Ipswich Bancshares, Inc. 2001 FORM 10K - ANNUAL REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 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, 2001 [ ] 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 (I.R.S. Employer incorporation or organization) 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 19, 2002, was $30,735,768. 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 19, 2002, was 1,934,474. 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 May 22, 2002. 1 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. On February 26, 2002 the Board of Directors of the Company approved an Agreement and Plan of Merger between Banknorth Group, Inc. (Banknorth) and Ipswich Bancshares, Inc. whereby Banknorth will acquire the Company for $41.1 million, or $20.50 per share of Company stock, payable in cash or in equivalent shares of Banknorth stock, at the option of each stockholder, subject to limitations intended to ensure that 51% of the outstanding common stock of the Company will be converted into the right to receive Banknorth common stock and 49% of the outstanding common stock of the Company will be converted into the right to receive cash. The transaction is subject to the approval of the Company's shareholders and various state and federal regulatory bodies. If approved, it is anticipated the transaction will be finalized in July 2002. 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). 2 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 Massachusetts Depositors Insurance Fund. At December 31, 2001, the Company had total assets of approximately $321 million, gross loans of $204 million, total deposits of $250 million, stockholders' equity of $15 million and a regulatory Tier 1 leverage capital ratio of 5.76%. Net income for 2001 was $2.8 million or $1.37 per fully diluted share. In 2001, the Company repurchased 150,900 shares at a weighted average price of $11.46 per share through the Company's stock repurchase plan. Shares outstanding at December 31, 2001 were 1,925,628. Since commencement of the Company's initial Share Repurchase Plan on March 16, 2000 the Company has repurchased 604,900 shares, or approximately 23.9% of the then outstanding shares at a cost of $5.8 million or $9.56 per share. LENDING ACTIVITIES General. At December 31, 2001, the Company's loan portfolio, including net deferred costs and unearned discounts, totaled $203.7 million, representing 63.4% of its total assets. The Company's loan portfolio increased by $0.6 million, or 0.3%, primarily from originations of commercial real estate loans. 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 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 $158.9 million, representing 78.0% of the loan portfolio at December 31, 2001, a decrease of $3.8 million or 2.3% from 2000. 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 2001, the Company originated approximately $108.5 million in residential mortgage loans. The Company sold approximately $44.0 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, 2001, the Company held $1.9 million of B and C rated loans. Residential Owner-Occupied Construction Loans. Residential owner-occupied construction loans totaled $2.0 million or 1% of total loans at December 31, 2001. 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. 3 Home Equity Loans. At December 31, 2001 home equity loans totaled $31.7 million or 15.6% of total loans. This was an increase of $500,000 or 1.7% in 2001. 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. Commercial/Commercial Real Estate Loans. Commercial and commercial real estate loans totaled $9.6 million at December 31, 2001 or 4.7% 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 $535,000 or 0.3% of the loan portfolio at December 31, 2001. The Company makes loans for personal or consumer purposes. The Company's consumer loans consist of passbook, installment and overdraft protection loans. Loan and OREO Concentrations. There were no loans or OREO concentrations that exceeded 5% of capital, or $755,900, at December 31, 2001. 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 seven loan originators employed by the Company at December 31, 2001. 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 three commercial officers 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. Exceptions to policy and commercial loans must also be approved 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. 4 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 servicing rights recognized in 2001 and 2000 were $78,000 and $229,000, respectively. The Company's mortgage servicing rights at December 31, 2001 and December 31, 2000 were $219,000 and $225,000, respectively, for which the Company determined that a valuation allowance of $58,000 was necessary at December 31, 2001. No allowance was deemed necessary at December 31, 2000. The Company realizes the value of the servicing as a component of the sales of mortgage loans. In 2001, the Company recognized a charge of $58,000 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 2001 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. 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 payments 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 $13.2 million, and $11.1 million at December 31, 2001 and 2000, respectively. 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 $100,000 in 2001, $60,000 in 2000 and $100,000 in 1999. 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, 2001, the Company maintained an investment portfolio comprised of adjustable-rate (ARM) and fixed-rate mortgage-backed securities (MBS), a collateralized mortgage obligation (CMO), U.S. Government Agency callable debentures, trust preferred securities and mutual funds totaling $85.7 million or 26.7% of assets. The Company has managed its investment portfolio with the intent of maintaining adequate liquidity and maximizing yields. The Company has categorized $23.1 million of MBS's, $4.6 million of U.S. Government Agency debentures and $7.6 million of trust preferred securities as held to maturity, carried at amortized cost, and $41 million of MBS's, a $2 million Washington Mutual CMO (with a book value of $2.0 million) and $6.8 million of mutual funds as available for sale, carried at market value. As of December 31, 2001, the Company has a net unrealized appreciation, net of taxes, on its available for sale securities, of $338,000. This amount is reported as accumulated other comprehensive income within stockholders' equity. The aggregate market value of the investment portfolio at December 31, 2001 was $86.3 million. At December 31, 2001, 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 2014. 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 $2 million CMO has a call date of October 2006 and a maturity date of January 2032. The portfolio of U.S. Government Agency callable debentures totaled $4.6 million with call dates in November 2002 and maturity dates of November 2006. The portfolio of trust preferred debentures totaled $7.6 million with call dates between 2006 and 2016 and maturity dates scheduled after 2025. At December 31, 2001 and 2000, except for the Washington Mutual CMO, 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 ten percent 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 $249.5 million at December 31, 2001. 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 $12.3 million or 5.2% during 2001. Total demand deposits, NOW accounts, money market deposit accounts and savings deposits totaled $190 million or 76.2% of total deposits at December 31, 2001, which represented a $26.7 million or 16.3% increase from 2000 levels of $163.3 million or 68.9% 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, 2001, the Company held $3.0 million of FHLB of Boston stock. At December 31, 2001, there were $47.9 million in borrowings outstanding at the FHLB of Boston and $32.1 million at December 31, 2000. The Company has a total borrowing capacity with the FHLB of Boston of $88.8 million at December 31, 2001, 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, 2001, Ipswich Bancshares, Inc. had two wholly-owned subsidiaries, Ipswich Savings Bank and Ipswich Statutory Trust I, a Connecticut statutory trust. At December 31, 2001, 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, 2001, ISC held a portfolio of fixed-rate and adjustable-rate mortgage-backed securities, a collateralized mortgage obligation and trust preferred debentures with total amortized cost of $14.7 million and an aggregate market value of $15.1 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, 2001, 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 under applicable law. 8 EMPLOYEES At December 31, 2001, the Company had 69 full-time employees and 40 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 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 a $100,000 maximum per separately insured account. The Bank 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, 2001. 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 15 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 adopted 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 Act), certain interstate transactions and activities are permitted. Interstate transactions and activities permitted 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, 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, 2001, the Company conducted its business from its headquarters and main office at 21-25 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 2006, with four 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. ITEM 3 LEGAL PROCEEDINGS The Company is not involved in any material legal proceedings other than ordinary routine litigation incidental to its business, none of which is material. ITEM 4 SUBMISSION OF MATTERS TO A VOTE OF SECURITIES HOLDERS None. PART II - ------- ITEM 5 MARKET FOR THE COMPANY'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 15, 2002, there were approximately 245 holders of record of the 1,934,474 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 2001, and 2000, 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, 2001 $13.04 $11.75 $.17 September 30, 2001 13.50 11.30 .11 June 30, 2001 12.09 9.25 .11 March 31, 2001 10.63 9.125 .11 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 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, -------------------------------------------------------------------------- 2001 2000 1999 1998 1997 ---------- ---------- ---------- ---------- ---------- (Dollars in thousands except for per share data) Balance Sheet Data: - ------------------- Total assets $ 321,115 $ 287,834 $ 276,298 $ 271,328 $ 227,244 Loans 203,710 203,137 193,327 188,991 165,453 Deposits 249,513 237,237 210,082 199,757 171,241 Mandatorily redeemable capital securities 3,500 -- -- -- -- Stockholders' equity 15,119 15,119 16,975 14,223 11,833 Income Statement Data: - ---------------------- Net interest income $ 9,784 $ 8,935 $ 8,698 $ 7,461 $ 6,435 Provision for loan losses 100 60 100 180 120 ---------- ---------- ---------- ---------- ---------- Net interest income after provision for loan losses 9,684 8,875 8,598 7,281 6,315 Total non-interest income 2,955 1,736 2,925 2,437 1,700 Total non-interest expenses 8,320 6,819 6,910 5,596 4,476 ---------- ---------- ---------- ---------- ---------- Pretax income 4,319 3,792 4,613 4,122 3,539 Income tax expense 1,511 1,137 1,324 1,484 1,327 ---------- ---------- ---------- ---------- ---------- Net income $ 2,808 $ 2,655 $ 3,289 $ 2,638 $ 2,212 ========== ========== ========== ========== ========== Per Share Data: - --------------- Book value per share (1) $ 7.85 $ 7.30 $ 6.72 $ 5.95 $ 4.96 Basic earnings per share (1) 1.40 1.12 1.33 1.10 .93 Diluted earnings per share (1) 1.37 1.10 1.29 1.03 .88 Dividends per share (1) .50 .41 .25 .17 .125 Selected Operating Ratios: - -------------------------- Return on average stockholders' equity 18.38% 15.79% 21.04% 20.09% 20.38% Return on average assets .94 .93 1.22 1.09 1.18 Gross interest margin 3.40 3.24 3.36 3.23 3.60 Operating expense to average assets 2.78 2.38 2.56 2.32 2.39 Dividends/net income 35.33 35.97 19.12 15.43 13.43 Shares outstanding 1,925,628 2,071,552 2,525,427 2,392,286 2,385,076 Capital Ratios: - ------ Average equity to average assets(2) 5.95% 5.99% 5.74% 5.37% 5.71% Total risk-based capital ratio 11.56 11.53 14.38 11.70 10.81 Other Data: - ------ Non-performing assets $ 181 $ 229 $ 142 $ 1,186 $ 2,164 Non-performing assets as a percent of total assets .06% .08% .05% .44% .95% Number of checking accounts 15,726 16,314 13,959 12,622 10.599 Number of employees 109 98 95 96 80 (1) Adjusted for 2 for 1 stock split effective August 27, 1997 (2) For 2001 includes $3,500 in capital securities as equity 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 at December 31, 2001 amounted to $321.1 million, an increase of $33.3 million, or 11.6%, from $287.8 million at December 31, 2000, resulting primarily from increases in total investment securities of $21.2 million and loans held for sale of $9.9 million. Cash and Cash Equivalents. Cash and cash equivalents increased by $2.1 million to $10.9 million at December 31, 2001, from the year-end 2000 balance of $8.8 million. This was primarily a result of increased required reserve balances maintained at the Federal Reserve Bank of Boston and cash reserves held at the branches. Investment Securities. Total investment securities increased by $21.2 million or 32.9% during 2001, primarily from the purchase of $22.7 million of mortgage-backed securities, $6.8 million of mutual funds and $4.4 million of trust preferred securities, offset by calls and maturities of $13.8 million of U.S. Government Agency Obligations. At December 31, 2001, the Company had identified $41.6 million in mortgage-backed securities as available for sale. The Company has also identified $6.8 million of ARM mutual funds and a $2 million collateralized mortgage obligation as available for sale. The Company included net unrealized gains on investment securities available for sale, net of taxes, of $338,000 in accumulated other comprehensive income within stockholders' equity at December 31, 2001. The Company's portfolio of held to maturity securities consisted of $23.1 million of fixed-rate mortgage-backed securities, $4.6 million of U.S. Government Agency Obligations and $7.6 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, 2001 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 $ - $ - $ 5,390 $ 22,397 $ 27,787 FHLMC participation certificates - - - 13,798 13,798 Collateralized mortgage obligations - - - 2,006 2,006 ARM mutual funds - - - 6,814 6,814 ------ ------ ------- -------- -------- $ - $ - $ 5,390 $ 45,015 $ 50,405 ====== ====== ======= ======== ======== Weighted average coupon - % - % 5.98% 5.99% 5.99% 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 $ - $ - $ - $ 12,295 $ 12,295 FHLMC participation certificates - - - 8,149 8,149 GNMA participation certificates - - - 2,683 2,683 U.S. Government Agency obligations - 4,621 - - 4,621 Trust preferred securities - - - 7,595 7,595 ----- ------ -------- -------- -------- $ - $ 4,621 $ - $ 30,722 $ 35,343 ===== ======= ======== ======== ======== Weighted average coupon - % 7.16% - % 6.73% 6.79% The carrying value of investments in debt and equity obligations at December 31, follows: 2001 2000 1999 -------- -------- -------- (Dollars in Thousands) Available for Sale (at market value) Mortgage-backed securities: FNMA participation certificates $ 27,787 $ 27,804 $ 25,631 FHLMC participation certificates 13,798 3,603 5,112 U.S. Treasury bills - - 4,865 U.S. Government Agency obligations - 1,999 3,894 Marketable equity securities - 822 - ARM mutual funds 6,814 - - Collateralized mortgage obligation 2,006 - - -------- -------- -------- $ 50,405 $ 34,228 $ 39,502 ======== ======== ======== Held to Maturity (at amortized cost) Mortgage-backed securities: FNMA participation certificates $ 12,295 $ 2,940 $ 3,077 FHLMC participation certificates 8,149 4,377 4,868 GNMA participation certificates 2,683 3,393 3,731 U.S. Government Agency obligations 4,621 16,381 16,393 Trust preferred securities 7,595 3,191 - -------- -------- -------- $ 35,343 $ 30,282 $ 28,069 ========= ========= ========= Loans. Total gross loans increased by $600,000, or 0.3%, to $203.7 million at December 31, 2001. The growth was principally in commercial and commercial real estate loans. Total residential real estate loans, which represent the largest component of the loan portfolio, decreased by $3.8 million in 2001. The decrease in residential real estate loans is primarily due to declining interest rates which increased prepayments. The low interest rate environment also created favorable market conditions for borrowers to obtain fixed rate loans. Origination of such loans for sale in the secondary market increased from $30 million in 2000 to $54 million in 2001. In addition to originating loans for sale in the secondary market the Company's focus in 2001 was on originating commercial and commercial real estate loans. As a result, outstanding commercial and commercial real estate loan balances increased by $4.0 million, or 69.3%, in 2001. 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, 2001 2000 1999 1998 1997 ---------------- --------------- ---------------- ---------------- ----------------- Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent ------ ------- ------ ------- ------ ------- ------ ------- ------ ------- (Dollars in Thousands) Mortgage Loans: Residential $158,898 78.3% $ 162,680 80.5% $ 162,633 84.4% $160,153 84.9% $ 136,345 82.6% Residential owner- occupied construction 1,991 1.0 1,353 0.7 890 0.5 1,412 0.7 2,638 1.6 Home equity 31,733 15.6 31,212 15.4 23,385 12.1 19,772 10.5 18,035 10.9 ------- ---- -------- ---- -------- ----- ------- ---- ------ ------ Subtotal 192,622 94.9 195,245 96.6 186,908 97.0 181,337 96.1 157,018 95.1 Commercial/commercial real estate 9,648 4.8 5,698 2.8 4,873 2.5 6,191 3.3 6,717 4.1 ------- ---- -------- ---- -------- ---- ------- ------ -------- ------ Commercial/mortgage loans, gross 202,270 99.7 200,943 99.4 191,781 99.5 187,528 99.4 163,735 99.2 Consumer loans 535 .3 1,302 0.6 1,060 0.5 1,188 0.6 1,255 0.8 ------- --- -------- ---- -------- ---- ------- ------ --------------- Gross loans 202,805 100.0% 202,245 100.0% 192,841 100.0% 188,716 100.0% 164,990 100.0% ===== ===== ===== ===== ===== Plus deferred loan origination costs 905 987 586 378 606 Less unearned discount - (95) (100) (103) (143) ------- -------- -------- ------- -------- Loans, net of deferred cost and unearned discount 203,710 203,137 193,327 188,991 165,453 Less allowance for loan losses (2,121) (1,803) (1,798) (1,742) (1,673) ------- -------- -------- ------- -------- Loans, net $201,589 $201,334 $191,529 $187,249 $163,780 = ======= ======== ======== ======== ======== The following table sets forth residential owner-occupied construction and commercial and commercial real estate loans by maturity date as of December 31, 2001: Residential Owner-Occupied Commercial/ Construction Loans Commercial Real Estate Loans ------------------ ---------------------------- Amount Percentage Amount Percentage ----------------- ------ ---------- (Dollars in Thousands) Within one year $1,991 100% $ 1,295 13.42% One to five years - 1,549 16.06 Over five years - 6,804 70.52 ----- - ------- ------- Total $1,991 100.0% $ 9,648 100.00% ====== ===== ======== ======= 16 Commercial real estate loans with maturity dates over one year: Amount ------ (Dollars in Thousands) Fixed interest rate $ 4,062 Adjustable interest rate 4,291 ------- Total $ 8,353 ======= 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, ------------------------------------------ 2001 2000 1999 ---- ---- ---- (Dollars in Thousands) Beginning balance $ 200,943 $ 191,781 $ 187,528 Mortgage and commercial loan originations: Residential 108,554 54,450 94,954 Residential owner-occupied construction 762 772 1,394 Commercial 5,379 1,526 - Home equity 15,379 18,086 15,339 -------- --------- --------- Total mortgage and commercial loan originations 130,074 74,834 111,687 Loans held for sale at January 1 5,003 - 24,000 Conventional loan sales: Servicing retained 5,030 9,787 67,101 Servicing released 38,939 15,477 16,444 Amortization, payoffs, charge-offs, unadvanced funds 74,836 34,821 38,831 Securitized and transferred to investment portfolio - 584 8,996 Transfers to OREO - - 62 Transfers to loans held for sale 14,945 5,003 - -------- --------- --------- Total loan sales, amortization, payoffs, charge-offs, transfers, and unadvanced funds 133,750 65,672 131,434 -------- --------- --------- Ending balance $ 202,270 $ 200,943 $ 191,781 ======== ========= ========= Residential loan originations totaled $109.3 million in 2001, $55.2 million in 2000 and $96.3 million in 1999. 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. The originations of residential loans are sensitive to market interest rates and in 2001 the Bank 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 on a servicing released basis amounted to $38.9 million in 2001, $15.5 million in 2000 and $16.4 million in 1999. Those sold on a servicing retained basis totaled $5.0 million, $9.8 million and $67.1 million, respectively, in 2001, 2000 and 1999. The portfolio of residential mortgage loans serviced for others totaled $13.2 million at December 31, 2001, compared to $11.1 million at December 31, 2000 and $0 at December 31, 1999. 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, ------------------------------------------------------ 2001 2000 1999 1998 1997 --------- --------- --------- -------- --------- (Dollars in Thousands) Average loans (1) $ 211,374 $ 201,011 $ 200,265 $ 190,072 $ 142,512 ========= ========= ========= ======== ========= Period-end loans (2) $ 203,710 $ 203,137 $ 193,327 $ 188,991 $ 165,453 ========= ========= ========= ======== ========= Allowance for loan losses at beginning of period $ 1,803 $ 1,798 $ 1,742 $ 1,673 $ 1,548 Loans charged-off: Commercial - - - - - Residential real estate - - 4 42 7 Home equity and other consumer 113 86 77 89 24 --------- --------- --------- -------- --------- 113 86 81 131 31 Loan recoveries: Commercial 149 - - - - Residential real estate 147 - 3 3 33 Home equity and other consumer 35 31 34 17 3 --------- --------- --------- -------- --------- 331 31 37 20 36 --------- --------- --------- -------- --------- Net charge-offs/(recoveries) (218) 55 44 111 (5) Provision charged to operations 100 60 100 180 120 --------- --------- --------- -------- --------- Allowance for loan losses at end of period $ 2,121 $ 1,803 $ 1,798 $ 1,742 $ 1,673 ========= ========= ========= ======== ========= Selected Ratios: - --------------- Allowance for loan losses to period-end loans, 1.04% 0.89% 0.93% 0.92% 1.01% net Net charge-offs/(recoveries) to average loans (.10)% 0.03% 0.02% 0.06% - % Net charge-offs/(recoveries) to allowance for loan losses (10.28)% 3.05% 2.45% 6.37% (0.30)% Allowance as a percentage of non-performing loans 1,171.8% 787.3% 5,800.0% 372.2% 176.1% (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 increased slightly to 1.04% at December 31, 2001, up marginally from .89% at December 31, 2000 and .93% at December 31, 1999. Recoveries increased substantially in 2001, principally due to the payoff of loans which were partially charged-off by the Bank in prior years. In establishing the level of the allowance at December 31, 2001, management gave consideration to the declining economy, the increase in loans three or more payments past due from $170,000 at December 31, 2000 to $650,000 at December 31, 2001 and the growth of the commercial loan portfolio. 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, 2001 2000 1999 1998 1997 --------------- ----------------- ---------------- ---------------- --------------- Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent ------ ------- ----- ------- ------ ------- ------ ------- ------ ------- (Dollars in Thousands) Commercial/commercial real estate $ 183 4.7% $ 158 2.8% $ 151 2.5% $ 215 3.3% $ 217 4.1% Residential real estate 1,203 79.5 976 81.2 1,065 84.9 1,030 85.6 1,014 84.2 Home equity and other consumer 735 15.8 669 16.0 582 12.6 497 11.1 442 11.7 ------ ----- ----- ----- ----- ----- ------ ------ ------ ------ $ 2,121 100.0% $1,803 100.0% $1,798 100.0% $ 1,742 100.0% $ 1,673 100.0% ====== ===== ===== ===== ===== ===== ====== ===== ====== ===== 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 $249.5 million, an increase of $12.3 million or 5.2% over the year-end 2000 balance of $237.2 million. The increase was most pronounced in money market deposit accounts which increased by $13.7 million in 2001. In addition, demand deposits increased by $4.0 million and savings accounts increased by $6.4 million offset by a decrease in certificates of deposit of $14.4 million. The increase in money market deposit account balances resulted from transfers out of maturing certificates of deposit and an increase in commercial customers. The growth in savings accounts resulted from customers transitioning funds from stock investments. Management attributes the decline in certificates of deposit to the generally low level of interest rates. 