - 185 14,223 Stock options exercised 133,141 14 226 - - - 240 Issuance of stock rights - - 27 - - - 27 Cash dividends - - - (629) - - (629) Comprehensive income: Net income - - - 3,289 - - 3,289 Other comprehensive income: Unrealized holding losses on securities, net of taxes of $150 - - - - - - (223) Reclassification adjustment for amounts included in net income, net of taxes of $33 - - - - - - 48 -------- Other comprehensive income (loss) - - - - - (175) (175) Total comprehensive income - - - - - - 3,114 --------- --- ----- ------ --- --------- --------- Balance at December 31, 1999 2,525,427 253 2,262 14,450 - 10 16,975 39 IPSWICH BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (CONTINUED) Years Ended December 31, 2000, 1999 and 1998 (Dollars in Thousands Except Per Share Data) Accumulated Other Total Additional Compre- Stock- Shares Common Paid-in Retained Treasury hensive holders' Issued Stock Capital Earnings Stock Income Equity ------ ----- ------- -------- ----- ------ ------ Balance at December 31, 1999 2,525,427 $ 253 $ 2,262 $14,450 $ - $ 10 $16,975 Stock options exercised 125 - 1 - - - 1 Issuance of stock rights - - 34 - - - 34 Cash dividends - - - (955) - - (955) Treasury stock purchased (454,000 shares at an average price of $8.93) - - - - (4,054) - (4,054) Comprehensive income: Net income - - - 2,655 - - 2,655 Other comprehensive income: Unrealized holding gains on securities, net of taxes of $286 - - - - - - 446 Reclassification adjustment for amounts included in net income, net of taxes of $10 - - - - - - 17 ------- Other comprehensive income - - - - - 463 463 ------- Total comprehensive income - - - - - - 3,118 --------- ----- ------- ------- ------- ----- ------- Balance at December 31, 2000 2,525,552 $ 253 $ 2,297 $16,150 $(4,054) $ 473 $15,119 ========= ===== ======= ======= ======= ===== ======= See accompanying notes. 40 IPSWICH BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 2000, 1999 and 1998 (Dollars in Thousands) 2000 1999 1998 -------- ---------- -------- Net cash flows from operating activities: Net income $ 2,655 $ 3,289 $ 2,638 Adjustments to reconcile net income to net cash provided (used) by operating activities: Provision for loan losses 60 100 180 Deferred income tax (benefit) expense (141) 88 61 Depreciation expense 347 337 244 Amortization of premiums on investment securities, net 62 148 59 Losses (gains) on sale of loans 147 (1,030) (1,466) Gains on sales of investment securities available for sale (33) (78) (93) Loss (gains) on sale of other real estate owned 1 (340) (224) Origination of loans held for sale (30,299) (59,545) (134,915) Proceeds from sale of loans 15,410 16,620 28,872 Proceeds from sale of securitized loans 9,739 67,955 91,540 (Increase) decrease in net loan origination costs (401) (208) 228 Increase (decrease) on loan discounts 5 (3) (40) (Increase) decrease in mortgage servicing rights (225) 229 257 (Increase) decrease in accrued interest receivable (187) (195) 83 (Increase) decrease in other assets, net (73) 65 (85) (Decrease) increase in accrued expenses and other liabilities (1,005) (28) 52 -------- ---------- -------- Net cash provided (used) by operating activities (3,938) 27,404 (12,609) Net cash flows from investing activities: Purchase of investment securities available for sale (13,543) (19,490) (16,722) Principal paydowns on investment securities available for sale 10,148 12,722 8,390 Proceeds from the sale of investment securities available for sale 9,976 4,963 3,475 Purchase of investment securities held to maturity (3,191) (20,826) (4,008) Principal paydowns on investment securities held to maturity 976 2,964 10,498 Redemption (purchases) of stock in FHLB of Boston 977 (1,072) (861) Net increase in loans (10,044) (13,216) (23,837) Proceeds from sales of other real estate owned 110 1,009 720 Purchases of equipment, net (162) (207) (883) -------- ---------- -------- Net cash used in investing activities (4,753) (33,153) (23,228) 41 IPSWICH BANCSHARES, INC. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) Years Ended December 31, 2000, 1999 and 1998 (Dollars in Thousands) 2000 1999 1998 --------- --------- --------- Cash flows from financing activities: Net increase in deposits $ 27,155 $ 10,325 $ 28,516 Proceeds from Federal Home Loan Bank advances 66,008 120,000 96,012 Repayment of Federal Home Loan Bank advances (78,900) (128,000) (83,372) (Decrease) increase in mortgagors' escrow accounts (21) (50) 345 Proceeds from the issuance of common stock and stock rights 35 267 40 Cash dividends (955) (629) (407) Purchase of treasury stock (4,054) - - --------- --------- --------- Net cash provided by financing activities 9,268 1,913 41,134 --------- --------- --------- Net increase (decrease) in cash and cash equivalents 577 (3,836) 5,297 Cash and cash equivalents at beginning of year 8,259 12,095 6,798 --------- --------- --------- Cash and cash equivalents at end of year $ 8,836 $ 8,259 $ 12,095 ========= ========= ========= Supplemental disclosure of cash flow information: Cash paid for: Interest on deposit accounts $ 8,052 $ 6,576 $ 6,542 Interest on borrowed funds 2,904 2,711 2,412 Income tax 2,534 601 1,191 Supplemental schedule of non-cash investing and financing activities: Conversion of residential real estate loans to mortgage- backed securities $ 584 $ 8,996 $ - Transfer of investment securities held to maturity to investment securities available for sale (note 2) - - 10,698 Transfer of loans to other real estate owned - 62 - Net (decrease) increase required by Statement of Financial Accounting Standards No. 115: Investment securities 759 (292) 199 Deferred income tax liability 296 (117) 80 Net unrealized gain on investment securities available for sale 463 (175) 119 See accompanying notes. 42 (This page intentionally left blank) 43 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 1. Summary of Significant Accounting Policies (a) Business Ipswich Bancshares, Inc. (the Company) is a Massachusetts corporation whose primary business is serving as the holding company for Ipswich Savings Bank - d/b/a IpswichBank - (the Bank), a state chartered savings bank located in Ipswich, Massachusetts. On July 1, 1999, in connection with the formation of the Company as the holding company for the Bank, each share of the Bank's common stock previously outstanding was converted automatically into one share of common stock of the Company, and the Bank became a wholly owned subsidiary of the Company. The reorganization had no impact on the consolidated financial statements. The Company is subject to regulation by the Federal Reserve Board (the FRB). The Bank provides a variety of loan and deposit services to its customers through eight branch locations. The Bank is subject to competition from other financial institutions. The Bank is subject to the regulations of, and periodic examination by, the Federal Deposit Insurance Corporation (FDIC) and the Massachusetts Commissioner of Banks (the Commissioner) and to certain requirements established by the FRB. The Bank's deposits are insured by the Bank Insurance Fund of the FDIC to the fullest extent authorized by law (generally $100 per depositor). All deposits in excess of FDIC limits are insured by the Depositors Insurance Fund. (b) Basis of Presentation The consolidated financial statements include the accounts of Ipswich Bancshares, Inc. and its wholly-owned subsidiary, IpswichBank, and the Bank's subsidiaries; Ipswich Preferred Capital Corporation, Ipswich Securities Corporation, Historic Ipswich, Inc., North Shore Financial Services, Inc. and Rowley Investment Corporation (collectively hereinafter referred to as the Company). All significant intercompany accounts and transactions have been eliminated in consolidation. Ipswich Preferred Capital Corporation, 99%-owned by the Bank, was formed as a mortgage real estate investment trust to hold residential mortgages as a subsidiary of IpswichBank. Ipswich Securities Corporation was formed to exclusively transact in securities on its own behalf as a subsidiary of IpswichBank. Historic Ipswich, Inc. and North Shore Financial Services, Inc. were incorporated for the purpose of holding direct investments in real estate and foreclosed real estate, respectively. Rowley Investment Corporation was incorporated to facilitate the holding and permitting of certain bank-owned real estate. During 2000, the Company dissolved Historic Ipswich, Inc. and Rowley Investment Corporation. The consolidated financial statements have been prepared in conformity with generally accepted accounting principles. In preparing the financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ significantly from those estimates. 