SECURITIES AND EXCHANGE COMMISSION
100 F Street NE
Washington, D.C. 20549
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934 For the Fiscal Year Ended March 31, 2008
or
[_] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
For the transition period from _______________ to ____________________
Commission File No. 0-51589
New England Bancshares
----------------------
(Exact name of registrant as specified in its charter)
Maryland 04-3693643
------------------------------- ---------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
855 Enfield Street, Enfield, Connecticut 06082
---------------------------------------- -----
(Address of Principal Executive Offices) Zip Code
(860) 253-5200
--------------
(Registrant's telephone number)
Securities Registered Pursuant to Section 12(b) of the Act:
Title of each class Name of each exchange on which registered
------------------- -----------------------------------------
Common Stock, $0.01 par value The NASDAQ Stock Market, LLC
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned
issuer, as defined in Rule 405 of the Securities Act. YES [_] NO [X]
Indicate by check mark if the registrant is not required to file
reports pursuant to Section 13 or Section 15(d) of the Act. YES [_] NO [X]
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 twelve months (or for such shorter period that the
Registrant was required to file such reports) and (2) has been subject to such
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. [X].
Indicate by check mark whether the registrant is a large accelerated
filer, an accelerated filer, or a non-accelerated filer. as defined in Rule
12b-2 of the Exchange Act).
Large accelerated filer [_] Accelerated filer [_]
Non-accelerated filer [_] Smaller reporting company [X]
(Do not check box if a smaller
reporting company)
Indicate by check mark whether the Registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). YES [_] NO [X]
As of June 2, 2008, there were outstanding 5,995,792 shares of the
Registrant's Common Stock.
The aggregate market value of the voting and non-voting common equity
held by non-affiliates of the Registrant, computed by reference to the last sale
price on June 2, 2008, is $56,529,722.
DOCUMENTS INCORPORATED BY REFERENCE
Proxy Statement for the 2008 Annual Meeting of Stockholders
of the Registrant (Part III).
INDEX
PAGE
PART I
ITEM 1. DESCRIPTION OF BUSINESS..........................................1
ITEM 1A. RISK FACTORS....................................................17
ITEM 1B. UNRESOLVED STAFF COMMENTS.......................................18
ITEM 2. PROPERTIES......................................................19
ITEM 3. LEGAL PROCEEDINGS...............................................20
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS.............20
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES...............20
ITEM 6. SELECTED FINANCIAL DATA.........................................21
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS
AND RESULTS OF OPERATIONS.......................................21
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK.......45
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.....................47
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING
AND FINANCIAL DISCLOSURE........................................78
ITEM 9A(T). CONTROLS AND PROCEDURES.........................................78
ITEM 9B. OTHER INFORMATION...............................................79
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE..........79
ITEM 11. EXECUTIVE COMPENSATION..........................................80
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS.................................81
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND
DIRECTOR INDEPENDENCE...........................................81
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES..........................82
PART IV
ITEM 15. EXHIBITS AND FINANCIAL SATEMENT SCHEDULES.......................82
SIGNATURES ...................................................................83
This annual report on Form 10-K contains certain forward-looking statements
which are based on certain assumptions and describe the Company's future plans,
strategies and expectations. These forward-looking statements may be identified
by the use of such words as "believe," "expect," "intend," "anticipate,"
"estimate," "project," or similar expressions. The Company's ability to predict
results or the actual effect of future plans or strategies is inherently
uncertain. Factors which could have a material adverse effect on the Company's
operations include, but are not limited to, the items described in "Risk
Factors" appearing in Part I, Item 1A of this annual report and changes in:
interest rates, general economic conditions, legislative/regulatory changes,
monetary and fiscal policies of the U.S. Government, including policies of the
U.S. Treasury and the Federal Reserve Board, the quality and composition of our
loan and investment portfolios, demand for loan products, deposit flows,
competition, demand for financial services in the Company's market area and
accounting principles and guidelines. These risks and uncertainties should be
considered in evaluating forward-looking statements and undue reliance should
not be placed on such statements. The Company does not undertake -- and
specifically disclaims any obligation -- to publicly release the result of any
revisions that may be made to any forward-looking statements to reflect events
or circumstances after the date of such statements or to reflect the occurrence
of anticipated or unanticipated events.
PART I
ITEM 1. DESCRIPTION OF BUSINESS
General
New England Bancshares, Inc. New England Bancshares, Inc. (the
"Company") is a Maryland corporation, which was organized in 2005. In December
2005, New England Bancshares, Inc. became the holding company parent of Enfield
Federal Savings following the completion of the "second-step" mutual-to-stock
conversion of Enfield Mutual Holding Company. Reference is made to "New England
Bancshares" or the "Company" for periods both before and after the second-step
conversion. The principal assets of the Company are its investments in Enfield
Federal Savings and Loan Association (the "Association" or "Enfield Federal")
and Valley Bank (the "Bank" or "Valley Bank"). In the second-step conversion,
the Company sold 3,075,855 shares resulting in net proceeds of $27.2 million, of
which $12.2 million was retained as capital by the Company and $15.0 million was
infused as capital into the Association. Shareholders of the Company immediately
prior to the completion of the second-step conversion received 2.3683 shares for
each share of common stock they held in the Company, resulting in an additional
1,311,863 shares being issued.
The second-step conversion was accounted for as a change in corporate
form with no subsequent change in the historical carrying amounts of the
Company's assets and liabilities. Consolidated stockholders' equity increased by
the net cash proceeds from the offering. All references in the consolidated
financial statements and notes thereto to share data (including the number of
shares and per share amounts) have been adjusted to reflect the additional
shares outstanding as a result of the offering and the share exchange.
On July 12, 2007 the Company acquired First Valley Bancorp, Inc.,
Bristol, Connecticut. First Valley Bancorp was the holding company for Valley
Bank, Bristol, Connecticut. Under the terms of the transaction, shareholders of
First Valley Bancorp received 0.8907 shares of Company common stock and $9.00 in
cash for each share of First Valley Bancorp common stock for a total of
1,068,625 shares and $10.8 million. In addition, the Company incurred cash
payments for transaction expenses, payout of stock options and employee expenses
totaling $2.4 million, creating $13.6 million of goodwill.
Enfield Federal Savings and Loan Association. The Association,
incorporated in 1916, is a federally chartered savings association headquartered
in Enfield, Connecticut. The Association's deposits are insured by the Federal
Deposit Insurance Corporation (the "FDIC"). The Association is engaged
principally in the business of attracting deposits from the general public and
investing those deposits primarily in residential and commercial real estate
loans, and to a lesser extent, in consumer, construction, commercial and small
business loans. In June 2002, the Association reorganized from the mutual form
of organization to the mutual holding company structure. In December 2003, the
Association acquired Windsor Locks Community Bank, FSL. At March 31, 2008, the
1
Association operated from eight locations in Connecticut and had total assets of
$288.9 million and total deposits of $189.2 million.
Valley Bank. The Bank, incorporated in 1999, is a state chartered
commercial bank headquartered in Bristol, Connecticut. The Bank's deposits are
insured by the FDIC. The Bank is engaged principally in the business of
attracting deposits from the general public and investing those deposits
primarily in commercial real estate loans, and commercial and small business
loans. At March 31, 2008, the Bank operated from four locations in Connecticut
and had total assets of $231.6 million and total deposits of $181.1 million.
New England Bancshares' Website and Availability of Securities and Exchange
Commission Filings
New England Bancshares' internet website is www.enfieldfederal.com. New
----------------------
England Bancshares makes available free of charge on or through its website its
annual reports on Forms 10-K, quarterly reports on Forms 10-Q, current reports
on Forms 8-K and any amendments to these reports filed or furnished pursuant to
the Securities and Exchange act of 1934, as soon as reasonably practicable after
New England Bancshares electronically files such material with, or furnishes it
to, the Securities and Exchange Commission. Except as specifically incorporated
by reference into this annual report, information on our website is not a part
of this annual report.
Market Area
The Association conducts its operations through its main office and one
additional branch office in Enfield and the branch offices in Broad Brook, East
Windsor, Manchester, Ellington, Suffield and Windsor Locks, Connecticut.
Deposits are gathered from, and lending activities are concentrated primarily in
the towns of, and the communities contiguous to, its branch offices.
The Bank conducts its operations through its main office and one other
branch office in Bristol and branch offices in Terryville and Southington,
Connecticut. Deposits are gathered from, and lending activities are concentrated
primarily in the towns of, and the communities contiguous to, its branch
offices.
According to published statistics, Hartford County's 2006 population
was approximately 882,000 and consisted of approximately 344,000 households. The
population increased approximately 2.1% from 2000. Per capita income in 2005 for
Hartford County was approximately $32,000, which was less than the Connecticut
average of approximately $35,000. Likewise, median household income for Hartford
County was $59,000, compared to approximately $63,000 for Connecticut.
Competition
We face intense competition both in making loans and attracting
deposits. As of June 30, 2007, the most recent date for which data is available
from the FDIC, we held approximately 1.3% of the deposits in Hartford County,
which was the 10th largest share of deposits out of 30 financial institutions in
the county. North-central Connecticut has a high concentration of financial
institutions and financial services providers, many of which are branches of
large money centers, super-regional and regional banks which have resulted from
the consolidation of the banking industry in New England. Many of these
competitors have greater resources than we do and may offer products and
services that we do not provide.
Our competition for loans comes from commercial banks, savings
institutions, mortgage banking firms, credit unions, finance companies,
insurance companies and brokerage and investment banking firms. Our most direct
competition for deposits has historically come from commercial banks, savings
banks, savings and loan associations, credit unions and mutual funds. We face
additional competition for deposits from short-term money market funds and other
corporate and government securities funds and from brokerage firms and insurance
companies.
2
We expect competition to increase in the future as a result of
legislative, regulatory and technological changes and the continuing trend of
consolidation in the financial services industry. Technological advances, for
example, have lowered the barriers to market entry, allowed banks to expand
their geographic reach by providing services over the Internet and made it
possible for non-depository institutions to offer products and services that
traditionally have been provided by banks. Changes in federal law permit
affiliation among banks, securities firms and insurance companies, which
promotes a competitive environment in the financial services industry.
Competition for deposits and the origination of loans could limit our future
growth.
Lending Activities
General. The largest segments of our loan portfolio are residential
real estate loans and commercial real estate loans. The other significant
segments of our loan portfolio are commercial loans, construction loans and
consumer loans. We originate loans for investment purposes.
Residential Loans. At March 31, 2008, residential loans, excluding home
equity loans and lines of credit, totaled $126.4 million or 33.6% of total
loans. At March 31, 2008, 84.2% of our residential loans were fixed-rate and
15.8% were adjustable-rate.
We originate fixed-rate fully amortizing loans with maturities ranging
between 10 and 30 years. Management establishes the loan interest rates based on
market conditions. We offer mortgage loans that conform to Fannie Mae and
Freddie Mac guidelines, as well as jumbo loans, which presently are loans in
amounts over $417,000.
We also currently offer adjustable-rate mortgage loans, with an
interest rate based on the one-year Constant Maturity Treasury Bill index, which
adjust annually from the outset of the loan or which adjust annually after a
three-, five- or ten-year initial fixed period and with terms of up to 30 years,
with the majority of adjustable rate loans adjusting after a five-year period.
Interest rate adjustments on such loans are generally limited to no more than 2%
during any adjustment period and 6% over the life of the loan.
We underwrite fixed-rate and variable-rate one- to four-family
residential mortgage loans with loan-to-value ratios of up to 100% and 95%,
respectively, provided that a borrower obtains private mortgage insurance on
loans that exceed 80% of the appraised value or sales price, whichever is less,
of the secured property. We also require that fire, casualty, title, hazard
insurance and, if appropriate, flood insurance be maintained on all properties
securing real estate loans made by us. An independent licensed appraiser
generally appraises all properties.
The Association offers its full-time employees who satisfy certain
criteria and our general underwriting standards fixed- and adjustable-rate
residential mortgage loans with reduced interest rates that are currently 50
basis points below the rates offered to our other customers. The employee
mortgage rate normally ceases upon termination of employment. Upon termination
of the employee mortgage rate, the interest rate reverts to the contract rate in
effect at the time that the loan was extended. All other terms and conditions
contained in the original mortgage and note continue to remain in effect.
Currently, the Bank does not offer this type of program. As of March 31, 2008,
we had $3.5 million of employee mortgage rate loans, or 0.94% of net loans.
Home Equity Loans and Lines of Credit. We offer home equity loans and
home equity lines of credit, both of which are secured by owner-occupied one- to
four-family residences. At March 31, 2008, home equity loans and equity lines of
credit totaled $31.9 million, or 8.5% of total loans. Additionally, at March 31,
2008, the unadvanced amounts of home equity lines of credit totaled $8.1
million. Home equity loans are offered with fixed rates of interest and with
terms up to 15 years. Home equity lines of credit are offered with adjustable
rates of interest that are indexed to the prime rate as reported in The Wall
Street Journal. Interest rate adjustments on home equity lines of credit are
limited to a maximum of 18% or 6% above the initial interest rate, whichever is
lower.
The procedures for underwriting home equity loans and lines of credit
include an assessment of the applicant's payment history on other debts and
ability to meet existing obligations and payments on the proposed loans. We will
offer home equity loans with maximum combined loan-to-value ratios of 90%,
provided that loans in
3
excess of 80% will be charged a higher rate of interest. A home equity line of
credit may be drawn down by the borrower for an initial period of 10 years from
the date of the loan agreement. During this period, the borrower has the option
of paying, on a monthly basis, either principal and interest or only interest.
If not renewed, the Association requires the borrower to pay back the amount
outstanding under the line of credit over a term not to exceed 10 years,
beginning at the end of the 10-year period. After the initial 10-year period,
the Bank requires the borrower to pay back the amount outstanding in full.
Commercial Real Estate Loans. We originate commercial real estate loans
that are generally secured by properties used for business purposes such as
small office buildings, industrial facilities or retail facilities primarily
located in our primary market area. At March 31, 2008, commercial real estate
loans totaled $138.5 million, or 36.8% of total loans. Our commercial real
estate loans are generally made with terms of up to 25 years. These loans are
offered with interest rates that are fixed or adjust periodically and are
generally indexed to the prime rate as reported in The Wall Street Journal plus
a margin of 100 basis points or the five-year Federal Home Loan Bank (the
"FHLB") Classic Advance Rate plus a margin of 225 to 325 basis points. At March
31, 2008, the largest commercial real estate loan was a $3.8 million loan, which
was secured by three car wash locations. This loan was performing according to
its terms at March 31, 2008. We generally do not make these loans with
loan-to-value ratios exceeding 80%.
Construction Loans. We originate construction loans to individuals for
the construction and acquisition of personal residences. At March 31, 2008,
residential construction loans amounted to $4.3 million, or 1.1% of total loans.
At March 31, 2008, the unadvanced portion of these construction loans totaled
$1.2 million. Our residential mortgage construction loans generally provide for
the payment of interest only during the construction phase, which is usually 12
months. At the end of the construction phase, the loan converts to a permanent
mortgage loan. Loans generally can be made with a maximum loan-to-value ratio of
90% of the appraised value or cost of the project, whichever is less. At March
31, 2008, the largest residential construction loan commitment was for $1.1
million, all of which was disbursed. The loan was performing according to its
terms at March 31, 2008.
We make construction loans for commercial and residential development
projects. The projects include subdivision, multi-family, apartment, small
industrial, retail and office buildings. These loans generally have an
interest-only phase during construction, which is usually 12 months, and then
convert to permanent financing. Disbursements of funds are at the sole
discretion of the Association and Bank and are based on the progress of
construction. At March 31, 2008, commercial construction loans totaled $16.8
million, or 4.5% of total loans. At March 31, 2008, the unadvanced portion of
these construction loans totaled $8.0 million. Loans generally can be made with
a maximum loan-to-value ratio of 75% of the appraised value or cost of the
project, whichever is less. At March 31, 2008, the largest commercial loan
commitment was for $3.0 million, $2.4 million of which was disbursed. The loan
was performing according to its terms at March 31, 2008.
Commercial Loans. At March 31, 2008, we had $52.0 million in commercial
loans, which amounted to 13.8% of total loans. In addition, at such date, we had
$19.5 million of unadvanced commercial lines of credit. We make commercial
business loans primarily in our market area to a variety of professionals, sole
proprietorships and small businesses. Commercial lending products include term
loans, revolving lines of credit and Small Business Administration guaranteed
loans. Commercial loans and lines of credit are made with either variable or
fixed rates of interest. Variable rates are based on the prime rate as published
in The Wall Street Journal, plus a margin. Fixed-rate business loans are
generally indexed to the two-, five- or ten-year FHLB Amortizing Advance Rate,
as corresponds to the term of the loan, plus a margin. The Company generally
does not make unsecured commercial loans.
When making commercial loans, we consider the financial statements of
the borrower, our lending history with the borrower, the debt service
capabilities of the borrower, the projected cash flows of the business and the
value of the collateral, primarily accounts receivable, inventory and equipment,
and are supported by personal guarantees. Depending on the collateral used to
secure the loans, commercial loans are made in amounts of up to 80% of the value
of the collateral securing the loan. At March 31, 2008, our largest commercial
loan was a $2.9
4
million loan secured by all business assets. This loan was performing according
to its original terms at March 31, 2008.
Consumer Loans. We offer fixed rate loans secured by mobile homes.
These loans have terms up to 25 years and loan to values up to 90% of the home's
value and require that the borrower obtain hazard insurance. At March 31, 2008,
mobile home loans totaled $3.1 million or 0.8% of total loans and 50.0% of
consumer loans. We also offer fixed-rate automobile loans for new or used
vehicles with terms of up to 66 months and loan-to-value ratios of up to 90% of
the lesser of the purchase price or the retail value shown in the NADA Car
Guide. At March 31, 2008, automobile loans totaled $1.9 or 0.5% of total loans
and 29.5% of consumer loans. For the fiscal year ended March 31, 2008, the
Company originated $1.8 million of mobile home loans.
Other consumer loans at March 31, 2008 amounted to $1.3 million, or
0.3% of total loans and 20.5% of consumer loans. These loans include secured and
unsecured personal loans. Personal loans generally have a fixed-rate, a maximum
borrowing limitation of $10,000 and a maximum term of four years. Collateral
loans are generally secured by a passbook account or a certificate of deposit.
Loan Underwriting Risks. While we anticipate that adjustable-rate loans
will better offset the adverse effects of an increase in interest rates as
compared to fixed-rate mortgages, the increased mortgage payments required of
adjustable-rate loan borrowers in a rising interest rate environment could cause
an increase in delinquencies and defaults. The marketability of the underlying
property also may be adversely affected in a high interest rate environment. In
addition, although adjustable-rate mortgage loans help make our asset base more
responsive to changes in interest rates, the extent of this interest sensitivity
is limited by the annual and lifetime interest rate adjustment limits.
Loans secured by multi-family and commercial real estate generally have
larger balances and involve a greater degree of risk than one- to four-family
residential mortgage loans. Of primary concern in multi-family and commercial
real estate lending is the borrower's creditworthiness and the feasibility and
cash flow potential of the project. Payments on loans secured by income
properties often depend on successful operation and management of the
properties. As a result, repayment of such loans may be subject to a greater
extent than residential real estate loans to adverse conditions in the real
estate market or the economy. To monitor cash flows on income properties, we
require borrowers and loan guarantors, if any, to provide annual financial
statements on multi-family and commercial real estate loans. In reaching a
decision on whether to make a multi-family and commercial real estate loan, we
consider the net operating income of the property, the borrower's expertise,
credit history, and profitability and the value of the underlying property. In
addition, with respect to commercial real estate rental properties, we will also
consider the term of the lease and the quality of the tenants. We have generally
required that the properties securing these real estate loans have debt service
coverage ratios (the ratio of earnings before debt service to debt service) of
at least 1.20x. Independent appraisals and environmental surveys are generally
required for commercial real estate loans of $250,000 or more.
Construction financing is generally considered to involve a higher
degree of risk of loss than long-term financing on improved, occupied real
estate. Risk of loss on a construction loan depends largely upon the accuracy of
the initial estimate of the property's value at completion of construction and
the estimated cost (including interest) of construction. During the construction
phase, a number of factors could result in delays and cost overruns. If the
estimate of construction costs proves to be inaccurate, we may be required to
advance funds beyond the amount originally committed to permit completion of the
building. If the estimate of value proves to be inaccurate, we may be
confronted, at or before the maturity of the loan, with a building having a
value which is insufficient to assure full repayment. If we are forced to
foreclose on a building before or at completion due to a default, there can be
no assurance that we will be able to recover all of the unpaid balance of, and
accrued interest on, the loan as well as related foreclosure and holding costs.
Unlike residential mortgage loans, which generally are made on the
basis of the borrower's ability to make repayment from his or her employment or
other income, and which are secured by real property whose value tends to be
more easily ascertainable, commercial loans are of higher risk and typically are
made on the basis of the borrower's ability to make repayment from the cash flow
of the borrower's business. As a result, the availability of
5
funds for the repayment of commercial loans may depend substantially on the
success of the business itself. Further, any collateral securing such loans may
depreciate over time, may be difficult to appraise and may fluctuate in value.
Consumer loans may entail greater risk than do residential mortgage
loans, particularly in the case of consumer loans that are unsecured or secured
by assets that depreciate rapidly. In such cases, repossessed collateral for a
defaulted consumer loan may not provide an adequate source of repayment for the
outstanding loan and the remaining deficiency often does not warrant further
substantial collection efforts against the borrower. In addition, consumer loan
collections depend on the borrower's continuing financial stability, and
therefore are more likely to be adversely affected by job loss, divorce, illness
or personal bankruptcy. Furthermore, the application of various federal and
state laws, including federal and state bankruptcy and insolvency laws, may
limit the amount which can be recovered on such loans.
Loan Originations, Purchases and Sales. Our mortgage lending activities
are conducted by our salaried loan representatives. We underwrite all loans that
we originate under our loan policies and procedures, which model those of Fannie
Mae and Freddie Mac. We originate both adjustable-rate and fixed-rate mortgage
loans. Our ability to originate fixed- or adjustable-rate loans is dependent
upon the relative customer demand for such loans, which is affected by the
current and expected future level of interest rates.
We generally retain most of the loans that we originate for our
portfolio; however, we will sell participation interests to local financial
institutions, primarily on the portion of loans that exceed our borrowing
limits. The sales occur at time of origination; therefore no loans have been
classified as held-for-sale. We sold $2.6 million of these loans in fiscal 2008
and $1.6 million in fiscal 2007. In fiscal 2007, the Association commenced
selling long-term, fixed rate residential loans to the Federal Home Loan Bank
(the "FHLB") to assist with managing our interest rate risk and increasing our
net interest margin. Loans are sold with servicing retained and the loans have
recourse to the Company on a formula basis. The Association sold $538,000 of
these loans in fiscal 2008. The Bank originates and sells one- to four-family
residential loans to several mortgage brokers and mortgage bankers. One such
arrangement requires the Bank to repurchase any loans which become delinquent
within four months after the date of sale; no such repurchases have been
required. The Bank sold $3.9 million of these loans in fiscal 2008.
We purchase participation interests from other community-based
financial institutions, primarily commercial real estate loans, commercial
construction loans, commercial loans and residential loans. Such loans totaled
$34.5 and $22.1 million at March 31, 2008 and 2007, respectively. We perform our
own underwriting analysis on each of our participation interests before
purchasing such loans and therefore believe there is no greater risk of default
on these obligations. However, in a purchased participation loan, we do not
service the loan and thus are subject to the policies and practices of the lead
lender with regard to monitoring delinquencies, pursuing collections and
instituting foreclosure proceedings. We are permitted to review all of the
documentation relating to any loan in which we participate, including any annual
financial statements provided by a borrower. Additionally, we receive periodic
updates on the loan from the lead lender. We have not historically purchased any
whole loans. However, we would entertain doing so if a loan was presented to us
that met our underwriting criteria and fit within our interest rate strategy.
Loan Approval Procedures and Authority. Our lending policies and loan
approval limits are recommended by senior management, reviewed by the Executive
Credit Committee of the Boards of Directors and approved by the Association's
and Bank's Board of Directors. The Executive Credit Committee consists of 5
independent directors of the Association's or Bank's Board of Directors and the
Chief Executive Officer and President of the Company. One of the independent
directors serves as the Chairman of the Committee. The Senior Loan Officer of
the Association and Bank also serve as non-voting members of the committee. Each
individual's lending authority limit is based on his or her experience and
capability and reviewed annually by the Association's and Bank's board. Loan
approvals consist of at least 2 management signatures with the higher lending
authority determining the level of approval. Any extension of credit that
exceeds management's authority requires the approval of the Association's or
Bank's Credit Committee. The Association's and Bank's Credit Committee can
approve extensions of credit in amounts up to $1.5 million. Extensions of credit
between $1.5 million and $4.5 million must be approved by the Executive Credit
Committee. Any extensions of credit which would exceed $4.5 million for the
Company also require the approval of each subsidiaries' Board of Directors.
Notwithstanding individual and joint lending authority, board approval is
required for any request involving any compromise of
6
indebtedness, such as the forgiveness of unpaid principal, accrued interest,
accumulated fees, or acceptance of collateral or other assets in lieu of
payment.
Loan Commitments. We issue commitments for fixed-rate and
adjustable-rate mortgage loans , and commercial loans conditioned upon the
occurrence of certain events. Commitments to originate mortgage loans are
legally binding agreements to lend to our customers.
Investment Activities
The Boards of Directors of the Association and the Bank review and
approve the respective investment policies annually. The Boards of Directors are
responsible for establishing policies for conducting investment activities,
including the establishment of risk limits. The Boards of Directors review the
investment portfolio and review investment transactions on a monthly basis and
is responsible for ensuring that the day-to-day management of the investment
portfolio is conducted by qualified individuals. The Boards of the Association
and the Bank have directed the Association and the Bank to implement investment
policies based on the Boards' established guidelines as reflected in the
respective written investment policies, and other established guidelines,
including those set periodically by the Asset/Liability Management Committees.
The Association and the Bank present the respective Asset/Liability Management
Committees with potential investment strategies and investment portfolio
performance reports, on a quarterly basis.
The investment portfolio is primarily viewed as a source of liquidity.
Our policy is to invest funds in assets with varying maturities that will result
in the best possible yield while maintaining the safety of the principal
invested and assists in managing interest rate risk. The investment portfolio
management policy is designed to:
1. enhance profitability by maintaining an acceptable spread over
the cost of funds;
2. absorb funds when loan demand is low and infuse funds into
loans when loan demand is high;
3. provide both the regulatory and the operational liquidity
necessary to conduct our daily business activities;
4. provide a degree of low-risk, quality assets to the balance
sheet;
5. provide a medium for the implementation of certain interest
rate risk management measures intended to establish and
maintain an appropriate balance between the sensitivity to
changes in interest rates of: (i) interest income from loans
and investments, and (ii) interest expense from deposits and
borrowings;
6. have collateral available for pledging requirements;
7. generate a favorable return on investments without undue
compromise of other objectives; and
8. evaluate and take advantage of opportunities to generate
tax-exempt income when appropriate.
In determining its investment strategies, we consider the interest rate
sensitivity, yield, credit risk factors, maturity and amortization schedules,
collateral value and other characteristics of the securities to be held. We also
consider the secondary market for the sale of assets and the ratings of debt
instruments in which it invests and the financial condition of the obligors
issuing such instruments.
We have authority to invest in various types of assets, including U.S.