19 The following table shows the distribution of the Company's deposits at December 31, 2001 2000 1999 ------------------------------ ------------------------------ ------------------------------- Weighted Weighted Weighted % of Average % of Average % of Average Amounts Deposits Rate Amounts Deposits Rate Amounts Deposits Rate ------- -------- ------ ------- -------- ------ ------- -------- ------ (Dollars in Thousands) Demand deposits $ 26,850 10.7% .00% $ 22,855 9.6% .00% $ 15,209 7.2% .00% Savings: Savings 45,902 18.4 1.31 39,531 16.7 2.26 37,704 17.9 2.31 NOW accounts 37,474 15.0 .51 34,871 14.7 .83 27,481 13.1 .76 Money markets 79,806 32.0 2.72 66,083 27.9 5.04 62,859 30.0 4.49 -------- ----- ------- ---- ------- ---- Total demand and savings 190,032 76.1 1.14 163,340 68.9 2.76 143,253 68.2 2.75 Certificates of deposit 59,481 23.9 4.55 73,897 31.1 5.93 66,829 31.8 5.09 -------- ---- ------- ----- ------- ----- Total deposits $ 249,513 100.0% 1.95% $237,237 100.0% 3.75% $210,082 100.0% 3.40% ======== ===== ==== ======= ===== ==== ======= ===== ==== Deposits of $100,000 or more totaled approximately $87.8 and $77.6 million at December 31, 2001 and 2000, 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, 2001 At December 31, ----------------------------------------- ---------------------------------------- Maturing Maturing Maturing 2001 2000 1999 Within 1 Year 1-3 Years Thereafter Total Total Total ------------- --------- ---------- ----- ----- ----- (Dollars In Thousands) Certificate accounts: 2.00% to 2.99% $ 9,119 $ 53 $ - $ 9,172 $ - $ - 3.00% to 3.99% 9,139 2,233 - 11,372 - - 4.00% to 4.99% 11,312 2,728 42 14,082 2,496 26,993 5.00% to 5.99% 10,328 2,355 440 13,123 35,189 30,677 6.00% to 6.99% 6,737 632 369 7,738 24,687 8,178 7.00% to 7.99% 2,315 1,344 335 3,994 11,525 981 ------ ----- ------ ------- ------- ------ Total $48,950 $9,345 $ 1,186 $ 59,481 $ 73,897 $66,829 ====== ===== ====== ======= ======= ====== Certificates at or over $100,000 totaled $12.9 million in 94 certificates at December 31, 2001 and $16.9 million in 108 certificates at December 31, 2000. The maturity distribution of certificates of deposit in amounts of $100,000 or more at December 31, 2001 follows: Amount ------ (Dollars in Thousands) Within 3 months $ 3,303 3 to 6 months 3,693 6 to 12 months 3,896 After one year 1,979 ------- $ 12,871 ======== 20 Borrowings. The Company borrows from the FHLB of Boston to support liquidity and manage its asset/liability position. Borrowings increased to $47.9 million, an increase of $15.8 million in 2001 from the year-end 2000 balance of $32.1 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 4.5% at December 31, 2001 versus 6.60% at December 31, 2000. The weighted average maturity of the borrowings at December 31, 2001 was 25 months versus twenty months at December 31, 2000. As of December 31, 2001, $8.9 million of the borrowings were short-term borrowings with a weighted-average rate of 2.0% and a weighted average maturity of 27 days. 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. Short-Term FHLB Advances (Dollars in thousands) For Years Ended December 31, -------------------------------------------------------------------------------------- 2001 2000 1999 ----------------------- ---------------------- ------------------------- Weighted Weighted Weighted Balance Rate Balance Rate Balance Rate ------- ------ ------- ------ ------- ------ Balance at year end $ 10,859 2.11% $ 108 6.77% $ 37,000 5.80% Average outstanding during year $ 3,241 4.13% $ 4,583 6.21% $ 6,086 5.10% Maximum outstanding at any month end $ 15,000 3.22% $ 40,000 5.94% $ 42,677 4.96% As of December 31, 2001 and 2000, the Company also had $5.0 million and $18.0 million of borrowings maturing within one year that had original maturities of greater than one year. NON-PERFORMING ASSETS General. Non-performing assets stood at $181,000 at December 31, 2001 and $229,000 at the end of 2000. 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, 2001 and 2000 that were considered troubled debt restructurings. 21 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 $650,000 in loans greater than 90 days past due and still accruing at December 31, 2001. These loans were not classified as non-performing loans. At December 31, ----------------------------------------------------- 2001 2000 1999 1998 1997 ---- ---- ---- ---- ---- (Dollars in Thousands) Delinquent loans 30-89 days past due (not included in non-performing loans) $ 536 $ 575 $ 250 $ 194 $ 1,218 Delinquent loans 90+ days past due (not included in non-performing loans) 650 170 650 442 3 ----- ---- ------ ------ ------ $1,186 $ 745 $ 900 $ 636 $ 1,221 ===== ==== ====== ====== ====== Delinquent loans as a percent of gross loans .58% .37% .47% .34% .74% ===== ===== ====== ====== ====== At December 31, ----------------------------------------------------- 2001 2000 1999 1998 1997 ---- ---- ---- ---- ---- (Dollars in Thousands) Non-performing loans: Loans accounted for on a non-accrual basis $ 181 $ 229 $ 31 $ 468 $ 358 Restructured loans - - - - 592 ----- ---- ------ ------ ------ Total non-performing loans 181 229 31 468 950 OREO, net of allowance for OREO losses - - 111 718 1,214 ----- ---- ------ ------ ------ Total non-performing assets $ 181 $ 229 $ 142 $ 1,186 $ 2,164 ===== ==== ====== ====== ====== Non-performing assets as a percent of total assets .06% .08% .05% .44% .95% ===== ===== ====== ====== ====== 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, 2001, the Company had classified an additional $741,324 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 commercial loans. 22 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, 2001 located in Essex County, Massachusetts currently carried at $1 each. At December 31, --------------------------------- 2001 2000 1999 ---- ---- ---- (Dollars in Thousands) Commercial $ - $ - $ 49 Residential 1-4 family - - 62 ---- ----- ---- OREO $ - $ - $ 111 ===== ====== ====== 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, 2001, the Company reported net income of $2.8 million, or $1.37 per fully diluted share ($1.40 basic), compared to $2.7 million or $1.10 per fully diluted share ($1.12 basic) for 2000 and $3.3 million or $1.29 per fully diluted share ($1.33 basic) for 1999. The Company's return on average stockholders' equity increased from 15.79% in 2000 to 18.38% in 2001. The Company's financial performance in 2001 benefited from decreases in market interest rates and the overall cost of funds which positively impacted the Company's net interest margin and revenues from mortgage banking. The Company's financial performance in 2000 was significantly impacted by the rise in market interest rates; both net interest margins and mortgage banking revenues were negatively impacted. The Company's financial performance in 1999 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 $9.7 million in 2001, $8.9 million in 2000 and $8.7 million in 1999. Net interest income increased $849,000 in 2001 primarily due to lower average costs of funds. Net interest income increased $237,000 in 2000 and $1.2 million during 1999, 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 2001, market interest rates decreased throughout the year. The Company was positively impacted by the lower rates paid on deposits and borrowings during 2001, the effect of which increased the interest rate spread to 2.95% and the gross interest margin to 3.40% in 2001. Average earning assets increased 4.5% in 2001 to $288.0 million and increased 6.6% during 2000 to $275.7 million over the previous year, respectively. The increase was primarily due to higher loan portfolio growth and higher investment portfolio growth in 2001 and 2000, respectively. The volatility in the interest rates has also impacted the yields earned on the investment portfolio. The yields earned on investment securities decreased 35 basis points in 2001 to 6.40% as compared to 6.75% in 2000 and 6.24% in 1999. Total average loans increased $10.4 million during 2001 primarily due to increased originations and increased by $746,000 in 2000 principally from home equity loan originations. The yield on loans decreased 46 basis points in 2001 to 6.95% and decreased 26 basis points during 2000 to 7.41%. The largest component of the yield on loans was residential loans. The rate paid on interest-bearing deposits decreased 59 basis points in 2001 to 3.45% and increased 42 basis points during 2000 to 4.04%. Core deposits, which include NOW, savings and money market accounts, typically have rates lower than those paid on certificates of deposit. To grow the core deposit balances, the Company has offered promotional rates on certain products. The balances maintained in NOW and money market deposit accounts have increased in both 2001 and 2000. Certificate of deposit average balances decreased $1.9 million during 2001 and increased $5.8 million during 2000. 23 In 2001, the average balance of borrowed funds decreased $10.7 million while the rate paid increased 9 basis points. 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. The combination of the factors mentioned above contributed to an 18 basis point increase to 2.95% in the interest rate spread in 2001 and a 19 basis point decrease in the interest rate spread to 2.77% during 2000. The gross interest margin on earnings assets was 3.40% for the year ended December 31, 2001 and 3.24% and 3.36%, respectively, for 2000 and 1999. 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. 24 Year Ended December 31, ------------------------------------------------------------------------------------------------------- 2001 2000 1999 -------------------------------- -------------------------------- ---------------- 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) $ 171,519 $ 11,891 6.93% $ 168,804 $ 12,036 7.13% $ 172,407 $ 12,170 7.06% Commercial 6,788 548 8.07 5,106 444 8.70 5,490 477 8.69 Home equity 32,016 2,145 6.70 26,098 2,299 8.81 21,251 1,561 7.35 Consumer 1,051 112 10.66 1,003 109 10.87 1,117 105 9.40 -------- -------- -------- -------- -------- -------- Total loans 211,374 14,696 6.95 201,011 14,888 7.41 200,265 14,313 7.15 Investments (2) 76,648 4,908 6.40 74,710 5,041 6.75 58,397 3,642 6.24 -------- -------- -------- -------- -------- -------- Total interest- Earning assets 288,022 19,604 6.81 275,721 19,929 7.23 258,662 17,955 6.94 Cash and due from banks 7,711 6,483 6,247 Other assets 3,023 2,963 4,248 -------- -------- -------- Total assets $ 298,756 $ 285,167 $ 269,157 ======== ======== ======== Interest-bearing liabilities: Savings deposits $ 43,142 891 2.07% $ 37,936 879 2.32% $ 35,987 868 2.41% NOW accounts 34,310 237 .69 28,399 233 .82 23,787 176 .74 Money market deposit accounts 72,743 2,793 3.84 63,477 3,055 4.81 58,115 2,441 4.20 Certificates of 67,495 3,585 5.31 69,436 3,885 5.60 63,608 3,091 4.86 -------- -------- -------- -------- -------- -------- deposit Total interest- bearing deposits 217,690 7,506 3.45 199,248 8,052 4.04 181,497 6,576 3.62 Borrowed funds 36,758 2,314 6.30 47,413 2,942 6.21 50,995 2,681 5.26 -------- -------- -------- -------- -------- -------- Total interest- bearing 254,448 9,820 3.86 246,661 10,994 4.46 232,492 9,257 3.98 liabilities Demand deposits 23,856 18,624 18,048 Other liabilities 2,672 2,808 3,154 -------- -------- -------- Total liabilities 280,976 268,093 253,694 Company obligated Mandatory redeemable capital securities 2,962 Stockholders' equity 14,818 17,074 15,463 -------- -------- -------- Total liabilities and Stockholders' equity $ 298,756 $ 285,167 $ 269,157 ======== -------- ======== -------- ======== Net interest income $ 9,784 $ 8,935 $ 8,698 ======== ======== ======== Interest rate spread 2.95% 2.77% 2.96% Gross interest margin 3.40% 3.24% 3.36% (1) Residential loans include portfolio loans and loans held for sale. (2) Includes Federal funds sold. 25 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. 2001 vs. 2000 2000 vs. 1999 Changes Due to Changes Due to Increased (Decreased) Increased (Decreased) ------------------------------ ------------------------------ Rate Volume Total Rate Volume Total ------- ------ -------- ------- ------- ------- (Dollars in Thousands) Interest income: Loans $ (912) $ 720 $ (192) $ 520 $ 55 $ 575 Mortgage-backed securities (226) 424 198 263 463 726 Short-term investments (91) (25) (116) 8 134 142 Investment securities 99 (314) (215) 27 504 531 ------- ------ -------- ------- ------- ------- Total (1,130) 805 (325) 818 1,156 1,974 Interest expense: Deposits (1,182) 636 (546) 759 717 1,476 Borrowed funds 43 (671) (628) 483 (222) 261 ------- ------ -------- ------- ------- ------- Total (1,139) (35) (1,174) 1,242 495 1,737 ------- ------ -------- ------- ------- ------- Net interest and dividend income $ 9 $ 840 $ 849 $ (424) $ 661 $ 237 ======= ====== ======== ======= ======= ======= Provision for Loan Losses. The provision for loan losses in 2001 was $100,000, an increase of $40,000 or 66.7% from 2000, principally as a result of an increase in commercial loans. 