44 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 1. Summary of Significant Accounting Policies (Continued) ----------------------------------------------------- Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the allowance for loan losses, the valuation of real estate acquired by foreclosure and the valuation of mortgage servicing rights. A substantial portion of the Company's loans are secured by real estate in Essex County in Massachusetts. Accordingly, the ultimate collectibility of a substantial portion of the Company's loan portfolio is susceptible to changes in market conditions in its geographic area. (c) Investments Debt securities that the Company has the positive intent and ability to hold to maturity are classified as held to maturity and reported at amortized cost; and debt and equity securities not classified as held to maturity are classified as available for sale and reported at fair value, with unrealized gains and losses excluded from earnings and reported, net of tax, as accumulated other comprehensive income within stockholders' equity. Premiums and discounts are taken into income by a method the result of which approximates that of the level yield method. Realized gains or losses are computed using the specific identification method. When, in management's judgment, an other than temporary decline in the value of a security occurs, the carrying value of such security is written down to its fair value and the amount of the impairment is charged to earnings. (d) Loans Loan origination fees and certain direct loan origination costs are capitalized and recognized over the life of the related loan by use of the level yield method or recognized as an adjustment to the gain or loss when loans are sold. (e) Loans Held for Sale Mortgage loans held for sale are carried at the lower of aggregate cost or fair value, based upon commitments from investors to purchase such loans and upon prevailing market values. Net deferred loan origination fees are included in the fair value determination and are included in the determination of gains or losses on sales of mortgage loans. Interest income on loans held for sale is accrued and classified as interest income on loans. When loans are sold, a gain or loss is recognized to the extent that the sale proceeds exceed or are less than the carrying value of the loans, net of the value of servicing rights retained, using the specific identification method. 45 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 1. Summary of Significant Accounting Policies (Continued) ----------------------------------------------------- The Company periodically enters into commitments to sell mortgage loans to investors at a fixed price. The Company recognizes these commitments as derivatives. In June 1998, the FASB issued Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities. The Statement requires the Company to recognize all derivatives on the balance sheet at fair value. Derivatives that are not hedges must be adjusted to fair value through income. If the derivative is a hedge, depending on the nature of the hedge, changes in the fair value of derivatives are either offset against the change in fair value of assets, liabilities, or firm commitments through earnings or recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value will be immediately recognized in earnings. The adoption of SFAS No. 133 on October 1, 1998, did not have a material effect on the Company's operations. (f) Allowance for Loan Losses The allowance for loan losses is established by management to absorb future charge-offs of loans deemed uncollectible. This allowance is increased by provisions charged to operating expense and by recoveries on loans previously charged off. Management, in evaluating current information and events regarding the borrowers' ability to repay their obligations, considers commercial loans over $200 to be impaired when it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the note agreement; other loans are evaluated collectively for valuation. When a loan is considered to be impaired, the amount of the impairment is measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or the fair value of collateral if the loan is collateral dependent. Impairment losses are included in the allowance for loan losses through a charge to the provision for loan losses. The Company sets the level of its allowance for loan losses based on a number of factors. Management uses available information (such as current economic conditions, levels of nonperforming loans, delinquency trends and collateral values) to assess the adequacy of the allowance and to determine future additions to the allowance. The process involves substantial uncertainties; ultimate losses may vary from current estimates. Management believes that the allowance for loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on judgments different from those of management. See "Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations - Provision for Loan Losses," and "Item 8 - Note 6 of Notes to Consolidated Financial Statements". 46 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 1. Summary of Significant Accounting Policies (Continued) ----------------------------------------------------- (g) Mortgage Loan Servicing Mortgage servicing rights are amortized in proportion to, and over the period of, estimated net servicing revenues. Industry average prepayment rates are considered when estimating the lives of the mortgage servicing rights. Impairment of mortgage servicing rights is assessed based on the fair value of those rights. Fair values are periodically obtained from an independent servicing portfolio valuation. For purposes of measuring impairment, the rights are stratified based on the following predominant risk characteristics of the underlying loans: maturity term, interest rate and product type (fixed-rate, adjustable-rate, etc.). The amount of impairment recognized is the amount by which the capitalized mortgage servicing rights for a stratum exceed their fair value. (h) Banking Premises and Equipment Banking premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed on the straight-line method over the estimated useful lives of the assets or the term of the lease, if shorter. Maintenance and repairs are charged to current expense as incurred and the cost of major renewals and betterments are capitalized. (i) Other Real Estate Owned Other real estate owned includes those properties acquired through foreclosure or deed-in-lieu of foreclosure which are carried at the lower of fair value minus estimated costs to sell or cost. Costs relating to the development and improvement of property are capitalized, whereas those relating to holding the property are charged to expense. Gains on sales subsequent to foreclosure are recognized in operations when realized. (j) Investment in Real Estate Limited Partnerships Investments in real estate limited partnerships are accounted for on the equity method. They are included in other assets. (k) Accrual of Interest Income and Expense Interest on loans and investment securities is taken into income using methods which relate the income earned to the balances of loans and investment securities outstanding. The recording of interest income on problem loan accounts generally ceases when the loans become 90 days past due and are not in the process of collection. Cash receipts on impaired loans are applied to reduce the principal amount of such loans until the principal has been reduced to an amount deemed collectable. Restructured loans are returned to accrual status when the borrower has complied with the repayment terms of the loan for a period of six to eighteen months. Interest expense on liabilities is derived by applying applicable interest rates to principal amounts outstanding. 47 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 1. Summary of Significant Accounting Policies (Continued) ----------------------------------------------------- (l) Advertising Costs Advertising costs are expensed as they are incurred. (m) Incentive Compensation The Company has a Management Incentive Compensation Plan as a means of recognizing achievement on the part of its Senior Management and certain other officers of the Company. Incentive awards are determined according to a formula based upon the Company's return on average stockholders' equity in the calendar year, as compared with a group of peer banks, as well as the individual participant's performance. Awards are paid as a bonus calculated as a percentage of an individual officer's salary within the limitations of the plan. SFAS No. 123, Accounting for Stock-Based Compensation, encourages, but does not require, companies to recognize compensation expense for grants of common stock, stock options and other equity instruments to employees based upon the fair value of the instruments when issued. Companies electing not to recognize compensation expense are required to disclose what net income and earnings per share would have been if the expense were recognized. The Company elected to adopt the disclosure option of SFAS No. 123 rather than recognition of compensation expense. (n) Pension Plan Pension costs are funded as accrued. (o) Income Taxes The Company recognizes income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are established for the temporary differences between the accounting basis and the tax basis of the Company's assets and liabilities at enacted tax rates expected to be in effect when the amounts related to such temporary differences are realized or settled. The Company's deferred tax asset is reviewed and adjustments to such asset are recognized as deferred income tax expense or benefit based upon management's judgment relating to the realizability of such asset. (p) Other Comprehensive Income Accumulated other comprehensive income consists solely of unrealized appreciation on investment securities available for sale, net of taxes. 