Treasury obligations, securities of various federal agencies, mortgage-backed
securities, certain certificates of deposit of insured financial institutions,
overnight and short-term loans to other banks, corporate debt instruments, and
auction market securities. We primarily invest in: U.S. agency obligations;
collateralized mortgage obligations and mortgage-backed securities; municipal
obligations; and equity investments. With respect to municipal obligations, our
investment policy
7
provides that all municipal issues must be rated investment grade or higher to
qualify for its portfolio. If any such municipal issues in our investment
portfolio are subsequently downgraded below the minimum requirements, it is our
general policy to liquidate the investment.
Deposit Activities and Other Sources of Funds
General. Deposits and loan repayments are the major sources of our
funds for lending and other investment purposes. Loan repayments are a
relatively stable source of funds, while deposit inflows and outflows and loan
prepayments are significantly influenced by general interest rates and money
market conditions.
Deposit Accounts. Substantially all of our depositors are residents of
the State of Connecticut. Deposits are attracted from within our market area
through the offering of a broad selection of deposit instruments, including non
interest-bearing demand accounts (such as checking accounts), interest-bearing
demand accounts (such as NOW and money market accounts), passbook and savings
accounts, and certificates of deposit. At March 31, 2008, core deposits, which
consist of savings, demand, NOW and money market accounts, comprised 45.8% of
our deposits. We do not currently utilize brokered funds. Deposit account terms
vary according to the minimum balance required, the time periods the funds must
remain on deposit and the interest rate, among other factors. In determining the
terms of our deposit accounts, we consider the rates offered by our competition,
our liquidity needs, profitability to us, matching deposit and loan products and
customer preferences and concerns. We generally review our deposit mix and
pricing weekly. Our current strategy is to offer competitive rates, but not to
be the market leader.
In addition to accounts for individuals, we also offer deposit accounts
designed for the businesses operating in our market area. Our business banking
deposit products and services include a non-interest-bearing commercial checking
account, a NOW account for sole proprietors and a commercial cash management
account for larger businesses. We have sought to increase our commercial
deposits through the offering of these products, particularly to our commercial
borrowers.
Borrowings. We utilize advances from the Federal Home Loan Bank of
Boston and securities sold under agreements to repurchase to supplement our
supply of investable funds and to meet deposit withdrawal requirements. The
Federal Home Loan Bank functions as a central reserve bank providing credit for
member financial institutions. As members, the Association and Bank are required
to own capital stock in the Federal Home Loan Bank and are authorized to apply
for advances on the security of such stock and certain of our mortgage loans and
other assets (principally securities which are obligations of, or guaranteed by,
the United States), provided certain standards related to creditworthiness have
been met. Advances are made under several different programs, each having its
own interest rate and range of maturities. Depending on the program, limitations
on the amount of advances are based either on a fixed percentage of an
institution's net worth or on the Federal Home Loan Bank's assessment of the
institution's creditworthiness. Under its current credit policies, the Federal
Home Loan Bank generally limits advances to 25% of a member's assets, and
short-term borrowings of less than one year may not exceed 10% of the
institution's assets. The Federal Home Loan Bank determines specific lines of
credit for each member institution.
Securities sold under agreements to repurchase are customer deposits
that are invested overnight in U.S. government or U.S. government agency
securities. The customers, predominantly commercial customers, set a
predetermined balance and deposits in excess of that amount are transferred into
the repurchase account from each customer's checking account. The next banking
day, the funds are recredited to their individual checking account along with
interest earned at market rates. These types of accounts are often referred to
as sweep accounts.
Financial Services
In 2006 the Bank started offering full-time access to advisory and
investment services to consumers and businesses on retirement planning,
individual investment portfolios, and strategic asset management. The services
provided by the Bank through Riverside Investment Services include mutual funds,
life insurance, tax and estate
8
planning, and investment portfolio analysis. The Bank has a broker/dealer
relationship with Linsco/Private Ledger. For the period ended March 31, 2008 the
Bank recorded income of $127,000 from such services.
The Association has a partnership with a third-party registered
broker-dealer, Infinex Investments, Inc. Infinex operates an office at Enfield
Federal and offers customers a complete range of nondeposit investment products,
including mutual funds, debt, equity and government securities, retirement
accounts, insurance products and fixed and variable annuities. The Association
receives a portion of the commissions generated by Infinex from sales to
customers. For the years ended March 31, 2008 and 2007, the Association received
fees of $17,000 and $41,000, respectively, through the relationship with
Infinex.
Personnel
As of March 31, 2008, we had 101 full-time employees and 20 part-time
employees, none of whom is represented by a collective bargaining unit. We
believe our relationship with our employees is good.
REGULATION AND SUPERVISION
General
As a bank holding company, New England Bancshares is required by
federal law to file reports with and otherwise comply with, the rules and
regulations, of the Federal Reserve. Enfield Federal, as a federal savings
association, is subject to extensive regulation, examination and supervision by
the Office of Thrift Supervision, as its primary federal regulator, and the
Federal Deposit Insurance Corporation, as its deposit insurer. Valley Bank, as a
state commercial bank, is subject to extensive regulation, examination and
supervision by the Connecticut Department of Banking, as its primary state
regulator, and the Federal Deposit Insurance Corporation, as its deposit
insurer. Both Enfield Federal and Valley Bank are members of the Federal Home
Loan Bank System. Enfield Federal must file reports with the Office of Thrift
Supervision and the Federal Deposit Insurance Corporation concerning its
activities and financial condition in addition to obtaining regulatory approvals
before entering into certain transactions such as mergers with, or acquisitions
of, other savings institutions. The Office of Thrift Supervision conducts
periodic examinations to test Enfield Federal's safety and soundness and
compliance with various regulatory requirements. Valley Bank must file reports
with the Connecticut Department of Banking and the Federal Deposit Insurance
Corporation concerning its activities and financial condition in addition to
obtaining regulatory approvals before entering into certain transactions such as
mergers with, or acquisitions of, other savings institutions. The Connecticut
Department of Banking and the Federal Deposit Insurance Corporation conduct
periodic examinations to test Valley Bank's safety and soundness and compliance
with various regulatory requirements. This regulation and supervision
establishes a comprehensive framework of activities in which an institution can
engage and is intended primarily for the protection of the insurance fund and
depositors. The regulatory structure also gives the regulatory authorities
extensive discretion in connection with their supervisory and enforcement
activities and examination policies, including policies with respect to the
classification of assets and the establishment of adequate loan loss reserves
for regulatory purposes. Any change in such regulatory requirements and
policies, whether by the Office of Thrift Supervision, Connecticut Department of
Banking, the Federal Deposit Insurance Corporation, the Federal Reserve Board or
the United States Congress, could have a material adverse impact on New England
Bancshares, Enfield Federal, Valley Bank and their operations.
Certain of the applicable regulatory requirements are referred to
below. This description of statutory provisions and regulations applicable to
savings institutions and their holding companies does not purport to be a
complete description of such statutes and regulations and their effect on New
England Bancshares, Enfield Federal and Valley Bank and is qualified in its
entirety by reference to the actual statutes and regulations involved.
Federal Banking Regulation
Business Activities. The activities of Enfield Federal, a federal
savings association, are governed by federal law and regulations. These laws and
regulations delineate the nature and extent of the activities in which federal
associations may engage. In particular, certain lending authority for federal
associations, e.g., commercial,
9
non-residential real property loans and consumer loans, is limited to a
specified percentage of the institution's capital or assets. The activities of
Valley Bank, a state commercial bank, are governed by the Connecticut Department
of Banking and the FDIC, which regulate, among other things, the scope of the
business of a bank, the investments a bank must maintain, the nature and amount
of collateral for certain loans a bank makes, the establishment of branches and
the activities of a bank with respect to mergers and acquisitions.
Loans-to-One-Borrower Limitations. Enfield Federal and Valley Bank are
generally subject to the same limits on loans to one borrower as a national
bank. With specified exceptions, the Association's and Bank's total loans or
extensions of credit to a single borrower cannot exceed 15% of its unimpaired
capital and surplus. They may lend additional amounts up to 10% of its
unimpaired capital and surplus, if the loans or extensions of credit are
fully-secured by readily-marketable collateral. At March 31, 2008, Enfield
Federal's and Valley Bank's loans-to-one borrower limitation were $4.1 million
and $3.9 million, respectively. Enfield Federal's and Valley Bank's largest
aggregate outstanding balance of loans to one borrower was $5.6 million and $3.7
million, respectively.
QTL Test. Under federal law, Enfield Federal must comply with the
qualified thrift lender, or "QTL" test. Under the QTL test, Enfield Federal is
required to maintain at least 65% of its "portfolio assets" in certain
"qualified thrift investments" in at least nine months of the most recent
12-month period. "Portfolio assets" means, in general, Enfield Federal's total
assets less the sum of:
(1) specified liquid assets up to 20% of total assets;
(2) goodwill and other intangible assets; and
(3) the value of property used to conduct Enfield Federal's
business.
"Qualified thrift investments" includes various types of loans made for
residential and housing purposes, investments related to such purposes,
including certain mortgage-backed and related securities, and loans for
personal, family, household and certain other purposes up to a limit of 20% of
Enfield Federal's portfolio assets. Recent legislation broadened the scope of
"qualified thrift investments" to include 100% of an institution's credit card
loans, education loans and small business loans. Enfield Federal may also
satisfy the QTL test by qualifying as a "domestic building and loan association"
as defined in the Internal Revenue Code of 1986 (the "Code").
If Enfield Federal fails the QTL test it must either operate under
certain restrictions on its activities or convert to a bank charter. Enfield
Federal met the QTL test at March 31, 2008, and in each of the prior 12 months,
and, therefore, qualifies as a thrift lender.
Capital Requirements. Office of Thrift Supervision regulations require
Enfield Federal to meet three minimum capital standards:
(1) a tangible capital ratio requirement of 1.5% of total assets,
as adjusted under the Office of Thrift Supervision
regulations;
(2) a leverage ratio requirement of 3% of core capital to adjusted
total assets, if a savings association has been assigned the
highest composite rating of 1 under the Uniform Financial
Institutions Ratings System (the minimum leverage capital
ratio for any other depository institution that does not have
a composite examination rating of 1 is 4%, unless a higher
leverage capital ratio is warranted by the particular
circumstances or risk profile of the depository institution)
and is not anticipating or expecting significant growth and
have well-diversified risks; and
(3) a risk-based capital ratio requirement of 8% of core and
supplementary capital to total risk-weighted assets of which
at least half must be core capital.
In determining compliance with the risk-based capital requirement,
Enfield Federal must compute its risk-weighted assets by multiplying its assets
and certain off-balance sheet items by risk-weights, which range from 0% for
cash and obligations issued by the United States Government or its agencies to
100% for consumer and
10
commercial loans, as assigned by the Office of Thrift Supervision capital
regulation based on the risks that the Office of Thrift Supervision believes are
inherent in the type of asset.
Tangible capital is defined, generally, as common stockholders' equity
(including retained earnings), certain non-cumulative perpetual preferred stock
and related surplus and minority interests in equity accounts of fully
consolidated subsidiaries, less intangibles (other than certain mortgage
servicing rights) and investments in and loans to subsidiaries engaged in
activities not permissible for a national bank. Core capital is defined
similarly to tangible capital, but core capital also includes certain qualifying
credit card relationships. Supplementary capital currently includes cumulative
and other perpetual preferred stock, mandatory convertible securities,
subordinated debt and intermediate preferred stock and the allowance for loan
and lease losses. In addition, up to 45% of unrealized gains on
available-for-sale equity securities with a readily determinable fair value may
be included in supplementary capital. The allowance for loan and lease losses
includable in supplementary capital is limited to a maximum of 1.25% of
risk-weighted assets, and the amount of supplementary capital that may be
included as total capital cannot exceed the amount of core capital.
The Office of Thrift Supervision also has authority to establish
individual minimum capital requirements in appropriate cases upon a
determination that an institution's capital level is or may become inadequate in
light of the particular circumstances. At March 31, 2008, Enfield Federal met
each of its capital requirements.
The following table presents the Association's capital position at
March 31, 2008.
OTS Minimum
Capital Requirements
---------------------
Actual Ratio Actual Ratio
---------- --------- ---------- ---------
(Dollar amounts in thousands)
Tangible................... $25,300 8.80% $ 4,313 1.5%
Core (Leverage)............ $25,300 8.80% $ 11,502 4.0%
Risk-based................. $27,376 14.13% $ 15,504 8.0%
Valley Bank is subject to capital adequacy rules and guidelines issued
by the FDIC. The rules require the Bank to maintain certain minimum ratios of
capital to adjusted total assets and/or risk-weighted assets. Under the
provision of the Federal Deposit Insurance Corp. Improvement Act of 1991, the
Federal regulatory agencies are required to implement and enforce these rules in
a stringent manner.
11
The following table presents the Bank's capital position at March 31,
2008.
For Capital
Actual Adequacy Purposes
------ -----------------
Amount Ratio Amount Ratio
---------- --------- ---------- ---------
(Dollar amounts in thousands)
Total Capital (to Risk Weighted Assets) $26,256 14.33% $14,658 >8.0%
-
Tier 1 Capital (to Risk Weighted Assets) 24,286 13.25 7,329 >4.0
-
Tier 1 Capital (to Average Assets) 24,286 11.56 8,402 >4.0
-
Standards For Safety and Soundness. The Office of Thrift Supervision
and Connecticut Department of Banking have adopted a set of guidelines
prescribing safety and soundness standards. These guidelines establish the
safety and soundness standards that the federal banking agencies use to identify
and address problems at insured depository institutions before capital becomes
impaired. If the Office of Thrift Supervision or Connecticut Department of
Banking determines that an institution fails to meet any standard prescribed by
the guidelines, it may require the institution to submit and implement an
acceptable plan to achieve compliance with the standard.
Limitation on Capital Distributions. Office of Thrift Supervision and
Connecticut Department of Banking regulations impose limitations on capital
distributions, including cash dividends, payments to repurchase its shares and
payments to stockholders of another institution in a cash-out merger. Under the
regulations, an application to and the prior approval of the appropriate
regulatory agency is required prior to any capital distribution if the
institution does not meet the criteria for "expedited treatment" of applications
under the regulations (i.e., generally, examination ratings, including safety
and soundness, compliance and Community Reinvestment Act, in the two top
categories), the total capital distributions for the calendar year exceed net
income for that year plus the amount of retained net income for the preceding
two years, the institution would be undercapitalized following the distribution
or the distribution would otherwise be contrary to a statute, regulation or
agreement with the regulatory agency. If an application is not required, the
institution must still provide prior notice to the regulatory agency of the
capital distribution if the institution is a subsidiary of a holding company. If
the Association's or Bank's capital fell below its regulatory requirements or a
regulatory agency notified it that it was in need of increased supervision, its
ability to make capital distributions could be restricted. In addition, a
regulatory agency could prohibit a proposed capital distribution by any
institution, which would otherwise be permitted by the regulation, if the
regulatory agency determines that such distribution would constitute an unsafe
or unsound practice.
Assessments. Savings institutions are required to pay assessments to
the Office of Thrift Supervision to fund the agency's operations. The general
assessments, paid on a semi-annual basis, are computed upon the savings
institution's total assets, including consolidated subsidiaries, as reported in
the institution's latest quarterly thrift financial report. The assessments paid
by Enfield Federal for the year ended March 31, 2008 totaled $77,000.
Valley Bank's operations are subject to examination by the FDIC and the
State of Connecticut Department of Banking. The assessments paid by Valley Bank
for the year ended March 31, 2008 totaled $9,000.
Prompt Corrective Regulatory Action. The Office of Thrift Supervision
is required to take certain supervisory actions against undercapitalized
institutions, the severity of which depends upon the institution's degree of
undercapitalization. Generally, a savings institution that has a ratio of total
capital to risk weighted assets of less than 8%, a ratio of Tier 1 (core)
capital to risk-weighted assets of less than 4% or a ratio of core capital to
total assets of less than 4% (3% or less for institutions with the highest
examination rating) is considered to be "undercapitalized." A savings
institution that has a total risk-based capital ratio less than 6%, a Tier 1
capital ratio of less than 3% or a leverage ratio that is less than 3% is
considered to be "significantly undercapitalized" and a savings institution that
has a tangible capital to assets ratio equal to or less than 2% is deemed to be
"critically undercapitalized." Subject to a narrow exception, the Office of
Thrift Supervision is required to appoint a receiver or conservator within
specified time frames for an institution that is "critically undercapitalized."
The regulation
12
also provides that a capital restoration plan must be filed with the Office of
Thrift Supervision within 45 days of the date a savings institution receives
notice that it is "undercapitalized," "significantly undercapitalized" or
"critically undercapitalized." Compliance with the plan must be guaranteed by
any parent holding company. In addition, numerous mandatory supervisory actions
become immediately applicable to an undercapitalized institution, including, but
not limited to, increased monitoring by regulators and restrictions on growth,
capital distributions and expansion. The Office of Thrift Supervision could also
take any one of a number of discretionary supervisory actions, including the
issuance of a capital directive and the replacement of senior executive officers
and directors.
Valley Bank is subject to capital adequacy rules and guidelines issued
by the FDIC. The rules require the Bank to maintain certain minimum ratios of
capital to adjusted total assets and/or risk-weighted assets. Under the
provision of the Federal Deposit Insurance Corp. Improvement Act of 1991, the
Federal regulatory agencies are required to implement and enforce these rules in
a stringent manner.
Enforcement. The Office of Thrift Supervision has primary enforcement
responsibility over savings institutions and has the authority to bring action
against the institution and all "institution-affiliated parties," including
stockholders, and any attorneys, appraisers and accountants who knowingly or
recklessly participate in wrongful action likely to have an adverse effect on an
insured institution. Formal enforcement action may range from the issuance of a
capital directive or cease and desist order to removal of officers or directors,
receivership, conservatorship or termination of deposit insurance. Civil
penalties cover a wide range of violations and can amount to $25,000 per day, or
$1.0 million per day in especially egregious cases. The Federal Deposit
Insurance Corporation has the authority to recommend to the Director of the
Office of Thrift Supervision that enforcement action be taken with respect to a
particular savings institution. If action is not taken by the Director, the
Federal Deposit Insurance Corporation has authority to take such action under
certain circumstances. Federal and state law also establishes criminal penalties
for certain violations. Valley Bank is subject to the federal regulations
promulgated pursuant to the Financial Institutions Supervisory Act to prevent
banks from engaging in unsafe and unsound practices, as well as various other
federal and state laws and consumer protection laws.
Insurance of Deposit Accounts. Deposits of Enfield Federal and Valley
Bank are insured by the Deposit Insurance Fund of the Federal Deposit Insurance
Corporation. The Federal Deposit Insurance Corporation determines insurance
premiums based on a number of factors, primarily the risk of loss that insured
institutions pose to the Deposit Insurance Fund. Recent legislation eliminated
the minimum 1.25% reserve ratio for the insurance funds, the mandatory
assessments when the ratio fall below 1.25% and the prohibition on assessing the
highest quality banks when the ratio is above 1.25%. The Federal Deposit
Insurance Corporation has the ability to adjust the new insurance fund's reserve
ratio between 1.15% and 1.5%, depending on projected losses, economic changes
and assessment rates at the end of a calendar year. The Federal Deposit
Insurance Corporation has adopted regulations that set assessment rates that
took effect at the beginning of 2007. The new assessment rates for most banks
vary between five cents and seven cents for every $100 of deposits. A change in
insurance premiums could have an adverse effect on the operating expenses and
results of operations of Enfield Federal and Valley Bank. We cannot predict what
insurance assessment rates will be in the future. Assessment credits have been
provided to institutions that paid high premiums in the past.
Insurance of deposits may be terminated by the Federal Deposit
Insurance Corporation upon a finding that the institution has engaged in unsafe
or unsound practices, is in an unsafe or unsound condition to continue
operations or has violated any applicable law, regulation, rule, order or
condition imposed by the Federal Deposit Insurance Corporation or the Office of
Thrift Supervision. The management of Enfield Federal and Valley Bank do not
know of any practice, condition or violation that might lead to termination of
deposit insurance.
Transactions with Related Parties. Enfield Federal's authority to
engage in transactions with its "affiliates" (e.g., any company that controls or
is under common control with an institution, including New England Bancshares)
is limited by federal law. In general, these transactions must be on terms which
are as favorable to Enfield Federal as comparable transactions with
non-affiliates. In addition, certain types of these transactions are restricted
to an aggregate percentage of Enfield Federal's capital. Collateral in specified
amounts must usually be provided by affiliates to receive loans from Enfield
Federal. The purchase of low quality assets from affiliates is generally
prohibited. In addition, the Office of Thrift Supervision regulations prohibit a
savings association from
13
lending to any of its affiliates that is engaged in activities that are not
permissible for bank holding companies and from purchasing the securities of any
affiliate, other than a subsidiary.
Valley Bank's authority to engage in transactions with its affiliates
is governed by the Federal Reserve Act and implementing regulations. The Federal
Reserve Act limits the extent to which a bank or its subsidiaries may engage in
"covered transactions" with any one affiliate to an amount equal to 10% of such
bank's capital stock and retained earnings, and limits all such transactions
with all affiliates to an amount equal to 20% of such capital stock and retained
earnings. Any covered transaction with an affiliate, such as the making of
loans, purchase of assets, issuance of guarantees and other similar types of
transactions, must be on terms that are substantially the same, or at least as
favorable to the bank, as those that would be provided to a non-affiliate.
The Sarbanes-Oxley Act generally prohibits loans by the Company to its
executive officers and directors. However, that act contains a specific
exception for loans by Enfield Federal and Valley Bank to its executive officers
and directors in compliance with federal banking laws. Under such laws, Enfield
Federal's and Valley Bank's authority to extend credit to executive officers,
directors and 10% stockholders ("insiders"), as well as entities such persons
control, is limited. Among other things, these provisions require that
extensions of credit to insiders be made on terms that are substantially the
same as, and follow credit underwriting procedures that are not less stringent
than, those prevailing for comparable transactions with unaffiliated persons and
that do not involve more than the normal risk of repayment or present other
unfavorable features. There is an exception for loans made pursuant to a benefit
or compensation program that is widely available to all employees of the
institution and does not give preference to insiders. There are also certain
limitations on the amount of credit extended to insiders, individually and in
the aggregate, which limits are based, in part, on the amount of Enfield
Federal's and Valley Bank's capital. In addition, extensions of credit in excess
of certain limits must be approved by Enfield Federal's and Valley Bank's board
of directors.
Community Reinvestment Act. Under the Community Reinvestment Act
("CRA"), as implemented by Office of Thrift Supervision and FDIC regulations,
Enfield Federal and Valley Bank have a continuing and affirmative obligation to
help meet the credit needs of its entire community, including low and moderate
income neighborhoods. The CRA does not establish specific lending requirements
or programs for Enfield Federal or Valley Bank, nor does it limit their
discretion to develop the types of products and services that it believes are
best suited to its particular community, consistent with the CRA. The CRA
requires the Office of Thrift Supervision and the FDIC, in connection with their
examinations of Enfield Federal and Valley Bank, respectively, to assess Enfield
Federal's and Valley Bank's record of meeting the credit needs of its community
and to take the record into account in its evaluation of certain applications by
Enfield Federal and Valley Bank. The CRA also requires all institutions to make
public disclosure of their CRA ratings. Both Enfield Federal and Valley Bank
received a "Satisfactory" CRA rating in their most recent examination.
Federal Home Loan Bank System. Enfield Federal and Valley Bank are
members of the Federal Home Loan Bank of Boston, which is one of the 12 regional
Federal Home Loan Banks making up the Federal Home Loan Bank System. Each
Federal Home Loan Bank provides a central credit facility primarily for its
member institutions. Enfield Federal is required to acquire and hold shares of
capital stock in that Federal Home Loan Bank. As of March 31, 2008, Enfield
Federal and Valley Bank were in compliance with this requirement with
investments in the capital stock of the Federal Home Loan Bank of Boston of $3.0
million and $602,000, respectively.
The Federal Home Loan Banks have been required to provide funds for the
resolution of insolvent thrifts and to contribute funds for affordable housing
programs. These requirements could reduce the amount of earnings that the
Federal Home Loan Banks can pay as dividends to their members and could also
result in the Federal Home Loan Banks imposing a higher rate of interest on
advances to their members. If dividends were reduced, or interest on future
Federal Home Loan Bank advances increased, Enfield Federal's and Valley Bank's
net interest income would be affected.
Federal Reserve System
Under Federal Reserve Board regulations, Enfield Federal and Valley
Bank are required to maintain noninterest-earning reserves against its
transaction accounts. The Federal Reserve Board regulations generally
14
require that reserves of 3% must be maintained against aggregate transaction
accounts of $48.3 million or less, subject to adjustment by the Federal Reserve
Board, and reserves of 10%, subject to adjustment by the Federal Reserve Board,
against that portion of total transaction accounts in excess of $48.3 million.
The first $7.8 million of otherwise reservable balances, subject to adjustment
by the Federal Reserve Board, are exempted from the reserve requirements.
Enfield Federal and Valley Bank are in compliance with these requirements.
Holding Company Regulation
After the completion of the merger, New England Bancshares became
subject to examination, regulation, and periodic reporting under the Bank
Holding Company Act of 1956, as amended, as administered by the Federal Reserve
Board. New England Bancshares is required to obtain the prior approval of the
Federal Reserve Board to acquire all, or substantially all, of the assets of any
bank or bank holding company. Prior Federal Reserve Board approval would be
required for New England Bancshares to acquire direct or indirect ownership or
control of any voting securities of any bank or bank holding company if, after
such acquisition, it would, directly or indirectly, own or control more than 5%
of any class of voting shares of the bank or bank holding company. In addition
to the approval of the Federal Reserve Board, before any bank acquisition can be
completed, prior approval may also be required to be obtained from other
agencies having supervisory jurisdiction over the bank to be acquired.
A bank holding company is generally prohibited from engaging in, or
acquiring, direct or indirect control of more than 5% of the voting securities
of any company engaged in non-banking activities. One of the principal
exceptions to this prohibition is for activities found by the Federal Reserve
Board to be so closely related to banking or managing or controlling banks as to
be a proper incident thereto. Some of the principal activities that the Federal
Reserve Board has determined by regulation to be so closely related to banking
are: (i) making or servicing loans; (ii) performing certain data processing
services; (iii) providing discount brokerage services; (iv) acting as fiduciary,
investment or financial advisor; (v) leasing personal or real property; (vi)
making investments in corporations or projects designed primarily to promote
community welfare; and (vii) acquiring a savings and loan association.
The Gramm-Leach-Bliley Act of 1999 authorizes a bank holding company
that meets specified conditions, including being "well capitalized" and "well
managed," to opt to become a "financial holding company" and thereby engage in a
broader array of financial activities than previously permitted. Such activities
can include insurance underwriting and investment banking.
New England Bancshares is subject to the Federal Reserve Board's
capital adequacy guidelines for bank holding companies (on a consolidated
basis), which are substantially similar to those of the Office of Thrift
Supervision for Enfield Federal.
A bank holding company is generally required to give the Federal
Reserve Board prior written notice of any purchase or redemption of then
outstanding equity securities if the gross consideration for the purchase or
redemption, when combined with the net consideration paid for all such purchases
or redemptions during the preceding 12 months, is equal to 10% or more of the
company's consolidated net worth. The Federal Reserve Board may disapprove such
a purchase or redemption if it determines that the proposal would constitute an
unsafe and unsound practice, or would violate any law, regulation, Federal
Reserve Board order or directive, or any condition imposed by, or written
agreement with, the Federal Reserve Board. The Federal Reserve Board has adopted
an exception to this approval requirement for well-capitalized bank holding
companies that meet certain other conditions.