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. 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 2001 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. 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. Non-interest Income. The company recorded income from non-interest sources of $3.0 million in 2001, $1.7 million in 2000 and $2.9 million in 1999. The increase of $1.2 million in 2001 resulted from an increase of $546,000 in mortgage banking gains due to favorable secondary market conditions and $443,000 in deposit account fees attributable to an increase in deposits. The decrease of $1.2 million in 2000 resulted from a decline of $1.2 million in mortgage banking gains. Deposit account fees totaled $2.1 million, $1.7 million and $1.5 million in 2001, 2000 and 1999, respectively, and was derived primarily from customer service charges and fees. Loan late charges and other fees increased during 2001 by $56,000 to $183,000, while decreasing by $90,000 in 2000 to $127,000. The majority of the increase in deposit fee income is due to increased debit card income, ATM usage 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. 26 Non-interest Expense. Non-interest expenses increased $1.5 million, or 22.0%, to $8.3 million in 2001 while decreasing $91,000, or 1.3%, to $6.8 million in 2000. The increase in 2001 was primarily due to the increases in salaries and benefits, costs associated with the distribution of the securities of subsidiary trust and the write-down of leasehold improvements in a branch that will be relocated. The decrease in 2000 was primarily due to the decline in professional fees. Salaries and employee benefits, the largest component of non-interest expense, increased $451,000 to $3.7 million in 2001 and decreased $20,000 in 2000 to $3.2 million. The increase in 2001 was primarily due to increased staffing for operations. Office occupancy and equipment increased $138,000 to $1.1 million in 2001 and decreased $2,000 in 2000 to $914,000. The increase in 2001 was primarily due to increased rent and maintenance costs. Data processing expenses totaled $1.1 million in 2001, $924,000 in 2000 and $798,000 in 1999. Data processing expenses increased $132,000 in 2001 and $126,000 in 2000 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 $364,000 in 2001, $337,000 in 2000 and $778,000 in 1999. Professional fees decreased $441,000 in 2000 due to the one time expense in 1999 to form the holding company and REIT. The Company incurred costs of $310,000 in 2001 resulting from payments on its mandatorily redeemable capital securities of $3.5 million, which were issued in 2001. The capital securities bear interest at 10.2%. Other operating expenses totaled $1.1 million in 2001, $859,000 in 2000 and $921,000 in 1999. The increase in 2001 was primarily due to the increase in postage, employee education and supplies. 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 $1.5 million, $1.1 million and $1.3 million in 2001, 2000 and 1999, respectively, and realized effective tax rates of 35%, 30% and 28.7%, respectively. The lower effective tax rates in 2000 and 1999 resulted from reductions in the valuation allowance of $190,000 in 2000 and $121,000 in 1999. 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, 2001, the Company's cumulative gap with respect to assets and liabilities maturing or repricing within one year was a negative $13.9 million or 4.33% 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, 2001: Assets/Liabilities Maturing or Repricing at December 31, 2001 in: ----------------------------------------------------------------- 0-6 6-12 1-2 3-5 Over 5 Months Months Years Years Years Total ------ ------ ----- ----- ----- ----- (Dollars in Thousands) Assets: Residential ARM loans $ 13,789 $ 15,393 $ 25,500 $ 32,718 $ - $ 87,400 Residential fixed rate mortgage loans 5,328 5,100 9,200 21,172 33,594 74,394 Loans held for sale 14,945 - - - - 14,945 Home equity loans 31,508 6 10 53 156 31,733 Commercial loans 1,918 879 740 3,629 2,482 9,648 Consumer loans 405 85 17 28 - 535 Fixed MBS held-to-maturity 1,700 1,672 3,140 7,251 9,364 23,127 Callable debentures held-to-maturity - 4,621 - - - 4,621 Corporate debt securities held-to-maturity - - - - 7,595 7,595 Fixed MBS available-for-sale 2,295 2,195 4,031 9,246 10,946 28,713 ARM MBS available-for-sale 7,173 5,699 - - - 12,872 ARM mutual funds 6,814 - - - - 6,814 CMO 228 228 456 1,094 - 2,006 Equity securities 3,000 - - - 253 3,253 Cash and due from banks 1 - - - 10,936 10,937 Non-earnings assets - - - - 2,522 2,522 -------- --------- --------- --------- -------- --------- Total 89,104 35,878 43,094 75,191 77,848 321,115 Liabilities and equity capital: Interest bearing NOW accounts - - - - 37,474 37,474 Demand deposits - - - - 26,850 26,850 Savings accounts - 10,220 - - 35,682 45,902 Money market accounts 47,883 15,960 7,981 7,982 - 79,806 Certificates of deposit 30,735 18,218 7,218 3,310 - 59,481 Borrowings 8,859 7,000 14,250 15,750 3,148 49,007 Other liabilities - - - - 3,976 3,976 Capital securities - - - - 3,500 3,500 Equity capital - - - - 15,119 15,119 -------- --------- --------- --------- -------- --------- Total 87,477 51,398 29,449 27,042 125,749 321,115 -------- --------- --------- --------- -------- --------- Excess (deficiency) of assets over liabilities and equity capital $ 1,627 $ (15,520) $ 13,645 $ 48,149 $ (47,901) $ - ========= ========== ========== ========== ========= ========== Cumulative Gap $ 1,627 $ (13,893) $ (248) $ 47,901 $ - $ - Cumulative assets as a % of cumulative liabilities and equity capital .51% (4.83)% 4.25% 14.99% (14.92)% Cumulative excess (deficiency) of assets over liabilities and equity capital as a % of total assets .51% (4.33)% (0.08)% 14.92% 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 $28.0 million, or 10.4%, during 2001, and increased by $14.3 million, or 5.6%, during 2000. During 2001 and 2000, 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, 2001 and 2000, approved loan commitments outstanding amounted to $13.6 million and $3.4 million, respectively. At the same dates, commitments of the Company to borrowers under unused lines of credit and home equity credit lines amounted to $36.6 million and $36.9 million, respectively, and the unadvanced portions of residential owner-occupied construction loans amounted to $671,000 and $484,000, 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, 2001, the total borrowing capacity was $88.8 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, 2001. The required ratios included in the table are the capital minimums for December 31, 2001, 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 $ 12,680 4.0% $ 18,259 5.76% (1) $ 5,579 1.76% Bank 12,505 4.0 17,357 5.55 (1) 4,852 1.55 Risk-based: Tier 1 Company $ 7,054 4.0% $ 18,259 10.35% (2) $ 11,205 6.35% Bank 7,049 4.0 17,357 9.85 (2) 10,308 5.85 Total risk-based Company $ 14,109 8.0% $ 20,380 11.56% (2) $ 6,271 3.56% Bank 14,097 8.0 19,478 11.05 (2) 5,381 3.05 (1) Regulatory Tier 1 leverage capital differs from the ratio of stockholders' equity to total assets calculated in accordance with accounting principles generally accepted in the United States of America. Additionally, the Regulatory Tier 1 leverage capital calculation utilizes average assets for the fourth quarter of 2001, which were $312,863 and $312,638 for the Company and Bank, respectively. (2) Based upon total risk-based assets of $176,360 and $176,216 for the Company and Bank, respectively. The Company, pursuant to stock repurchase plans, repurchased 454,000 shares in 2000 at a weighted average price of $8.93 per share and 150,900 shares in 2001 at a weighted average price of $11.46 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 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 The Company declared dividends of $992,000, $955,000 and $629,000 or $.50, $.41 and $.25 per share in 2001, 2000 and 1999, respectively. The declaration of future cash dividends will be subject to operating results, financial conditions, regulatory, tax considerations and other factors. The number of shares outstanding at December 31, 2001 and 2000 was approximately 1.9 million and 2.1 million, respectively. In accordance with the terms of the Agreement and Plan of Merger between Banknorth Group, Inc. and the Company, the Company may continue to pay its regular quarterly dividend at a rate not to exceed $.12 per quarter. 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 accounting principles generally accepted in the United States of America 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. In August of 2001 the FASB issued Statement No. 144 "Accounting for the Impairment or Disposal of Long-Lived Assets" This Statement addresses financial accounting and reporting for the impairment or disposal of long-lived assets. For long-lived assets to be held and used this Statement retains the requirements of Statement 121 to (a) recognize an impairment loss only if the carrying amount of a long-lived asset is not recoverable from its undiscounted cash flows and (b) measure an impairment loss as the difference between the carrying amount and fair value of the asset. For long-lived assets to be disposed of other than by sale this Statement requires that a long-lived asset to be abandoned, exchanged for a similar productive asset, or distributed to owners in a spinoff be considered held and used until it is disposed of. This Statement requires that the depreciable life of a long-lived asset to be abandoned be revised in accordance with APB Opinion No. 20, Accounting Changes and amends APB Opinion No. 29, Accounting for Nonmonetary Transactions, to require that an impairment loss be recognized at the date a long-lived asset is exchanged for a similar productive asset or distributed to owners in a spinoff if the carrying amount of the asset exceeds its fair value. The accounting model for long-lived assets to be disposed of by sale is used for all long-lived assets, whether previously held and used or newly acquired. That accounting model retains the requirement of Statement 121 to measure a long-lived asset classified as held for sale at the lower of its carrying amount or fair value less cost to sell and to cease depreciation (amortization). Therefore, discontinued operations are no longer measured on a net realizable value basis, and future operating losses are no longer recognized before they occur. The provisions of this Statement are effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years, with early application encouraged. The provisions of this Statement generally are to be applied prospectively. The adoption of this Statement will not have a significant effect on the Company's financial condition , liquidity or results of operations. In June of 2001 the FASB Issued Statement No. 143, Accounting for Asset Retirement Obligations. This statement addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. This statement applies to legal obligations associated with the retirement of long-lived assets that result from the acquisition, construction, development and (or) the normal operation of a long-lived asset, except for certain obligations of lessees. This statement is effective for financial statements issued for fiscal years beginning after June 15, 2002. The Company has not determined the impact of adoption of this statement. In June 2001 the FASB Issued Statement No. 141, Business Combinations and Statement No. 142, Goodwill and Other Intangible Assets. These statements address the accounting for business combination and accounting and reporting for acquired goodwill and other intangible assets. These statements are not expected to impact the Company. 31 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. The following reflects the Company's NII sensitivity analysis as of December 31: Estimated Rate Change NII Sensitivity ----------- --------------- 2001 2000 ---- ---- +200bp (1.38)% (3.10)% -200bp (0.93)% (0.24)% 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. 32 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. 33 ITEM 8 FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA Page Independent Auditors' Report 35 Consolidated Balance Sheets 36 Consolidated Statements of Income 38 Consolidated Statements of Changes in Stockholders' Equity 40 Consolidated Statements of Cash Flows 42 Notes to Consolidated Financial Statements 45 34 INDEPENDENT AUDITORS' REPORT The Board of Directors Ipswich Bancshares, Inc. We have audited the accompanying consolidated balance sheets of Ipswich Bancshares, Inc. and Subsidiaries (the Company) as of December 31, 2001 and 2000, 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, 2001. 