48 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 1. Summary of Significant Accounting Policies (Continued) ----------------------------------------------------- (q) Earnings per Share The computation of basic earnings per share is based on the weighted average number of shares of common stock outstanding during each period. The computation of diluted earnings per share is based on the weighted average number of shares of common stock outstanding and dilutive potential common stock equivalents outstanding during each period. Stock option grants are included only in periods when the results are dilutive. (r) Statement of Cash Flows For purposes of the statement of cash flows, cash and cash equivalents include cash, due from banks, interest-bearing deposits and federal funds sold. (s) Reclassification Certain amounts in the 1999 and 1998 financial statements have been reclassified to conform to 2000 presentation without effect on stockholders' equity or net income. 2. Federal Funds Sold, Reserve Requirements and Compensating Balance Agreements Federal funds sold at December 31, 2000 and 1999 were $0 and $1,705, respectively, stated at cost, which approximates market, and mature within one month. The Federal Reserve Board requires the Company to maintain a reserve balance; the amount of this reserve balance at December 31, 2000 was $1,999. The Company has arrangements with a third party for processing money orders and treasurers checks. The arrangement requires the maintenance of a compensating balance. At December 31, 2000, the Company was required to maintain a compensating balance of $263. 3. Investment Securities The Company adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, as of October 1, 1998. In conjunction with adopting this statement, the Company transferred $4,700 of mortgage-backed securities and $6,000 of U.S. Government Agency obligations from held to maturity to available for sale. 49 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 3. Investment Securities (Continued) Available for Sale The amortized cost and approximate market values of investment securities available for sale at December 31 are summarized as follows: 2000 ------------------------------------------------- Amortized Unrealized Unrealized Market Cost Gains Losses Value --------- --------- --------- -------- U.S. Government Agency obligations $ 2,000 $- $ (1) $ 1,999 Mortgage-backed securities 30,705 702 - 31,407 Marketable equity securities 747 75 - 822 ------- ----- ----- -------- $33,452 $ 777 $ (1) $ 34,228 ======= ===== ===== ======== 1999 ------------------------------------------------- Amortized Unrealized Unrealized Market Cost Gains Losses Value --------- --------- --------- -------- U.S. Treasury bills and U.S. Government Agency obligations $ 8,865 $ - $(106) $ 8,759 Mortgage-backed securities 30,620 217 (94) 30,743 ------- ----- ----- -------- $39,485 $ 217 $(200) $ 39,502 ======= ===== ===== ======== The following table sets forth the maturity distribution of investment securities available for sale at December 31. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. 2000 1999 ---------------------- ---------------------- Amortized Market Amortized Market Cost Value Cost Value ------- -------- ------- -------- Within one year $ - $ - $ 4,865 $ 4,865 Due after five years through ten years 2,000 1,999 4,000 3,894 Maturing after ten years: Mortgage-backed securities FNMA participation certificates 27,168 27,804 25,531 25,631 FHLMC participation certificates 3,537 3,603 5,089 5,112 ------- -------- ------- -------- $32,705 $ 33,406 $39,485 $ 39,502 ======= ======== ======= ======== 50 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 3. Investment Securities (Continued) Proceeds from sales of investment securities available for sale during 2000, 1999 and 1998 amounted to $9,976, $4,963 and $3,475, respectively. The realized gains and losses on investment securities available for sale, for each of the three years ended December 31, is as follows: 2000 1999 1998 ------------------- ------------------- -------------------- Realized Realized Realized Realized Realized Realized Gains Losses Gains Losses Gains Losses ----- ------ ----- ------ ----- ------ U.S. Treasury notes $ - $ (3) $ - $ - $ - $ - U.S. Government Agency obligations - - - - 63 - Mortgage-backed securities 5 (2) 49 - 16 (1) Marketable equity securities 37 (4) 29 - 15 - ----- ----- ---- ----- ----- ----- $ 42 $ (9) $ 78 $ - $ 94 $ (1) ===== ===== ==== ===== ===== ===== The Company had $217 of investment securities pledged for Treasury, Tax and Loan purposes to the FRB as of December 31, 2000. The following table summarizes the amounts of unrealized gains and losses on investment securities at December 31 which are included in accumulated other comprehensive income within stockholders' equity: 2000 1999 ------ ----- Net unrealized gain on available for sale securities $ 776 $ 17 Related income tax benefit (303) (7) ------ ----- $ 473 $ 10 ====== ===== Held to Maturity The amortized cost and approximate market values of investment securities held to maturity at December 31 are summarized as follows: 2000 --------------------------------------------------- Amortized Unrealized Unrealized Market Cost Gains Losses Value ------- ----- ----- -------- U.S. Government Agency obligations $16,381 $ 120 $ (94) $ 16,407 Mortgage-backed securities 10,710 67 (58) 10,719 Trust preferred debt securities 3,191 59 (2) 3,248 ------- ----- ----- -------- $30,282 $ 246 $(154) $ 30,374 ======= ===== ===== ======== 51 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 3. Investment Securities (Continued) 1999 --------------------------------------------------- Amortized Unrealized Unrealized Market Cost Gains Losses Value ------- --- ------- -------- U.S. Government Agency obligations $16,393 $ - $ (617) $ 15,776 Mortgage-backed securities 11,676 - (391) 11,285 ------- --- ------- -------- $28,069 $ - $(1,008) $ 27,061 ======= === ======= ======== The following table sets forth the maturity distribution of investment securities held to maturity at December 31. Actual maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties. 2000 1999 -------------------- ------------------- Amortized Market Amortized Market Cost Value Cost Value ------- ------- -------- ------- After one to five years $ 2,000 $ 1,993 $ 2,000 $ 1,935 After five to ten years 12,383 12,466 14,393 13,841 Maturing after ten years: Mortgage-backed securities: FNMA participation certificates 2,940 2,954 3,077 3,004 FHLMC participation certificates 4,377 4,429 4,868 4,796 GNMA participation certificates 3,393 3,336 3,731 3,485 FHLMC debt obligations 1,998 1,948 - - Trust preferred debt obligations 3,191 3,248 - - ------- ------- -------- ------- $30,282 $30,374 $ 28,069 $27,061 ======= ======= ======== ======= 4. Loans Held for Sale and Gains on Sales of Loans The following table summarizes the amortized cost and estimated market value of loans held for sale at December 31: 2000 1999 ------------------------- ------------------------- Estimated Estimated Amortized Market Amortized Market Cost Value Cost Value --------- --------- --------- --------- Loans held for sale $ 5,003 $ 5,003 $- $- 52 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 4. Loans Held for Sale and Gains on Sales of Loans (Continued) ---------------------------------------------------------- The realized gains and losses on mortgage loans sold for each of the three years ended December 31, is as follows: Net Realized Realized Gains Gains Losses (Losses) ------- -------- -------- 2000 $ 163 $ (310) $ (147) 1999 1,036 (6) 1,030 1998 1,474 (8) 1,466 Certain loans sold by the Company are subject to repurchase. In the event one of these loans becomes 60 days or more delinquent in the first six months, beginning with the first payment due the purchaser, the Company would be required to repurchase the loan. Total loans sold subject to repurchase were approximately $918, $5,096 and $0 at December 31, 2000, 1999 and 1998, respectively. 5. Loans The Company's lending activities are conducted principally in Essex and Middlesex Counties in Massachusetts and Southern New Hampshire. The Company grants residential and consumer loans, commercial real estate and industrial loans, and loans for the construction of residential owner-occupied homes. Substantially all loans granted by the Company are secured by real estate collateral. The ability and willingness of residential mortgage and consumer loan borrowers to honor their repayment commitments is generally dependent on the level of overall economic activity within the borrower's geographic areas and real estate values. The ability and willingness of commercial real estate and construction loan borrowers to honor their repayment commitments is generally dependent on the health of the real estate economic sector in the borrower's geographic areas and the general economy. The Bank is generally prohibited by Massachusetts banking statutes from lending to any one borrower amounts in excess of 20% of stockholders' equity. 