The Federal Reserve Board has issued a policy statement regarding the
payment of dividends by bank holding companies. In general, the Federal Reserve
Board's policies provide that dividends should be paid only out of current
earnings and only if the prospective rate of earnings retention by the bank
holding company appears consistent with the organization's capital needs, asset
quality and overall financial condition. The Federal Reserve Board's policies
also require that a bank holding company serve as a source of financial strength
to its subsidiary banks by standing ready to use available resources to provide
adequate capital funds to those banks during periods of financial stress or
adversity and by maintaining the financial flexibility and capital-raising
capacity to obtain additional resources for assisting its subsidiary banks where
necessary. Under the prompt corrective action laws, the ability of a bank
holding company to pay dividends may be restricted if a subsidiary bank becomes
undercapitalized.
15
These regulatory policies can affect the ability of New England Bancshares to
pay dividends or otherwise engage in capital distributions.
Under the Federal Deposit Insurance Act, depository institutions are
liable to the Federal Deposit Insurance Corporation for losses suffered or
anticipated by the Federal Deposit Insurance Corporation in connection with the
default of a commonly controlled depository institution or any assistance
provided by the Federal Deposit Insurance Corporation to such an institution in
danger of default.
New England Bancshares, Enfield Federal and Valley Bank are affected by
the monetary and fiscal policies of various agencies of the United States
Government, including the Federal Reserve System. In view of changing conditions
in the national economy and in the money markets, it is impossible for
management to accurately predict future changes in monetary policy or the effect
of such changes on the business or financial condition of New England
Bancshares, Enfield Federal or Valley Bank.
The status of New England Bancshares as a registered bank holding
company under the Bank Holding Company Act will not exempt it from certain
federal and state laws and regulations applicable to corporations generally,
including, without limitation, certain provisions of the federal securities
laws.
FEDERAL AND STATE TAXATION
Federal Taxation
General. New England Bancshares, Enfield Federal and Valley Bank report
their consolidated taxable income on a fiscal year basis ending March 31, using
the accrual method of accounting and are subject to federal income taxation in
the same manner as other corporations. The following discussion of tax matters
is intended only as a summary and does not purport to be a comprehensive
description of the tax rules applicable to New England Bancshares, Enfield
Federal and Valley Bank. The Company is not currently under audit nor has it
ever been audited by the Internal Revenue Service.
Distributions. To the extent that the Company makes "non-dividend
distributions" to stockholders, such distributions will be considered to result
in distributions from its unrecaptured tax bad debt reserve as of December 31,
1987 (the "base year reserve"), to the extent thereof and then from the
Company's supplemental reserve for losses on loans, and an amount based on the
amount distributed will be included in the Company's income. Non-dividend
distributions include distributions in excess of the Company's current and
accumulated earnings and profits, distributions in redemption of stock and
distributions in partial or complete liquidation. Dividends paid out of the
Company's current or accumulated earnings and profits will not be included in
the Company's income.
The amount of additional income created from a non-dividend
distribution is equal to the lesser of the base year reserve and supplemental
reserve for losses on loans or an amount that, when reduced by the tax
attributable to the income, is equal to the amount of the distribution. Thus, in
some situations, approximately one and one-half times the non-dividend
distribution would be includable in gross income for federal income tax
purposes, assuming a 34% federal corporate income tax rate. The Company does not
intend to pay dividends that would result in the recapture of any portion of the
bad debt reserves.
Corporate Alternative Minimum Tax. The Code imposes a tax on
alternative minimum taxable income at a rate of 20%. Only 90% of alternative
minimum taxable income can be offset by alternative minimum tax net operating
loss carryovers of which the Company currently has none. Alternative minimum
taxable income is also adjusted by determining the tax treatment of certain
items in a manner that negates the deferral of income resulting from the regular
tax treatment of those items. Alternative minimum tax is due when it exceeds the
regular income tax. The Company has not had a liability for a tax on alternative
minimum taxable income during the past five years.
Elimination of Dividends. New England Bancshares may exclude from its
income 100% of dividends received from Enfield Federal and Valley Bank as a
member of the same affiliated group of corporations.
16
State Taxation
New England Bancshares, Enfield Federal and Valley Bank file
Connecticut income tax returns on a consolidated basis. Generally, the income of
financial institutions in Connecticut, which is calculated based on federal
taxable income, subject to certain adjustments, is subject to Connecticut tax.
The Company is not currently under audit with respect to its Connecticut income
tax returns and its state tax returns have not been audited for the past five
years.
ITEM 1A. RISK FACTORS
Our increased emphasis on commercial and construction lending may expose us to
increased lending risks.
At March 31, 2008, our loan portfolio consisted of $138.5 million, or
36.8% of commercial real estate loans, $21.0 million, or 5.6% of construction
loans and $52.0 million, or 13.8% of commercial business loans. We intend to
increase our emphasis on these types of loans. These types of loans generally
expose a lender to greater risk of non-payment and loss than residential
mortgage loans because repayment of the loans often depends on the successful
operation of the property, the income stream of the borrowers and, for
construction loans, the accuracy of the estimate of the property's value at
completion of construction and the estimated cost of construction. Such loans
typically involve larger loan balances to single borrowers or groups of related
borrowers compared to residential mortgage loans. Commercial business loans
expose us to additional risks since they typically are made on the basis of the
borrower's ability to make repayments from the cash flow of the borrower's
business and are secured by non-real estate collateral that may depreciate over
time. In addition, since such loans generally entail greater risk than
residential mortgage loans, we may need to increase our allowance for loan
losses in the future to account for the likely increase in probable incurred
credit losses associated with the growth of such loans. Also, many of our
commercial and construction borrowers have more than one loan outstanding with
us. Consequently, an adverse development with respect to one loan or one credit
relationship can expose us to a significantly greater risk of loss compared to
an adverse development with respect to a one- to four-family residential
mortgage loan.
Changes in interest rates could have an impact on earnings.
The Company's earnings and financial condition are dependent to a large
degree upon net interest income, which is the difference between interest earned
from loans and investments, and interest paid on deposits and borrowings. The
financial services industry has been experiencing a narrowing of interest rate
spreads, the difference between interest rates earned on loans and investments
and the interest rates paid on deposits and borrowings. This situation could
adversely affect the Company's earnings and financial condition. While the
Company cannot predict or control changes in interest rates, the Company has
policies and procedures to manage the risks associated with changes in market
interest rates.
Changes in interest rates also affect the value of our interest-earning
assets, and in particular our securities portfolio. Generally, the value of
fixed-rate securities fluctuates inversely with changes in interest rates.
Unrealized gains and losses on securities available for sale are reported as a
separate component of equity, net of tax. Decreases in the fair value of
securities available for sale resulting from increases in interest rates could
have an adverse effect on stockholders' equity.
Strong competition within our market area could hurt our profits and slow
growth.
We face intense competition both in making loans and attracting
deposits. This competition has made it more difficult for us to make new loans
and has occasionally forced us to offer higher deposit rates. Price competition
for loans and deposits might result in us earning less on our loans and paying
more on our deposits, which reduces net interest income. As of June 30, 2007, we
held 1.3% of the deposits in Hartford County, which was the 10th largest market
share of deposits out of the 30 financial institutions in the county. Some of
the institutions with which we compete have substantially greater resources and
lending limits than we have and may offer services that we do not provide. We
expect competition to increase in the future as a result of legislative,
regulatory and technological changes and the continuing trend of consolidation
in the financial services industry. Our profitability depends upon our continued
ability to compete successfully in our market area.
17
If we do not achieve profitability on our new branches, they may negatively
impact our earnings.
The Association opened its East Windsor branch office in October 2005
and its Ellington branch in April 2006, and the Bank opened its Farmington
Avenue branch office in March 2007 and its Southington branch office in January
2007. Numerous factors contribute to the performance of a new branch, such as a
suitable location, qualified personnel and an effective marketing strategy.
Additionally, it takes time for a new branch to generate significant deposits
and make sufficient loans to produce enough income to offset expenses, some of
which, like salaries and occupancy expense, are relatively fixed costs. We
expect that it may take a period of time before the new branch offices can
become profitable. During this period, operating these new branch offices may
negatively impact our net income.
A downturn in the Connecticut economy or a decline in real estate values could
hurt our profits.
Nearly all of our real estate loans are secured by real estate in
Connecticut. As a result of this concentration, a downturn in the Connecticut
economy could cause significant increases in non-performing loans, which would
hurt our profits. Additionally, a decrease in asset quality could require
additions to our allowance for loan losses through increased provisions for loan
losses, which would hurt our profits. In recent years, there have been
significant increases in real estate values in our market area. As a result of
rising home prices, our loans have been well collateralized. A decline in real
estate values could cause some of our mortgage loans to become inadequately
collateralized, which would expose us to a greater risk of loss.
We operate in a highly regulated environment and we may be adversely affected by
changes in laws and regulations.
The Company and its subsidiaries are subject to extensive regulation,
supervision and examination by the Office of Thrift Supervision, the
Association's chartering authority, the Connecticut Department of Banking, the
Bank's chartering authority, and by the Federal Deposit Insurance Corporation,
as insurer of its deposits. New England Bancshares is subject to regulation and
supervision by the Federal Reserve. Such regulation and supervision govern the
activities in which an institution and its holding company may engage, and are
intended primarily for the protection of the insurance fund and for the
depositors and borrowers of Enfield Federal. The regulation and supervision by
the Office of Thrift Supervision, Connecticut Department of Banking, Federal
Reserve and the Federal Deposit Insurance Corporation are not intended to
protect the interests of investors in New England Bancshares common stock.
Regulatory authorities have extensive discretion in their supervisory and
enforcement activities, including the imposition of restrictions on our
operations, the classification of our assets and determination of the level of
our allowance for loan losses. Any change in such regulation and oversight,
whether in the form of regulatory policy, regulations, legislation or
supervisory action, may have a material impact on our operations.
ITEM 1B. UNRESOLVED STAFF COMMENTS
Not applicable.
18
ITEM 2. PROPERTIES
The Company currently conducts its business through twelve full-service
banking offices and two administrative offices. The net book value of the
Company's properties or leasehold improvements was $5.2 million at March 31,
2008.
Original
Leased or Year Leased Date of Lease
Location Owned or Acquired Expiration
--------- ----------- -------------
Executive/Branch Office:
855 Enfield Street, Enfield, Connecticut.......... Leased 2006 2031
Enfield Federal Branch Offices:
268 Hazard Avenue, Enfield, Connecticut........... Owned 1962 --
112 Mountain Road, Suffield, Connecticut.......... Leased 1988 2010
23 Main Street, Manchester, Connecticut........... Owned 2002 --
124 Main Street, Broad Brook, Connecticut......... Owned 2003 --
20 Main Street, Windsor Locks, Connecticut........ Leased 2002 2012 (1)
One Shoham Road, East Windsor, Connecticut........ Leased 2005 2015 (2)
287 Somers Road, Ellington, Connecticut........... Owned 2005 --
Valley Bank Branch Offices:
Four Riverside Avenue, Bristol, Connecticut....... Leased 1999 2014 (3)
Eight South Main Street, Terryville, Connecticut.. Leased 2002 2012 (4)
98 Main Street, Southington, Connecticut.......... Leased 2006 2028 (5)
888 Farmington Avenue, Bristol, Connecticut....... Owned 2004 --
Valley Bank Operations Center:
45 North Main Street, Bristol, Connecticut........ Leased 2006 2017 (6)
- -----------------------------------------------------------------------------------------
(1) We have an option to renew this lease for one additional five-year term.
(2) We have an option to renew this lease for two additional seven-year terms.
(3) We have an option to renew this lease for three additional five-year terms.
(4) We have an option to renew this lease for one additional ten-year term.
(5) We have an option to terminate this lease in 2018.
(6) We have an option to renew this lease for two additional five-year terms.
19
ITEM 3. LEGAL PROCEEDINGS
Periodically, there have been various claims and lawsuits involving the
Company, the Association and the Bank, such as claims to enforce liens,
condemnation proceedings on properties in which the Association or the Bank hold
security interests, claims involving the making and servicing of real property
loans and other issues incident to the Association's or the Bank's business. In
the opinion of management, after consultation with the Company's legal counsel,
no such pending claims or lawsuits are expected to have a material adverse
effect on the financial condition or operations of the Company, taken as a
whole. The Company is not a party to any material pending legal proceedings.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the
fourth quarter of the year ended March 31, 2008.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER
MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Beginning on December 28, 2005, the Company's common stock was quoted
on the NASDAQ Global Market under the symbol "NEBS." Before that date, the
Company's common stock was quoted on the OTC Bulletin Board under the symbol
"NEBS." According to the records of its transfer agent, the Company had
approximately 1,014 stockholders of record as of June 2, 2008. This number does
not reflect stockholders who hold their shares in "street name." The following
table sets forth the high and low bid information for the Company's common stock
for each of the fiscal quarters in the two-year period ended March 31, 2008. The
stock prices and dividends have been adjusted to reflect that each share of
former New England Bancshares common stock was exchanged for 2.3683 shares of
current New England Bancshares common stock in connection with the Company's
second-step conversion on December 28, 2005.
High Low Dividends
------------ ------------- ------------
Fiscal 2008:
Fourth Quarter.............. $ 11.35 $ 10.50 $ 0.03
Third Quarter............... 12.20 10.00 0.03
Second Quarter.............. 10.90 10.26 0.03
First Quarter............... 13.57 12.31 0.03
Fiscal 2007:
Fourth Quarter.............. $ 13.65 $ 12.85 $ 0.03
Third Quarter............... 13.30 12.50 0.03
Second Quarter.............. 13.05 11.41 0.03
First Quarter............... 11.66 10.77 0.03
20
The Company repurchased 70,986 shares of its common stock in the
quarter ended March 31, 2008 as follows:
Total number of shares Maximum number
For the three Average purchased as part of shares that may
months ended Total shares price paid of publicly announced yet be purchased under
March 31, 2008 repurchased per share plan or program the plan or program
- ------------------------------------------------------------------------------------------------------
January 1-31 -- $ -- 250,000 70,986
February 1-29(1) 46,300 11.04 296,300 24,686
March 1-31(1) 24,686 11.00 320,986 --
- ------------------------------------------------------------------------------------------------------
Total 70,986 $11.03
- ------------------------------------------------------------------------------------------------------
(1) This repurchase of stock was pursuant to the Company's stock repurchase
program that was authorized on October 9, 2007 and completed on March 7, 2008.
The Company repurchased 320,986 shares, or 5% of the Company's outstanding
shares, at an average price of $11.70 per share. The repurchases were made on
the open market and through privately negotiated transactions.
ITEM 6. SELECTED FINANCIAL DATA
Not completed due to Registrant's status as a smaller reporting
company.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITIONS AND
RESULTS OF OPERATIONS
The objective of this section is to help understand our views on our
results of operations and financial condition. You should read this discussion
in conjunction with the consolidated financial statements and notes to the
consolidated financial statements that appear under Part II, Item 8 of this
annual report.
Overview
Income. Our primary source of pre-tax income is net interest and
dividend income. Net interest and dividend income is the difference between
interest and dividend income, which is the income that we earn on our loans and
investments, and interest expense, which is the interest that we pay on our
deposits and borrowings. To a much lesser extent, we also recognize pre-tax
income from service charge income - mostly from service charges on deposit
accounts, from the increase in cash surrender value of our bank-owned life
insurance and from the sale of securities and loans.
Allowance for Loan Losses. The allowance for loan losses is a valuation
allowance for probable losses inherent in the loan portfolio. We evaluate the
need to establish allowances against losses on loans on a monthly basis. When
additional allowances are necessary, a provision for loan losses is charged to
earnings.
Expenses. The expenses we incur in operating our business consist of
salaries and employee benefits expenses, occupancy and equipment expenses,
advertising and promotion expenses, professional fees, data processing expense,
stationery and supplies expense, amortization of identifiable intangible assets
and other miscellaneous expenses.
Salaries and employee benefits expenses consist primarily of the
salaries and wages paid to our employees, payroll taxes and expenses for health
insurance, retirement plans and other employee benefits. It also includes
expenses related to our employee stock ownership plan and restricted stock
awards granted under our stock-based incentive plan. Expense for the employee
stock ownership plan is based on the average market value of the shares
committed to be released. An equal number of shares are released each year over
terms of the two loans from New England Bancshares that were used to fund the
employee stock ownership plan's purchase of shares in the stock offering in both
the mutual holding company reorganization and the second-step conversion.
Expense for shares of
21
restricted stock awards is based on the fair market value of the shares on the
date of grant. Compensation and related expenses is recognized on a
straight-line basis over the vesting period. We began expensing stock options in
fiscal 2007 and are included in salaries and employee benefits expenses and the
consolidated statements of income.
Occupancy and equipment expenses, which are the fixed and variable
costs of land, building and equipment, consist primarily of lease payments, real
estate taxes, depreciation charges, furniture and equipment expenses,
maintenance and costs of utilities. Depreciation of premises and equipment is
computed using the straight-line method based on the useful lives of the related
assets, which range from ten to 50 years for buildings and premises and three to
20 years for furniture, fixtures and equipment. Leasehold improvements are
amortized over the shorter of the useful life of the asset or term of the lease.
Advertising and promotion expenses include expenses for print
advertisements, promotions and premium items.
Professional fees primarily include fees paid to our independent
auditors, our attorneys, our internal auditor and any consultants we employ,
such as to review our loan or investment portfolios.
Data processing expenses include fees paid to our third-party data
processing service and ATM expense.
Stationery and supplies expense consists of expenses for office
supplies.
Amortization of identifiable intangible assets consists of the
amortization, on a straight-line basis over a ten-year period, of the $886,000
core deposit intangible that was incurred in connection with Enfield Federal's
acquisition of Windsor Locks Community Bank, FSL in December 2003 and on a
sum-of-years digits basis over a ten year period, of the $2.5 million core
deposit intangible that was incurred in conjunction with the Company's
acquisition of First Valley.
Other expenses include federal insurance deposit premiums, charitable
contributions, regulatory assessments, telephone, insurance and other
miscellaneous operating expenses.
Critical Accounting Policies
We consider accounting policies involving significant judgments and
assumptions by management that have, or could have, a material impact on the
carrying value of certain assets or income to be critical accounting policies.
We consider accounting policies relating to the allowance for loan losses and
goodwill and other intangibles to be critical accounting policies.
Allowance for Loan Losses. The allowance for loan losses is the amount
estimated by management as necessary to cover losses inherent in the loan
portfolio at the balance sheet date. The allowance is established through the
provision for loan losses, which is charged to income. Determining the amount of
the allowance for loan losses necessarily involves a high degree of judgment.
Among the material estimates required to establish the allowance are: loss
exposure at default; the amount and timing of future cash flows on impacted
loans; the value of collateral; and determination of loss factors to be applied
to the various elements of the portfolio. All of these estimates are susceptible
to significant change.
Management reviews the level of the allowance on a monthly basis and
establishes the provision for loan losses based on an evaluation of the
portfolio, past loss experience, economic conditions and business conditions
affecting our primary market area, credit quality trends, collateral value, loan
volumes and concentrations, seasoning of the loan portfolio, the duration of the
current business cycle, bank regulatory examination results and other factors
related to the collectability of the loan portfolio. Although we believe that we
use the best information available to establish the allowance for loan losses,
future additions to the allowance may be necessary if certain future events
occur that cause actual results to differ from the assumptions used in making
the evaluation. For example, a downturn in the local economy could cause
increases in non-performing loans. Additionally, a decline in real estate values
could cause some of our loans to become inadequately collateralized. In either
case, this may require us to
22
increase our provisions for loan losses, which would negatively impact earnings.
Further, the Office of Thrift Supervision, and Federal Deposit Insurance
Corporation and State of Connecticut Department of Banking, as an integral part
of their examination processes, review the Association's and Bank's allowances
for loan losses. Such agencies may require us to recognize adjustments to the
allowance based on its judgments about information available to it at the time
of its examination. An increase to the allowance required to be made by an
agency would negatively impact our earnings. Additionally, a large loss could
deplete the allowance and require increased provisions to replenish the
allowance, which would negatively affect earnings. See notes 2 and 4 to the
notes to consolidated financial statements included in Part II, Item 8 of this
annual report.
Goodwill and Other Intangibles. We record all assets and liabilities
acquired in purchase acquisitions, including goodwill and other intangibles, at
fair value as required by Statement of Financial Accounting Standards No. 141.
Goodwill is subject, at a minimum, to annual tests for impairment. Other
intangible assets are amortized over their estimated useful lives using
straight-line and accelerated methods, and are subject to impairment if events
or circumstances indicate a possible inability to realize the carrying amount.
The initial goodwill and other intangibles recorded, and subsequent impairment
analysis, requires us to make subjective judgments concerning estimates of how
the acquired assets will perform in the future. Events and factors that may
significantly affect the estimates include, among others, customer attrition,
changes in revenue grown trends, specific industry conditions and changes in
competition.
Operating Strategy
Our mission is to operate and further expand a profitable
community-oriented financial institution. We plan to achieve this by executing
our strategy of:
o pursuing opportunities to increase multi-family and commercial
real estate and commercial business lending in our market
area;
o continuing to emphasize the origination of one- to four-family
residential real estate loans;
o expanding our delivery system through a combination of
increased uses of technology and additional branch facilities;
o aggressively attracting core deposits;
o managing our net interest margin and net interest spread by
having a greater percentage of our assets in loans, especially
higher-yielding loans, which generally have a higher yield
than securities; and
o managing interest rate risk by emphasizing the origination of
adjustable-rate or shorter duration loans.
Pursue opportunities to increase commercial real estate and commercial
business lending in our market area
Commercial real estate and commercial business loans provide us with
the opportunity to earn more income because they tend to have higher interest
rates than residential mortgage loans. In addition, these loans are beneficial
for interest rate risk management because they typically have shorter terms and
adjustable interest rates. Commercial real estate and commercial business loans
increased $84.4 million and $37.2 million for the years ended March 31, 2008 and
2007, respectively, and at March 31, 2008 comprised approximately 50.6% of total
loans. There are many multi-family and commercial properties and businesses
located in our market area, and with the additional capital we raised in the
offering we may pursue the larger lending relationships associated with these
opportunities, while continuing to originate any such loans in accordance with
what we believe are our conservative underwriting guidelines. We have added
expertise in our commercial loan department in recent years. Additionally,
23
we may employ additional commercial lenders in the future to help increase our
multi-family and commercial lending.
However, these types of loans generally expose a lender to greater risk
of non-payment and loss than one- to four-family residential mortgage loans
because repayment of the loans often depends on the successful operation of the
property and the income stream of the borrowers. Such loans typically involve
larger loan balances to single borrowers or groups of related borrowers compared
to one- to four-family residential mortgage loans. Commercial business loans
expose us to additional risks since they typically are made on the basis of the
borrower's ability to make repayments from the cash flow of the borrower's
business and are secured by non-real estate collateral that may depreciate over
time. In addition, since such loans generally entail greater risk than one- to
four-family residential mortgage loans, we may need to increase our allowance
for loan losses in the future to account for the likely increase in probable
incurred credit losses associated with the growth of such loans. Also, many of
our commercial borrowers have more than one loan outstanding with us.
Consequently, an adverse development with respect to one loan or one credit
relationship can expose us to a significantly greater risk of loss compared to
an adverse development with respect to a one- to four-family residential
mortgage loan.
Expand our delivery system through a combination of increased uses of
technology and additional branch
facilities
We intend to expand the ways in which we reach and serve our customers.
We implemented internet banking in fiscal 2003, which allows our customers to
access their accounts and pay bills online. In fiscal 2006, we introduced an
enhancement to our website to enable customers to obtain loan information to
apply for a residential or commercial loan online. Additionally, in fiscal 2008
we introduced remote deposit capture, a product which allows commercial
customers to deposit checks from their office with the use of a scanner; thereby
eliminating the need to physically visit an office to make a deposit. Also, we
opened new branch offices in East Windsor, Connecticut in October 2005 and
Ellington, Connecticut in April 2006 and the Bank opened its Farmington Avenue
branch office in March 2007 and its Southington branch office in January 2007.
We intend to pursue expansion in our market area in the future, whether through
de novo branching or acquisition. However, we have not entered into any binding
commitments regarding our expansion plans.
Aggressively attract core deposits
Core deposits (accounts other than certificates of deposit) comprised
45.8% of our total deposits at March 31, 2008. We value core deposits because
they represent longer-term customer relationships and a lower cost of funding
compared to certificates of deposit. We aggressively seek core deposits through
competitive pricing and targeted advertising. In addition, we offer business
checking accounts for our commercial customers. We also hope to increase core
deposits by pursuing expansion inside and outside of our market area through de
novo branching.
Manage net interest margin and net interest spread by having a greater
percentage of our assets in loans, especially higher-yielding loans, which
generally have a higher yield than securities
We intend to continue to manage our net interest margin and net
interest spread by seeking to increase lending levels and by originating
higher-yielding loans. Loans secured by multi-family and commercial real estate
and commercial business loans are generally larger and involve a greater degree
of risk than one-to four-family residential mortgage loans. Consequently,
multi-family and commercial real estate and commercial business loans typically
have higher yields, which increase our net interest margin and net interest
spread. In addition, the Bank has started, and expects to continue, to sell one-
to four-family mortgage loans in an effort to increase yields on the overall
loan portfolio.
Manage interest rate risk by emphasizing the origination of
adjustable-rate or shorter duration loans
We manage our interest rate sensitivity to minimize the adverse effects
of changes in the interest rate environment. Deposit accounts typically react
more quickly to changes in market interest rates than longer-term loans because
of the shorter maturities of deposits. As a result, sharp increases in interest
rates may adversely affect our earnings while decreases in interest rates may
beneficially affect our earnings. To reduce the potential volatility
24
of our earnings, we have sought to: (1) improve the match between asset and
liability maturities and rates, while maintaining an acceptable interest rate
spread; and (2) decrease the maturities of our assets, in part by the
origination of adjustable-rate and shorter-term loans. To this end the Company
started to sell some of its long term fixed rate residential mortgage loans.
Balance Sheet Analysis
Loans. We originate real estate loans secured by residential real
estate, commercial real estate and construction loans, which are secured by
residential and commercial real estate. At March 31, 2008, real estate loans
totaled $317.8 million, or 84.5% of total loans, compared to $183.0 million, or
91.3%, of total loans at March 31, 2007.
The largest segment of our real estate loans is residential real estate
loans. At March 31, 2008, residential real estate loans totaled $158.3 million,
which represented 49.8% of real estate loans and 42.1% of total loans compared
to $120.2 million at March 31, 2007, which represented 65.7% of real estate
loans and 60.0% of total loans. Residential real estate loans increased $38.1
million, or 31.7%, for the year ended March 31, 2008 primarily due to the merger
with First Valley Bancorp and new originations caused by the prevailing low
interest rate environment.
Commercial real estate loans totaled $138.5 million at March 31, 2008,
which represented 43.6% of real estate loans and 36.8% of total loans, compared
to $54.1 million at March 31, 2007, which represented 29.5% of real estate loans
and 27.0% of total loans. Commercial real estate loans increased $84.4 million,
or 156.2%, for the year ended March 31, 2008 primarily due to the merger with
First Valley Bancorp and the continued emphasis of this type of lending.