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 auditing standards generally accepted in the United States of America. 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 Subsidiaries at December 31, 2001 and 2000, and the consolidated results of their operations and their cash flows for each of the three years in the period ended December 31, 2001 in conformity with accounting principles generally accepted in the United States of America. Portland, Maine Limited Liability Company January 25, 2002 (except note 22, as to which the date is February 26, 2002) 35 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS December 31, 2001 and 2000 (Dollars in Thousands Except Per Share Data) ASSETS ------ 2001 2000 --------- --------- Cash and due from banks (note 2) $ 10,937 $ 8,836 Investment securities available for sale, at market value; amortized cost of $49,843 and $33,452 (notes 3 and 12) 50,405 34,228 Investment securities held to maturity, at cost; market value of $35,930 and $30,374 (notes 3 and 12) 35,343 30,282 Loans held for sale (note 4) 14,945 5,003 Loans (notes 5 and 12) 203,710 203,137 Allowance for loan losses (note 6) (2,121) (1,803) --------- --------- Net loans 201,589 201,334 Stock in Savings Bank Life Insurance Company 253 253 Stock in FHLB of Boston (notes 9 and 12) 3,000 3,000 Banking premises and equipment, net (note 7) 2,824 2,983 Accrued interest receivable 1,251 1,435 Mortgage servicing rights, net (note 10) 219 225 Other assets 349 255 --------- --------- Total assets $ 321,115 $ 287,834 ========= ========= 36 LIABILITIES AND STOCKHOLDERS' EQUITY 2001 2000 --------- --------- Liabilities: Deposits (note 11) $ 249,513 $ 237,237 Borrowed funds (note 12) 47,859 32,108 Mortgagors' escrow accounts 1,148 972 Accrued expenses and other liabilities 3,302 1,726 Deferred income tax liability (note 14) 674 672 --------- --------- Total liabilities 302,496 272,715 Commitments and contingencies (notes 4, 7, 15 and 18) Company obligated, mandatorily redeemable capital securities (note 13) 3,500 -- Stockholders' equity (notes 15 and 16): 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, 2,530,528 and 2,525,552 shares issued 253 253 Additional paid-in capital 2,345 2,297 Retained earnings 17,966 16,150 Treasury stock at cost (604,900 and 454,000 shares in 2001 and 2000) (5,783) (4,054) Accumulated other comprehensive income (note 3) 338 473 --------- --------- Total stockholders' equity 15,119 15,119 Total liabilities and stockholders' equity $ 321,115 $ 287,834 ========= ========= See accompanying notes. 37 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME Years Ended December 31, 2001, 2000 and 1999 (Dollars in Thousands, Except Per Share Data) 2001 2000 1999 -------- -------- -------- Interest and dividend income: Loans $ 14,696 $ 14,888 $ 14,313 Federal funds sold and interest bearing deposits 214 328 187 Investment securities available for sale 2,607 2,822 2,233 Investment securities held to maturity 2,087 1,891 1,222 -------- -------- -------- Total interest and dividend income 19,604 19,929 17,955 Interest expense: Deposits (note 11) 7,506 8,052 6,576 Borrowed funds 2,314 2,942 2,681 -------- -------- -------- Total interest expense 9,820 10,994 9,257 -------- -------- -------- Net interest and dividend income 9,784 8,935 8,698 Provision for loan losses (note 6) 100 60 100 -------- -------- -------- Net interest and dividend income after provision for loan losses 9,684 8,875 8,598 Non-interest income: Net mortgage banking gains (losses) (note 4) 443 (147) 1,030 Net gain (loss) on sale of mortgage servicing rights (note 10) -- 15 63 Loan servicing (expenses) income, net (note 10) (46) (2) 21 Deposit account fees 2,144 1,701 1,504 Other loan fees 183 127 217 Gains on sales of securities available for sale, net (note 3) 182 33 78 Other 49 9 12 -------- -------- -------- Total non-interest income 2,955 1,736 2,925 -------- -------- -------- Net interest, dividend and non-interest income 12,639 10,611 11,523 38 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME (CONTINUED) Years Ended December 31, 2001, 2000 and 1999 (Dollars in Thousands, Except Per Share Data) 2001 2000 1999 ------- ------- ------- Non-interest expenses: Salaries and employee benefits (note 16) $ 3,663 $ 3,212 $ 3,232 Occupancy and equipment expenses (note 7) 1,052 914 916 Data processing expenses 1,056 924 798 Professional fees 364 337 778 Advertising and marketing expenses 498 524 537 FDIC and DIF deposit insurance 55 52 36 OREO expense (income), net (note 8) 5 (3) (308) Distribution on securities of subsidiary trust (note 13) 310 -- -- Loss on banking premises and equipment (note 7) 234 -- -- Other 1,083 859 921 ------- ------- ------- Total non-interest expenses 8,320 6,819 6,910 ------- ------- ------- Income before income taxes 4,319 3,792 4,613 Income tax expense (note 14) 1,511 1,137 1,324 ------- ------- ------- Net income $ 2,808 $ 2,655 $ 3,289 ======= ======= ======= Basic earnings per share (notes 1 and 17) $ 1.40 $ 1.12 $ 1.33 Diluted earnings per share (notes 1 and 17) 1.37 1.10 1.29 Dividends per share .50 .41 .25 See accompanying notes. 39 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY Years Ended December 31, 2001, 2000 and 1999 (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, 1998 2,392,286 $ 239 $ 2,009 $ 11,790 $- $ 185 $ 14,223 Stock options exercised (note 6) 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 Stock options exercised 125 - 1 - - - 1 Issuance of stock rights (note 6) - 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 40 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (CONTINUED) Years Ended December 31, 2001, 2000 and 1999 (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, 2000 2,525,552 $ 253 $ 2,297 $ 16,150 $(4,054) $ 473 $ 15,119 Stock options exercised (note 6) 4,976 - 31 - - - 31 Issuance of stock rights - - 17 - - - 17 Cash dividends - - - (992) - - (992) Treasury stock purchased (150,900 shares at an average price of $11.46) - - - - (1,729) - (1,729) Comprehensive income: Net income - - - 2,808 - - 2,808 Other comprehensive income: Unrealized holding gains on securities, net of taxes of $50 - - - - - - (88) Reclassification adjustment for amounts included in net income, net of taxes of $30 - - - - - - (47) ------- Other comprehensive income - - - - - (135) (135) ------- Total comprehensive income - - - - - - 2,673 ----------- ---- ------ ------- ------ ---- ------- Balance at December 31, 2001 2,530,528 $ 253 $ 2,345 $ 17,966 $(5,783) $ 338 $ 15,119 =========== ==== ====== ======= ====== ==== ======= See accompanying notes. 41 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS Years Ended December 31, 2001, 2000 and 1999 (Dollars in Thousands) 2001 2000 1999 --------- ---------- --------- Net cash flows from operating activities: Net income $ 2,808 $ 2,655 $ 3,289 Adjustments to reconcile net income to net cash provided (used) by operating activities: Provision for loan losses 100 60 100 Deferred income tax (benefit) expense 82 (141) 88 Depreciation expense 350 347 337 Amortization of premiums on investment securities, net 111 62 148 (Gains) losses on sale of loans (443) 147 (1,030) Gains on sales of investment securities available for sale (182) (33) (78) Loss (gains) on sale of other real estate owned - 1 (340) Loss on banking premises and equipment 234 - - Origination of loans held for sale (54,140) (30,299) (59,545) Proceeds from sale of loans 39,640 15,410 16,620 Proceeds from sale of securitized loans 5,001 9,739 67,955 Increase in net loan origination costs/discounts (13) (396) (211) Decrease (increase) in mortgage servicing rights 6 (225) 229 Decrease (increase) in accrued interest receivable 184 (187) (195) Decrease (increase) in other assets, net (94) (73) 65 Increase (decrease) in accrued expenses and other liabilities 1,476 (1,005) (28) --------- ---------- --------- Net cash (used) provided by operating activities (4,880) (3,938) 27,404 Net cash flows from investing activities: Purchase of investment securities available for sale (39,693) (13,543) (19,490) Principal paydowns on investment securities available for sale 19,736 10,148 12,722 Proceeds from the sale of investment securities available for sale 3,642 9,976 4,963 Purchase of investment securities held to maturity (19,783) (3,191) (20,826) Principal paydowns on investment securities held to maturity 14,716 976 2,964 Redemption (purchases) of stock in FHLB of Boston - 977 (1,072) Net increase in loans (342) (10,044) (13,216) Proceeds from sales of other real estate owned - 110 1,009 Purchases of equipment, net (425) (162) (207) --------- ---------- --------- Net cash used in investing activities (22,149) (4,753) (33,153) 42 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED) Years Ended December 31, 2001, 2000 and 1999 (Dollars in Thousands) 2001 2000 1999 ---------- ---------- ---------- Cash flows from financing activities: Net increase in deposits $ 12,276 $ 27,155 $ 10,325 Proceeds from Federal Home Loan Bank advances 66,951 66,008 120,000 Repayment of Federal Home Loan Bank advances (51,200) (78,900) (128,000) Increase (decrease) in mortgagors' escrow accounts 176 (21) (50) Proceeds from the issuance of common stock and stock rights 48 35 267 Proceeds from issuance of capital securities 3,500 - - Cash dividends (892) (955) (629) Purchase of treasury stock (1,729) (4,054) - ---------- ---------- ---------- Net cash provided by financing activities 29,130 9,268 1,913 ---------- ---------- ---------- Net increase (decrease) in cash and cash equivalents 2,101 577 (3,836) Cash and cash equivalents at beginning of year 8,836 8,259 12,095 ---------- ---------- ---------- Cash and cash equivalents at end of year $ 10,937 $ 8,836 $ 8,259 ========== ========== ========== Supplemental disclosure of cash flow information: Cash paid for: Interest on deposit accounts $ 7,506 $ 8,052 $ 6,576 Interest on borrowed funds 2,328 2,904 2,711 Income tax 210 2,534 601 Supplemental schedule of non-cash investing and financing activities: Conversion of residential real estate loans to mortgage- backed securities $ - $ 584 $ 8,996 Transfer of loans to other real estate owned - - 62 Net (decrease) increase required by Statement of Financial Accounting Standards No. 115: Investment securities (215) 759 (292) Deferred income tax liability (80) 296 (117) Accumulated other comprehensive income (135) 463 (175) See accompanying notes. 43 (This page intentionally left blank) 44 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (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 Massachusetts Depositors Insurance Fund. (b) Basis of Presentation --------------------- The consolidated financial statements include the accounts of Ipswich Bancshares, Inc. and its wholly-owned subsidiaries, IpswichBank and Ipswich Statutory Trust I, 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 Statutory Trust I was formed in February 2001 to issue and sell common securities to the Company and preferred securities to the public. 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 accounting principles generally accepted in the United States of America. 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. 45 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (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. 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. 46 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 1. Summary of Significant Accounting Policies (Continued) ------------------------------------------------------ (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. (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. 47 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 1. Summary of Significant Accounting Policies (Continued) ------------------------------------------------------ (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. (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. The Company also has three stock option plans. 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. 48 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 1. Summary of Significant Accounting Policies (Continued) ------------------------------------------------------ (n) Derivatives ----------- The Company accounts for derivatives in accordance with Statement of Financial Accounting Standards (SFAS) No. 133, Accounting for Derivative Instruments and Hedging Activities, which 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 Company did not participate in derivative instruments during 2001, 2000 and 1999. (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. (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 2000 and 1999 financial statements have been reclassified to conform to 2001 presentation without effect on stockholders' equity or net income. 