53 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 5. Loans (Continued) Loans at December 31 are summarized as follows: 2000 1999 --------- --------- Loans: Residential $ 162,680 $ 162,633 Residential owner-occupied construction 1,837 1,463 Land 28 28 Commercial real estate 5,670 4,845 Home equity 64,974 52,706 --------- --------- 235,189 221,675 Less: Unadvanced funds on home equity loans (33,762) (29,321) Unadvanced funds on owner-occupied construction loans (484) (573) Deferred loan origination costs, net 987 586 Unearned discount (95) (100) --------- --------- Loans, net 201,835 192,267 Other loans, net 1,302 1,060 --------- --------- Total loans $ 203,137 $ 193,327 ========= ========= In the ordinary course of business, the Company has granted loans to officers, directors and employees on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the same time for comparable transactions with unrelated borrowers. These loans do not, in the opinion of management, involve more than normal credit risk or present other unfavorable features. The following schedule summarizes the loan activity to such related parties for the years ended December 31, 2000, 1999 and 1998. 2000 1999 1998 ---- ---- ---- Balance at beginning of year $ 432 $ 468 $ 655 Loan originations 584 413 317 Amortization and payoffs (104) (239) (353) Loans sold (170) (112) - Directors/employees left company (33) (98) (151) ----- ----- ----- Balance at end of year $ 709 $ 432 $ 468 ===== ===== ===== 54 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 5. Loans (Continued) The recorded investment in loans for which an impairment has been recognized at December 31, 2000 and 1999 was $229 and $31, respectively. The related allowance for loan losses at December 31, 2000 and 1999 was $11 and $16, respectively. The average recorded investment in impaired loans during 2000 and 1999 was $45 and $333, respectively. Interest income recognized on impaired loans during 2000 and 1999 and 1998 was $2, $71and $37, respectively, all of which was recorded on a cash basis. The Company has no material outstanding commitments to lend additional funds to customers whose loans have been placed on non-accrual status or the terms of which have been modified. 6. Allowance for Loan Losses An analysis of the allowance for loan losses for the years ended December 31, is as follows: 2000 1999 1998 ------- ------- ------- Balance at beginning of year $ 1,798 $ 1,742 $ 1,673 Provision charged to operations 60 100 180 Less loans charged-off (86) (81) (131) Recoveries on loans previously charged-off 31 37 20 ------- ------- ------- Net charge-offs (55) (44) (111) ------- ------- ------- Balance at end of year $ 1,803 $ 1,798 $ 1,742 ======= ======= ======= The allowance for loan losses is allocated as follows: 2000 1999 ------- ------- Commercial real estate $ 158 $ 151 Residential real estate 962 1,056 Home equity and other consumer 669 582 Residential owner-occupied construction 14 9 ------- ------- Total allowance $ 1,803 $ 1,798 ======= ======= 56 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 7. Banking Premises and Equipment A summary of banking premises and equipment at December 31 is as follows: 2000 1999 -------- -------- Land $ 207 $ 207 Building 2,179 2,179 Equipment 2,804 2,646 Leasehold improvements 793 788 -------- -------- 5,983 5,820 Less accumulated depreciation (3,000) (2,652) -------- -------- $ 2,983 $ 3,168 ======== ======== As of December 31, 2000, the Company was obligated under six non-cancelable operating leases for banking premises. Minimum future rentals over the next five years under the non-cancelable operating leases are as follows: Year ending December 31, Amount ----------- ------ 2001 $ 231 2002 230 2003 176 2004 89 2005 38 Rent expense amounted to $248, $235 and $199 for the years ended December 31, 2000, 1999 and 1998, respectively. The Company leased out part of its facility, located in Ipswich, under a non-cancelable lease agreement. Rental income under this lease totaled $69, $50 and $56 at December 31, 2000, 1999 and 1998, respectively. 56 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 8. Other Real Estate Owned Other real estate owned at December 31, for which the Company has determined no allowance for losses is necessary, is as follows: 2000 1999 ----- ------ Commercial $ - $ 49 Residential - 62 ----- ------ $ - $ 111 ===== ====== An analysis of activity in other real estate owned for each of the years ended December 31, is as follows: 2000 1999 1998 ------- ------- ------- Balance at beginning of year $ 111 $ 718 $ 1,214 Foreclosures - 62 - Net sales proceeds (110) (1,009) (720) Gains (losses) on sales, net (1) 340 224 ------- ------- ------- Balance at end of year $ - $ 111 $ 718 ======= ======= ======= An analysis of income for other real estate owned for each of the years ended December 31, is as follows: 2000 1999 1998 ---- ---- ---- Rental income $ 4 $ 8 $ 26 Gains (losses) on sales (1) 340 224 Permitting costs - (29) (112) Foreclosure (expense reimbursement) - (11) 10 ----- ----- ----- $ 3 $ 308 $ 148 ===== ===== ===== 57 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 9. Stock in Federal Home Loan Bank of Boston As a member of the Federal Home Loan Bank of Boston (FHLB of Boston), the Company is required to invest in $100 par value (per share) stock of the FHLB of Boston in the amount of 1% of its outstanding loans secured by residential housing, or 1% of 30% of total assets, or 5% of its outstanding advances from the FHLB of Boston, whichever is higher. As and when such stock is redeemed, the Company would receive from the FHLB of Boston an amount equal to the par value of the stock. As of December 31, 2000 and 1999, the Company held the required investment of $3,000 and $3,977, respectively. 10. Mortgage Servicing Rights Loans serviced for others amounted to approximately $11,092, $0 and $18,848 at December 31, 2000, 1999 and 1998, respectively. Net servicing (expense) income amounted to approximately $(2), $21 and $(341) for the years ended December 31, 2000, 1999 and 1998, respectively. The following table summarizes the changes in mortgage servicing rights at December 31: 2000 1999 1998 ------- ------- ------- Balance at beginning of year $ - $ 229 $ 543 Additions 229 1,171 1,452 Normal amortization (4) (86) (174) Sale of mortgage servicing rights - (1,314) (1,417) Additional amortization for prepayments - - (175) ------- ------- ------- Balance at end of year $ 225 $ - $ 229 ======= ======= ======= Fair value at end of year $ 225 $ - $ 229 ======= ======= ======= During 1999 the Company sold the rights to service approximately $90,000 in loans and recognized a gain of $15 in 2000 and $63 in 1999 as a result of the sale. During 1998 the Company sold the rights to service approximately $90,000 in loans and recognized a loss of $196 as a result of the sale. An analysis of the mortgage servicing rights valuation account at December 31 is as follows: 2000 1999 1998 ---- ---- ---- Balance at beginning of year $ - $ - $ (57) Write up (down) of servicing rights through charge to servicing income - - (141) Sale of mortgage servicing rights - - 198 ----- ----- ----- Balance at end of year $ - $ - $ - ===== ===== ===== 58 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 11. Deposits Deposits at December 31 are summarized as follows: 2000 1999 -------- --------- Demand deposits (non-interest bearing) $ 22,855 $ 15,209 NOW accounts 34,871 27,481 Savings accounts 39,531 37,704 Money market deposit accounts 66,083 62,859 Certificates of deposit 73,897 66,829 -------- --------- $237,237 $ 210,082 ======== ========= Deposits of $100 or more totaled approximately $77,554 and $72,592 at December 31, 2000 and 1999, respectively, of which $16,885 and $11,211 are certificates of deposit in 2000 and 1999, respectively. The following table shows the scheduled maturity of certificates of deposit accounts at December 31: 2000 1999 ----------------------- ----------------------- Amount Percent Amount Percent ------ ------- ------ ------- Within one year $58,616 79.3% $ 51,923 77.7% 1-2 years 11,846 16.0 12,374 18.5 2-3 years 1,495 2.0 2,339 3.5 3-4 years 1,233 1.7 193 .3 4-5 years 707 1.0 - - ------- ---- -------- ---- $73,897 100.0% $ 66,829 100.0% ======= ===== ======== ===== Interest on deposits classified by type for the years ended December 31 is as follows: 2000 1999 1998 ------ ------ ------ NOW accounts $ 233 $ 176 $ 203 Saving accounts 879 868 937 Money market deposit accounts 3,055 2,441 2,030 Certificates of deposits 3,885 3,091 3,372 ------ ------ ------ $8,052 $6,576 $6,542 ====== ====== ====== 59 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 12. Borrowed Funds A summary of Federal Home Loan Bank of Boston advances at December 31, follows: 2000 1999 ----------------------- ------------------------- Weighted Weighted Average Average Amount Rate Amount Rate ------- ---- -------- ---- Maturity in: 2000 $ - - % $ 40,000 5.82% 2001 18,108 6.29 5,000 5.18 2002 7,000 6.70 - - 2003 2,000 6.91 - - 2005 5,000 7.45 - - ------- ---- -------- ---- $32,108 6.60% $ 45,000 5.75% ======= ==== ======== ==== The Company has a total borrowing capacity of $104,152 with the Federal Home Loan Bank of Boston at December 31, 2000. Advances from the Federal Home Loan Bank of Boston are secured by FHLB of Boston stock, a blanket lien on the residential first mortgage loans and investment securities owned by Ipswich Savings Bank. 13. Income Taxes The components of income tax expense for each of the years ended December 31, are as follows: 2000 1999 1998 ------- ------- ------- Federal income tax expense: Current $ 1,229 $ 1,204 $ 1,219 Deferred 36 91 149 State income tax