We originate construction loans secured by residential and commercial
real estate. This portfolio totaled $21.0 million at March 31, 2008, which
represented 5.6% of total loans, compared to $8.8 million at March 31, 2007,
which represented 4.4% of total loans. Construction loans increased $12.3
million, or 139.8%, for the year ended March 31, 2008 primarily due to the
merger with First Valley Bancorp and the Company funding additional construction
projects, partially offset by the loans on such projects converting to permanent
financing.
We also originate commercial business loans secured by business assets
other than real estate, such as business equipment, inventory and accounts
receivable and letters of credit. Commercial business loans totaled $52.0
million at March 31, 2008, which represented 13.8% of total loans, compared to
$14.7 million at March 31, 2007, which represented 7.4% of total loans.
Commercial business loans increased $37.2 million, or 252.4% for the year ended
March 31, 2008 primarily due to the merger with First Valley Bancorp and the
continued emphasis of this type of lending.
We originate a variety of consumer loans, including loans secured by
mobile homes, automobiles and passbook or certificate accounts. Consumer loans
totaled $6.3 million and represented 1.7% of total loans at March 31, 2008 and
$2.7 million at March 31, 2007 which represented 1.3% of total loans.
25
The following table sets forth the composition of our loan portfolio at
the dates indicated.
At March 31,
------------------------------------------------------------------------------------------------------
2008 2007 2006 2005 2004
------------------ ------------------ ------------------ ------------------ ------------------
Percent Percent Percent Percent Percent
Of Of Of Of Of
Amount Total Amount Total Amount Total Amount Total Amount Total
--------- ------ --------- ------ --------- ------ --------- ------ --------- ------
(Dollars in thousands)
Mortgage loans:
Residential (1) ....... $ 158,268 42.09% $ 120,199 59.96% $ 94,682 63.07% $ 89,223 66.42% $ 82,571 67.10%
Commercial real estate 138,477 36.82 54,057 26.97 40,596 27.04 27,588 20.54 22,827 18.55
Construction loans .... 21,043 5.60 8,774 4.38 8,459 5.63 10,949 8.15 9,947 8.08
--------- ------ --------- ------ --------- ------ --------- ------ --------- ------
Total mortgage loans 317,788 84.51 183,030 91.31 143,737 95.74 127,760 95.11 115,345 93.73
Consumer loans .......... 6,292 1.67 2,692 1.34 1,005 0.67 1,097 0.81 1,406 1.14
Commercial loans ........ 51,958 13.82 14,733 7.35 5,384 3.59 5,477 4.08 6,307 5.13
--------- ------ --------- ------ --------- ------ --------- ------ --------- ------
Total loans ........ 376,038 100.00% 200,455 100.00% 150,126 100.00% 134,334 100.00% 123,058 100.00%
====== ====== ====== ====== ======
Deferred loan origination (223) (133) (377) (340) (353)
fees, net
Allowance for loan losses (4,046) (1,875) (1,636) (1,437) (1,301)
--------- --------- --------- --------- ---------
Total loans, net ... $ 371,769 $ 198,447 $ 148,113 $ 132,557 $ 121,404
========= ========= ========= ========= =========
(1) Includes $31.9 million, $17.6 million, $13.9 million, $9.6
million and $8.4 million of home equity loans and lines of
credit at March 31, 2008, 2007, 2006, 2005 and 2004,
respectively.
26
The following table sets forth certain information at March 31, 2008
regarding the dollar amount of principal repayments becoming due during the
periods indicated. The table does not include any estimate of prepayments that
significantly shorten the average life of our loans and may cause our actual
repayment experience to differ from that shown below. Demand loans having no
stated schedule of repayments and no stated maturity are reported as due in one
year or less.
Commercial
Resi- Real Total
dential Estate Construction Consumer Commercial Loans
-------- -------- ------------ -------- ---------- --------
(In thousands)
Amounts due in:
One year or less ................... $ 898 $ 5,067 $ 19,735 $ 427 $ 15,929 $ 42,056
More than one year to three years.. 1,789 4,086 208 1,250 12,743 20,076
More than three years to five years 2,861 948 1,100 1,428 10,924 17,261
More than five years to ten years.. 26,297 23,915 -- 40 10,610 60,862
More than ten years to fifteen years 23,299 18,038 -- 1,101 160 42,598
More than fifteen years ............ 103,124 86,423 -- 2,046 1,592 193,185
-------- -------- -------- -------- -------- --------
Total amount due ................ $158,268 $138,477 $ 21,043 $ 6,292 $ 51,958 $376,038
======== ======== ======== ======== ======== ========
The following table sets forth the dollar amount of all loans at March
31, 2008 that are due after March 31, 2009 and have either fixed interest rates
or floating or adjustable interest rates. The amounts shown below exclude
applicable loans in process, unearned interest on consumer loans and deferred
loan fees.
Due After March 31, 2008
------------------------------------------------
Floating or
Fixed Rates Adjustable Rates Total
-------------- ---------------- --------------
(In thousands)
Mortgage loans:
Residential loans ........ $ 132,472 $ 24,898 $ 157,370
Commercial real estate ... 30,235 103,175 133,410
Construction loans ....... 1,308 -- 1,308
-------------- -------------- --------------
Total mortgage loans 164,015 128,073 292,088
Consumer loans .............. 5,863 2 5,865
Commercial loans ............ 29,775 6,254 36,029
-------------- -------------- --------------
Total loans .. $ 199,653 $ 134,329 $ 333,982
============== ============== ==============
27
The following table shows loan activity during the periods indicated.
For the Fiscal Year Ended March 31,
-----------------------------------
2008 2007 2006
--------- --------- ---------
(In thousands)
Beginning balance, loans, net ................. $ 198,447 $ 148,113 $ 132,557
--------- --------- ---------
Originations:
Mortgage loans:
Residential loans .................... 27,978 29,478 20,106
Commercial real estate ............... 29,735 19,161 10,921
Construction loans ................... 6,691 12,505 8,984
--------- --------- ---------
Total mortgage loans ........... 64,404 61,144 40,011
Consumer loans .......................... 3,262 2,290 553
Commercial loans ........................ 14,201 11,170 1,297
--------- --------- ---------
Total loan originations ........ 81,867 74,604 41,861
Loans sold .................................... (6,958) (3,816) --
Loan participations purchased ................. 5,860 18,268 4,127
Loans acquired in merger ...................... 141,041 -- --
Deduct:
Principal loan repayments and other, net (48,371) (38,719) (30,421)
Loan charge-offs, net of recoveries .... (117) (3) (11)
--------- --------- ---------
Ending balance, loans, net .................... $ 371,769 $ 198,447 $ 148,113
========= ========= =========
Securities. Our securities portfolio consists primarily of U.S.
government and agency securities, mortgage-backed securities, marketable equity
securities, municipal securities and, to a lesser extent, corporate debt
securities. Although corporate debt securities and municipal securities
generally have greater credit risk than U.S. Treasury and government securities,
they generally have higher yields than government securities of similar
duration. Securities increased $14.1 million, or 28.5%, in the year ended March
31, 2008 due to the acquisition of $22.6 million of securities in the First
Valley Bancorp merger, partially offset by calls of U.S. agency securities and
the sale of the majority of the marketable equity securities. The majority of
our mortgage-backed securities were issued by Ginnie Mae, Fannie Mae or Freddie
Mac.
The following table sets forth the carrying values and fair values of
our securities portfolio at the dates indicated.
At March 31,
--------------------------------------------------------------------------
2008 2007 2006
---------------------- ---------------------- ----------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
--------------------------------------------------------------------------
(In thousands)
Investments in available-for-sale securities:
U.S. government and federal agencies ..... $ 11,426 $ 11,501 $ 23,774 $ 23,575 $ 25,666 $ 25,125
Municipal securities ..................... 12,719 12,504 7,493 7,405 8,199 8,099
Corporate debt securities ................ 65 66 100 101 101 102
Mortgage-backed securities ............... 38,982 39,473 12,030 11,941 12,689 12,530
Marketable equity securities ............. 5,373 5,373 7,224 7,034 9,403 9,207
--------- --------- --------- --------- --------- ---------
Total .............................. 68,565 68,917 50,621 50,056 56,058 55,063
Money market mutual funds included in cash
and cash equivalents ................... (5,373) (5,373) (587) (587) (2,766) (2,766)
--------- --------- --------- --------- --------- ---------
Total ............................... $ 63,192 $ 63,544 $ 50,034 $ 49,469 $ 53,292 $ 52,297
========= ========= ========= ========= ========= =========
28
The following table sets forth our available-for-sale securities:
At and For the Fiscal Year Ended March 31,
--------------------------------------------
2008 2007 2006
------------ ------------ ------------
(In thousands)
Mortgage-related securities:
Mortgage-related securities, beginning of period (1) ..... $ 11,941 $ 12,530 $ 12,893
Acquired in merger ....................................... 11,589 -- --
Purchases ................................................ 22,533 2,609 6,160
Sales .................................................... (2,438) -- (368)
Repayments and prepayments ............................... (4,705) (3,224) (5,963)
Decrease in net premium .................................. (27) (44) (101)
Increase (decrease) in net unrealized gain ............... 580 70 (91)
------------ ------------ ------------
Net increase (decrease) in mortgage-related securities 27,532 (589) (363)
------------ ------------ ------------
Mortgage-related securities, end of period (1) ........... $ 39,473 $ 11,941 $ 12,530
============ ============ ============
Investment securities:
Investment securities, beginning of period (1) ........... $ 37,528 $ 39,767 $ 33,692
Acquired in merger ....................................... 11,059 -- --
Purchases ................................................ 19,575 15,218 11,161
Sales .................................................... (19,215) (14,842) (4,199)
Maturities ............................................... (21,785) (2,996) (630)
Increase (decrease) in net premium ....................... 96 21 (35)
Reclass from securities to other assets .................. (3,524) -- --
Increase (decrease) in net unrealized gain ............... 337 360 (222)
------------ ------------ ------------
Net (decrease) increase in investment securities ..... (13,457) (2,239) 6,075
------------ ------------ ------------
Investment securities, end of period (1) ................. $ 24,071 $ 37,528 $ 39,767
============ ============ ============
- ------------------------
(1) At fair value
The following table sets forth the maturities and weighted average
yields of securities at March 31, 2008. Weighted average yields are presented on
a tax-equivalent basis.
Within One Year One To Five Years Five To Ten Years After Ten Years Total
------------------ ------------------ ------------------ ------------------ ------------------
Weighted Weighted Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield Value Yield Value Yield
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
(Dollars in thousands)
Available-for-sale securities:
U.S. Government and
Federal agencies ....... $ 501 3.69% $ 100 3.00% $ 4,247 5.10% $ (6,653) 5.74% $ 11,501 5.39%
Municipal securities ....... 131 6.02 373 5.13 3,442 5.79 8,558 6.57 12,504 6.30
Corporate debt securities .. -- -- -- -- 66 7.03 -- -- 66 7.03
Mortgage-backed securities . 2,977 4.63 7,000 4.68 4,638 5.02 24,858 5.37 39,473 5.15
-------- -------- -------- -------- --------
Total .................. $ 3,609 4.55% $ 7,473 4.68% $ 12,393 5.27% $ 40,069 5.69% $ 63,544 5.42%
======== ======== ======== ======== ========
Deposits. Our primary source of funds is our deposit accounts, which
are comprised of demand deposits, savings accounts and time deposits. These
deposits are provided primarily by individuals and, to a lesser extent,
commercial customers, within our market area. We do not currently use brokered
deposits as a source of funding. Deposits increased $188.6 million for the year
ended March 31, 2008 due primarily to the merger with First Valley Bancorp
during the current fiscal year. The Company has continued to experience
disintermediation, as rates on other types of investments (CDs and money market
accounts) have increased substantially over the past several years resulting in
customers moving funds from the generally lower rates of savings accounts.
29
The following table sets forth the balances of our deposit products at the dates
indicated.
At March 31,
-------------------
2008 2007
-------- --------
(In thousands)
Non-interest bearing accounts $ 40,347 $ 16,075
NOW and money market accounts 74,017 35,305
Savings accounts ............ 55,211 40,184
Certificates of deposit ..... 200,737 90,111
-------- --------
Total .................. $370,312 $181,675
======== ========
The following table indicates the amount of jumbo certificates of
deposit by time remaining until maturity as of March 31, 2008. Jumbo
certificates of deposit require minimum deposits of $100,000.
Weighted
Maturity Period Amount Average Rate
--------------- ------------ ------------
(Dollars in thousands)
Three months or less ......... $ 17,326 4.48%
Over three through six months 20,732 4.64
Over six through twelve months 17,473 4.14
Over twelve months ........... 13,344 4.46
------------
Total ............... $ 68,875 4.44%
============
The following table sets forth the time deposits classified by rates at
the dates indicated.
At March 31,
------------------------------
2008 2007 2006
-------- -------- --------
(In thousands)
Certificate accounts:
0.00 to 2.00% ............. $ 111 $ 756 $ 5,858
2.01 to 3.00% ............. 19,291 6,332 25,820
3.01 to 4.00% ............. 63,448 29,176 29,634
4.01 to 5.00% ............. 88,801 51,130 21,797
5.01 to 6.00% ............. 29,086 2,717 372
Fair value adjustment. .... -- -- 73
-------- -------- --------
Total .................. $200,737 $ 90,111 $ 83,554
======== ======== ========
The following table sets forth the amount and maturities of time
deposits classified by rates at March 31, 2008.
Amount Due
-------------------------------------------------
Percent of
One Two to Over Total
Less than to Two Three Three Certificate
One Year Years Years Years Total Accounts
---------- ---------- ---------- ---------- ---------- ----------
(In thousands)
Certificate accounts:
0 to 2.00% ..... $ 111 $ -- $ -- $ -- $ 111 0.1%
2.01 to 3.00% .... 15,937 2,765 589 -- 19,291 9.6
3.01 to 4.00% .... 54,214 5,138 2,098 1,998 63,448 31.6
4.01 to 5.00% .... 60,450 15,111 7,911 5,329 88,801 44.2
5.01 to 6.00% .... 26,384 261 149 2,292 29,086 14.5
---------- ---------- ---------- ---------- ---------- ----------
Total ......... 157,096 $ 23,275 $ 10,747 $ 9,619 $ 200,737 100.0%
========== ========== ========== ========== ========== ==========
30
The following table sets forth the deposit activity for the periods indicated.
For the Fiscal Year Ended March 31,
-----------------------------------
2008 2007 2006
---- ---- ----
(In thousands)
Net deposits (withdrawals) .............. $ 10,696 $ 8,427 $ 3,203
Deposits acquired through merger ........ 168,369 -- --
Interest credited on deposit accounts (1) 9,572 4,204 2,850
---------- ---------- ----------
Total increase in deposit accounts ...... $ 188,637 12,631 6,053
========== ========== ==========
- ----------------------------------------
(1) Includes amortization of fair value adjustment.
Borrowings. We use advances from the Federal Home Loan Bank to
supplement our supply of funds for loans and investments and to meet deposit
withdrawal requirements.
The following table sets forth certain information regarding our
borrowed funds:
At or For the Years
Ended March 31,
-----------------------------
2008 2007 2006
------- ------- -------
(Dollars in thousands)
Federal Home Loan Bank advances:
Average balance outstanding ................................. $47,400 $27,465 $20,129
Maximum amount outstanding at any month-end during the period 62,221 33,587 21,642
Balance outstanding at end of period ........................ 61,928 33,587 21,642
Weighted average interest rate during the period ............ 4.70% 4.34% 3.98%
Weighted average interest rate at end of period ............. 4.33% 4.50% 4.00%
Subordinated Debentures. On July 28, 2005, FVB Capital Trust I ("Trust
I"), a Delaware statutory trust formed by First Valley Bancorp, completed the
sale of $4.1 million of 6.42%, 5 Year Fixed-Floating Capital Securities
("Capital Securities"). Trust I also issued common securities to First Valley
Bancorp and used the net proceeds from the offering to purchase a like amount of
6.42% Junior Subordinated Debentures ("Debentures") of First Valley Bancorp.
Debentures are the sole assets of Trust I.
Capital Securities accrue and pay distributions quarterly at an annual
rate of 6.42% for the first 5 years of the stated liquidation amount of $10 per
Capital Security. First Valley Bancorp fully and unconditionally guaranteed all
of the obligations of the Trust, which are now guaranteed by the Company. The
guaranty covers the quarterly distributions and payments on liquidation or
redemption of Capital Securities, but only to the extent that Trust I has funds
necessary to make these payments.
Capital Securities are mandatorily redeemable upon the maturing of
Debentures on August 23, 2035 or upon earlier redemption as provided in the
Indenture. The Company has the right to redeem Debentures, in whole or in part
on or after August 23, 2010 at the liquidation amount plus any accrued but
unpaid interest to the redemption date.
The trust and guaranty provide for the binding of any successors in the
event of a merger, as is the case in the merger of First Valley Bancorp and the
Company. The Company has assumed the obligations of First Valley Bancorp in
regards to the subordinated debentures due to the acquisition of First Valley
Bancorp by the Company.
31
Results of Operations for the Years Ended March 31, 2008 and 2007
Overview.
2008 2007 % Change
------ ------ --------
(Dollars in thousands)
Net income............................. $1,215 $ 970 25.3
Return on average assets............... 0.27% 0.36% (25.0)
Return on average equity............... 1.83% 1.70% 7.6
Average equity to average assets....... 15.04% 21.22% (29.1)
Net income increased due primarily to increases in net interest and
dividend income and noninterest income, partially offset by increases in
noninterest expense, the provision for loan losses and income tax expense. Net
interest income increased primarily as a result of a higher volume of and yield
on interest-earning assets, partially offset by an increase in the cost of
funds.
Net Interest and Dividend Income. Net interest and dividend income
totaled $13.9 million for the year ended March 31, 2008, an increase of $4.5
million or 47.9%. This resulted mainly from a $147.0 million increase in average
interest-earning assets during the year, partially offset by a $139.4 million
increase in average interest-bearing liabilities. Our interest rate spread
decreased 20 basis points to 2.93% for the year ended March 31, 2008 and net
interest margin decreased 26 basis points to 3.53% for the same time period.
Interest and dividend income increased $10.8 million, or 71.5%, from
$15.2 million for fiscal 2007 to $26.0 million for fiscal 2008. Average
interest-earning assets were $399.5 million for fiscal 2008, an increase of
$147.0 million, or 58.2%, compared to $252.5 million for fiscal 2007. The
increase in average interest-earning assets resulted primarily from the merger
of First Valley Bancorp and the growth in the loan portfolio. The yield on
interest-earning assets increased from 6.09% to 6.55% as a greater percentage of
the Company's balance sheet was invested in the loan portfolio, which generally
carries a higher interest rate than securities.
Interest expense increased $6.4 million, or 109.7%, from $5.8 million
for fiscal 2007 to $12.1 million for fiscal 2008. Average interest-bearing
liabilities grew $139.4 million, or 71.7%, from $194.5 million for fiscal 2007
to $333.9 million for fiscal 2008 due primarily to the merger with First Valley
Bancorp. The average rate paid on interest-bearing liabilities increased to
3.63% for fiscal 2008 from 2.98% for fiscal 2007 due primarily to increased
rates paid on certificates of deposit, and to a lesser extent, money market
accounts.
32
Average Balances and Yields. The following table presents information
regarding average balances of assets and liabilities, as well as the total
dollar amounts of interest income and dividends from average interest-earning
assets and interest expense on average interest-bearing liabilities and the
resulting average yields and costs. The yields and costs for the periods
indicated are derived by dividing income or expense by the average balances of
assets or liabilities, respectively, for the periods presented. For purposes of
this table, average balances have been calculated using the average of month-end
balances and non-accrual loans are included in average balances; however,
accrued interest income has been excluded from these loans.
For the Fiscal Years Ended March 31,
----------------------------------------------------------------------------------------
2008 2007 2006
---------------------------- ---------------------------- ----------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
-------- -------- -------- -------- -------- -------- -------- -------- --------
(Dollars in thousands)
Assets:
Federal funds sold,
interest-bearing
deposits and marketable
equity securities ................... $ 20,796 $ 874 4.20% $ 18,710 $ 966 5.16% $ 21 $ 871 3.97%
Investments in
available for sale
securities, other than
mortgage-backed
and mortgage-related
securities (1) ...................... 38,451 2,254 5.86 44,283 2,179 4.92 35,420 1,597 4.51
Mortgage-backed and
mortgage-related
securities .......................... 24,087 1,278 5.31 12,549 643 5.13 12,774 555 4.35
Federal Home Loan Bank stock .......... 2,859 168 5.88 1,735 95 5.50 1,383 64 4.63
Loans, net (2) ........................ 313,334 21,674 6.92 175,238 11,483 6.55 141,802 9,001 6.35
-------- -------- -------- -------- -------- --------
Total interest-earning
assets ..................... 399,527 26,248 6.57 252,515 15,366 6.09 213,327 12,088 5.67
-------- -------- --------
Noninterest-earning assets ............ 36,520 11,813 12,028
Cash surrender value of
life insurance ..................... 4,338 4,138 3,979
-------- -------- --------
Total assets .................. $440,385 $268,466 $229,334
======== ======== ========
Liabilities and Stockholders' Equity:
Deposits:
Savings accounts .................... $ 50,820 $ 361 0.71% $ 43,810 $ 266 0.61% $ 51,371 $ 319 0.62%
NOW accounts ........................ 10,470 91 0.87 7,564 32 0.42 7,413 19 0.26
Money market accounts ............... 47,081 1,660 3.52 19,021 651 3.42 9,413 180 1.91
Certificate accounts ................ 166,563 7,434 4.46 86,174 3,255 3.78 82,414 2,332 2.83
-------- -------- -------- -------- -------- --------
Total deposits ................ 274,934 9,546 3.47 156,569 4,204 2.68 150,611 2,850 1.89
Federal Home Loan Bank
advances and
subordinated debentures ............. 47,400 2,234 4.71 27,721 1,204 4.34 20,129 801 3.98
Advanced payments by borrowers
for taxes and
insurance ........................... 890 12 1.35 846 10 1.22 876 11 1.26
Securities sold under agreements
to repurchase ...................... 10,678 356 3.33 9,335 376 4.03 5,802 175 3.02
-------- -------- -------- -------- -------- --------
Total interest-bearing
liabilities ................. 333,902 12,148 3.64 194,471 5,794 2.98 177,418 3,837 2.16
-------- -------- --------
Demand deposits ....................... 31,177 15,294 14,440
Other liabilities ..................... 9,083 1,741 1,425
-------- -------- --------
Total liabilities ............. 374,162 211,506 193,283
Stockholders' Equity .................. 66,223 56,960 36,051
-------- -------- --------
Total liabilities and
stockholders' equity ...... $440,385 $268,466 $229,334
======== ======== ========
Net interest income/net
interest rate spread (3) ............ $ 14,100 2.93% $ 9,572 3.11% $ 8,251 3.51%
======== ======= ======== ======= ======== =======
Net interest margin (4) ............... 3.53% 3.79% 3.87%
======= ======= =======
Ratio of interest-earning assets
to interest-bearing liabilities ..... 119.65% 129.85% 120.24%
======== ======== ========
- ------------------------
(1) Reported on a tax equivalent basis, using a 34% tax rate.
(2) Amount is net of deferred loan origination costs, undisbursed proceeds of
construction loans in process, allowance for loan losses and includes
non-accruing loans. We record interest income on non-accruing loans on a
cash basis. Loan fees are included in interest income.
(3) Net interest rate spread represents the difference between the weighted
average yield on interest-earning assets and the weighted average cost of
interest-bearing liabilities.
(4) Net interest margin represents net interest income as a percentage of
average interest-earning assets.
33
Rate/Volume Analysis. The following table sets forth the effects of
changing rates and volumes on our net interest income. The rate column shows the
effects attributable to changes in rate (changes in rate multiplied by prior
volume). The volume column shows the effects attributable to changes in volume
(changes in volume multiplied by prior rate). The net column represents the sum
of the prior columns. For purposes of this table, changes attributable to
changes in both rate and volume that cannot be segregated have been allocated
proportionately based on the changes due to rate and the changes due to volume.
Fiscal Year Ended Fiscal Year Ended
March 31, 2008 March 31, 2007
Compared to Compared to
Fiscal Year Ended Fiscal Year Ended
March 31, 2007 March 31, 2006
-------------------------------- --------------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
-------------------- --------------------
Rate Volume Net Volume Rate Net
-------- -------- -------- -------- -------- --------
(In thousands)
Interest-earning assets:
Federal funds sold, interest-bearing
deposits and marketable equity securities ..... $ (230) $ 138 $ (92) $ 186 $ (91) $ 95
Investments in available-for-sale securities,
other than mortgage-backed and
mortgage-related securities ................... 241 (166) 75 156 426 582
Mortgage-backed and mortgage-related
securities .................................... 23 612 635 97 (9) 88
Federal Home Loan Bank stock ..................... 7 66 73 13 18 31
Loans, net (1) ................................... 672 9,519 10,191 300 2,182 2,482
-------- -------- -------- -------- -------- --------
Total interest-earning assets .............. 713 10,169 10,882 752 2,526 3,278
-------- -------- -------- -------- -------- --------
Interest-bearing liabilities:
Savings accounts ................................. 48 47 95 (7) (46) (53)
NOW accounts ..................................... 43 16 59 13 -- 13
Money market accounts ............................ 21 988 1,009 206 265 471
Certificate accounts ............................. 681 3,498 4,179 812 111 923
Federal Home Loan Bank advances and
subordinated debentures ....................... 110 920 1,030 79 324 403
Advanced payments by borrowers for taxes
and insurance ................................. 1 1 2 -- (1) (1)
Securities sold under agreements to repurchase ... (122) 102 (20) 71 130 201
-------- -------- -------- -------- -------- --------
Total interest-bearing liabilities ......... 782 5,572 6,354 1,174 783 1,957
-------- -------- -------- -------- -------- --------
Increase in net interest income ..................... $ (69) $ 4,597 $ 4,528 $ (422) $ 1,743 $ 1,321
======== ======== ======== ======== ======== ========
- ------------------------------
(1) Amount is net of deferred loan origination costs, undisbursed proceeds of
construction loans in process, allowance for loan losses and includes
non-accruing loans. We record interest income on non-accruing loans. We
record interest income on non-accruing loans on a cash basis. Loan fees are
included in interest income.
Provision for Loan Losses. The provision for loan losses are charges to
earnings to bring the total allowance for losses to a level considered by
management as adequate to provide for estimated losses inherent in the loan
portfolio. The size of the provision for each year is dependent upon many
factors, including loan growth, net charge-offs, changes in the composition of
the loan portfolio, delinquencies, management's assessment of loan portfolio
quality, the value of collateral and general economic factors.
We recorded a $307,000 and $242,000 provision for loan losses in the
years ended March 31, 2008 and 2007, respectively. The increase in the provision
was caused primarily by increased loan growth, primarily in the generally higher
risk commercial real estate loan and commercial loan categories, and a slight
increase in non-accrual loans and classified assets, partially offset by low net
loan charge-offs for fiscal year 2007.
34
Although management utilizes its best judgment in providing for losses,
there can be no assurance that we will not have to change its provisions for
loan losses in subsequent periods. Management will continue to monitor the
allowance for loan losses and make additional provisions to the allowance as
appropriate.
An analysis of the changes in the allowance for loan losses,
non-performing loans and classified loans is presented under "--Risk
Management--Analysis of Non-Performing and Classified Assets" and "--Risk
Management--Analysis and Determination of the Allowance for Loan Losses."