49 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 2. Reserve Requirements and Compensating Balance Agreements -------------------------------------------------------- The Federal Reserve Board requires the Company to maintain a reserve balance; the amount of this reserve balance at December 31, 2001 was $2,649. 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, 2001, the Company was required to maintain a compensating balance of $290. 3. Investment Securities --------------------- Available for Sale ------------------ The amortized cost and approximate market values of investment securities available for sale at December 31 are summarized as follows: 2001 ------------------------------------------------------------ Amortized Unrealized Unrealized Market Cost Gains Losses Value ----------- ----------- ----------- --------- Mortgage-backed securities $ 41,043 $ 618 $ (76) $ 41,585 Collateralized mortgage obligation 2,000 6 - 2,006 Mutual funds 6,800 14 - 6,814 -------- ---- ----- -------- $ 49,843 $ 638 $ (76) $ 50,405 ======== ==== ===== ======== 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 ======== ==== ===== ======== 50 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 3. Investment Securities (Continued) --------------------------------- 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. 2001 2000 -------------------------- --------------------------- Amortized Market Amortized Market Cost Value Cost Value ----------- -------- ----------- --------- Within one year $ - $ - $ - $ - Due after five years through ten years 5,384 5,390 2,000 1,999 Maturing after ten years: Mortgage-backed securities FNMA participation certificates 21,949 22,397 27,168 27,804 FHLMC participation certificates 13,710 13,798 3,537 3,603 Collateralized mortgage obligation 2,000 2,006 - - Mutual funds 6,800 6,814 - - Marketable equity securities - - 747 822 -------- ------- -------- -------- $ 49,843 $ 50,405 $ 33,452 $ 34,228 ======== ======= ======== ======== Proceeds from sales of investment securities available for sale during 2001, 2000 and 1999 amounted to $3,642, $9,976 and $4,963, respectively. The realized gains and losses on investment securities available for sale, for each of the three years ended December 31, is as follows: 2001 2000 1999 --------------------- --------------------- ---------------------- Realized Realized Realized Realized Realized Realized Gains Losses Gains Losses Gains Losses --------- --------- --------- --------- --------- --------- U.S. Treasury notes $ - $ - $ - $ (3) $ - $ - Mortgage-backed securities - - 5 (2) 49 - Marketable equity securities 184 (2) 37 (4) 29 - ----- ---- ---- ---- ----- ----- $ 184 $ (2) $ 42 $ (9) $ 78 $ - ===== ==== ==== ==== ===== ===== The Company had $214 of investment securities pledged for Treasury, Tax and Loan purposes to the FRB as of December 31, 2001. 51 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 3. Investment Securities (Continued) --------------------------------- 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: 2001 2000 Net unrealized gain on available for sale securities $ 562 $ 776 Related income tax benefit (224) (303) ------ ------ $ 338 $ 473 ====== ====== Held to Maturity ---------------- The amortized cost and approximate market values of investment securities held to maturity at December 31 are summarized as follows: 2001 ------------------------------------------------------------ Amortized Unrealized Unrealized Market Cost Gains Losses Value ----------- ----------- ----------- --------- U.S. Government Agency obligations $ 4,621 $ 181 $ - $ 4,802 Mortgage-backed securities 23,127 199 (198) 23,128 Trust preferred debt securities 7,595 464 (59) 8,000 -------- ---- -------- -------- $ 35,343 $ 844 $ (257) $ 35,930 ======== ==== ======== ======== 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 ======== ==== ===== ======== 52 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 3. Investment Securities (Continued) --------------------------------- 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. 2001 2000 ------------------------ ------------------------ Amortized Market Amortized Market Cost Value Cost Value ----------- --------- ----------- -------- After one to five years $ 4,621 $ 4,802 $ 2,000 $ 1,993 After five to ten years - - 12,383 12,466 Maturing after ten years: Mortgage-backed securities: FNMA participation certificates 12,295 12,158 2,940 2,954 FHLMC participation certificates 8,149 8,290 4,377 4,429 GNMA participation certificates 2,683 2,680 3,393 3,336 FHLMC debt obligations - - 1,998 1,948 Trust preferred debt obligations 7,595 8,000 3,191 3,248 ------- -------- -------- ------- $ 35,343 $ 35,930 $ 30,282 $ 30,374 ======= ======== ======== ======= 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: 2001 2000 ------------------------------- -------------------------------- Estimated Estimated Amortized Market Amortized Market Cost Value Cost Value ----------- ----------- ----------- ------------ Loans held for sale $ 14,945 $ 14,945 $5,003 $5,003 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) --------- --------- -------- 2001 $ 458 $ (15) $ 443 2000 163 (310) (147) 1999 1,036 (6) 1,030 53 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 4. Loans Held for Sale and Gains on Sales of Loans (Continued) ---------------------------------------------------------- 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 $7,401, $918 and $5,096 at December 31, 2001, 2000 and 1999, 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. Loans at December 31 are summarized as follows: 2001 2000 --------- --------- Loans: Residential $ 158,898 $ 162,680 Residential owner-occupied construction 2,662 1,837 Land 26 28 Commercial real estate 9,622 5,670 Home equity 67,704 64,974 --------- --------- 238,912 235,189 Less: Unadvanced funds on home equity loans (35,971) (33,762) Unadvanced funds on owner-occupied construction loans (671) (484) Deferred loan origination costs, net 905 987 Unearned discount - (95) --------- --------- Loans, net 203,175 201,835 Other loans, net 535 1,302 --------- --------- Total loans $ 203,710 $ 203,137 ========= ========= 54 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 5. Loans (Continued) ----------------- 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. There were no material related party loans as of December 31, 2001 and 2000. The recorded investment in loans for which an impairment has been recognized at December 31, 2001 and 2000 was $14 and $229, respectively. The related allowance for loan losses at December 31, 2001 and 2000 was $7 and $11, respectively. The average recorded investment in impaired loans during 2001 and 2000 was $19 and $45, respectively. Interest income recognized on impaired loans during 2001, 2000 and 1999 was $2, $2 and $71, 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: 2001 2000 1999 -------- -------- -------- Balance at beginning of year $ 1,803 $ 1,798 $ 1,742 Provision charged to operations 100 60 100 Less loans charged-off (113) (86) (81) Recoveries on loans previously charged-off 331 31 37 -------- -------- -------- Net recoveries (charge-offs) 218 (55) (44) -------- -------- -------- Balance at end of year $ 2,121 $ 1,803 $ 1,798 ======== ======== ======== 55 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 6. Allowance for Loan Losses (Continued) ------------------------------------- The allowance for loan losses is allocated as follows: 2001 2000 ------- ------- Commercial real estate $ 183 $ 158 Residential real estate 1,183 962 Home equity and other consumer 735 669 Residential owner-occupied construction 20 14 -------- -------- Total allowance $ 2,121 $ 1,803 ======== ======== 7. Banking Premises and Equipment A summary of banking premises and equipment at December 31 is as follows: 2001 2000 ------- ------- Land $ 207 $ 207 Building 2,101 2,179 Equipment 2,245 2,804 Leasehold improvements 570 793 ------- ------- 5,123 5,983 Less accumulated depreciation (2,299) (3,000) ------- ------- $ 2,824 $ 2,983 ======= ======= The Company recorded a loss of $234 in 2001 to writedown the unamortized costs of branch leasehold improvements. The Company will abandon such leasehold improvements in 2002 as it moves the branch to a different facility owned by its landlord. As of December 31, 2001, the Company was obligated under six non-cancelable operating leases for banking premises. Minimum future rentals under the non-cancelable operating leases are as follows: Year ending December 31, Amount ----------- ------ 2002 $ 269 2003 216 2004 129 2005 78 2006 13 Rent expense amounted to $277, $248 and $235 for the years ended December 31, 2001, 2000 and 1999, respectively. 56 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 7. Banking Premises and Equipment (Continued) ------------------------------------------ The Company leased out part of its facility, located in Ipswich, under a non-cancelable lease agreement. Rental income under this lease totaled $51, $69 and $50 for the years ended December 31, 2001, 2000 and 1999, respectively. 8. Other Real Estate Owned ----------------------- The Company had no recorded investment in other real estate owned at December 31, 2001 and 2000: An analysis of activity in other real estate owned for each of the years ended December 31, is as follows: 2001 2000 1999 ----- ------ ------- Balance at beginning of year $ - $ 111 $ 718 Foreclosures - - 62 Net sales proceeds - (110) (1,009) Gains (losses) on sales, net - (1) 340 ----- ------ ------- Balance at end of year $ - $ - $ 111 ===== ====== ======= An analysis of income for other real estate owned for each of the years ended December 31, is as follows: 2001 2000 1999 ----- ------ ------- Rental income $ 1 $ 4 $ 8 Gains (losses) on sales - (1) 340 Permitting costs (6) - (29) Foreclosure (expense reimbursement) - - (11) ----- ------ ------- $ (5) $ 3 $ 308 ===== ====== ======= 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, 2001 and 2000, the Company held the required investment of $3,000. 57 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 10. Mortgage Servicing Rights ------------------------- Loans serviced for others amounted to approximately $13,243, $11,092 and $0 at December 31, 2001, 2000 and 1999, respectively. Net servicing (expense) income amounted to approximately $(46), $(2) and $21 for the years ended December 31, 2001, 2000 and 1999, respectively. The following table summarizes the changes in mortgage servicing rights at December 31: 2001 2000 1999 ---- ---- ---- Balance at beginning of year $ 225 $- $ 229 Additions 78 229 1,171 Normal amortization (26) (4) (86) Sale of mortgage servicing rights - - (1,314) Write-down of mortgage servicing rights (58) - - ----- ----- -------- Balance at end of year $ 219 $ 225 $ - ===== ===== ======== Fair value at end of year $ 219 $ 225 $ - ===== ===== ======== 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. An analysis of the mortgage servicing rights valuation account at December 31 is as follows: 2001 2000 1999 ---- ---- ---- Balance at beginning of year $ - $ - $ - Write-down of servicing rights through charge to servicing income (58) - - ----- ----- ----- Balance at end of year $ (58) $ - $ - ===== ===== ===== 58 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 11. Deposits -------- Deposits at December 31 are summarized as follows: 2001 2000 ---- ---- Demand deposits (non-interest bearing) $ 26,850 $ 22,855 NOW accounts 37,474 34,871 Savings accounts 45,902 39,531 Money market deposit accounts 79,806 66,083 Certificates of deposit 59,481 73,897 ---------- ---------- $ 249,513 $ 237,237 ========== ========== Deposits of $100 or more totaled approximately $87,754 and $77,554 at December 31, 2001 and 2000, respectively, of which $12,871 and $16,885 are certificates of deposit in 2001 and 2000, respectively. The following table shows the scheduled maturity of certificates of deposit accounts at December 31: 2001 2000 ---------------------------- ----------------------------- Amount Percent Amount Percent ------ ------- ------ ------- Within one year $ 48,950 82.3 % $ 58,616 79.3% 1-2 years 7,220 12.1 11,846 16.0 2-3 years 2,125 3.6 1,495 2.0 3-4 years 850 1.4 1,233 1.7 4-5 years 336 .6 707 1.0 --------- ------- -------- ------- $ 59,481 100.0 % $ 73,897 100.0% ========= ======= ======== ======= Interest on deposits classified by type for the years ended December 31 is as follows: 2001 2000 1999 ---- ---- ---- NOW accounts $ 237 $ 233 $ 176 Saving accounts 891 879 868 Money market deposit accounts 2,793 3,055 2,441 Certificates of deposit 3,585 3,885 3,091 =------- =------- =------- $ 7,506 $ 8,052 $ 6,576 ======== ======== ======== 59 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (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: 2001 2000 -------------------------------- ------------------------------ Weighted Weighted Average Average Amount Rate Amount Rate ------ ----------- ------ ----------- Maturity in: 2001 $ - - % $ 18,108 6.29% 2002 15,859 3.55 7,000 6.70 2003 14,250 4.60 2,000 6.91 2004 5,250 4.35 - - 2005 7,000 6.44 5,000 7.45 2006 3,500 4.72 - - 2011 2,000 4.57 - - -------- ----- -------- --- $ 47,859 4.50% $ 32,108 6.60% ======== ===== ======== ==== The Company has a total borrowing capacity of $88,800 with the Federal Home Loan Bank of Boston at December 31, 2001. 