expense: Current 50 32 204 Deferred 12 118 (66) Change in valuation reserve (190) (121) (22) ------- ------- ------- $ 1,137 $ 1,324 $ 1,484 ======= ======= ======= 60 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 13. Income Taxes (Continued) The effective income tax rate for each of the years ended December 31, 2000, 1999 and 1998 was 30.0%, 28.7% and 36.0%, respectively. A reconciliation of expected tax expense at the statutory federal income tax rate to income before income taxes, is as follows: 2000 1999 1998 --------------------- --------------------- --------------------- % of % of % of Pretax Pretax Pretax Amount Income Amount Income Amount Income ------ ------ ------ ------ ------ ------ Computed expected tax expense at statutory rate $ 1,289 34.0% $ 1,568 34.0% $ 1,401 34.0% Items affecting the federal income tax rate: State income taxes, net of federal tax benefit 41 1.1 99 2.1 91 2.2 Other (3) (0.1) (222) (4.8) 14 0.3 Reduction in valuation reserve (190) (5.0) (121) (2.6) (22) (0.5) ------- ---- ------- ---- ------- ---- $ 1,137 30.0% $ 1,324 28.7% $ 1,484 36.0% ======= ==== ======= ==== ======= ==== The tax effect of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31 are presented below: 2000 1999 ------- ------- Deferred tax asset: Loan loss reserves $ 720 $ 708 Other real estate owned 17 15 Net operating loss carryforward 138 184 Alternative minimum tax credit 40 40 Business credits carryforward 425 425 All other 80 100 ------- ------- Total gross deferred tax asset 1,420 1,472 Less valuation reserve (235) (425) ------- ------- Net deferred tax asset 1,185 1,047 61 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 13. Income Taxes (Continued) 2000 1999 ------ ------ Deferred tax liabilities: Difference between book and tax carrying value of investment securities $ 303 $ 7 Banking premises and equipment, due to depreciation differences 324 351 Servicing asset and deferred costs 613 603 Carrying basis of limited partnerships 617 603 ------ ------ Total gross deferred tax liability 1,857 1,564 ------ ------ Net deferred tax liability $(672) $ (517) ====== ====== Management believes the existing net deductible temporary differences that give rise to the net deferred income tax asset will reverse in periods the Company generates net taxable income. In addition, gross deductible temporary differences are expected to reverse in periods during which off-setting gross taxable temporary differences are expected to reverse. Management believes that it is more likely than not that the net deferred income tax asset, including the net operating loss carryforward, at December 31, 2000 will be realized through the use of the on-going earnings capabilities of the Company. It should be noted, however, that factors beyond management's control, such as the general state of the economy and real estate values, can affect future levels of taxable income and that no assurance can be given that sufficient taxable income will be generated to fully absorb gross deductible temporary differences. As of December 31, 2000, the Company had a net operating loss carry-forward for federal tax purposes of $406 expiring in 2007. Tax credit carry-forwards of approximately $425 expire in years 2003 through 2007. The 1993 Common Stock Offering resulted in a change in control for income tax purposes. As a result, the net operating loss and tax credit carry-forwards are limited so that only $136 per year can be utilized to offset taxable income generated during the years in the carry-forward period which expires in 2007. Tax effect of pre-1988 bad debt reserves subject to recapture in the case of certain excess distributions is approximately $670, none of which has been recognized in the financial statements. The use of this amount for purposes other than to absorb losses on loans would result in taxable income and financial statement tax expense at the then current tax rate. 62 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 14. Stockholders' Equity The Company and Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and Bank must meet specific capital guidelines that involve quantitative measures of the Company's and Bank's assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The Company's and Bank's capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined) and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2000, that the Company and Bank meet all capital adequacy requirements to which they are subject. The most recent notification from the FDIC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action as of December 31, 2000 and 1999. To be categorized as well capitalized the Bank must maintain minimum total risk-based, Tier 1 risk-based, Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the institution's category. The Company is also subject to similar capital adequacy requirements and the regulatory requirements of federal banking agencies. The actual capital amounts and ratios and minimum required amounts and ratios for the Company and the Bank as of December 31, 2000 and December 31, 1999 are presented in the following tables: To be Well Capital- ized Under For Capital Prompt Cor- Adequacy rective Action Actual Purposes Provisions --------------- --------------- -------------- Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- As of December 31, 2000 ----------------------- Total capital (to risk-weighted assets) Company $ 16,398 11.53% $11,377 8.00% $14,221 10.00% Bank 16,638 11.72 11,358 8.00 14,197 10.00 Tier I capital (to risk-weighted assets) Company $ 14,623 10.28% $ 5,688 4.00% $ 8,533 6.00% Bank 14,863 10.47 5,679 4.00 8,518 6.00 Tier I capital (to average assets) Company $ 14,623 5.04% $11,614 4.00% $14,518 5.00% Bank 14,863 5.14 11,560 4.00 14,451 5.00 63 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 14. Stockholders' Equity (Continued) To be Well Capital- ized Under For Capital Prompt Cor- Adequacy rective Action Actual Purposes Provisions --------------- --------------- -------------- Amount Ratio Amount Ratio Amount Ratio ------ ----- ------ ----- ------ ----- As of December 31, 1999 ----------------------- Total capital (to risk-weighted assets) Company $ 18,582 14.38% $10,338 8.00% $12,923 10.00% Bank 18,469 14.29 10,337 8.00 12,921 10.00 Tier I capital (to risk-weighted assets) Company $ 16,964 13.13% $ 5,169 4.00% $ 7,754 6.00% Bank 16,852 13.04 5,169 4.00 7,753 6.00 Tier I capital (to average assets) Company $ 16,964 6.33% $10,713 4.00% $13,392 5.00% Bank 16,852 6.29 10,717 4.00 13,391 5.00 In accordance with Massachusetts banking regulations, the Bank established a Liquidation Account, in the amount equal to the consolidated net worth of the Bank at December 31, 1991, for the benefit of eligible account holders who continue to maintain their accounts in the Bank after the Bank's conversion from mutual to stock form. The Liquidation Account amounted to approximately $1,000 (unaudited) at December 31, 1992. The balance will be reduced in proportion to reductions in the balances of eligible account holders as determined on each subsequent fiscal year end. Subsequent increases will not restore an eligible account holder's interest in his liquidation sub-account. In the event of complete liquidation or dissolution of the Bank, eligible account holders are entitled to their interest in the Liquidation Account in the same proportion of the balance of their qualifying deposit account at that date. The existence of the Liquidation Account restricts the use or application of net worth. 15. Benefit Plans Management Compensation Plan The Company has a Management Incentive Compensation Plan as a means of recognizing achievement on the part of its Senior Management and certain other officers of the Company. Incentive awards are determined according to a formula based upon the Company's return on average stockholders' equity in the calendar year as compared with a group of peer banks, as well as the individual participant's performance. Awards are paid as a bonus, calculated as a percentage of an individual officer's salary within the limitations of the plan. Bonus expense totaled $110, $150 and $157 during years ended December 31, 2000, 1999 and 1998, respectively. 