Noninterest Income. The following table shows the components of
noninterest income and the percentage changes from 2008 to 2007.
2008 2007 % Change
------- ------- --------
(In thousands)
Service charges on deposit accounts ....................... $ 886 $ 519 70.7%
(Loss) gain on securities, net ............................ (93) 32 (390.6)
Gain on sale of loans ..................................... 53 28 89.3
Increase in cash surrender value of life insurance policies 154 154 --
Other income .............................................. 338 258 31.0
------- -------
Total ............................................... $ 1,338 $ 991 35.0
======= =======
The increase in noninterest income was due primarily to an increase in
service charge income on deposit accounts from the additional deposits from the
merger with First Valley Bancorp.
Noninterest Expense. The following table shows the components of
noninterest expense and the percentage changes from fiscal 2008 to fiscal 2007.
2008 2007 % Change
------- ------- --------
(In thousands)
Salaries and employee benefits ............... $ 6,966 $ 4,930 41.3%
Occupancy and equipment expenses ............. 2,653 1,670 58.9
Advertising and promotion .................... 229 152 50.7
Professional fees ............................ 534 373 43.2
Data processing expense ...................... 450 345 30.4
Stationery and supplies ...................... 165 96 71.9
Amortization of identifiable intangible assets 387 88 339.8
Other expense ................................ 1,565 989 58.2
------- -------
Total .................................. $12,949 $ 8,643 49.8
======= =======
Efficiency ratio (1) ......................... 85.2% 83.4%
- ------------------------
(1) Computed as noninterest expense divided by the sum of net interest and
dividend income and other income.
During fiscal 2008, the Company merged with First Valley Bancorp, which
caused increases in each of the noninterest expense categories.
Income Taxes. Income tax expense for the year ended March 31, 2008
increased to $728,000 from $505,000 in the previous year. The increase was
primarily due to the increase in income before taxes. The effective tax rate
increased from 34.3% for the year ended March 31, 2007 to 37.4% for the year
ended March 31, 2008 as a result of a net $155,000 capital loss. The $155,000 is
allowed to be carried forward for five years to offset future capital gains. A
valuation allowance has been established for the full $155,000 as the Company
does not expect to utilize the capital loss carry forward.
35
Risk Management
Overview. Managing risk is an essential part of successfully managing a
financial institution. Our most prominent risk exposures are credit risk,
interest rate risk and market risk. Credit risk is the risk of not collecting
the interest and/or the principal balance of a loan or investment when it is
due. Interest rate risk is the potential reduction of interest income as a
result of changes in interest rates. Market risk arises from fluctuations in
interest rates that may result in changes in the values of financial
instruments, such as available-for-sale securities that are accounted for on a
mark-to-market basis. Other risks that we encounter are operational risks,
liquidity risks and reputation risk. Operational risks include risks related to
fraud, regulatory compliance, processing errors, technology and disaster
recovery. Liquidity risk is the possible inability to fund obligations to
depositors, lenders or borrowers. Reputation risk is the risk that negative
publicity or press, whether true or not, could cause a decline in our customer
base or revenue.
Credit Risk Management. Our strategy for credit risk management focuses
on having well-defined credit policies and uniform underwriting criteria and
providing prompt attention to potential problem loans.
When a borrower fails to make a required loan payment, we take a number
of steps to have the borrower cure the delinquency and restore the loan to
current status. We make initial contact with the borrower when the loan becomes
15 days past due. If payment is not received by the 30th day of delinquency,
additional letters and phone calls generally are made. Typically, when the loan
becomes 60 days past due, we send a letter notifying the borrower that we may
commence legal proceedings if the loan is not paid in full within 30 days.
Generally, loan workout arrangements are made with the borrower at this time;
however, if an arrangement cannot be structured before the loan becomes 90 days
past due, we will send a formal demand letter and, once the time period
specified in that letter expires, commence legal proceedings against any real
property that secures the loan or attempt to repossess any business assets or
personal property that secures the loan. If a foreclosure action is instituted
and the loan is not brought current, paid in full or refinanced before the
foreclosure sale, the real property securing the loan generally is sold at
foreclosure.
Management informs the Boards of Directors monthly of the amount of
loans delinquent more than 90 days, all loans in foreclosure and all foreclosed
and repossessed property that we own.
Analysis of Non-performing and Classified Assets. We consider
repossessed assets and loans that are 90 days or more past due to be
non-performing assets. When a loan becomes 90 days delinquent, the loan is
placed on non-accrual status at which time the accrual of interest ceases and an
allowance for any uncollectible accrued interest is established and charged
against operations. Typically, payments received on a non-accrual loan are
applied to the outstanding principal and interest as determined at the time of
collection of the loan.
Real estate that we acquire as a result of foreclosure or by
deed-in-lieu of foreclosure is classified as foreclosed real estate until it is
sold. When property is acquired, it is recorded at the lower of the recorded
investment in the loan or at fair value. Thereafter, we carry foreclosed real
estate at fair value, net of estimated selling costs. Holding costs and declines
in fair value after acquisition of the property result in charges against
income.
Non-performing assets totaled $1.2 million, or 0.23% of total assets,
at March 31, 2008, which was an increase of $343,000, or 41.6%, from March 31,
2008. However, nonperforming loans as a percentage of loans declined from 0.41%
at March 31, 2007 to 0.31% at March 31, 2008 due to the increase in loans.
Non-accrual loans accounted for all of non-performing assets at March 31, 2008
and March 31, 2007. At March 31, 2008, non-accrual loans consisted of six
residential real estate loans, one construction loan, one consumer loan and one
commercial loan compared to six residential real estate loans on non-accrual
status at March 31, 2007.
36
The following table provides information with respect to our
non-performing assets at the dates indicated. We did not have any troubled debt
restructurings at the dates presented.
At March 31,
--------------------------------------------------------
2008 2007 2006 2005 2004
-------- -------- -------- -------- --------
(Dollars in thousands)
Non-accruing loans:
Mortgage loans:
Residential loans ............................. $ 737 $ 824 $ 331 $ 464 $ 254
Commercial real estate ........................ -- -- -- -- 155
Construction loans ............................ 398
-------- -------- -------- -------- --------
Total mortgage loans ....................... 1,135 824 331 464 409
Consumer loans ................................... 22 -- -- -- --
Commercial loans ................................. 10 -- 269 -- 528
-------- -------- -------- -------- --------
Total nonaccrual loans .................. 1,167 824 600 464 937
Other real estate owned ............................. -- -- -- -- --
-------- -------- -------- -------- --------
Total nonperforming assets .............. $ 1,167 $ 824 $ 600 $ 464 $ 937
======== ======== ======== ======== ========
Impaired loans ...................................... $ 398 $--- $--- $--- $ 755
Accruing loans 90 days or more past due ............. 9 -- -- -- 411
Allowance for loan losses as a percent of loans ..... 1.08% 0.94% 1.09% 1.07% 1.06%
(1)
Allowance for loan losses as a percent
of nonperforming loans (2) ....................... 346.70% 227.55% 272.67% 309.70% 138.85%
Nonperforming loans as a percent of loans (1)(2) .... 0.31% 0.41% 0.40% 0.35% 0.76%
Nonperforming assets as a percent of total assets ... 0.23% 0.29% 0.23% 0.22% 0.46%
- -----------------------------
(1) Loans are presented before allowance for loan losses.
(2) Non-performing loans consist of all loans 90 days or more past due and
other loans which have been identified as presenting uncertainty with
respect to the collectibility of interest or principal.
Other than as disclosed in the above table, there were no other loans
at March 31, 2008 that management has serious doubts about the ability of the
borrowers to comply with the present repayment terms.
Interest income that would have been recorded for the year ended March
31, 2008 had non-accruing loans been current according to their original terms
amounted to $25,000, none of which was recognized in interest income.
Banking regulations require us to review and classify our assets on a
regular basis. In addition, the Office of Thrift Supervision and FDIC have the
authority to identify problem assets and, if appropriate, require them to be
classified. There are three classifications for problem assets: substandard,
doubtful and loss. "Substandard assets" must have one or more defined weaknesses
and are characterized by the distinct possibility that we will sustain some loss
if the deficiencies are not corrected. "Doubtful assets" have the weaknesses of
substandard assets with the additional characteristic that the weaknesses make
collection or liquidation in full on the basis of currently existing facts,
conditions and values questionable and there is a high possibility of loss. An
asset classified "loss" is considered uncollectible and of such little value
that continuance as an asset of the institution is not warranted. The
regulations also provide for a "special mention" category, described as assets
that do not currently expose us to a sufficient degree of risk to warrant
classification but do possess credit deficiencies or potential weaknesses
deserving our close attention. When we classify an asset as substandard or
doubtful, we establish a specific allowance for loan losses. If we classify an
asset as loss, we charge off an amount equal to 100% of the portion of the asset
classified as loss.
37
The following table shows the aggregate amounts of our classified
assets at the dates indicated.
At March 31,
-----------------
2008 2007
------- -------
(In thousands)
Special mention assets ... $23,598 $ 3,993
Substandard assets ....... 7,890 1,378
Doubtful assets .......... -- --
------- -------
Loss assets .............. -- --
Total classified assets $31,488 $ 5,371
======= =======
----------
Classified assets at March 31, 2008 included nine loans totaling $1.2
million that were considered non-performing. Classified assets at March 31, 2007
included six loans totaling $824,000 that were considered non-performing.
Classified assets increased $26.1 million to $31.5 million at March 31,
2008 and were 8.4% and 2.7% of total loans at March 31, 2008 and 2007,
respectively. The increase was caused primarily by the inclusion of classified
loans due to the merger of First Valley Bancorp in the March 31, 2008 amount.
Delinquencies. The following table provides information about
delinquencies in our loan portfolio at the dates indicated.
At March 31, 2008 At March 31, 2007 At March 31, 2006
---------------------------------- --------------------------------- -------------------------------
30-89 Days 90 Days or More 30-89 Days 90 Days or More 30-89 Days 90 Days or More
---------------- ---------------- ---------------- --------------- --------------- ---------------
Principal Principal Principal Principal Principal Principal
Number Balance Number Balance Number Balance Number Balance Number Balance Number Balance
of of of of of of of of of of of of
Loans Loans Loans Loans Loans Loans Loans Loans Loans Loans Loans Loans
------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
(Dollars in Thousands)
Mortgage loans:
Residential loans .......... 7 $ 784 1 $ 57 30 $ 3,403 -- $ -- 24 $ 2,086 1 $ 284
Commercial real estate ..... 3 315 -- -- -- -- -- -- 1 430 -- --
Construction loans ......... 1 183 1 398 -- -- -- -- -- -- -- --
------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total mortgage loans .... 11 1,282 2 455 30 3,403 -- -- 25 2,516 1 284
Consumer loans ............... 1 -- -- -- 3 12 -- -- 3 37 -- --
Commercial loans ............. 8 204 -- -- -- -- -- -- -- -- 3 269
------- ------- ------- ------- ------- ------- ------- ------- ------- ------- ------- -------
Total ................... 20 $ 1,486 2 $ 455 33 $ 3,415 -- $ -- 28 $ 2,553 4 $ 553
======= ======= ======= ======= ======= ======= ======= ======= ======= ======= ======= =======
Delinquent loans
to loans (1) ............... 0.40% 0.12% 1.70% --% 1.70% 0.37%
- ------------------
(1) Loans are presented before the allowance for loan losses and net of
deferred loan origination fees.
Analysis and Determination of the Allowance for Loan Losses. We
maintain an allowance for loan losses to absorb probable losses inherent in the
existing portfolio. When a loan, or portion thereof, is considered
uncollectible, it is charged against the allowance. Recoveries of amounts
previously charged-off are added to the allowance when collected. The adequacy
of the allowance for loan losses is evaluated on a regular basis by management.
Based on management's judgment, the allowance for loan losses covers all known
losses and inherent losses in the loan portfolio.
Our methodology for assessing the appropriateness of the allowance for
loan losses consists of specific allowances for identified problem loans and a
general valuation allowance on the remainder of the loan portfolio. Although we
determine the amount of each element of the allowance separately, the entire
allowance for loan losses is available for the entire portfolio.
Specific Allowances for Identified Problem Loans. We establish an
allowance on identified problem loans based on factors including, but not
limited to: (1) the borrower's ability to repay the loan; (2) the type and value
of the collateral; (3) the strength of our collateral position; and (4) the
borrower's repayment history.
General Valuation Allowance on the Remainder of the Portfolio. We also
establish a general allowance by applying loss factors to the remainder of the
loan portfolio to capture the inherent losses associated with the lending
activity. This general valuation allowance is determined by segregating the
loans by loan category and assigning
38
loss factors to each category. The loss factors are determined based on our
historical loss experience, delinquency trends and management's evaluation of
the collectibility of the loan portfolio. Based on management's judgment, we may
adjust the loss factors due to: (1) changes in lending policies and procedures;
(2) changes in existing general economic and business conditions affecting our
primary market area; (3) credit quality trends; (4) collateral value; (5) loan
volumes and concentrations; (6) seasoning of the loan portfolio; (7) recent loss
experience in particular segments of the portfolio; (8) duration of the current
business cycle; and (9) bank regulatory examination results. Loss factors are
reevaluated quarterly to ensure their relevance in the current real estate
environment.
The Office of Thrift Supervision, as an integral part of its
examination process, periodically reviews our loan and foreclosed real estate
portfolios and the related allowance for loan losses and valuation allowance for
foreclosed real estate. The Office of Thrift Supervision may require the
Association to increase the allowance for loan losses or the valuation allowance
for foreclosed real estate based on their judgments of information available to
them at the time of their examination, thereby adversely affecting our results
of operations. Similarly, the Connecticut Department of Banking and the Federal
Deposit Insurance Corporation periodically reviews the Bank's loan and
foreclosed loan portfolio and related allowance for loan losses and valuation
allowance for foreclosed real estate, and may require an increase to the Bank's
allowance for loan losses or the valuation allowance for foreclosed real estate.
At March 31, 2008, our allowance for loan losses represented 1.08% of
total loans and 346.70% of non-performing loans. The allowance for loan losses
increased $2.2 million from March 31, 2007 to March 31, 2008 due to $2.0 million
of allowance for loan losses acquired through the merger with First Valley
Bancorp, a provision for loan losses of $307,000, offset by net charge-offs of
$117,000. The provision for loan losses for the year ended March 31, 2008
reflected continued growth of the loan portfolio, particularly the increase in
commercial real estate and commercial loans, which carry a higher risk of
default than one-to four-family residential real estate loans and a slight
increase in non-accrual loans and classified assets.
The following table sets forth the breakdown of the allowance for loan
losses by loan category at the dates indicated.
At March 31,
------------------------------------------------------------------------------------------------------
2008 2007 2006 2005 2004
------------------ ------------------ ------------------ ------------------ ------------------
Percent of Percent of Percent of Percent of Percent of
Loans in Loans in Loans in Loans in Loans in
Each Each Each Each Each
Category Category Category Category Category
to Total to Total to Total to Total to Total
Amount Loans Amount Loans Amount Loans Amount Loans Amount Loans
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
(Dollars in thousands)
Mortgage loans:
Residential loans ...... $ 819 42.09 $ 508 59.96 $ 483 63.07 $ 428 66.42 $ 523 67.1
Commercial real estate . 1,944 36.82 1,033 26.97 1,002 27.04 637 20.54 368 18.55
Construction loans ..... 258 5.6 156 4.38 84 5.63 235 8.15 180 8.08
Consumer loans ............ 53 1.67 6 1.34 12 0.67 20 0.81 15 1.14
Commercial loans .......... 972 13.82 172 7.35 55 3.59 117 4.08 215 5.13
-------- -------- -------- -------- -------- -------- -------- -------- -------- --------
Total allowance for
loan losses ....... $ 4,046 100.00% $ 1,875 100.00% $ 1,636 100.00% $ 1,437 100.00% $ 1,301 100.00%
======== ======== ======== ======== ======== ======== ======== ======== ======== ========
Although we believe that we use the best information available to
establish the allowance for loan losses, future adjustments to the allowance for
loan losses may be necessary and results of operations could be adversely
affected if circumstances differ substantially from the assumptions used in
making the determinations. Furthermore, while we believe we have established our
allowance for loan losses in conformity with generally accepted accounting
principles, there can be no assurance that regulators, in reviewing our loan
portfolio, will not request us to increase our allowance for loan losses. In
addition, because future events affecting borrowers and collateral cannot be
predicted with certainty, there can be no assurance that the existing allowance
for loan losses is adequate or that increases will not be necessary should the
quality of any loan deteriorate as a result of the factors discussed above. Any
material increase in the allowance for loan losses may adversely affect our
financial condition and results of operations.
39
Analysis of Loan Loss Experience. The following table sets forth an
analysis of the allowance for loan losses for the periods indicated. Where
specific loan loss allowances have been established, any difference between the
loss allowance and the amount of loss realized has been charged or credited to
current income.
At or For the Fiscal Year
Ended March 31,
-------------------------------------------------------------------
2008 2007 2006 2005 2004
---------- ---------- ---------- ---------- ----------
(Dollars in thousands)
Balance at beginning of period ...................... $ 1,875 $ 1,636 $ 1,437 $ 1,301 $ 1,008
Provision for loan losses ........................... 307 242 210 131 240
Charge-offs:
Residential loans ................................ 24 -- -- 83 42
Construction loans ............................... 58 -- -- -- --
Consumer loans ................................... 34 5 17 16 --
Commercial loans ................................. 15 -- -- -- 65
---------- ---------- ---------- ---------- ----------
Total charge-offs ............................. 131 5 17 99 107
---------- ---------- ---------- ---------- ----------
Recoveries:
Residential loans ............................... -- -- -- 80 --
Consumer loans ................................... 3 2 6 2 --
Commercial loans ................................. 11 -- -- 22 --
---------- ---------- ---------- ---------- ----------
Total Recoveries .............................. 14 2 6 104 --
---------- ---------- ---------- ---------- ----------
Net charge-offs (recoveries) ........................ 117 3 11 (5) 107
---------- ---------- ---------- ---------- ----------
Allowance obtained through merger ................... 1,981 -- -- -- 160
---------- ---------- ---------- ---------- ----------
Balance at end of period ............................ $ 4,046 $ 1,875 $ 1,636 $ 1,437 $ 1,301
========== ========== ========== ========== ==========
Ratio of net charge-offs during the period to
average loans outstanding during the period. ..... 0.04% ---% 0.01% ---% 0.10%
Allowance for loan losses as a percent of loans (1).. 1.08% 0.94% 1.09% 1.07% 1.06%
Allowance for loan losses as a percent of
nonperforming loans (2) .......................... 346.70% 227.55% 272.67% 309.70% 138.85%
- -------------------------------
(1) Loans are presented before allowance for loan losses.
(2) Non-performing loans consist of all loans 90 days or more past due and
other loans which have been identified by the Company as presenting
uncertainty with respect to the collectibility of interest or principal.
During the fiscal year ended March 31, 2008, we acquired $2.0 million
of allowance for loan losses in connection with the acquisition of First Valley
Bancorp. The loans acquired in the merger were primarily commercial real estate
loans, residential loans and commercial loans, which had a face value of $141.1
million and a fair value of $141.0 million. In determining the fair value of the
loans, we used a discounted cash flow method utilizing the current loan rate as
of the date of the consummation of the merger. The amount of the allowance for
loan losses that was attributable to these loans was calculated based on the
collectibility of the loans, the nature and volume of the loan portfolio,
adverse situations that may affect the borrower's ability to repay, estimated
value of any underlying collateral and prevailing economic conditions.
During the fiscal year ended March 31, 2004, we acquired $160,000 of
allowance for loan losses in connection with the acquisition of Windsor Locks
Community Bank. The loans acquired in the merger were primarily one- to
four-family loans, which had a face value of $16.7 million and a fair value of
$16.6 million. In determining the fair value of the loans, we used a discounted
cash flow method utilizing the current loan rate as of the date of the
consummation of the merger. The amount of the allowance for loan losses that was
attributable to these loans was calculated based on the collectibility of the
loans, the nature and volume of the loan portfolio, adverse situations that may
affect the borrower's ability to repay, estimated value of any underlying
collateral and prevailing economic conditions.
Liquidity Management. Liquidity is the ability to meet current and
future financial obligations of a short-term nature. Our primary sources of
funds consist of deposit inflows, loan repayments, maturities and sales of
investment securities, borrowings from the Federal Home Loan Bank of Boston and
securities sold under agreements to repurchase. While maturities and scheduled
amortization of loans and securities are predictable
40
sources of funds, deposit flows and mortgage prepayments are greatly influenced
by general interest rates, economic conditions and competition.
We regularly adjust our investments in liquid assets based upon our
assessment of (1) expected loan demand, (2) expected deposit flows, (3) yields
available on interest-earning deposits and securities and (4) the objectives of
our asset/liability management program. Excess liquid assets are invested
generally in money market mutual funds, federal funds sold and short- and
intermediate-term agency and municipal securities.
Our most liquid assets are cash and cash equivalents and
interest-bearing deposits. The levels of these assets are dependent on our
operating, financing, lending and investing activities during any given period.
At March 31, 2008, cash and cash equivalents totaled $36.2 million. Securities
classified as available for sale, which provide additional sources of liquidity,
totaled $63.5 million at March 31, 2008. In addition, at March 31, 2008, we had
the ability to borrow approximately $77.6 million from the Federal Home Loan
Bank of Boston. On that date, we had $61.9 million outstanding.
At March 31, 2008, we had $47.1 million in loan commitments
outstanding, which included $9.2 million in undisbursed construction loans and
$27.6 in unused lines of credit. Certificates of deposit due within one year of
March 31, 2008 totaled $157.1 million, or 42.4% of total deposits. If these
maturing deposits do not remain with us, we will be required to seek other
sources of funds, including other certificates of deposit and lines of credit.
Depending on market conditions, we may be required to pay higher rates on such
deposits or other borrowings than we currently pay on the certificates of
deposit due on or before March 31, 2009. We believe, however, based on past
experience, that a significant portion of our certificates of deposit will
remain with us. We have the ability to attract and retain deposits by adjusting
the interest rates offered.
The following table presents our contractual obligations at March 31,
2008.
Payments Due by Period
--------------------------------------------------------------
Less than One to Three to More than
Total One Year Three Years Five Years Five Years
---------- ----------- ----------- ---------- ----------
(In thousands)
Long-Term Debt Obligations (1) .... $ 61,965 $ 6,106 $ 36,971 $ 8,615 $ 10,273
Operating Lease Obligations ....... 13,872 796 1,645 1,691 9,740
---------- ---------- ---------- ---------- ----------
Total ......................... $ 75,837 $ 6,902 $ 38,616 $ 10,306 $ 20,013
========== ========== ========== ========== ==========
- ------------------
(1) Consists of Federal Home Loan Bank advances.
Our primary investing activities are the origination and purchase of
loans and the purchase of securities. Our primary financing activities consist
of activity in deposit accounts, Federal Home Loan Bank advances and securities
sold under agreements to repurchase. Deposit flows are affected by the overall
level of interest rates, the interest rates and products offered by us and our
local competitors and other factors. We generally manage the pricing of our
deposits to be competitive and to increase core deposits and commercial banking
relationships. Occasionally, we offer promotional rates on certain deposit
products to attract certain deposit products.
41
The following table presents our primary investing and financing
activities during the periods indicated.
Years Ended March 31,
--------------------------------
2008 2007 2006
--------- --------- ---------
(In thousands)
Investing activities:
Loan originations ....................... $ 77,994 $ 74,604 $ 41,861
--------- --------- ---------
Loan participations purchased ........... 5,860 18,268 4,127
Securities purchased .................... 40,285 17,827 17,321
Financing activities:
Increase in deposits .................... $ 188,637 $ 12,631 $ 6,053
Increase in FHLB advances ............ 28,341 11,945 6,022
(Decrease) increase in securities sold
under agreements to repurchase .... (622) 1,852 3,081
Capital Management. The Association and Bank each manage their capital
to maintain strong protection for depositors and creditors and are subject to
various regulatory capital requirements. The risk-based capital guidelines
include both a definition of capital and a framework for calculating
risk-weighted assets by assigning balance sheet assets and off-balance sheet
items to broad risk categories. At March 31, 2008, each of the Association and
Bank exceeded all of their regulatory capital requirements. They are considered
"well capitalized" under regulatory guidelines. See Item 1. Description of
Business and note 15 of the notes to the consolidated financial statements.
Off-Balance Sheet Arrangements. In the normal course of operations, we
engage in a variety of financial transactions that, in accordance with generally
accepted accounting principles, are not recorded in our financial statements.
These transactions involve, to varying degrees, elements of credit, interest
rate and liquidity risk. Such transactions are used primarily to manage
customers' requests for funding and take the form of loan commitments and lines
of credit. A presentation of our outstanding loan commitments and unused lines
of credit at March 31, 2008 and their effect on our liquidity is presented at
note 19 of the notes to the consolidated financial statements included in this
annual report and under "--Risk Management--Liquidity Management."
For the year ended March 31, 2008, we did not engage in any
off-balance-sheet transactions reasonably likely to have a material effect on
our financial condition, results of operations or cash flows.
Impact of Recent Accounting Pronouncements
In February 2006, the Financial Accounting Standards Board (FASB)
issued SFAS No. 155, "Accounting for Certain Hybrid Instruments" (SFAS 155),
which permits, but does not require, fair value accounting for any hybrid
financial instrument that contains an embedded derivative that would otherwise
require bifurcation in accordance with SFAS 133. The statement also subjects
beneficial interests issued by securitization vehicles to the requirements of
SFAS No. 133. The statement is effective as of April 1, 2007. The adoption of
SFAS 155 did not have a material impact on the Company's financial condition and
results of operations.
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing
of Financial Assets- an amendment of FASB Statement No. 140" (SFAS No. 156).
SFAS No. 156 requires an entity to recognize a servicing asset or servicing
liability each time it undertakes an obligation to service a financial asset by
entering into a servicing contract in specific situations. Additionally, the
servicing asset or servicing liability shall be initially measured at fair
value; however, an entity may elect the "amortization method" or "fair value
method" for subsequent balance sheet reporting periods. SFAS No. 156 is
effective as of an entity's first fiscal year beginning after September 15,
2006. Early adoption is permitted as of the beginning of an entity's fiscal
year, provided the entity has not yet issued financial statements, including
interim financial statements, for any period of that fiscal year. The adoption
of this statement did not have a material impact on its financial condition,
results of operations or cash flows.
42
In June 2006 the FASB issued Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes - an interpretation of FASB Statement 109" ("FIN
48"). FIN 48 prescribes a recognition threshold and measurement attribute for
the financial statement recognition and measurement of a tax position taken, or
expected to be taken, in a tax return and provides guidance on derecognition,
classification, interest and penalties, accounting in interim periods,
disclosure and transition. FIN 48 is effective for fiscal years beginning after
December 15, 2006. The adoption of FIN 48 did not have a material impact on the
Company's financial statements.
In September 2006, the FASB ratified the consensus reached by the
Emerging Issues Task Force ("EITF") on Issue No. 06-4 "Accounting for Deferred
Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life
Insurance Arrangements," ("EITF 06-4"). EITF 06-4 requires companies with an
endorsement split-dollar life insurance arrangement to recognize a liability for
future postretirement benefits. The effective date is for fiscal years beginning
after December 15, 2007, with earlier application permitted. Companies should
recognize the effects of applying this issue through either (a) a change in
accounting principle through a cumulative effect adjustment to retained earnings
or (b) a change in accounting principle through retrospective application to all
periods. The Company's adoption of this issue is not expected to have a material
impact on its financial position, results of operations or cash flows.