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. Included within interest expense on borrowed funds for the year ended December 31, 2001 is $256 of prepayment penalties, which includes $152 to prepay advances which were scheduled to mature in 2001. 13. Capital Securities ------------------ In February 2001, the company sponsored the creation of Ipswich Statutory Trust I, (the Trust) a Connecticut statutory trust. The Company is the owner of all of the common securities of the Trust and therefore the Trust is a subsidiary of the Company. On February 22, 2001, the Trust issued $3,500 of 10.2% capital securities and $109 of common securities, the proceeds of which were used by the Trust to acquire $3,609 of the Company's 10.2% Junior Subordinated Deferrable Interest Debentures due February 22, 2031, which, with related accrued income, constitute the sole assets of the Trust. The Company has the right, subject to certain conditions, to redeem the debentures on or after February 22, 2001 at a redemption price specified in the indenture. The company has fully and unconditionally guaranteed all of the obligations of the Trust, but only to the extent of funds held in the Trust. The capital securities are mandatorily redeemable upon the maturity of the Junior Subordinated Debentures. The costs of issuance of the trust preferred securities was approximately $150, and is included in other assets on the consolidated balance sheet, net of accumulated amortization. The costs are being amortized over the life of the securities. 60 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 14. Income Taxes ------------ The components of income tax expense for each of the years ended December 31, are as follows: 2001 2000 1999 ------- ------- ------- Federal income tax expense: Current $ 1,386 $ 1,229 $ 1,204 Deferred 73 36 91 State income tax expense: Current 43 50 32 Deferred 9 12 118 Change in valuation reserve -- (190) (121) ------- ------- ------- $ 1,511 $ 1,137 $ 1,324 ======= ======= ======= A reconciliation of expected tax expense at the statutory federal income tax rate to income before income taxes, is as follows: 2001 2000 1999 ------------------- ------------------- ------------------- % of % of % of Pretax Pretax Pretax Amount Income Amount Income Amount Income ------ ------ ------ ------ ------ ------ Computed expected tax expense at statutory rate $ 1,468 34.0 % $1,289 34.0% $1,568 34.0 % Items affecting the federal income tax rate: State income taxes, net of federal tax benefit 34 .8 41 1.1 99 2.1 Other 9 .2 (3) (0.1) (222) (4.8) Reduction in valuation reserve - - (190) (5.0) (121) (2.6) ------ ------- ----- ------- ------ ------ $ 1,511 35.0% $1,137 30.0% $1,324 28.7% ====== ======= ===== ======= ===== ====== 61 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 14. Income Taxes (Continued) 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: 2001 2000 ------- ------- Deferred tax asset: Loan loss reserves $ 860 $ 720 Other real estate owned 8 17 Net operating loss carryforward 92 138 Alternative minimum tax credit 40 40 Business credits carryforward 425 425 All other 103 80 ------- ------- Total gross deferred tax asset 1,528 1,420 Less valuation reserve (235) (235) ------- ------- Net deferred tax asset 1,293 1,185 Deferred tax liabilities: Difference between book and tax carrying value of investment securities 224 303 Banking premises and equipment, due to depreciation differences 324 324 Servicing asset and deferred costs 809 613 Carrying basis of limited partnerships 610 617 ------- ------- Total gross deferred tax liability 1,967 1,857 ------- ------- Net deferred tax liability $ (674) $ (672) ======= ======= 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, 2001 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. 62 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 14. Income Taxes (Continued) ------------------------ As of December 31, 2001, the Company had a net operating loss carry-forward for federal tax purposes of $271 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. The 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. These reserves are also subject to recapture should the Company's assets exceed $500,000. 15. 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, 2001, 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, 2001 and 2000. 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. 63 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 15. Stockholders' Equity (Continued) -------------------------------- The actual capital amounts and ratios and minimum required amounts and ratios for the Company and the Bank as of December 31, 2001 and December 31, 2000 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, 2001 ----------------------- Total capital (to risk-weighted assets) Company $ 20,380 11.56 % $ 14,109 8.00% $ 17,636 10.00% Bank 19,478 11.05 14,097 8.00 17,621 10.00 Tier I capital (to risk-weighted assets) Company $ 18,259 10.35 % $ 7,054 4.00% $ 10,581 6.00% Bank 17,357 9.85 7,049 4.00 10,573 6.00 Tier I capital (to average assets) Company $ 18,259 5.76% $ 12,680 4.00% $ 15,850 5.00% Bank 17,357 5.55 12,505 4.00 15,630 5.00 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 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. 64 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 16. 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 $169, $110 and $150 during years ended December 31, 2001, 2000 and 1999, respectively. 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 $51, $52 and $49 during the years ended December 31, 2001, 2000 and 1999, 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, 2001, 2000 and 1999. Stock Option Plans ------------------ At December 31, 2001, 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. 65 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 16. Benefit Plans (Continued) ------------------------- 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: 2001 2000 1999 ---- ---- ---- Net income As reported $ 2,808 $ 2,655 $ 3,289 Pro forma 2,795 2,627 3,141 Basic earnings per share As reported $ 1.40 1.12 $1.33 Pro forma 1.39 1.10 1.29 Diluted earnings per share As reported $ 1.37 1.10 $1.29 Pro forma 1.36 1.09 1.24 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: 2001 2000 1999 ---- ---- ---- Dividend yield 3.4% 1.5% 2.5% Expected volatility 17.8% 30.5% 23.0% Risk-free interest rates 4.7% 4.7% 6.7% Expected lives 10 years (1) 10 years 10 years The weighted average fair values of options granted during 2001, 2000 and 1999 were $1.81, $3.40 and $2.83, respectively. (1) Except for 10,389 options granted during 2001 that have a contractual life of five years. 66 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 16. Benefit Plans (Continued) ------------------------- 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: 2001 2000 1999 ------------------------- ------------------------ ------------------------ 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 158,651 $8.69 219,051 $ 9.82 251,442 $ 5.43 Granted 65,600 10.02 6,400 8.34 105,750 10.25 Exercised (4,976) 6.21 (125) 6.20 (133,141) 1.80 Cancelled - - (61,550) 12.67 - - Forfeited (8,250) 9.72 (5,125) 8.94 (5,000) 11.33 ------- ------- -------- Outstanding at end of year 211,025 $9.12 158,651 $ 8.69 219,051 $ 9.82 ======== ======= ======== Options exercisable at year end 192,584 $9.00 140,698 $ 8.55 192,210 $ 9.71 The following table summarizes information about stock options outstanding at December 31, 2001: 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 1.9 $ 1.00 1,500 $ 1.00 $5.75 45,300 5.0 5.75 45,300 5.75 $8.00 1,975 8.5 8.00 962 8.00 $9.3125 to 10.25 146,661 8.0 10.02 133,134 10.04 $10.5875 10,389 4.1 10.5875 10,389 10.5875 $11.70 500 9.5 11.70 125 11.70 $12.86 4,700 9.9 12.86 1,174 12.86 ------- ------- 211,025 192,584 ======== ======= Employment and Severance Agreements ----------------------------------- The Company's President, the clerk of the corporation and five 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. 67 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 16. Benefit Plans (Continued) ------------------------- 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 $106, $89 and $55 at December 31, 2001, 2000 and 1999 representing 10,228, 8,545 and 4,573 stock units, respectively. The stock units have been treated as common stock for the purposes of calculating both basic and diluted earnings per share. Director Recognition and Retirement Plan ---------------------------------------- The Company has a Director Recognition and Retirement Plan as a means of recognizing and retaining the valuable services of its Directors. The Plan provides that if a Director should at any time cease to serve as a member of the Board of Directors of the Bank for any reason, the Bank will immediately pay to the Director in one lump sum an amount equal to tow times the highest annual aggregate compensation paid too or for the benefit of the Director for his or her service on the Board during the them most recently concluded three calendar years. The Plan provides for payment of benefits in the event of a change in control of the Company under specific situations. The Company accrued $80 in 2001 for payment under the plan. 17. 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, 2001, 2000 and 1999, respectively: Shares Income (Denominator Per-Share (Numerator) in thousands) Amount ---------- ------------ -------- 2001 Basic EPS $ 2,808 2,006 $1.40 Effect of stock options - 43 - ------ ------- ---- Diluted EPS $ 2,808 2,049 $1.37 ====== ======= ==== 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 ====== ======= ==== 68 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 18. 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. Financial instruments with off-balance sheet risk at December 31, are as follows: 2001 2000 ---- ---- Commitments to originate residential loans $ 11,651 $ 3,354 Commitments to originate commercial loans 1,996 - Unused lines of credit on home equity loans 35,971 33,762 Unadvanced portions of residential owner-occupied construction loans 671 484 Unused lines of credit on overdraft protection, personal lines of credit and credit cards 586 3,151 Commitments to sell loans 6,073 4,156 Standby letters of credit 10 10 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. 69 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 18. Financial Instruments with Credit Risk and Off-Balance Sheet Risk, ------------------------------------------------------------------ Commitments and Contingencies Continued) ---------------------------------------- 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, 2001 and 2000, the Company had identified $14,020 and $5,003, respectively, of loans to fulfill the outstanding commitments at weighted average rates which will satisfy the commitments without loss to the Company. 19. Condensed Parent Information ---------------------------- Condensed financial statements for Ipswich Bancshares, Inc. at December 31, 2001 and 2000 and for the years ended December 31, 2001 and 2000. 