64 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 15. Benefit Plans (Continued) 401(k) Plan The Company has a 401(k) savings plan covering all salaried employees who become eligible to participate upon attaining the age of 21 and completing ninety days of continuous service. Participants may contribute from 1% to 15% of their pretax compensation. The Company matches participants' contributions at the rate of 50% of the first 6% of compensation contributed by the employee after one year of continuous service. Such matching contributions, which are fully vested when made, amounted to $52, $49 and $41 during the years ended December 31, 2000, 1999 and 1998, respectively. Split Dollar Agreement and Irrevocable Insurance Trust The Company has a split dollar agreement and irrevocable insurance trust agreement for the President of the Company whereby the Company may contribute to the trust an amount necessary to permit the trust to pay the premiums due under the policy. The retirement expense related to this contribution totaled $60 for each of the years ended December 31, 2000, 1999 and 1998. Stock Option Plans At December 31, 2000 the Company had three stock option plans. Under the 1992 Stock Option Plan, the Company may grant options to its officers and other employees for up to 230,000 shares of common stock. Under the 1996 Stock Incentive Plan, the Company may grant options to its officers, directors and other employees for up to 118,000 shares. Under the 1998 Stock Incentive Plan, the Company may grant options to its officers, directors and other employees for up to 100,000 shares. Both incentive stock options and non-qualified stock options may be granted under all three plans. The exercise price of each option equals the market price of the Company's stock on the date of grant and an option's maximum term is 10 years under all plans. The vesting of option grants are at the discretion of the Compensation Committee of the Board of Directors. The Company applies APB Opinion 25, Accounting for Stock Issued to Employees and Related Interpretations, in accounting for its plans. Accordingly, no compensation cost has been recognized for its stock option plans. Had compensation cost for the Company's stock-based compensation plans been determined based on the fair value at the grant dates for awards under those plans consistent with the method of SFAS No. 123, Accounting for Stock-Based Compensation, the Company's net income and earnings per share would have been reduced to the pro forma amounts indicated below: 2000 1999 1998 ------- ------- ------- Net income As reported $ 2,655 $ 3,289 $ 2,638 Pro forma 2,627 3,141 2,608 Basic earnings per share As reported $ 1.12 $1.33 $1.10 Pro forma 1.10 1.29 1.09 Diluted earnings per share As reported $ 1.10 $1.29 $1.03 Pro forma 1.09 1.24 1.02 65 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 15. Benefit Plans (Continued) The pro forma amounts reflect only stock options granted after June 30, 1995. Therefore, the full impact of calculating the cost for stock options under Statement No. 123 is not reflected in the pro forma amounts presented above because the cost for options granted prior to July 1, 1995 is not considered under the requirements of Statement No. 123. The fair value of each option grant is estimated on the date of grant using the Black-Scholes option-pricing model with the following weighted-average assumptions: 2000 1999 1998 ---- ---- ---- Dividend yield 1.5% 2.5% 1.5% Expected volatility 30.5% 23.0% 50.0% Risk-free interest rates 4.7% 6.7% 4.4% Expected lives 10 years 10 years 10 years The weighted average fair values of options granted during 2000, 1999 and 1998 were $3.40, $2.83 and $7.38, respectively. A summary of the status of the Company's three stock options plans as of December 31 and changes during the years ending on those dates is presented below: 2000 1999 1998 ---------------------- -------------------- ---------------------- Weighted- Weighted- Weighted- Shares Average Shares Average Shares Average Under Exercise Under Exercise Under Exercise Option Price Option Price Option Price ------- --------- ------- --------- ------- --------- Outstanding at beginning of year 219,051 $ 9.82 251,442 $ 5.43 261,527 $ 5.16 Granted 6,400 8.34 105,750 10.25 3,675 15.46 Exercised (125) 6.20 (133,141) 1.80 (7,210) 2.63 Cancelled (61,550) 12.67 - - - - Forfeited (5,125) 8.94 (5,000) 11.33 (6,550) 3.68 ------- --------- ------- --------- ------- --------- Outstanding at end of year 158,651 $ 8.69 219,051 $ 9.82 251,442 $ 5.43 ------- --------- ------- --------- ------- --------- Options exercisable at year end 140,698 $ 8.55 192,210 $ 9.71 240,234 $ 5.17 66 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 15. Benefit Plans (Continued) The following table summarizes information about stock options outstanding at December 31, 2000: Options Outstanding Options Exercisable ---------------------------------------- ------------------------ Weighted Average Weighted- Weighted- Remaining Average Average Range of Number Contractual Exercise Number Exercise Exercise Prices Outstanding Life (Years) Price Exercisable Price --------------- ----------- ------------ --------- ----------- --------- $1.00 1,500 2.9 $ 1.00 1,500 $ 1.00 $2.50 1,126 4.6 2.50 1,126 2.50 $4.9375 to 5.75 46,200 5.3 5.74 46,200 5.74 $7.4375 to 8.00 6,400 8.3 7.82 3,079 7.63 $9.3125 to 10.25 103,425 8.9 10.23 88,793 10.25 ------- ------- 158,651 140,698 ======= ======= Employment and Severance Agreements The Company's President, the clerk of the corporation and three other senior officers have entered into agreements with the Company which provide for severance and other benefits in the event of a change in control of the Company under specific situations. Directors' Deferred Compensation Plan The Company has a directors' deferred compensation plan whereby the directors accrue deferred compensation in the form of common stock units. The accumulated deferred compensation, which has been recorded as additional paid-in capital, was $89, $55 and $28 at December 31, 2000, 1999 and 1998 representing 8,545, 4,573 and 1,942 stock units, respectively. The stock units have been treated as common stock for the purposes of calculating earnings per share. 67 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 16. Earnings Per Share (EPS) The following tables represent a reconciliation of the numerators and denominators for the basic and diluted per share computation for earnings for the years ended December 31, 2000, 1999 and 1998, respectively: Income Shares Per-Share (Numerator) (Denominator) Amount ---------- ----------- -------- 2000 ---- Basic EPS $ 2,655 2,379 $1.12 Effect of stock options - 25 - ------ ----- ---- Diluted EPS $ 2,655 2,404 $1.10 ====== ===== ==== 1999 ---- Basic EPS $ 3,289 2,480 $1.33 Effect of stock options - 63 - ------ ----- ---- Diluted EPS $ 3,289 2,543 $1.29 ====== ===== ==== 1998 ---- Basic EPS $ 2,638 2,392 $1.10 Effect of stock options - 164 - ------ ----- ---- Diluted EPS $ 2,638 2,556 $1.03 ====== ===== ==== 17. Financial Instruments with Credit Risk and Off-Balance Sheet Risk, Commitments and Contingencies Off-Balance Sheet Risk The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include unused lines of credit, unadvanced portions of construction loans, commitments to originate loans and commitments to sell loans. The instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. The Company's exposure to credit loss in the event of non-performance by the other party to its financial instruments (for unused lines of credit and loan commitments) is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The Company evaluates each customer's credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management's credit evaluation of the borrower. 68 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 17. Financial Instruments with Credit Risk and Off-Balance Sheet Risk, Commitments and Contingencies (Continued) Financial instruments with off-balance sheet risk at December 31, are as follows: 2000 1999 --------- -------- Commitments to originate residential loans $ 3,354 $ 6,816 Unused lines of credit on home equity loans 33,762 29,321 Unadvanced portions of residential owner-occupied construction loans 484 573 Unused lines of credit on overdraft protection, personal lines of credit and credit cards 3,151 2,545 Commitments to sell loans 4,156 - Commitments to originate loans, unused lines of credit and unadvanced portions of residential owner-occupied construction loans are agreements to lend to a customer provided there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Legal Proceedings The Company is involved in various legal proceedings incidental to its business. After review with legal counsel, management does not believe resolution of any present litigation will have a material adverse effect on the financial condition of the Company. Commitments to Sell Loans Forward commitments to sell loans are contracts which the Company enters into for the purpose of reducing interest rate risk and to improve liquidity. In order to fulfill a forward commitment, the Company typically receives cash in exchange for loans at a future date agreed to by both parties. Risk may arise from the possible inability of the Company to deliver the loans specified. As of December 31, 2000 and 1999, the Company had identified $5,003 and $0, respectively, of loans to fulfill the outstanding commitments at weighted average rates which will satisfy the commitments without loss to the Company. 69 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 18. Condensed Parent Information Condensed financial statements for Ipswich Bancshares, Inc. at December 31, 2000 and 1999 and for the year ended December 31, 2000 and for the period from inception to December 31, 1999 are presented below. As Ipswich Bancshares, Inc. was formed in 1999, parent information does not exist for the year ended December 31, 1998. 