In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements" (SFAS 157). SFAS 157 defines fair value, establishes a framework
for measuring fair value under generally accepted accounting principles (GAAP)
and enhances disclosures about fair value measurements. SFAS 157 retains the
exchange price notion and clarifies that the exchange price is the price that
would be received for an asset or paid to transfer a liability (an exit price)
in an orderly transaction between market participants on the measurement date.
SFAS 157 is effective for the Company's consolidated financial statements for
the year beginning on April 1, 2008, with earlier adoption permitted. The
Company does not expect the adoption of this statement to have a material impact
on its financial condition and results of operations.
In February 2007, the FASB issued SFAS No. 159 "The Fair Value Option
for Financial Assets and Financial Liabilities including an amendment of FASB
Statement No. 115" (SFAS 159). SFAS 159 permits entities to choose to measure
many financial instruments and certain other items at fair value that are not
currently required to be measured at fair value. The objective is to improve
financial reporting by providing entities with the opportunity to mitigate
volatility in reported earnings caused by measuring related assets and
liabilities differently without having to apply complex hedge accounting
provisions. This statement also establishes presentation and disclosure
requirements designed to facilitate comparisons between entities that choose
different measurement attributes for similar types of assets and liabilities.
The new standard is effective at the beginning of the Company's fiscal year
beginning April 1, 2009, and early adoption may be elected in certain
circumstances. The adoption of this statement is not expected to have a
significant impact on the Company's financial position, results of operations or
cash flow.
In December 2007, the FASB issued SFAS No. 141 (Revised 2008),
"Business Combinations" (SFAS 141(R)). SFAS 141(R) will significantly change the
accounting for business combinations. Under SFAS 141(R), an acquiring entity
will be required to recognize all the assets acquired and liabilities assumed in
a transaction at the acquisition-date fair value with limited exceptions. It
also amends the accounting treatment for certain specific items including
acquisition costs and non controlling minority interests and includes a
substantial number of new disclosure requirements. SFAS 141(R) applies
prospectively to business combinations for which the acquisition date is on or
after January 1, 2009. The Company does not expect the adoption of this
statement to have a material impact on its financial condition and results of
operations.
In March 2008, the FASB issued SFAS No. 161, "Disclosures about
Derivative Instruments and Hedging Activities-an amendment of FASB Statement No.
133" (SFAS 161). SFAS 161 changes the disclosure requirements for derivative
instruments and hedging activities. Entities are required to provide enhanced
disclosures about (a) how and why an entity uses derivative instruments, (b) how
derivative instruments and related hedged items are accounted for under
Statement 133 and its related interpretations, and (c) how derivative
instruments and related hedged items affect an entity's financial position,
financial performance, and cash flows. The guidance in SFAS
43
161 is effective for financial statements issued for fiscal years and interim
periods beginning after November 15, 2008, with early application encouraged.
This statement encourages, but does not require, comparative disclosures for
earlier periods at initial adoption. The Company does not expect the adoption of
this statement to have a material impact on its financial condition and results
of operations.
Effect of Inflation and Changing Prices
The financial statements and related financial data presented in this annual
report have been prepared in accordance with generally accepted accounting
principles in the United States, which require the measurement of financial
position and operating results in terms of historical dollars without
considering the change in the relative purchasing power of money over time due
to inflation. The primary impact of inflation on our operations is reflected in
increased operating costs. Unlike most industrial companies, virtually all the
assets and liabilities of a financial institution are monetary in nature. As a
result, interest rates generally have a more significant impact on a financial
institution's performance than do general levels of inflation. Interest rates do
not necessarily move in the same direction or to the same extent as the prices
of goods and services.
44
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Interest Rate Risk Management. The Association and Bank manage the
interest rate sensitivity of their interest-bearing liabilities and
interest-earning assets in an effort to minimize the adverse effects of changes
in the interest rate environment. Deposit accounts typically react more quickly
to changes in market interest rates than mortgage loans because of the shorter
maturities of deposits. As a result, sharp increases in interest rates may
adversely affect their earnings while decreases in interest rates may
beneficially affect their earnings. To reduce the potential volatility of their
earnings, the Association and Bank have sought to improve the match between
asset and liability maturities and rates, while maintaining an acceptable
interest rate spread. Also, they attempt to manage their interest rate risk
through: their investment portfolio, an increased focus on commercial and
multi-family and commercial real estate lending, which emphasizes the
origination of shorter-term adjustable-rate loans; and efforts to originate
adjustable-rate residential mortgage loans. In addition, the Association has
commenced a program of selling long term, fixed-rate one- to four-family
residential loans in the secondary market. The Association and the Bank
currently do not participate in hedging programs, interest rate swaps or other
activities involving the use of off-balance sheet derivative financial
instruments.
The Association and Bank each have Asset/Liability Committees, which
includes members of both the board of directors and management, to communicate,
coordinate and control all aspects involving asset/liability management. The
committees establishes and monitors the volume, maturities, pricing and mix of
assets and funding sources with the objective of managing assets and funding
sources to provide results that are consistent with liquidity, growth, risk
limits and profitability goals.
Net Interest Income Simulation Analysis. The Association and Bank
analyze their interest rate sensitivity position to manage the risk associated
with interest rate movements through the use of interest income simulation. The
matching of assets and liabilities may be analyzed by examining the extent to
which such assets and liabilities are "interest sensitive." An asset or
liability is said to be interest rate sensitive within a specific time period if
it will mature or reprice within that time period.
The Association's and Bank's goal is to manage asset and liability
positions to moderate the effects of interest rate fluctuations on net interest
income. Interest income simulations are completed quarterly and presented to the
Asset/Liability Committees. The simulations provide an estimate of the impact of
changes in interest rates on net interest income under a range of assumptions.
The numerous assumptions used in the simulation processes are reviewed by the
Asset/Liability Committees on a quarterly basis. Changes to these assumptions
can significantly affect the results of the simulation. The simulations
incorporate assumptions regarding the potential timing in the repricing of
certain assets and liabilities when market rates change and the changes in
spreads between different market rates. The simulation analyses incorporate
managements' current assessment of the risk that pricing margins will change
adversely over time due to competition or other factors.
The simulation analyses are only an estimate of the Association's and
Bank's interest rate risk exposure at a particular point in time. They
continually review the potential effect changes in interest rates could have on
the repayment of rate sensitive assets and funding requirements of rate
sensitive liabilities.
The table below sets forth an approximation of the Association's and
Bank's exposures as a percentage of estimated net interest income for the next
twelve months and for the twelve month period thereafter using interest income
simulation. The simulations use projected repricing of assets and liabilities at
March 31, 2008 on the basis of contractual maturities, anticipated repayments
and scheduled rate adjustments. Prepayment rates can have a significant impact
on interest income simulation. Because of the large percentage of loans the
Association and Bank holds, rising or falling interest rates have a significant
impact on the prepayment speeds of our earning assets that in turn affect the
rate sensitivity position. When interest rates rise, prepayments tend to slow.
When interest rates fall, prepayments tend to rise. The Association's and Bank's
asset sensitivity would be reduced if prepayments slow and vice versa. While we
believe such assumptions to be reasonable, there can be no assurance that
assumed prepayment rates will approximate actual future mortgage-backed security
and loan repayment activity.
45
The following table reflects changes in the Association's estimated net
interest income.
At March 31, 2008
Percentage Change in
Estimated
Net Interest Income Over
-----------------------------
First Second
12 Months 12 Months
------------- -------------
200 basis point increase in rates (4.32)% (6.64)%
100 basis point decrease in rates (0.43) (4.57)
The changes in rates in the above table are assumed to occur evenly
over the following twelve months. Based on the scenarios above, net interest
income would be adversely affected in the first twelve months and the twelve
months thereafter if rates rose by 200 basis points. In addition, if rates
declined by 200 basis points net interest income would be adversely affected in
the first twelve months and the twelve months thereafter. The above changes are
all within the Association's internal guidelines for net interest income
simulation.
The following table reflects changes in the Bank's estimated net
interest income.
At March 31, 2008
Percentage Change in
Estimated
Net Interest Income Over
-----------------------------
First Second
12 Months 12 Months
------------- -------------
200 basis point increase in rates 1.19% 1.61%
100 basis point decrease in rates (0.79) (2.43)
The changes in rates in the above table are assumed to occur at the
beginning of the first twelve month period. Based on the scenario above, net
interest income would be favorably affected in the first twelve months and the
twelve months thereafter if rates rose by 200 basis points. In addition, if
rates declined by 100 basis points net interest income would be adversely
affected in the first twelve months and the twelve months thereafter. The above
changes are all within the Bank's internal guidelines for net interest income
simulation.
46
ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS
The Board of Directors
New England Bancshares, Inc.
Enfield, Connecticut
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
-------------------------------------------------------
We have audited the consolidated balance sheets of New England Bancshares, Inc.
and Subsidiaries as of March 31, 2008 and 2007, and the related consolidated
statements of income, changes in stockholders' equity and cash flows for the
years then ended. These consolidated financial statements are the responsibility
of the Company's management. Our responsibility is to express an opinion on
these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. The Company
is not required to have, nor were we engaged to perform, an audit of its
internal control over financial reporting. Our audit included consideration of
internal control over financial reporting as a basis for designing audit
procedures that are appropriate in the circumstances, but not for the purpose of
expressing an opinion on the effectiveness of the Company's internal control
over financial reporting. Accordingly, we express no such opinion. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of New
England Bancshares, Inc. and Subsidiaries as of March 31, 2008 and 2007, and the
results of their operations and their cash flows for the years then ended, in
conformity with accounting principles generally accepted in the United States of
America.
SHATSWELL, MacLEOD & COMPANY, P.C.
West Peabody, Massachusetts
June 25, 2008
47
NEW ENGLAND BANCSHARES, INC. AND SUBSIDIARIES
---------------------------------------------
CONSOLIDATED BALANCE SHEETS
---------------------------
March 31, 2008 and 2007
-----------------------
(Dollars In Thousands, Except Per Share Amounts)
------------------------------------------------
ASSETS 2008 2007
- ------ --------- ---------
Cash and due from banks $ 9,115 $ 4,400
Interest-bearing demand deposits with other banks 160 43
Federal funds sold 21,591 13,610
Money market mutual funds 5,373 587
--------- ---------
Total cash and cash equivalents 36,239 18,640
Interest-bearing time deposits with other banks 693 1,877
Investments in available-for-sale securities (at fair value) 63,544 49,469
Federal Home Loan Bank stock, at cost 3,571 1,979
Loans, net of the allowance for loan losses of $4,046 as of
March 31, 2008 and $1,875 as of March 31, 2007 371,769 198,447
Premises and equipment, net 6,678 4,244
Accrued interest receivable 2,165 1,323
Deferred income taxes, net 1,140 1,132
Cash surrender value of life insurance 8,847 4,218
Identifiable intangible assets 2,671 599
Goodwill 14,701 1,090
Other assets 6,161 1,140
--------- ---------
Total assets $ 518,179 $ 284,158
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Deposits:
Noninterest-bearing $ 40,347 $ 16,075
Interest-bearing 329,965 165,600
--------- ---------
Total deposits 370,312 181,675
Advanced payments by borrowers for taxes and insurance 909 796
Federal Home Loan Bank advances 61,928 33,587
Subordinated debentures 3,893 --
Securities sold under agreements to repurchase 8,555 9,177
Other liabilities 3,845 1,657
--------- ---------
Total liabilities 449,442 226,892
--------- ---------
Stockholders' equity:
Common stock, par value $.01 per share; 19,000,000 shares authorized;
6,420,891 shares issued as of March 31, 2008 and
5,346,583 shares issued as of March 31, 2007 64 53
Paid-in capital 56,412 42,742
Retained earnings 19,055 18,521
Unearned ESOP shares, 283,183 shares as of March 31, 2008 and
317,063 shares as of March 31, 2007 (2,428) (2,666)
Treasury stock, 322,399 shares (3,772) --
Unearned shares, stock-based incentive plans, 67,898 shares
as of March 31, 2008 and 95,786 as of March 31, 2007 (796) (1,026)
Accumulated other comprehensive income (loss) 202 (358)
--------- ---------
Total stockholders' equity 68,737 57,266
--------- ---------
Total liabilities and stockholders' equity $ 518,179 $ 284,158
========= =========
The accompanying notes are an integral part of these consolidated financial statements.
48
NEW ENGLAND BANCSHARES, INC. AND SUBSIDIARIES
---------------------------------------------
CONSOLIDATED STATEMENTS OF INCOME
---------------------------------
For the Years Ended March 31, 2008 and 2007
-------------------------------------------
(Dollars In Thousands, Except Per Share Amounts)
------------------------------------------------
2008 2007
-------- --------
Interest and dividend income:
Interest and fees on loans $ 21,674 $ 11,483
Interest on debt securities:
Taxable 2,830 2,223
Tax-exempt 463 396
Dividends on Federal Home Loan Bank stock 168 95
Interest on federal funds sold, interest-bearing deposits and dividends
on marketable equity securities 874 966
-------- --------
Total interest and dividend income 26,009 15,163
-------- --------
Interest expense:
Interest on deposits 9,546 4,204
Interest on advanced payments by borrowers for taxes and insurance 12 10
Interest on Federal Home Loan Bank advances 2,039 1,204
Interest on subordinated debentures 195 --
Interest on securities sold under agreements to repurchase 356 376
-------- --------
Total interest expense 12,148 5,794
-------- --------
Net interest and dividend income 13,861 9,369
Provision for loan losses 307 242
-------- --------
Net interest and dividend income after provision for loan losses 13,554 9,127
-------- --------
Noninterest income:
Service charges on deposit accounts 886 519
(Loss) gain on securities, net (93) 32
Gain on sale of loans 53 28
Increase in cash surrender value of life insurance policies 154 154
Other income 338 258
-------- --------
Total noninterest income 1,338 991
-------- --------
Noninterest expense:
Salaries and employee benefits 6,966 4,930
Occupancy and equipment expense 2,653 1,670
Advertising and promotion 229 152
Professional fees 534 373
Data processing expense 450 345
Stationery and supplies 165 96
Amortization of identifiable intangible assets 387 88
Other expense 1,565 989
-------- --------
Total noninterest expense 12,949 8,643
-------- --------
Income before income taxes 1,943 1,475
Income taxes 728 505
-------- --------
Net income $ 1,215 $ 970
======== ========
Earnings per share:
Basic $ 0.22 $ 0.20
======== ========
Diluted $ 0.21 $ 0.19
======== ========
The accompanying notes are an integral part of these consolidated financial statements.
49
NEW ENGLAND BANCSHARES, INC. AND SUBSIDIARIES
---------------------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
----------------------------------------------------------
For the Years Ended March 31, 2008 and 2007
-------------------------------------------
(Dollars In Thousands, Except Per Share Amounts)
------------------------------------------------
Unearned
Shares Accumulated
Stock- Other
Unearned Based Comprehensive
Common Paid-in Retained ESOP Incentive Treasury Income
Stock Capital Earnings Shares Plans Stock (Loss) Total
--------- --------- --------- --------- --------- --------- --------- ---------
Balance, March 31, 2006 $ 53 $ 42,339 $ 18,151 ($ 2,903) ($ 211) $ -- ($ 608) $ 56,821
ESOP shares released -- 162 -- 237 -- -- -- 399
Tax benefit relating to stock-based -- 45 -- -- -- -- -- 45
Compensation cost for stock-based
incentive plans
Compensation cost for stock-based
incentive plans -- 203 -- -- 197 -- -- 400
Dividends paid ($0.12 per share) -- -- (600) -- -- -- -- (600)
Purchase of stock for equity incentive plan -- (7) -- -- (1,012) -- -- (1,019)
Comprehensive income:
Net income -- -- 970 -- -- -- -- --
Net change in unrealized holding loss on
available-for-sale securities, net of -- -- -- -- -- -- 263 --
tax effect Comprehensive income -- -- -- -- -- -- -- 1,233
Adjustment to initially apply FASB
Statement No. 158 -- -- -- -- -- -- (13) (13)
--------- --------- --------- --------- --------- --------- --------- ---------
Balance, March 31, 2007 53 42,742 18,521 (2,666) (1,026) -- (358) 57,266
Issuance of stock for merger 11 13,230 -- -- -- -- -- 13,241
Issuance of stock for option exercise -- 40 -- -- -- -- -- 40
ESOP shares released -- 179 -- 238 -- -- -- 417
Compensation cost for stock-based
incentive plans -- 221 -- -- 230 -- -- 451
Dividends paid ($0.12 per share) -- -- (681) -- -- -- -- (681)
Treasury stock purchases -- -- -- -- -- (3,772) -- (3,772)
Comprehensive income:
Net income -- -- 1,215 -- -- -- -- --
Other comprehensive income, net of tax
effect -- -- -- -- -- -- 560 --
Comprehensive income -- -- -- -- -- -- -- 1,775
--------- --------- --------- --------- --------- --------- --------- ---------
Balance, March 31, 2008 $ 64 $ 56,412 $ 19,055 ($ 2,428) ($ 796) ($ 3,772) $ 202 $ 68,737
========= ========= ========= ========= ========= ========= ========= =========
The accompanying notes are an integral part of these consolidated financial statements.
50
NEW ENGLAND BANCSHARES, INC. AND SUBSIDIARIES
---------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
For the Years Ended March 31, 2008 and 2007
-------------------------------------------
(In Thousands)
--------------
2008 2007
-------- --------
Cash flows from operating activities:
Net income $ 1,215 $ 970
Adjustments to reconcile net income to net cash provided by operating activities:
Net accretion of fair value adjustments (44) (63)
(Accretion) amortization of securities, net (68) 23
Loss (gain) on securities, net 93 (32)
Provision for loan losses 307 242
Change in deferred loan origination fees (146) (244)
Gain on sale of loans, net (53) (28)
Depreciation and amortization 788 474
Disposal of property and equipment 2 2
Increase in accrued interest receivable (8) (345)
Deferred income tax benefit (149) (139)
Increase in cash surrender value life insurance policies (154) (154)
Increase in prepaid expenses and other assets (135) (430)
Amortization of identifiable intangible assets 387 88
Increase in accrued expenses and other liabilities 166 264
Compensation cost for stock-based incentive plan 451 400
ESOP shares released 417 399
-------- --------
Net cash provided by operating activities 3,069 1,427
-------- --------
Cash flows from investing activities:
Purchases of available-for-sale securities (41,457) (18,453)
Proceeds from sales of available-for-sale securities 20,851 14,874
Proceeds from maturities of available-for-sale securities 26,489 6,220
Proceeds from maturities of interest-bearing time deposits with other banks 1,184 2,345
Cash and cash equivalents acquired from First Valley Bancorp, net of expenses
and cash paid to shareholders 6,589 --
Loan originations and principal collections, net (33,748) (35,892)
Purchases of loans (5,860) (18,268)
Loans sold 7,011 3,844
Recoveries of loans previously charged off 14 2
Proceeds from other real estate owned 198 --
Capital expenditures (300) (258)
Proceeds from sales/disposals of fixed assets 7 --
Purchases of Federal Home Loan Bank stock (990) (562)
Investment in life insurance policies (4,505) (4)
Redemption of life insurance policies 130 --
-------- --------
Net cash used in investing activities (24,387) (46,152)
-------- --------
51
NEW ENGLAND BANCSHARES, INC. AND SUBSIDIARIES
---------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
For the Years Ended March 31, 2008 and 2007
-------------------------------------------
(In Thousands)
--------------
(continued)
2008 2007
--------- ---------
Cash flows from financing activities:
Net increase in demand deposits, NOW and savings accounts 11,031 6,074
Net increase in time deposits 9,297 6,630
Net decrease in advanced payments by borrowers for taxes and insurance (79) (173)
Proceeds from Federal Home Loan Bank long-term advances 30,500 16,000
Principal payments on Federal Home Loan Bank long-term advances (6,797) (4,055)
Net (decrease) increase in securities sold under agreements to repurchase (622) 1,852
Purchase of stock for stock incentive plan -- (1,019)
Purchase of treasury stock (3,772) --
Proceeds from exercise of stock options 40 --
Payments of cash dividends on common stock (681) (600)
--------- ---------
Net cash provided by financing activities 38,917 24,709
--------- ---------
Net increase (decrease) in cash and cash equivalents 17,599 (20,016)
Cash and cash equivalents at beginning of year 18,640 38,656
--------- ---------
Cash and cash equivalents at end of year $ 36,239 $ 18,640
========= =========
Supplemental disclosures:
Interest paid $ 12,115 $ 5,721
Income taxes paid 1,555 533
Reclass from securities to other assets 3,524 --
Increase (decrease) in due to broker 653 (626)
Increase in due from broker 714 --
Loans transferred to other real estate owned 198 --
Acquisition of First Valley Bancorp:
Assets acquired:
Cash and cash equivalents $ 19,013 $ --
Investments in available-for-sale securities 22,648 --
Federal Home Loan Bank stock, at cost 602 --
Loans, net of allowance for loan losses 141,041 --
Premises and equipment, net 2,946 --
Accrued interest receivable 837 --
Deferred income taxes, net 216 --
Other assets 733 --
Identifiable intangible assets 2,459 --
--------- ---------
Total assets acquired 190,495 --
--------- ---------
Liabilities assumed:
Deposits 168,369 --
Advanced payments by borrowers for taxes and insurance 192 --
Federal Home Loan Bank advances 4,623 --
Subordinated debentures 3,888 --
Other liabilities 1,369 --
--------- ---------
Total liabilities assumed 178,441 --
--------- ---------
Net assets acquired 12,054 --
Acquisition costs 25,665 --
--------- ---------
Goodwill $ 13,611 $ --
The accompanying notes are an integral part of these consolidated financial statements.
52
NEW ENGLAND BANCSHARES, INC. AND SUBSIDIARIES
---------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
For the Years Ended March 31, 2008 and 2007
-------------------------------------------
NOTE 1 - NATURE OF OPERATIONS
- -----------------------------
On September 7, 2005, NEBS Bancshares, Inc. (the "Company") was incorporated
under Maryland law to facilitate the conversion of Enfield Federal Savings and
Loan Association (the "Association") from the mutual holding company form of
organization to the stock form of organization (the "second-step conversion").
As a result of the second-step conversion, NEBS Bancshares, Inc. became the
holding company for the Association and was immediately renamed New England
Bancshares, Inc. A total of 3,075,855 shares of common stock were sold in the
stock offering at the price of $10.00 per share. In addition, a total of
2,270,728 shares were issued to the minority shareholders of the former New
England Bancshares at an exchange ratio of 2.3683. Total shares outstanding
after the stock offering and the exchange totaled 5,346,583 shares. The
second-step conversion was accounted for as a change in corporate form with no
resulting change in the historical basis of the former New England Bancshares'
assets, liabilities and equity. Direct offering costs totaling $1.1 million were
deducted from the proceeds of the shares sold in the offering. Net proceeds of
$27.2 million were raised in the stock offering, excluding $2.5 million which
was loaned by the Company to a trust for the Employee Stock Ownership Plan
(ESOP) enabling it to purchase 246,068 shares of common stock in the stock
offering. In addition, as part of the second-step conversion and dissolution of
Enfield Federal Mutual Holding Company, the former mutual holding company parent
of the Company, and the former New England Bancshares, the Association received
$901,000 of cash previously held by these entities.
As a result of the second-step conversion, all share and per share amounts have
been restated giving retroactive recognition to the second-step exchange ratio
of 2.3683. Options granted under the Company's 2003 Stock-Based Incentive Plan
and common shares held by the Association's ESOP and shares of restricted stock
before the second-step conversion were also exchanged using the conversion ratio
of 2.3683.
On July 12, 2007 the Company acquired First Valley Bancorp, Inc., Bristol,
Connecticut. First Valley Bancorp was the holding company for Valley Bank (the
"Bank"), Bristol, Connecticut. Under the terms of the transaction, shareholders
of First Valley Bancorp received 0.8907 shares of Company common stock and $9.00
in cash for each share of First Valley Bancorp common stock for a total of
1,068,625 shares and $10.8 million. In addition, the Company incurred cash
payments for deal expenses, payout of stock options and employee expenses
totaling $2.4 million, creating $13.6 million of goodwill, none of which is
deductible for tax purposes.
The Association is a federally chartered stock savings and loan association
which was incorporated in 1916 and is headquartered in Enfield, Connecticut. The
Association operates its business from eight banking offices located in
Connecticut. The Association is engaged principally in the business of
attracting deposits from the general public and investing those deposits in
residential and commercial real estate loans, and in consumer, construction,
commercial and small business loans. Valley Bank is a state chartered commercial
bank that commenced operations on November 15, 1999. The Bank is engaged
principally in the business of attracting deposits from the general public and
investing those deposits in small business, commercial real estate, residential
real estate and consumer loans. The Bank operates from four locations in
Connecticut.
NOTE 2 - ACCOUNTING POLICIES
- ----------------------------
The accounting and reporting policies of the Company and its subsidiaries
conform to accounting principles generally accepted in the United States of
America and predominant practices within the banking industry. The consolidated
financial statements of the Company were prepared using the accrual basis of
accounting. The significant accounting policies of the Company are summarized
below to assist the reader in better understanding the consolidated financial
statements and other data contained herein.
53
USE OF ESTIMATES:
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States of
America requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the consolidated
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
BASIS OF PRESENTATION:
The accompanying consolidated financial statements include the accounts
of the Company and its subsidiaries. All significant intercompany
accounts and transactions have been eliminated in the consolidation.
CASH AND CASH EQUIVALENTS:
For purposes of reporting cash flows, cash and cash equivalents include
cash on hand, cash items, due from banks, interest bearing demand
deposits with other banks, federal funds sold and money market mutual
funds. Cash and due from banks as of March 31, 2008 and 2007 includes
$434,000 and $361,000, respectively, which is subject to withdrawals
and usage restrictions to satisfy the reserve requirements of the
Federal Reserve Bank for Enfield Federal Savings and Loan Association.
SECURITIES:
Investments in debt securities are adjusted for amortization of
premiums and accretion of discounts computed so as to approximate the
interest method. Gains or losses on sales of investment securities are
computed on a specific identification basis.
The Company classifies debt and equity securities with readily
determinable fair values into one of two categories: available for sale
or held to maturity. In general, securities may be classified as
held-to-maturity only if the Company has the positive intent and
ability to hold them to maturity. All other securities must be
classified as available for sale.
-- Available-for-sale securities are carried at fair value on
the consolidated balance sheets. Unrealized holding gains
and losses are not included in earnings but are reported as
a net amount (less expected tax) in a separate component of
stockholders' equity until realized.
-- Held-to-maturity securities are measured at amortized cost
in the consolidated balance sheets. Unrealized holding gains
and losses are not included in earnings or in a separate
component of capital. They are merely disclosed in the notes
to the consolidated financial statements.
Declines in the fair value of held-to-maturity and available-for-sale
securities below their cost that are deemed to be other than temporary
are reflected in earnings as realized losses.
LOANS:
Loans receivable that management has the intent and ability to hold
until maturity or payoff, are reported at their outstanding principal
balances adjusted for amounts due to borrowers on unadvanced loans, any
charge-offs, the allowance for loan losses and any deferred fees or
costs on originated loans, or unamortized premiums or discounts on
purchased loans.
Interest on loans is recognized on a simple interest basis.