2001 2000 ------- ------- Balance Sheet Assets Cash (deposited with subsidiary) $ 1,298 $ 11 Investment in subsidiaries 17,699 15,359 Other assets 145 -- ------- ------- Total assets $19,142 $15,370 ======= ======= Liabilities and Stockholders' Equity Accrued expenses and other liabilities $ 414 $ 251 Capital securities 3,609 -- Stockholders' equity 15,119 15,119 ------- ------- Total liabilities and stockholders' equity $19,142 $15,370 ======= ======= 70 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 19. Condensed Parent Information (Continued) ---------------------------------------- Statement of Income 2001 2000 - -------------------- ------- ------ Income: Dividends from banking subsidiary $ 576 $ 4,659 Other 10 1 ------- ------- Total income 586 4,660 Expenses: Other expenses 417 27 ------- ------- Total expenses 417 27 ------- ------- Income before income tax (expense) benefit and equity in undistributed net income of subsidiary 169 4,633 Income tax (expense) benefit 138 (15) ------- ------- Income before equity in undistributed net income of subsidiary 307 4,618 Equity in undistributed net income of subsidiary 2,501 (1,963) ------- ------- Net income $ 2,808 $ 2,655 ======= ======= Statement of Cash Flows Cash flows from operating activities: Net income $ 2,808 $ 2,655 Adjustments to reconcile net income to net cash provided by operations: Undistributed earnings of subsidiary (2,501) 1,963 Other 49 74 ------- ------- Net cash provided by operating activities 356 4,692 Cash flows from investing activities: Purchase of investment in subsidiary (109) -- Cash flows from financing activities: Proceeds from issuance of common stock and rights 48 35 Purchase of treasury stock (1,729) (4,054) Proceeds from issuance of long-term debt 3,609 -- Dividends paid to stockholders (888) (952) ------- ------- Net cash provided (used) by financing activities 1,040 (4,971) ------- ------- Net increase (decrease) in cash 1,287 (279) Cash, beginning of year 11 290 ------- ------- Cash, end of year $ 1,298 $ 11 ======= ======= 71 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 20. 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 and cash equivalents approximates their relative book values at December 31, 2001 and 2000, 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, 2001 and 2000. 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, 2001 and 2000. 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, 2001 and 2000. 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. 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. 72 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 20. Fair Value of Financial Instruments (Continued) ----------------------------------------------- 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 SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 20. Fair Value of Financial Instruments (Continued) ----------------------------------------------- The following table presents the estimated fair value of the Company's significant financial instruments at December 31: 2001 2000 -------------------------- ------------------------- Carrying Estimated Carrying Estimated Value Fair Value Value Fair Value ----- ---------- ----- ---------- Financial assets: Cash and cash equivalents $ 10,937 $ 10,937 $ 8,836 $ 8,836 Available for sale securities 50,405 50,405 34,228 34,228 Held to maturity securities 35,343 35,930 30,282 30,374 Stock in other financial institutions 3,253 3,253 3,253 3,253 Loans held for sale 14,945 14,945 5,003 5,003 Loans, net 201,589 202,741 201,334 202,278 Accrued interest receivable 1,251 1,251 1,435 1,435 Financial liabilities: Deposits (with no stated maturity) 190,032 190,032 163,340 163,340 Time deposits 59,481 60,283 73,897 74,192 Mortgagors' escrow accounts 1,148 1,148 972 972 Borrowed funds 47,859 48,380 32,108 32,360 21. Quarterly Results of Operations (Unaudited) ------------------------------------------- 2001 Quarters 2000 Quarters ------------------------------------- --------------------------------------- Fourth Third Second First Fourth Third Second First ------ ----- ------ ----- ------ ----- ------ ----- Interest and dividend income $ 4,889 $ 4,900 $ 4,802 $ 5,013 $ 5,171 $ 5,114 $ 4,969 $ 4,675 Interest expense 2,198 2,335 2,520 2,767 2,888 2,866 2,763 2,477 ------ ------ ------ ------ -------- ------- ------- ------- Net interest and dividend income 2,691 2,565 2,282 2,246 2,283 2,248 2,206 2,198 Provision for loan losses (25) (25) (25) (25) (15) (15) (15) (15) Non-interest income 817 742 829 567 460 370 478 428 Non-interest expense (2,364) (2,084) (2,079) (1,793) (1,733) (1,654) (1,674) (1,758) ------ ------ ------ ------ -------- ------- ------- ------- Income before income taxes 1,119 1,198 1,007 995 995 949 995 853 Income tax expense (391) (420) (352) (348) (348) (332) (351) (106) ------ ------ ------ ------ -------- ------- ------- ------- Net income $ 728 $ 778 $ 655 $ 647 $ 647 $ 617 $ 644 $ 747 ====== ====== ====== ====== ======== ======= ======= ======== Basic earnings per share $ .37 $ .39 $ .32 $ .32 $ .30 $ .26 $ .26 $ .30 ====== ====== ====== ====== ======== ======= ======= ======== Diluted earnings per share $ .36 $ .38 $ .32 $ .31 $ .30 $ .26 $ .26 $ .29 ====== ====== ====== ====== ======== ======= ======= ======== Cash dividends declared per share $ .17 $ .11 $ .11 $ .11 $ .11 $ .10 $ .10 $ .10 ====== ====== ====== ====== ======== ======= ======= ======== Quarterly figures may not total to the full year amount due to rounding. 74 IPSWICH BANCSHARES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS December 31, 2001, 2000 and 1999 (All Dollar Amounts Expressed in Thousands, Except Per Share Data) 22. Subsequent Event ---------------- On February 26, 2002, the Board of Directors of the Company approved an Agreement and Plan of Merger between Banknorth Group, Inc. (Banknorth) and Ipswich Bancshares, Inc. whereby Banknorth will acquire the Company for $41.1 million, or $20.50 per share of Company stock, payable in cash or in equivalent shares of Banknorth stock, at the option of each stockholder, subject to limitations intended to ensure that 51% of the outstanding common stock of the Company will be converted into the right to receive Banknorth common stock and 49% of the outstanding common stock of the Company will be converted into the right to receive cash. The transaction is subject to the approval of the Company's shareholders and various state and federal regulatory bodies. 75 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 2001, 2000 and 1999. 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 2001. (c) Exhibits 2.1 Agreement and Plan of Merger, dated as of February 26, 2002, between Banknorth Group, Inc. and the Company is incorporated by reference from Exhibit 2.1 of Banknorth's Current Report on Form 8-K filed February 28, 2002 (File No. 0-16947). 2.2 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. 76 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 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 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. 77 *10.13(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. *10.13(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. 10.14 Contract with Bank's data processor dated August 31, 2001 is incorporated by reference herein from the Company's September 30, 2001 Form 10-Q. *10.15 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. *10.16 1996 Stock Incentive Plan incorporated by reference to the Company's Registration Statement on Form S-8 filed on July 22, 1999. *10.17 1998 Stock Incentive Plan incorporated by reference to the Company's Registration Statement on Form S-8 filed on July 22, 1999. *10.18 Deferred Compensation Plan for Directors incorporated by reference to the Company's Form S-8 filed on July 22, 1999. 10.19 Form of Stock Option Agreement between Banknorth Group, Inc. (as grantee) and the Company (as issuer) is incorporated by reference from Exhibit 10.1 of Banknorth's Current Report on Form 8-K filed February 28, 2002 (File No. 0-16947). 10.20 Form of Shareholder Agreement between each director of the Company and Banknorth Group, Inc. is incorporated by reference from Exhibit 10.2 of Banknorth's Current Report on Form 8-K filed February 28, 2002 (File No. 0-16947). *10.21 Form of Termination Agreement by and among Banknorth, the Company, Ipswich Savings Bank, Eastern Bank, as Trustee, and David L. Grey is incorporated by reference from Exhibit 10.3 of Banknorth's Current Report on Form 8-K filed February 28, 2002 (File No. 0-16947). *10.22 Form of Employment and Noncompetition Agreement between Banknorth Group, Inc. and David L. Grey is incorporated by reference from Exhibit 10.4 of Banknorth's Current Report on Form 8-K filed February 28, 2002 (File No. 0-16947). *10.23 Severance Agreement dated November 6, 2001 between Ipswich Savings Bank and Philip Bryan. *10.24 Severance Agreement dated November 8, 2001 between Ipswich Savings Bank and Kevin Dean. 10.25 Contract dated April 6, 2000 with U.S. Bancorp for ATM processing services is incorporated by reference to the Company's March 31, 2000 Form 10-Q. *10.26 Split Dollar Agreement and Collateral Assignment dated July 20, 2000 and March 30, 2001, respectively, between Ipswich Savings Bank and Francis Kenney is incorporated by reference herein from the Company's March 31, 2001 Form 10-Q. (11) A statement regarding the computation of earnings per share is included in the notes to consolidated financial statements. 78 (12) Not applicable. (21) Subsidiaries - Ipswich Savings Bank, Ipswich Statutory Trust I. (23) Consent of Baker Newman & Noyes, LLC. * Denotes management contract or compensation plan. 79 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 27, 2002 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 March 27, 2002 -------------------- Officer, and Director David L. Grey (Principal Executive Officer) By: /s/ Francis Kenney Senior Vice President, --------------------- Treasurer, and Chief Financial March 27, 2002 Francis Kenney Officer (Principal Financial Officer, Principal Accounting Officer) By: /s/ William M.Craft Director March 27, 2002 ------------------- William M. Craft By: /s/ Thomas A. Ellsworth Director March 27, 2002 ----------------------- Thomas A. Ellsworth By: Director -------------------- William E. George By: /s/ John H. Morrow Director March 27, 2002 ------------------ John H. Morrow By: /s/ Lawrence J. Pszenny Director March 27, 2002 ----------------------- Lawrence J. Pszenny By: /s/ William J. Tinti Director March 27, 2002 -------------------- William J. Tinti 80 INDEX TO EXHIBITS ITEM PAGE ---- ---- 2.1 Agreement and Plan of Merger, dated as of February 26, 2002, between Banknorth Group, Inc. and the Company is incorporated by reference from Exhibit 2.1 of Banknorth's Current Report on Form 8-K filed February 28, 2002 (File No. 0-16947). * 2.2 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. * 81 *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 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. * *10.13(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. * *10.13(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. * 10.14 Contract with Bank's data processor dated August 31, 2001 is incorporated by reference herein from the Company's September 31, 2001 Form 10-Q. * *10.15 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. * *10.16 1996 Stock Incentive Plan incorporated by reference to the Company's 6Registration Statement on Form S-8 filed on July 22, 1999. * *10.17 1998 Stock Incentive Plan incorporated by reference to the Company's Registration Statement on Form S-8 filed on July 22, 1999. * *10.18 Deferred Compensation Plan for Directors incorporated by reference to the Company's Form S-8 filed on July 22, 1999. * 10.19 Form of Stock Option Agreement between Banknorth Group, Inc. (as grantee) and the Company (as issuer) is incorporated by reference from Exhibit 10.1 of Banknorth's Current Report on Form 8-K filed February 28, 2002 (File No. 0-16947). * 10.20 Form of Shareholder Agreement between each director of the Company and Banknorth Group, Inc. is incorporated by reference from Exhibit 10.2 of Banknorth's Current Report on Form 8-K filed February 28, 2002 (File No. 0-16947). * 82 *10.21 Form of Termination Agreement by and among Banknorth, the Company, Ipswich Savings Bank, Eastern Bank, as Trustee, and David L. Grey is incorporated by reference from Exhibit 10.3 of Banknorth's Current Report on Form 8-K filed February 28, 2002 (File No. 0-16947). * *10.22 Form of Employment and Noncompetition Agreement between Banknorth Group, Inc. and David L. Grey is incorporated by reference from Exhibit 10.4 of Banknorth's Current Report on Form 8-K filed February 28, 2002 (File No. 0-16947). * *10.23 Severance Agreement dated November 6, 2001 between Ipswich Savings Bank and Philip Bryan. 84 *10.24 Severance Agreement dated November 8, 2001 between Ipswich Savings Bank and Kevin Dean. 84 10.25 Contract dated April 6, 2000 with U.S. Bancorp for ATM processing services is incorporated by reference to the Company's March 31, 2000 Form 10-Q. * *10.26 Split Dollar Agreement and Collateral Assignment dated July 20, 2000 and March 30, 2001, respectively, between Ipswich Savings Bank and Francis Kenney is incorporated by reference herein from the Company's March 31 2001 Form 10-Q. * (11) A statement regarding the computation of earnings per share is included in the notes to consolidated financial statements. * (12) Not applicable. * (21) Subsidiaries - Ipswich Savings Bank, Ipswich Statutory Trust I. (23) Consent of Baker Newman & Noyes, LLC. * Denotes management contract or compensation plan. 83