2000 1999 -------- -------- Balance Sheet Assets Cash (deposited with subsidiary) $ 11 $ 290 Investment in subsidiary 15,359 16,862 -------- -------- Total assets $ 15,370 $ 17,152 ======== ======== Liabilities and Stockholders' Equity Accrued expenses and other liabilities $ 251 $ 177 Stockholders' equity 15,119 16,975 -------- -------- Total liabilities and stockholders' equity $ 15,370 $ 17,152 ======== ======== Statement of Income Income: Dividends from banking subsidiary $ 4,659 $ 681 Other 1 - -------- -------- Total income 4,660 681 Expenses: Professional fees - 133 Other expenses 27 59 -------- -------- Total expenses 27 192 -------- -------- Income before income tax (expense) benefit and equity in undistributed net income of subsidiary 4,633 489 Income tax (expense) benefit (15) 125 -------- -------- Income before equity in undistributed net income of subsidiary 4,618 614 Equity in undistributed net (loss) income of subsidiary (1,963) 2,675 -------- -------- Net income $ 2,655 $ 3,289 ======== ======== 70 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 18. Condensed Parent Information (Continued) 2000 1999 ------- ------- Statement of Cash Flows Cash flows from operating activities: Net income $ 2,655 $ 3,289 Adjustments to reconcile net income to net cash provided by operations: Undistributed earnings of subsidiary 1,963 (2,675) Increase in accrued expenses and other liabilities 74 177 ------- ------- Net cash provided by operating activities 4,692 791 Cash flows from financing activities: Proceeds from issuance of common stock 35 11 Purchase of treasury stock (4,054) - Dividends paid to stockholders (952) (512) ------- ------- Net cash used by financing activities (4,971) (501) ------- ------- Net (decrease) increase in cash (279) 290 Cash, beginning of year 290 - ------- ------- Cash, end of year $ 11 $ 290 ======= ======= 19. Fair Value of Financial Instruments SFAS No. 107, Disclosures about Fair Value of Financial Instruments, requires that the Company disclose estimated fair values for its financial instruments. Fair value estimates, methods and assumptions are set forth below for the Company's financial instruments. Cash and Cash Equivalents The fair value of cash, due from banks and Federal funds sold, approximates their relative book values at December 31, 2000 and 1999, as these financial instruments have short maturities. Available for Sale and Held to Maturity Securities The fair value of available for sale and held to maturity securities is estimated based on bid prices published in financial newspapers or bid quotations received from securities dealers at or near December 31, 2000 and 1999. 71 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 19. Fair Value of Financial Instruments (Continued) Stock in Other Financial Institutions This financial instrument does not have a market nor is it practical to estimate the fair value without incurring excessive costs. Loans Held for Sale and Forward Commitments The fair value of loans held for sale approximates its relative book value at December 31, 2000. There were no loans held for sale at December 31, 1999. Loans Fair values are estimated for portfolios of loans with similar financial characteristics. The fair values of performing loans are calculated by discounting scheduled cash flows through the estimated maturity using estimated market discount rates that reflect the credit and interest rate risk inherent in the loan. The estimates of maturity are based on the Company's historical experience with repayments for each loan classification, modified, as required, by an estimate of the effect of current economic, lending conditions and the effects of estimated prepayments. Fair values for significant non-performing loans are based on estimated cash flows discounted using a rate commensurate with the risk associated with the estimated cash flows. Assumptions regarding credit risk, cash flows and discount rates are judgmentally determined using available market information and historical information. Accrued Interest Receivable The fair market value of this financial instrument approximates the book value as this financial instrument has a short maturity. It is the Company's policy to stop accruing interest on loans past due by more than ninety days. Therefore this financial instrument has been adjusted for estimated credit loss. Deposits and Mortgagors' Escrows The fair value of deposits, with no stated maturity, such as non-interest-bearing demand deposits, savings, NOW accounts, money market and checking accounts, and mortgagors' escrows, is equal to the amount payable on demand as of December 31, 2000 and 1999. The fair values of certificates of deposit are based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. 72 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 19. Fair Value of Financial Instruments (Continued) Borrowed Funds The fair value of the Company's borrowings with the FHLB is estimated by discounting the cash flows through maturity or the next repricing date based on current rates available to the Company for borrowings with similar maturities. Commitments to Originate Loans The fair value of commitments to extend credit cannot be reasonably estimated without incurring excessive costs as the Company does not charge fees for such commitments and there is no ready market for this financial instrument. Limitations Fair value estimates are made at a specific point in time, based on relevant market information and information about the financial instrument. These values do not reflect any premium or discount that could result from offering for sale at one time the Company's entire holdings of a particular financial instrument. Because no market exists for a significant portion of the Company's financial instruments, fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and therefore cannot be determined with precision. Changes in assumptions could significantly affect the estimates. Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Other significant assets and liabilities that are not considered financial instruments include the deferred tax assets, mortgage servicing rights, and bank premises and equipment. In addition, the tax ramifications related to the realization of the unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in any of the estimates. 73 IPSWICH BANCSHARES, INC. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2000, 1999 and 1998 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 19. Fair Value of Financial Instruments (Continued) The following table presents the estimated fair value of the Company's significant financial instruments at December 31: 2000 1999 --------------------- --------------------- Carrying Estimated Carrying Estimated Value Fair Value Value Fair Value Financial assets: Cash and cash equivalents $ 8,836 $ 8,836 $ 8,259 $ 8,259 Available for sale securities 34,228 34,228 39,502 39,502 Held to maturity securities 30,282 30,374 28,069 27,061 Stock in other financial institutions 3,253 3,253 4,230 4,230 Loans held for sale 5,003 5,003 - - Loans, net 201,334 202,278 191,529 191,256 Accrued interest receivable 1,435 1,435 1,248 1,248 Financial liabilities: Deposits (with no stated maturity) 163,340 163,340 143,253 143,253 Time deposits 73,897 74,192 66,829 66,878 Mortgagors' escrow accounts 972 972 993 993 Borrowed funds 32,108 32,360 45,000 44,900 20. Quarterly Results of Operations (Unaudited) 2000 Quarters 1999 Quarters ------------------------------------- ---------------------------------------- Fourth Third Second First Fourth Third Second First ------ ----- ------ ----- ------ ----- ------ ----- Interest and dividend income $5,171 $5,114 $ 4,969 $ 4,675 $ 4,588 $ 4,536 $ 4,289 $4,542 Interest expense 2,888 2,866 2,763 2,477 2,332 2,257 2,242 2,426 ------ ------ ------- ------- -------- ------- ------- ------ Net interest and dividend income 2,283 2,248 2,206 2,198 2,256 2,279 2,047 2,116 Provision for loan losses (15) (15) (15) (15) - (10) (45) (45) Non-interest income 460 370 478 428 548 819 666 892 Non-interest expense (1,733) (1,654) (1,674) (1,758) (1,592) (1,618) (1,678) (2,022) ------ ------ ------- ------- -------- ------- ------- ------ Income before income taxes 995 949 995 853 1,212 1,470 990 941 Income tax expense (348) (332) (351) (106) (303) (441) (297) (283) ------ ------ ------- ------- -------- ------- ------- ------ Net income $ 647 $ 617 $ 644 $ 747 $ 909 $ 1,029 $ 693 $ 658 ====== ====== ======= ======= ======== ======= ======= ====== Basic earnings per share $ .30 $ .26 $ .26 $ .30 $ .36 $ .41 $ .28 $ .28 Diluted earnings per share $ .30 $ .26 $ .26 $ .29 $ .36 $ .40 $ .27 $ .26 Cash dividends declared per share $ .11 $ .10 $ .10 $ .10 $ .10 $ .05 $ .05 $ .05 Quarterly per share figures may not total to the full year amount due to rounding. 74 ITEM 9 CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None. PART III ITEM 10 DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT Information called for by Item 10 of this report is incorporated by reference herein from the Company's Proxy Statement. ITEM 11 EXECUTIVE COMPENSATION Information called for by Item 11 of this report is incorporated by reference herein from the Company's Proxy Statement. ITEM 12 SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT Information called for by Item 12 of this report is incorporated by reference herein from the Company's Proxy Statement. ITEM 13 CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Information called for by Item 13 of this report is incorporated by reference herein from the Company's Proxy Statement. PART IV ITEM 14 EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (a) Financial Statements and Schedules (1) Financial Statements for 2000, 1999 and 1998. See Item 8 of this Report. (b) Reports on Form 8-K (1) No Reports on Form 8-K were filed during the last quarter of 2000. (c) Exhibits 2.1 Plan of Reorganization and Acquisition dated as of February 17, 1999 between the Company and Ipswich Savings Bank incorporated by reference to the Company's Form 8-K filed on July 9, 1999. 