54
Loan origination, commitment fees and certain direct origination costs
are deferred and the net amount amortized as an adjustment of the
related loan's yield by the interest method. Deferred amounts are
recognized for fixed rate loans over the contractual life of the
related loans. If the loan's stated interest rate varies with changes
in an index or rate, the effective yield used by the Association for
amortization is the index or rate that is in effect at the inception of
the loan. Home equity line deferred fees are recognized using the
straight-line method over the period the home equity line is active,
assuming that borrowings are outstanding for the maximum term provided
in the contract.
Residential real estate loans are generally placed on nonaccrual when
reaching 90 days past due or in process of foreclosure. All closed-end
consumer loans 90 days or more past due and any equity line in the
process of foreclosure are placed on nonaccrual status. Secured
consumer loans are written down to realizable value and unsecured
consumer loans are charged-off upon reaching 120 or 180 days past due
depending on the type of loan. Commercial real estate loans and
commercial business loans and leases which are 90 days or more past due
are generally placed on nonaccrual status, unless secured by sufficient
cash or other assets immediately convertible to cash. When a loan has
been placed on nonaccrual status, previously accrued and uncollected
interest is reversed against interest on loans. A loan can be returned
to accrual status when collectibility of principal is reasonably
assured and the loan has performed for a period of time, generally six
months.
Cash receipts of interest income on impaired loans are credited to
principal to the extent necessary to eliminate doubt as to the
collectibility of the net carrying amount of the loan if the total of
such credits reduces the carrying amount of the loan to an amount less
than the collateral value. Some or all of the cash receipts of interest
income on impaired loans is recognized as interest income if the
remaining net carrying amount of the loan is deemed to be fully
collectible. When recognition of interest income on an impaired loan on
a cash basis is appropriate, the amount of income that is recognized is
limited to that which would have been accrued on the net carrying
amount of the loan at the contractual interest rate. Any cash interest
payments received in excess of the limit and not applied to reduce the
net carrying amount of the loan are recorded as recoveries of
charge-offs until the charge-offs are fully recovered.
ALLOWANCE FOR LOAN LOSSES:
The allowance for loan losses is established as losses are estimated to
have occurred through a provision for loan losses charged to earnings.
Loan losses are charged against the allowance when management believes
the uncollectibility of a loan balance is confirmed. Subsequent
recoveries, if any, are credited to the allowance.
The allowance for loan losses is evaluated on a regular basis by
management and is based upon management's periodic review of the
collectibility of the loans in light of historical experience, the
composition and size of the loan portfolio, adverse situations that may
affect the borrower's ability to repay, the estimated value of any
underlying collateral and prevailing economic conditions. This
evaluation is inherently subjective as it requires estimates that are
susceptible to significant revision as more information becomes
available.
A loan is considered impaired when, based on current information and
events, it is probable that the Company will be unable to collect the
scheduled payments of principal or interest when due according to the
contractual terms of the loan agreement. Factors considered by
management in determining impairment include payment status, collateral
value, and the probability of collecting scheduled principal and
interest payments when due. Loans that experience insignificant payment
delays and payment shortfalls generally are not classified as impaired.
Management determines the significance of payment delays and payment
shortfalls on a case-by-case basis, taking into consideration all of
the circumstances surrounding the loan and the borrower, including the
length of the delay, the reasons for the delay, the borrower's prior
payment record, and the amount of the shortfall in relation to the
principal and interest owed. Impairment is measured on a loan by loan
basis for commercial and construction loans by either the present value
of expected future cash flows discounted at the loan's effective
interest rate, the loan's obtainable market price, or the fair value of
the collateral if the loan is collateral dependent.
55
Large groups of smaller balance homogeneous loans are collectively
evaluated for impairment. Accordingly, the Company does not separately
identify individual consumer and residential loans for impairment
disclosures.
PREMISES AND EQUIPMENT:
Premises and equipment are stated at cost, less accumulated
depreciation and amortization. Cost and related allowances for
depreciation and amortization of premises and equipment retired or
otherwise disposed of are removed from the respective accounts with any
gain or loss included in income or expense. Depreciation and
amortization are calculated principally on the straight-line method
over the estimated useful lives of the assets. Estimated lives are 10
to 50 years for buildings and premises and 3 to 20 years for furniture,
fixtures and equipment. Expenditures for replacements or major
improvements are capitalized; expenditures for normal maintenance and
repairs are charged to expense as incurred.
OTHER REAL ESTATE OWNED AND IN-SUBSTANCE FORECLOSURES:
Other real estate owned includes properties acquired through
foreclosure and properties classified as in-substance foreclosures in
accordance with Statement of Financial Accounting Standards ("SFAS")
No. 15, "Accounting by Debtors and Creditors for Troubled Debt
Restructuring." These properties are carried at the lower of cost or
estimated fair value less estimated costs to sell. Any writedown from
cost to estimated fair value required at the time of foreclosure or
classification as in-substance foreclosure is charged to the allowance
for loan losses. Expenses incurred in connection with maintaining these
assets, subsequent writedowns and gains or losses recognized upon sale,
are included in other expense.
In accordance with SFAS No. 114, "Accounting by Creditors for
Impairment of a Loan," the Company classifies loans as in-substance
repossessed or foreclosed if the Company receives physical possession
of the debtor's assets regardless of whether formal foreclosure
proceedings take place.
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.
EXECUTIVE SUPPLEMENTAL RETIREMENT PLAN:
In connection with its Executive Supplemental Retirement Plan, the
Company established a Rabbi Trust to assist in the administration of
the plan. The accounts of the Rabbi Trust are consolidated in the
Company's financial statements. Any available-for-sale securities held
by the Rabbi Trust are accounted for in accordance with SFAS No. 115.
Until the plan benefits are paid, creditors may make claims against the
trust's assets if the Company becomes insolvent.
EARNINGS PER SHARE ("EPS"):
Basic EPS is computed by dividing income available to common
stockholders by the weighted-average number of common shares
outstanding for the period. Diluted EPS reflects the potential dilution
that could occur if securities or other contracts to issue common stock
were exercised or converted into common stock or resulted in the
issuance of common stock that then shared in the earnings of the
entity. The Company had 121,963 and 108,563 anti-dilutive shares at
March 31, 2008 and 2007, respectively. Anti-dilutive shares are stock
options with weighted-average exercise prices in excess of the
weighted-average market value for the same period. Unallocated common
shares held by the Association's employee stock ownership plan are not
included in the weighted-average number of common shares outstanding
for purposes of calculating both basic and diluted EPS.
56
FAIR VALUES OF FINANCIAL INSTRUMENTS:
SFAS No. 107, "Disclosures about Fair Value of Financial Instruments,"
requires that the Company disclose the estimated fair value for its
financial instruments. Fair value methods and assumptions used by the
Company in estimating its fair value disclosures are as follows:
Cash and cash equivalents: The carrying amounts reported in the balance
sheet for cash and cash equivalents approximate those assets' fair
values.
Interest-bearing time deposits with other banks: Fair values of
interest-bearing time deposits with other banks are estimated using
discounted cash flow analyses based on current rates for similar types
of deposits.
Securities (including mortgage-backed securities): Fair values for
securities are based on quoted market prices, where available. If
quoted market prices are not available, fair values are based on quoted
market prices of comparable instruments.
Loans receivable: For variable-rate loans that reprice frequently and
with no significant change in credit risk, fair values are based on
carrying values. The fair values for other loans are estimated using
discounted cash flow analyses, using interest rates currently being
offered for loans with similar terms to borrowers of similar credit
quality.
Accrued interest receivable: The carrying amount of accrued interest
receivable approximates its fair value.
Deposit liabilities: The fair values disclosed for demand deposits
(e.g., interest and non-interest checking, passbook savings and money
market accounts) are, by definition, equal to the amount payable on
demand at the reporting date (i.e., their carrying amounts). Fair
values for fixed-rate certificates of deposit are estimated using a
discounted cash flow calculation that applies interest rates currently
being offered on certificates to a schedule of aggregated expected
monthly maturities on time deposits.
Advanced payments by borrowers for taxes and insurance: The carrying
amounts of advance payments by borrowers for taxes and insurance
approximate their fair values.
Federal Home Loan Bank advances: The fair value of Federal Home Loan
Bank advances was determined by discounting the anticipated future cash
payments by using the rates currently available to the Company for debt
with similar terms and remaining maturities.
Securities sold under agreements to repurchase: The carrying amount
reported on the consolidated balance sheet for securities sold under
agreements to repurchase maturing within ninety days approximate its
fair value. Fair values of other securities sold under agreements to
repurchase are estimated using discounted cash flow analyses based on
the current rates for similar types of borrowing arrangements.
Subordinated debentures: Fair values of subordinated debentures are
estimated using discounted cash flow analyses, using interest rates
currently being offered for debentures with similar terms.
Due to or from broker: The carrying amount of due to or from broker
approximates its fair value.
Off-balance sheet instruments: The fair value of commitments to
originate loans is estimated using the fees currently charged to enter
similar agreements, taking into account the remaining terms of the
agreements and the present creditworthiness of the counterparties. For
fixed-rate loan commitments and the unadvanced portion of loans, fair
value also considers the difference between current levels of interest
rates and the committed rates. The fair value of letters of credit is
based on fees currently charged for similar agreements or on the
estimated cost to terminate them or otherwise settle the obligation
with the counterparties at the reporting date.
57
STOCK-BASED COMPENSATION:
At March 31, 2008, the Company has two stock-based incentive plans
which are described more fully in Note 13. The Company accounts for the
plans under SFAS No. 123(R) "Share-Based Payment." During the year
ended March 31, 2008 and 2007, $221,000 and $203,000, respectively in
stock-based employee compensation was recognized.
RECENT ACCOUNTING PRONOUNCEMENTS:
In February 2006, the Financial Accounting Standards Board (FASB)
issued SFAS No. 155, "Accounting for Certain Hybrid Instruments" (SFAS
155), which permits, but does not require, fair value accounting for
any hybrid financial instrument that contains an embedded derivative
that would otherwise require bifurcation in accordance with SFAS 133.
The statement also subjects beneficial interests issued by
securitization vehicles to the requirements of SFAS No. 133. The
statement is effective as of April 1, 2007. The adoption of SFAS 155
did not have a material impact on the Company's financial condition and
results of operations.
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing
of Financial Assets- an amendment of FASB Statement No. 140" (SFAS No.
156). SFAS No. 156 requires an entity to recognize a servicing asset or
servicing liability each time it undertakes an obligation to service a
financial asset by entering into a servicing contract in specific
situations. Additionally, the servicing asset or servicing liability
shall be initially measured at fair value; however, an entity may elect
the "amortization method" or "fair value method" for subsequent balance
sheet reporting periods. SFAS No. 156 is effective as of an entity's
first fiscal year beginning after September 15, 2006. Early adoption is
permitted as of the beginning of an entity's fiscal year, provided the
entity has not yet issued financial statements, including interim
financial statements, for any period of that fiscal year. The adoption
of this statement did not have a material impact on its financial
condition, results of operations or cash flows.
In June 2006 the FASB issued Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes - an interpretation of FASB Statement 109"
("FIN 48"). FIN 48 prescribes a recognition threshold and measurement
attribute for the financial statement recognition and measurement of a
tax position taken, or expected to be taken, in a tax return and
provides guidance on derecognition, classification, interest and
penalties, accounting in interim periods, disclosure and transition.
FIN 48 is effective for fiscal years beginning after December 15, 2006.
The adoption of FIN 48 did not have a material impact on the Company's
financial statements.
In September 2006, the FASB ratified the consensus reached by the
Emerging Issues Task Force ("EITF") on Issue No. 06-4 "Accounting for
Deferred Compensation and Postretirement Benefit Aspects of Endorsement
Split-Dollar Life Insurance Arrangements," ("EITF 06-4"). EITF 06-4
requires companies with an endorsement split-dollar life insurance
arrangement to recognize a liability for future postretirement
benefits. The effective date is for fiscal years beginning after
December 15, 2007, with earlier application permitted. Companies should
recognize the effects of applying this issue through either (a) a
change in accounting principle through a cumulative effect adjustment
to retained earnings or (b) a change in accounting principle through
retrospective application to all periods. The Company's adoption of
this issue is not expected to have a material impact on its financial
position, results of operations or cash flows.
In September 2006, the FASB issued SFAS No. 157, "Fair Value
Measurements" (SFAS 157). SFAS 157 defines fair value, establishes a
framework for measuring fair value under generally accepted accounting
principles (GAAP) and enhances disclosures about fair value
measurements. SFAS 157 retains the exchange price notion and clarifies
that the exchange price is the price that would be received for an
asset or paid to transfer a liability (an exit price) in an orderly
transaction between market participants on the measurement date. SFAS
157 is effective for the Company's consolidated financial statements
for the year beginning on April 1, 2008, with earlier adoption
permitted. The Company does not expect the adoption of this statement
to have a material impact on its financial condition and results of
operations.
58
In February 2007, the FASB issued SFAS No. 159 "The Fair Value Option
for Financial Assets and Financial Liabilities including an amendment
of FASB Statement No. 115" (SFAS 159). SFAS 159 permits entities to
choose to measure many financial instruments and certain other items at
fair value that are not currently required to be measured at fair
value. The objective is to improve financial reporting by providing
entities with the opportunity to mitigate volatility in reported
earnings caused by measuring related assets and liabilities differently
without having to apply complex hedge accounting provisions. This
statement also establishes presentation and disclosure requirements
designed to facilitate comparisons between entities that choose
different measurement attributes for similar types of assets and
liabilities. The new standard is effective at the beginning of the
Company's fiscal year beginning April 1, 2009, and early adoption may
be elected in certain circumstances. The adoption of this statement is
not expected to have a significant impact on the Company's financial
position, results of operations or cash flow.
In December 2007, the FASB issued SFAS No. 141 (Revised 2008),
"Business Combinations" (SFAS 141(R)). SFAS 141(R) will significantly
change the accounting for business combinations. Under SFAS 141(R), an
acquiring entity will be required to recognize all the assets acquired
and liabilities assumed in a transaction at the acquisition-date fair
value with limited exceptions. It also amends the accounting treatment
for certain specific items including acquisition costs and non
controlling minority interests and includes a substantial number of new
disclosure requirements. SFAS 141(R) applies prospectively to business
combinations for which the acquisition date is on or after January 1,
2009. The Company does not expect the adoption of this statement to
have a material impact on its financial condition and results of
operations.
In March 2008, the FASB issued SFAS No. 161, "Disclosures about
Derivative Instruments and Hedging Activities-an amendment of FASB
Statement No. 133" (SFAS 161). SFAS 161 changes the disclosure
requirements for derivative instruments and hedging activities.
Entities are required to provide enhanced disclosures about (a) how and
why an entity uses derivative instruments, (b) how derivative
instruments and related hedged items are accounted for under Statement
133 and its related interpretations, and (c) how derivative instruments
and related hedged items affect an entity's financial position,
financial performance, and cash flows. The guidance in SFAS 161 is
effective for financial statements issued for fiscal years and interim
periods beginning after November 15, 2008, with early application
encouraged. This statement encourages, but does not require,
comparative disclosures for earlier periods at initial adoption. The
Company does not expect the adoption of this statement to have a
material impact on its financial condition and results of operations.
ADVERTISING COSTS:
It is the Company's policy to expense advertising costs as incurred.
Advertising and promotion expense is shown as a separate line item in
the consolidated Statements of Income.
59
NOTE 3 - INVESTMENTS IN AVAILABLE-FOR-SALE SECURITIES
Debt securities have been classified in the consolidated balance sheets
according to management's intent. The amortized cost of securities and their
approximate fair values are as follows as of March 31:
Amortized Gross Gross
Cost Unrealized Unrealized Fair
Basis Gains Losses Value
---------- ---------- ---------- ----------
(In Thousands)
March 31, 2008:
Debt securities issued by the U.S. Treasury
and other U.S. government corporations and
agencies $ 11,426 $ 76 $ 1 $ 11,501
Debt securities issued by states of the United
States and political subdivisions of the states 12,719 122 337 12,504
Corporate debt securities 65 1 -- 66
Mortgage-backed securities 38,982 654 163 39,473
Marketable equity securities 5,373 -- -- 5,373
---------- ---------- ---------- ----------
68,565 853 501 68,917
Money market mutual funds included in
cash and cash equivalents (5,373) -- -- (5,373)
---------- ---------- ---------- ----------
$ 63,192 $ 853 $ 501 $ 63,544
========== ========== ========== ==========
Amortized Gross Gross
Cost Unrealized Unrealized Fair
Basis Gains Losses Value
---------- ---------- ---------- ----------
(In Thousands)
March 31, 2007:
Debt securities issued by the U.S. Treasury
and other U.S. government corporations and
agencies $ 23,774 $ 36 $ 235 $ 23,575
Debt securities issued by states of the United
States and political subdivisions of the states 7,493 9 97 7,405
Corporate debt securities 100 1 -- 101
Mortgage-backed securities 12,030 46 135 11,941
Marketable equity securities 7,224 -- 190 7,034
---------- ---------- ---------- ----------
50,621 92 657 50,056
Money market mutual funds included in
cash and cash equivalents (587) -- -- (587)
---------- ---------- ---------- ----------
$ 50,034 $ 92 $ 657 $ 49,469
========== ========== ========== ==========
Mortgage-backed securities are insured or issued by Ginnie Mae, Freddie Mac and
Fannie Mae or private issuers, substantially all of which are backed by
fixed-rate mortgages.
The scheduled maturities of available-for-sale debt securities were as follows
as of March 31, 2008:
Fair
Value
------------
(In Thousands)
Due within one year $ 632
Due after one year through five years 473
Due after five years through ten years 7,755
Due after ten years 15,211
Mortgage-backed securities 39,473
------------
$ 63,544
============
60
Proceeds from sales of available-for-sale securities for the year ended March
31, 2008 were $20.9 million. Gross realized gains on those sales amounted to
$138,000 and $242,000 of gross realized losses were recognized. Proceeds from
sales from sales of available-for-sale securities for the year ended March 31,
2007 were $14.9 million. Gross realized gains on those sales amounted to $49,000
and $22,000 of gross realized losses were recognized. The tax (benefit) expense
applicable to these net realized (losses) gains in the years ended March 31,
2008 and 2007 amounted to $(21,000) and $11,000, respectively.
As of March 31, 2008 and 2007, securities with carrying amounts of $8.9 million
and $12.1 million, respectively, were pledged to secure securities sold under
agreements to repurchase. As of March 31, 2008 securities with a carrying value
of $1.9 million were pledged as collateral to secure municipal deposits.
The aggregate fair value and unrealized losses of securities that have been in a
continuous unrealized-loss position for less than twelve months and for twelve
months or more, and are not other than temporarily impaired, are as follows:
Less than 12 Months 12 Months or Longer Total
-------------------------- -------------------------- --------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
----------- ------------ ----------- ------------ ----------- ------------
(In Thousands)
March 31, 2008:
Debt securities issued by the U.S. Treasury
and other U.S. government corporations
and agencies $ 949 $ 1 $ -- $ -- $ 949 $ 1
Debt securities issued by states of the
United States and political subdivisions
of the states 5,907 217 649 120 6,556 337
Mortgage-backed securities 2,844 77 3,163 86 6,007 163
----------- ------------ ----------- ------------ ----------- ------------
Total temporarily impaired securities $ 9,700 $ 295 $ 3,812 $ 206 $ 13,512 $ 501
=========== ============ =========== ============ =========== ============
March 31, 2007:
Debt securities issued by the U.S. Treasury
and other U.S. government corporations
and agencies $ 3,072 $ 11 $ 16,349 $ 224 $ 19,421 $ 235
Debt securities issued by states of the
United States and political subdivisions
of the states 1,873 34 3,806 63 5,679 97
Mortgage-backed securities 839 3 7,063 132 7,902 135
Marketable equity securities -- -- 6,447 190 6,447 190
----------- ------------ ----------- ------------ ----------- ------------
Total temporarily impaired securities $ 5,784 $ 48 $ 33,665 $ 609 $ 39,449 $ 657
=========== ============ =========== ============ =========== ============
Management has assessed the securities which are classified as
available-for-sale and in an unrealized loss position at March 31, 2008 and
determined the decline in fair value below amortized cost to be temporary. In
making this determination management considered the period of time the
securities were in a loss position, the percentage decline in comparison to the
securities' amortized cost, the financial condition of the issuer and the
Company's ability and intent to hold these securities until their fair value
recovers to their amortized cost. Management believes the decline in fair value
is primarily related to the current interest rate environment and not to the
credit deterioration of the individual issuer.
61
NOTE 4 - LOANS
- --------------
Loans consisted of the following as of March 31:
2008 2007
--------- ---------
(In Thousands)
Mortgage loans:
Residential $ 158,268 $ 120,199
Commercial 138,477 54,057
Construction 21,043 8,774
--------- ---------
Total mortgage loans 317,788 183,030
Consumer loans 6,292 2,692
Commercial loans 51,958 14,733
--------- ---------
376,038 200,455
Deferred loan origination fees, net (223) (133)
Allowance for loan losses (4,046) (1,875)
--------- ---------
Loans, net $ 371,769 $ 198,447
========= =========
Certain directors and executive officers of the Company and companies in which
they have significant ownership interest were customers of the Association and
the Bank during the year ended March 31, 2008. Total loans to such persons and
their companies amounted to $5.0 million as of March 31, 2008. During the year
ended March 31, 2008, principal payments totaled $268,000 and principal advances
amounted to $960,000.
Changes in the allowance for loan losses were as follows for the years ended
March 31:
2008 2007
------- -------
(In Thousands)
Balance at beginning of period $ 1,875 $ 1,636
Acquired in merger 1,981 --
Provision for loan losses 307 242
Recoveries of loans previously charged off 14 2
Loans charged off (131) (5)
------- -------
Balance at end of period $ 4,046 $ 1,875
======= =======
The following table sets forth information regarding nonaccrual loans and
accruing loans 90 days or more overdue as of March 31:
2008 2007
------ ------
(In Thousands)
Total nonaccrual loans $1,167 $ 824
====== ======
Accruing loans which are 90 days or more overdue $ 8 $ --
====== ======
62
Information about loans that met the definition of an impaired loan in Statement
of Financial Accounting Standards No. 114 was as follows as of March 31:
2008 2007
--------------------------- ---------------------------
Recorded Related Recorded Related
Investment Allowance Investment Allowance
In Impaired For Credit In Impaired For Credit
Loans Losses Losses Loans
------------ ------------ ------------ ------------
(In Thousands)
Loans for which there is a related allowance for credit losses $ -- $ -- $ -- $ --
Loans for which there is no related allowance for credit losses 398 -- -- --
------------ ------------ ------------ ------------
Totals $ 398 $ -- $ -- $ --
============ ============ ============ ============
Average recorded investment in impaired loans during the
year ended March 31 $ 80 $ --
============ ============
Related amount of interest income recognized during the time,
in the year ended March 31 that the loans were impaired
Total recognized $ -- $ --
============ ============
Amount recognized using a cash-basis method
of accounting $ -- $ --
============ ============
NOTE 5 - PREMISES AND EQUIPMENT, NET
- ------------------------------------
The following is a summary of premises and equipment as of March 31:
2008 2007
------- -------
(In Thousands)
Land $ 834 $ 364
Buildings and building improvements 2,650 2,045
Furniture, fixtures and equipment 2,854 2,013
Leasehold improvements 2,453 1,226
------- -------
8,791 5,648
Accumulated depreciation and amortization (2,113) (1,404)
------- -------
$ 6,678 $ 4,244
======= =======
NOTE 6 - GOODWILL AND OTHER INTANGIBLE ASSETS
- ---------------------------------------------
The changes in the carrying amounts of goodwill and other intangibles for the
years ended March 31, 2008 and 2007 were as follows:
Core Deposit
Goodwill Intangibles
---------- -----------
(In Thousands)
Balance, March 31, 2006 $ 1,090 $ 687
Amortization expense -- (88)
---------- ----------
Balance, March 31, 2007 1,090 599
Additional due to merger 13,611 2,459
Amortization expense -- (387)
---------- ----------
Balance, March 31, 2008 $ 14,701 $ 2,671
========== ==========
63
Estimated annual amortization expense of identifiable intangible assets is as
follows:
(In Thousands)
Years Ended March 31,
2009 $ 506
2010 461
2011 417
2012 372
2013 326
Thereafter 589
--------
Total $ 2,671
========
A summary of acquired identifiable intangible assets is as follows as of March
31, 2008:
Gross Carrying Accumulated Net Carrying
Amount Amortization Amount
---------------- ---------------- --------------
(In Thousands)
Core deposit intangibles $3,345 $(674) $2,671
There was no impairment recorded in fiscal years 2008 and 2007 based on
valuations at March 31, 2008 and 2007.
NOTE 7 - DEPOSITS
- -----------------
The aggregate amount of time deposit accounts in denominations of $100,000 or
more was $68.9 million and $21.1 million as of March 31, 2008 and 2007,
respectively. With the exception of self-directed retirement accounts which are
insured up to $250,000, deposits in excess of $100,000 are not federally
insured.
For time deposits as of March 31, 2008, the scheduled maturities for each of the
following five years ended March 31, are:
(In Thousands)
2009 $157,096
2010 23,275
2011 10,747
2012 2,400
2013 7,219
--------
Total $200,737
========
NOTE 8 - FEDERAL HOME LOAN BANK ADVANCES
- ----------------------------------------
Advances consist of funds borrowed from the Federal Home Loan Bank of Boston
(the "FHLB").
Maturities of advances from the FHLB for the years ending after March 31, 2008
are summarized as follows:
(In Thousands)
2009 $ 6,106
2010 9,978
2011 26,993
2012 6,143
2013 2,472
Thereafter 10,273
Fair value adjustment (37)
--------
$ 61,928
========
64
Amortizing advances are being repaid in equal monthly payments and are being
amortized from the date of the advance to the maturity date on a direct
reduction basis. As of March 31, 2008, the Company has two advances which the
FHLB has the option of calling as of the put date, and quarterly thereafter:
Amount Maturity Date Put Date Interest Rate
------ ------------- -------- -------------
(In Thousands)
$5,000 August 1, 2016 August 3, 2009 4.89%
2,000 September 2, 2014 May 30, 2008 3.89
Borrowings from the FHLB are secured by a blanket lien on qualified collateral,
consisting primarily of loans with first mortgages secured by one-to four-family
properties and other qualified assets.
At March 31, 2008, the interest rates on FHLB advances ranged from 2.95% to
5.21%. At March 31, 2008, the weighted average interest rate on FHLB advances
was 4.33%.
NOTE 9 - SUBORDINATED DEBENTURES
- --------------------------------
On July 28, 2005, FVB Capital Trust I ("Trust I"), a Delaware statutory trust
formed by First Valley Bancorp, completed the sale of $4.1 million of 6.42%, 5
Year Fixed-Floating Capital Securities ("Capital Securities"). Trust I also
issued common securities to First Valley Bancorp and used the net proceeds from
the offering to purchase a like amount of 6.42% Junior Subordinated Debentures
("Debentures") of First Valley Bancorp. Debentures are the sole assets of Trust
I.
Capital Securities accrue and pay distributions quarterly at an annual rate of
6.42% for the first 5 years of the stated liquidation amount of $10 per Capital
Security. First Valley Bancorp fully and unconditionally guaranteed all of the
obligations of the Trust, which are now guaranteed by the Company. The guaranty
covers the quarterly distributions and payments on liquidation or redemption of
Capital Securities, but only to the extent that Trust I has funds necessary to
make these payments.
Capital Securities are mandatorily redeemable upon the maturing of Debentures on
August 23, 2035 or upon earlier redemption as provided in the Indenture. The
Company has the right to redeem Debentures, in whole or in part on or after
August 23, 2010 at the liquidation amount plus any accrued but unpaid interest
to the redemption date.