3.1 Articles of Organization of the Company are incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. 3.2 By-laws of the Company is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. 75 4.1 Specimen stock certificate for the Company's Common Stock is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. 10.1 Lease dated September 15, 2000 for premises located at Route 133 and Route 1, Rowley, Massachusetts is incorporated by reference herein from the Company's September 30, 2000 Form 10-Q. 10.2 Lease dated April 25, 1994 for premises located at 451 Andover Street, North Andover, Massachusetts is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. 10.3 Lease dated March 4, 1996 for premises located at 588 Cabot Street, Beverly, Massachusetts is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. 10.4 Lease dated July 27, 1997 for premises located at 600 Loring Avenue, Salem, Massachusetts is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. 10.5 Lease dated February 27, 1998 for premises located at 89 Pleasant Street, Marblehead, Massachusetts is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. 10.6 Lease dated June 12, 1998 for premises located at 470 Main Street, Reading, Massachusetts is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. *10.7 Incentive Compensation Plan for Senior Management and certain other officers dated September 15, 1995 is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. *10.8 Director Recognition and Retirement Plan adopted as of May 18, 1999 is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. *10.9 Merger and Severance Benefits Program dated February 18, 1998 is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. *10.10 Amended and Restated Employment and Severance Agreement dated May 18, 1999 between Ipswich Savings Bank and David L. Grey is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. *10.11 Amended and Restated Employment and Severance Agreement dated May 18, 1999 between Ipswich Savings Bank and Francis Kenney is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. *10.12 Amended and Restated Severance Agreement dated May 18, 1999 between Ipswich Savings Bank and Thomas R. Girard is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. *10.13 Severance Agreement dated August 8, 2000 between Ipswich Savings Bank and Mark E. Foley is incorporated by reference herein from the Company's September 30, 2000 Form 10-Q. *10.14(a)Amended and Restated Split Dollar Agreement dated May 18, 1999 among Ipswich Savings Bank, Eastern Bank and David L. Grey is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. 76 *10.14(b)Amended and Restated Ipswich Irrevocable Insurance Trust dated as of May 18, 1999 by and between Ipswich Savings Bank and Eastern Bank is incorporated by reference herein from the Company's June 30, 1999 form 10-Q. 10.15 Contract with Bank's data processor dated February 14, 1997 is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. *10.16 1992 Incentive and Non-Qualified Stock Option Plan incorporated by reference to the Company's Registration Statement on Form S-8 filed on July 22, 1999. *10.17 1996 Stock Incentive Plan incorporated by reference to the Company's Registration Statement on Form S-8 filed on July 22, 1999. *10.18 1998 Stock Incentive Plan incorporated by reference to the Company's Registration Statement on Form S-8 filed on July 22, 1999. *10.19 Deferred Compensation Plan for Directors incorporated by reference to the Company's Form S-8 filed on July 22, 1999. (11) A statement regarding the computation of earnings per share is included in the notes to consolidated financial statements. (12) Not applicable. (21) Subsidiary - Ipswich Savings Bank. (23) Consent of Baker Newman & Noyes, LLC. * Denotes management contract or compensation plan. 77 SIGNATURES Pursuant to the requirements of Section 13 or 15(d) the Securities Exchange Act of 1934, the Company has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. IPSWICH BANCSHARES, INC. DATE: March 28, 2001 By: /s/David L. Grey ---------------- David L. Grey, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the Company and in the capacities and on the dates indicated: SIGNATURE TITLE DATE --------- ----- ---- By:/s/David L. Grey President, Chief Executive Officer, and March 28, 2001 - ------------------- Director (Principal Executive Officer) David L. Grey By:/s/Francis Kenney Senior Vice President, Treasurer, and Chief March 28, 2001 - -------------------- Financial Officer (Principal Financial Francis Kenney Officer, Principal Accounting Officer) By:/s/William M. Craft Director March 28, 2001 - ---------------------- William M. Craft By:/s/Thomas A. Ellsworth Director March 28, 2001 - ------------------------- Thomas A. Ellsworth By: Director William E. George By:/s/John H. Morrow Director March 28, 2001 - -------------------- John H. Morrow By:/s/Lawrence J. Pszenny Director March 28, 2001 - ------------------------- Lawrence J. Pszenny By:/s/William J. Tinti Director March 28, 2001 - ---------------------- William J. Tinti 78 INDEX TO EXHIBITS ITEM PAGE ---- ---- 2.1 Plan of Reorganization and Acquisition dated as of February 17, 1999 between the Company and Ipswich Savings Bank incorporated by reference to the Company's Form 8-K filed on July 9, 1999. * 3.1 Articles of Organization of the Company dated February 12, 1999 is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. * 3.2 By-laws of the Company is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. * 4.1 Specimen stock certificate for the Company's Common Stock is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. * 10.1 Lease dated September 15, 2000 for premises located at Route 133 and Route 1, Rowley, Massachusetts is incorporated by reference herein from the Company's September 30, 2000 Form 10-Q. * 10.2 Lease dated April 25, 1994 for premises located at 451 Andover Street, North Andover, Massachusetts is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. * 10.3 Lease dated March 4, 1996 for premises located at 588 Cabot Street, Beverly, Massachusetts is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. * 10.4 Lease dated July 27, 1997 for premises located at 600 Loring Avenue, Salem, Massachusetts is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. * 10.5 Lease dated February 27, 1998 for premises located at 89 Pleasant Street, Marblehead, Massachusetts is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. * 10.6 Lease dated June 12, 1998 for premises located at 470 Main Street, Reading, Massachusetts is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. * *10.7 Incentive Compensation Plan for Senior Management and certain other officers dated September 15, 1995 is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. * *10.8 Director Recognition and Retirement Plan adopted as of May 18, 1999 is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. * *10.9 Merger and Severance Benefits Program dated February 18, 1998 is incorporated by reference herein from the Company's June 30, 1999 79 *10.10 Amended and Restated Employment and Severance Agreement dated May 18, 1999 between Ipswich Savings Bank and David L. Grey is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. * *10.11 Amended and Restated Employment and Severance Agreement dated May 18, 1999 between Ipswich Savings Bank and Francis Kenney is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. * *10.12 Amended and Restated Severance Agreement dated May 18, 1999 between Ipswich Savings Bank and Thomas R. Girard is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. * *10.13 Severance Agreement dated August 8, 2000 between Ipswich Savings Bank and Mark E. Foley is incorporated by reference herein from the Company's September 30, 2000 Form 10-Q. * *10.14(a)Amended and Restated Split Dollar Agreement dated May 18, 1999 among Ipswich Savings Bank, Eastern Bank and David L. Grey is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. * *10.14(b)Amended and Restated Ipswich Irrevocable Insurance Trust dated as of May 18, 1999 by and between Ipswich Savings Bank and Eastern Bank is incorporated by reference herein from the Company's June 30, 1999 form 10-Q. * 10.15 Contract with Bank's data processor dated February 14, 1997 is incorporated by reference herein from the Company's June 30, 1999 Form 10-Q. * *10.16 1992 Incentive and Non-Qualified Stock Option Plan incorporated by reference to the Company's Registration Statement on Form S-8 filed on July 22, 1999. * *10.17 1996 Stock Incentive Plan incorporated by reference to the Company's Registration Statement on Form S-8 filed on July 22, 1999. * *10.18 1998 Stock Incentive Plan incorporated by reference to the Company's Registration Statement on Form S-8 filed on July 22, 1999. * *10.19 Deferred Compensation Plan for Directors incorporated by reference to the Company's Form S-8 filed on July 22, 1999. * (11) A statement regarding the computation of earnings per share is included in the notes to consolidated financial statements. * (12) Not applicable. * (21) Subsidiary - Ipswich Savings Bank. (23) Consent of Baker Newman & Noyes, LLC. * Denotes management contract or compensation plan. 80