The trust and guaranty provide for the binding of any successors in the event of
a merger, as is the case in the merger of First Valley Bancorp and the Company.
The Company has assumed the obligations of First Valley Bancorp in regards to
the subordinated debentures due to the acquisition of First Valley Bancorp by
the Company.
NOTE 10 - SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE
- --------------------------------------------------------
The securities sold under agreements to repurchase as of March 31, 2008 are
securities sold, primarily on a short-term basis, by the Company that have been
accounted for not as sales but as borrowings. The securities consisted of U.S.
Agencies and mortgage-backed securities. The securities were held in the
Company's safekeeping account under the control of the Company and pledged to
the purchasers of the securities. The purchasers have agreed to sell to the
Company substantially identical securities at the maturity of the agreements.
65
NOTE 11 - INCOME TAXES
- ----------------------
The components of income tax expense are as follows for the years ended March
31:
2008 2007
----- -----
(In Thousands)
Current:
Federal $ 763 $ 511
State 214 133
Benefit of operating loss carryforward (100) --
----- -----
877 644
----- -----
Deferred:
Federal (217) (113)
State 7 (26)
Change in valuation allowance 61 --
----- -----
(149) (139)
----- -----
Total income tax expense $ 728 $ 505
===== =====
The reasons for the differences between the statutory federal income tax rate
and the effective tax rates are summarized as follows for the years ended March
31:
2008 2007
---- ----
Federal income tax at statutory rate 34.0% 34.0%
Increase (decrease) in tax resulting from:
Nontaxable interest income (8.0) (8.0)
Nontaxable life insurance income (2.7) (5.5)
Excess book basis of Employee Stock Ownership Plan 3.9 5.9
Other adjustments 2.9 3.1
Change in valuation allowance 3.2 --
State tax, net of federal tax benefit 4.1 4.8
---- ----
Effective tax rates 37.4% 34.3%
==== ====
The Company had gross deferred tax assets and gross deferred tax liabilities as
follows as of March 31:
2008 2007
------- -------
(In Thousands)
Deferred tax assets:
Excess of allowance for loan losses over tax bad debt reserve $ 1,552 $ 730
Deferred loan origination fees 87 52
Net unrealized holding loss on available-for-sale securities -- 220
Deferred compensation 664 434
FASB Statement No. 158 adjustment 8 8
Capital loss carryforward 61 --
Other 66 43
------- -------
Gross deferred tax assets 2,438 1,487
Valuation allowance (61) --
------- -------
Gross deferred tax assets, net of valuation allowance 2,377 1,487
------- -------
Deferred tax liabilities:
Premises and equipment, principally due to differences in depreciation (60) (92)
Net mark-to-market adjustments (1,035) (258)
Net unrealized holding gain on available-for-sale securities (137) --
Other (5) (5)
------- -------
Gross deferred tax liabilities (1,237) (355)
------- -------
Net deferred tax asset $ 1,140 $ 1,132
======= =======
66
Based on the Company's historical and current pretax earnings and anticipated
results of future operations, management believes the existing net deductible
temporary differences will reverse during periods in which the Company will
generate sufficient net taxable income, and that it is more likely than not that
the Company will realize the net deferred tax assets existing as of March 31,
2008.
Legislation was enacted in 1996 to repeal most of Section 593 of the Internal
Revenue Code pertaining to how a qualified savings institution calculates its
bad debt deduction for federal income tax purposes. This repeal eliminated the
percentage-of-taxable-income method to compute the tax bad debt deduction. Under
the legislation, the recapture of the pre-1988 tax bad debt reserves has been
suspended and would occur only under very limited circumstances. Therefore, a
deferred tax liability has not been provided for this temporary difference. The
Company's pre-1988 tax bad debt reserves, which are not expected to be
recaptured, amount to $3.3 million. The potential tax liability on the pre-1988
reserves for which no deferred income taxes have been provided is approximately
$1.3 million as of March 31, 2008.
NOTE 12 - BENEFIT PLANS
- -----------------------
The Association has a non-contributory defined benefit trusteed pension plan
through the Financial Institutions Retirement Fund covering all eligible
employees. The Association contributed $70,000 and $383,000 to the plan during
the years ended March 31, 2008 and 2007, respectively. The Association's plan is
part of a multi-employer plan for which detail as to the Association's relative
position is not readily determinable. Effective January 1, 2006, the Association
excluded from membership in the plan those employees hired on or after January
1, 2006. Effective February 1, 2007, the Association ceased benefit accruals
under the plan.
The Association established the Enfield Federal Savings and Loan Association
Director Fee Continuation Plan (the "Plan") to provide the directors serving on
the board as of the date of the plan's implementation with a retirement income
supplement. The plan has six directors. Participant-directors are entitled to an
annual benefit, as of their Retirement Date, equal to $1,000 for each full year
of service as a director from June 1, 1995, plus $250 for each full year of
service as a director prior to June 1, 1995, with a maximum benefit of $6,000
per year payable in ten annual installments.
The following table sets forth information about the Plan as of March 31:
2008 2007
----- -----
(In Thousands)
Change in projected benefit obligation:
Benefit obligation at beginning of year $ 190 $ 159
Service cost 4 14
Interest cost 9 11
Benefits paid (47) (18)
Prior service cost -- 14
Actuarial loss -- 10
----- -----
Benefit obligation at end of year 156 190
Plan assets -- --
----- -----
Funded status/accrued pension cost included in other liabilities $(156) $(190)
===== =====
Amounts recognized in accumulated other comprehensive loss, before tax effect,
consist of the following as of March 31, 2008:
2008 2007
---- ----
(In Thousands)
Unrecognized net loss $ 10 $ 10
Unrecognized prior service cost 11 11
---- ----
$ 21 $ 21
==== ====
The accumulated benefit obligation for the Plan was $156,000 and $190,000 at
March 31, 2008 and 2007, respectively.
67
2008 2007
---- ----
(In Thousands)
Components of net periodic cost:
Service cost $ 4 $ 14
Interest cost 9 11
Loss recognized -- --
Unrecognized prior service cost recognized -- 3
---- ----
Net periodic pension cost 13 28
---- ----
Other changes in benefit obligations recognized in other comprehensive loss:
Unrecognized net loss -- --
Prior service cost -- --
---- ----
Total recognized in other comprehensive loss -- --
---- ----
Total recognized in net periodic pension cost and
other comprehensive loss $ 13 $ 28
==== ====
The estimated unrecognized loss and prior service cost that will be accreted
into accumulated other comprehensive loss from net periodic benefit cost over
the year ended March 31, 2009 is $0 and $1,000, respectively.
The discount rate used in determining the projected benefit obligation and net
periodic benefit cost was 6.0% for the year ended March 31, 2008 and 2007.
Estimated future benefit payments are as follows for the years ended March 31:
(In Thousands)
2009 $12
2010 18
2011 18
2012 18
2013 18
2014-2018 90
The Association sponsors a 401(k) Plan whereby the Association matches 50% of
the first 6% of employee contributions. During the years ended March 31, 2008
and 2007, the Association contributed $105,000 and $61,000, respectively under
this plan.
The Association has an Executive Supplemental Retirement Plan Agreement and a
Life Insurance Endorsement Method Split Dollar Plan Agreement for the benefit of
the President of the Association. The plan provides the President with an annual
retirement benefit equal to approximately $173,000 over a period of 240 months.
Following the initial 240 month period, certain additional amounts may be
payable to the President until his death based on the performance of the life
insurance policies that the Association has acquired as an informal funding
source for its obligation to the President. The income recorded on the life
insurance policies amounted to $154,000 for the years ended March 31, 2008 and
2007. A periodic amount is being expensed and accrued to a liability reserve
account during the President's active employment so that the full present value
of the promised benefit will be expensed at his retirement. The expense of this
plan to the Association for the years ended March 31, 2008 and 2007 was $269,000
and $245,000, respectively. The cumulative liability for this plan is reflected
in other liabilities on the consolidated balance sheets as of March 31, 2008 and
2007 in the amounts of $1.0 million and $764,000, respectively.
68
The Association formed a Rabbi Trust for the Executive Supplemental Retirement
Plan. The Trust's assets consist of split dollar life insurance policies. The
cash surrender values of the policies are reflected as an asset on the
consolidated balance sheets. As of March 31, 2008 and 2007, total assets in the
Rabbi Trust were $4.2 million and $4.0 million, respectively.
The Association adopted the Enfield Federal Savings and Loan Association
Supplemental Executive Retirement Plan (SERP), effective June 4, 2002. The SERP
provides restorative payments to executives designated by the Board of Directors
who are prevented by certain provisions of the Internal Revenue Code from
receiving the full benefits contemplated by other benefit plans. The Board of
Directors has designated the President to participate in the Plan. The expense
of this plan to the Association for the year ending March 31, 2008 is $10,000.
The Company and the Association each entered into an employment agreement with
its President. The employment agreements provide for the continued payment of
specified compensation and benefits for specified periods. The agreements also
provide for termination of the executive for cause (as defined in the
agreements) at any time. The employment agreements provide for the payment,
under certain circumstances, of amounts upon termination following a "change in
control" as defined in the agreements. The agreements also provide for certain
payments in the event of the officer's termination for other than cause and in
the case of voluntary termination.
The Association maintains change in control agreements with several employees.
The agreements are renewable annually. The agreements provide that if
involuntary termination or, under certain circumstances, voluntary termination
follows a change in control of the Association, the employee would be entitled
to receive a severance payment equal to a multiple of his "base amount," as
defined under the Internal Revenue Code. The Association would also continue
and/or pay for life, health and disability coverage for a period of time
following termination.
NOTE 13 - STOCK COMPENSATION PLANS
- ----------------------------------
In 2003, the Company adopted the New England Bancshares, Inc. 2003 Stock-Based
Incentive Plan (the "2003 Plan") which includes grants of options to purchase
Company stock and awards of Company stock. The number of shares of common stock
reserved for grants and awards under the 2003 Plan is 473,660, consisting of
338,327 shares for stock options and 135,333 shares for stock awards. All
employees and outside directors of the Company are eligible to participate in
the 2003 Plan.
In 2006, the Company adopted the New England Bancshares, Inc. 2006 Equity
Incentive Plan (the "2006 Plan") which includes grants of options to purchase
Company stock and awards of Company stock. The number of shares of common stock
reserved for grants and awards under the 2006 Plan is 274,878, consisting of
196,342 shares for stock options and 78,536 shares for stock awards.
The 2003 and 2006 Plans define the stock option exercise price as the fair
market value of the Company stock at the date of the grant. The Company
determines the term during which a participant may exercise a stock option, but
in no event may a participant exercise a stock option more than ten years from
the date of grant. The stock options vest in installments over five years.
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 used for stock option grants in the year ended March 31, 2008 and
2007.
2008 2007
---- ----
Dividend yield 0.89% 0.93%
Expected life 10 years 10 years
Expected volatility 13.0% 14.0%
Risk-free interest rate 4.65% 4.80%
69
A summary of the status of the Plans as of March 31, 2008 and 2007 and changes
during the years then ended is presented below:
2008 2007
----------------------------- -----------------------------
Weighted-Average Weighted-Average
Shares Exercise Price Shares Exercise Price
------------ -------------- ------------ --------------
Outstanding at beginning of year 356,778 $ 8.55 252,004 $ 6.68
Granted 15,000 13.29 108,563 12.84
Exercised (5,683) 6.99 -- --
Forfeited (16,098) 7.04 (3,789) 7.73
------------ ------------
Outstanding at end of year 349,997 $ 8.84 356,778 $ 8.55
============ ============
Options exercisable at year-end 236,233 186,195
Weighted-average fair value of options
granted during the year $ 4.20 $ 4.14
The following table summarizes information about stock options outstanding as of
March 31, 2008:
Options Outstanding Options Exercisable
- ---------------------------------------------------------- ---------------------------------
Number Weighted-Average Number
Outstanding Remaining Weighted-Average Exercisable Weighted-Average
as of 3/31/08 Contractual Life Exercise Price as of 3/31/08 Exercise Price
- ------------- ------------------ --------------------- ------------- ------------------
195,250 4.9 years $6.40 195,250 $6.40
30,784 6.1 years 8.17 18,470 8.17
2,000 7.9 years 10.81 800 10.81
106,963 8.4 years 12.84 21,713 12.84
15,000 9.1 years 13.29 --- ---
-------- ---------
349,997 6.3 years 8.84 236,233 7.15
======== =========
Under the 2003 and 2006 Plans, common stock of the Company may be granted at no
cost to employees and outside directors of the Company. Plan participants are
entitled to cash dividends and to vote such shares. Such shares vest in five
equal annual installments. Upon issuance of shares of restricted stock under the
Plans, unearned compensation equivalent to the market value at the date of grant
is charged to the capital accounts and subsequently amortized to expense over
the five-year vesting period. In February 2003, 86,251 shares were awarded under
the 2003 Plan and in September 2006, 53,189 shares were awarded under the 2006
Plan. The awards vest in installments over five years. The compensation cost
that has been charged against income for the granting of stock awards under the
plan was $230,000 and $197,000 for the years ended March 31, 2008 and 2007,
respectively.
Upon a change in control as defined in the 2003 and 2006 Plans, options held by
participants will become immediately exercisable and shall remain exercisable
until the expiration of the term of the option, regardless of whether the
participant is employed or in service with the Company; and all stock awards
held by a participant will immediately vest and further restrictions lapse.
As of March 31, 2008, there was $393,000 of unrecognized compensation cost
related to unvested stock options granted under the Plans. That cost is expected
to be recognized over a weighted-average period of 3.4 years.
70
NOTE 14 - EMPLOYEE STOCK OWNERSHIP PLAN
- ---------------------------------------
On June 4, 2002, the date the mutual holding company reorganization was
consummated, the Association implemented the Enfield Federal Savings and Loan
Association Employee Stock Ownership Plan (the "ESOP") effective as of January
1, 2002. On June 4, 2002, the ESOP purchased 73,795 shares of the common stock
of the Company (174,768 as adjusted for the 2.3683 share exchange). To fund the
purchases, the ESOP borrowed $738,000 from the Company. The borrowing is
currently at an interest rate of 4.75% and is to be repaid in equal annual
installments through December 31, 2011. In fiscal 2006, the ESOP purchased
246,068 shares of common stock in the second-step conversion with a $2.5 million
loan from the Company, which has a 15 year term at an interest rate of 7.25%.
Dividends paid on unreleased shares are used to reduce the principal balance of
the loan. The collateral for the borrowing is the common stock of the Company
purchased by the ESOP. Contributions by the Association to the ESOP are
discretionary; however, the Association intends to make annual contributions to
the ESOP in an aggregate amount at least equal to the principal and interest
requirements on the debt. The shares of stock of the Company are held in a
suspense account until released for allocation among participants. The shares
will be released annually from the suspense account and the released shares will
be allocated among the participants on the basis of the participant's
compensation for the year of allocation compared to all other participants. As
any shares are released from collateral, the Company reports compensation
expense equal to the current market price of the shares and the shares will be
outstanding for earnings-per-share purposes. The shares not released are
reported as unearned ESOP shares in the capital accounts section of the balance
sheet. ESOP expense for the years ended March 31, 2008 and 2007 was $399,000 and
$421,000, respectively.
The ESOP shares as of March 31 were as follows:
2008 2007
---------- ----------
Allocated shares 117,936 95,038
Unreleased shares 283,183 317,063
---------- ----------
Total ESOP shares 401,119 412,101
========== ==========
Fair value of unreleased shares $3,185,809 $4,277,180
========== ==========
NOTE 15 - REGULATORY MATTERS
- ----------------------------
The Company, as a Federal Reserve multi-bank holding company, is not subject to
capital requirements. The Association and Bank (collectively "Subsidiaries") 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 Subsidiaries'
financial statements. Under capital adequacy guidelines and the regulatory
framework for prompt corrective action, the Subsidiaries must meet specific
capital guidelines that involve quantitative measures of its assets, liabilities
and certain off-balance-sheet items as calculated under regulatory accounting
practices. 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 Subsidiaries 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), of Core capital (as defined) to adjusted
tangible assets (as defined) and Tangible capital (as defined) to Tangible
assets (as defined). Management believes, as of March 31, 2008 and 2007, that
the Subsidiaries meet all capital adequacy requirements to which they are
subject.
As of March 31, 2008, the most recent notification from the Office of Thrift
Supervision categorized the Association as well capitalized under the regulatory
framework for prompt corrective action. To be categorized as well capitalized
the Association must maintain minimum total risk-based, Tier 1 risk-based, Core
and Tangible capital ratios as set forth in the table. There are no conditions
or events since that notification that management believes have changed the
Association's category.
71
The Association's actual capital amounts and ratios are also presented in the
table.
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
----------------- ------------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(Dollar Amounts in Thousands)
As of March 31, 2008:
Total Capital (to Risk Weighted Assets) $27,376 14.13% $15,504 > 8.0% $19,381 > 10.0%
- -
Tangible Capital (to Tangible Assets) 25,300 8.80 4,313 > 1.5 N/A N/A
-
Core Capital (to Adjusted Tangible Assets) 25,300 8.80 11,502 > 4.0 14,378 > 5.0
- -
Tier 1 Capital (to Risk Weighted Assets) 25,300 13.05 N/A N/A 11,628 > 6.0
-
As of March 31, 2007:
Total Capital (to Risk Weighted Assets) $43,350 25.26% $13,730 > 8.0% $17,162 > 10.0%
- -
Tangible Capital (to Tangible Assets) 41,476 14.66 4,243 > 1.5 N/A N/A
-
Core Capital (to Adjusted Tangible Assets) 41,476 14.66 11,315 > 4.0 14,143 > 5.0
- -
Tier 1 Capital (to Risk Weighted Assets) 41,476 24.17 N/A N/A 10,297 > 6.0
-
The Association will not be able to declare or pay a cash dividend on, or
repurchase any of its common stock, if the effect thereof would cause the
regulatory capital of the Association to be reduced below the amount required
under OTS rules and regulations.
As of March 31, 2008, the most recent notification from the Federal Deposit
Insurance Corporation categorized the Bank as well capitalized under the
regulatory framework for prompt corrective action. To be categorized as well
capitalized the Bank must maintain minimum total risk-based, Tier 1 risk-based
and 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 Bank's
category.
The Bank's actual capital amounts and ratios are also presented in the table.
To Be Well
Capitalized Under
For Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
---------------- ------------------- ------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
(Dollar amounts in thousands)
As of March 31, 2008:
Total Capital (to Risk Weighted Assets) $26,256 14.33% $14,658 >8.0% $18,322 >10.0%
- -
Tier 1 Capital (to Risk Weighted Assets) 24,286 13.25 7,329 >4.0 10,993 >6.0
- -
Tier 1 Capital (to Average Assets) 24,286 11.56 8,402 >4.0 10,502 >5.0
- -
72
NOTE 16 - EARNINGS PER SHARE (EPS)
- ----------------------------------
Reconciliation of the numerators and denominators of the basic and diluted per
share computations for net income are as follows:
Income Shares Per-Share
(Numerator) (Denominator) Amount
------------ ------------- ------------
(In Thousands)
Year ended March 31, 2008
Basic EPS
Net income and income available to common stockholders $ 1,215 5,620,196 $ 0.22
Effect of dilutive securities options -- 160,153
------------ ------------
Diluted EPS
Income available to common stockholders and
assumed conversions $ 1,215 5,780,349 $ 0.21
============ ============
Year ended March 31, 2007
Basic EPS
Net income and income available to common stockholders $ 970 4,945,603 $ 0.20
Effect of dilutive securities options -- 179,964
------------ ------------
Diluted EPS
Income available to common stockholders and
assumed conversions $ 970 5,125,567 $ 0.19
============ ============
NOTE 17 - COMMITMENTS AND CONTINGENT LIABILITIES
- ------------------------------------------------
The Company is obligated under non-cancelable operating leases for banking
premises and equipment expiring between fiscal year 2009 and 2031. The total
minimum rental due in future periods under these existing agreements is as
follows as of March 31, 2008:
Year Ended March 31 (In Thousands)
-------------------
2009 $ 796
2010 815
2011 830
2012 863
2013 828
Thereafter 9,740
-------
Total minimum lease payments $13,872
=======
Certain leases contain provisions for escalation of minimum lease payments
contingent upon increases in real estate taxes and percentage increases in the
consumer price index. Certain leases contain options to extend for periods from
one to five years. The total rental expense amounted to $788,000 and $540,000
for the years ended March 31, 2008 and 2007, respectively.
73
NOTE 18 - OTHER COMPREHENSIVE INCOME
- ------------------------------------
Other comprehensive income for the years ended March 31, 2008 and 2007 are as
follows:
March 31, 2008
--------------------------------------------
Before Tax Tax Net of Tax
Amount Effects Amount
------------ ------------ ------------
(Dollars in Thousands)
Net unrealized holding gains on available-for-sale securities $ 824 $ (321) $ 503
Reclassification adjustment for realized losses in net income 93 (36) 57
------------ ------------ ------------
Total $ 917 $ (357) $ 560
============ ============ ============
March 31, 2007
--------------------------------------------
Before Tax Tax Net of Tax
Amount Effects Amount
------------ ------------ ------------
(Dollars in Thousands)
Net unrealized holding gains on available-for-sale securities $ 462 $ (180) $ 282
Reclassification adjustment for realized gains in net income (32) 13 (19)
------------ ------------ ------------
Total $ 430 $ (167) $ 263
============ ============ ============
NOTE 19 - FINANCIAL INSTRUMENTS
- -------------------------------
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 commitments to originate loans, standby letters of
credit and unadvanced funds on loans. The instruments involve, to varying
degrees, elements of credit risk in excess of the amount recognized in the
balance sheets. The contract 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 nonperformance by the
other party to the financial instrument for loan commitments and standby letters
of credit is represented by the contractual amounts of those instruments. The
Company uses the same credit policies in making commitments and conditional
obligations as it does for on-balance sheet instruments.
Commitments to originate 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 are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Company evaluates each customer's
creditworthiness 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. Collateral held varies, but may
include secured interests in mortgages, accounts receivable, inventory,
property, plant and equipment and income-producing properties.
Standby letters of credit are conditional commitments issued by the Company to
guarantee the performance by a customer to a third party. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan facilities to customers. As of March 31, 2008 and 2007, the
maximum potential amount of the Company's obligation was $2,012,000 and $10,000
for financial and standby letters of credit, respectively. The Company's
outstanding letters of credit generally have a term of less than one year. If a
letter of credit is drawn upon, the Company may seek recourse through the
customer's underlying line of credit. If the customer's line of credit is also
in default, the Company may take possession of the collateral, if any, securing
the line of credit.
74
The following are carrying amounts and estimated fair values of the Company's
financial assets and liabilities as of March 31:
2008 2007
--------------------------- ---------------------------
Carrying Estimated Carrying Estimated
Amount Fair Value Amount Fair Value
------------ ------------ ------------ ------------
(In Thousands)
Financial assets:
Cash and cash equivalents $ 36,239 $ 36,239 $ 18,640 $ 18,640
Interest-bearing time deposits with other banks 693 693 1,877 1,903
Available-for-sale securities 63,544 63,544 49,469 49,469
Federal Home Loan Bank stock 3,571 3,571 1,979 1,979
Loans, net 371,769 375,982 198,447 197,812
Other investment securities 3,400 3,400 -- --
Accrued interest receivable 2,165 2,165 1,323 1,323
Due from broker 714 714 -- --
Financial liabilities:
Deposits 370,312 372,478 181,675 182,330
Advanced payments by borrowers for taxes and insurance 909 909 796 796
FHLB advances 61,928 63,953 33,587 33,432
Securities sold under agreements to repurchase 8,555 8,558 9,177 9,182
Subordinated debentures 3,893 3,094 -- --
Due to broker 653 653 -- --
The carrying amounts of financial instruments shown in the above tables are
included in the consolidated balance sheets under the indicated captions except
for other investments, due from broker and due to broker which are included in
other assets and other liabilities. Accounting policies related to financial
instruments are described in Note 2.
The notional amounts of financial instrument liabilities with off-balance sheet
credit risk are as follows as of March 31:
2008 2007
------- -------
(In Thousands)
Commitments to originate loans $ 8,305 $ 2,947
Standby letters of credit 2,012 10
Unadvanced portions of loans:
Construction 9,233 6,281
Home equity 8,088 1,726
Commercial lines of credit 19,473 4,300
------- -------
$47,111 $15,264
======= =======
There is no material difference between the notional amounts and the estimated
fair values of the off-balance sheet liabilities.
75
NOTE 20 - ACQUISITION
- ---------------------
The results of operations of Valley Bank have been included in the Company's
consolidated financial statements since the acquisition date of July 12, 2007.
The following information assumes that the acquisition of First Valley Bancorp
had occurred on April 1, 2006, the beginning of fiscal year 2007.
For the Years Ended March 31,
-----------------------------
2008 2007
---------- ----------
(unaudited)
Total revenue $ 30,893 $ 28,230
Net income $ 1,044 $ 1,510
Earnings per share:
Basic $ 0.18 $ 0.25
Diluted $ 0.17 $ 0.24
Fair values of assets acquired and liabilities assumed at the date of
acquisition is presented in the Consolidated Statements of Cash Flows.
NOTE 21 - SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK
- ---------------------------------------------------------
Most of the Company's business activity is with customers located within
Connecticut. There are no concentrations of credit to borrowers that have
similar economic characteristics. The majority of the Company's loan portfolio
is comprised of loans collateralized by real estate located in the state of
Connecticut.
NOTE 22 - RECLASSIFICATION
- --------------------------
Certain amounts in the prior year have been reclassified to be consistent with
the current year's statement presentation.
NOTE 23 - PARENT COMPANY ONLY FINANCIAL STATEMENTS
- --------------------------------------------------
The following financial statements are for the Company (Parent Company Only) and
should be read in conjunction with the consolidated financial statements of the
Company.
NEW ENGLAND BANCSHARES, INC.
----------------------------
(Parent Company Only)
Balance Sheets
--------------
(In Thousands)
March 31,
-----------------
ASSETS 2008 2007
------- -------
Cash on deposit with Enfield Federal Savings and Loan Association $ 1,762 $11,376
Investment in subsidiaries 67,197 42,852
Loans to ESOP 2,593 2,770
Accrued interest receivable 46 48
Other assets 1,100 359
Due from subsidiary 109 139
------- -------
Total assets $72,807 $57,544
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Other liabilities $ 70 $ 259
Subordinated debentures 3,893 --
Deferred tax liability 107 19
Stockholders' equity 68,737 57,266
------- -------
Total liabilities and stockholders' equity $72,807 $57,544
======= =======
76
NEW ENGLAND BANCSHARES, INC.
----------------------------
(Parent Company Only)
Statements of Income
--------------------
(In Thousands)
For the Years Ended
March 31,
------------------------
2008 2007
---------- ----------
Interest income $ 432 $ 762
Interest expense 195 --
---------- ----------
Net interest income 237 762
Other expense 263 235
---------- ----------
(Loss) income before income tax (benefit) expense and equity in
undistributed net income of subsidiaries (26) 527
Income tax (benefit) expense (9) 211
---------- ----------
(Loss) Income before equity in undistributed net income of subsidiaries (17) 316
Equity in undistributed net income of subsidiaries 1,232 654
---------- ----------
Net income $ 1,215 $ 970
========== ==========
Statements of Cash Flows
------------------------
(In Thousands)
For the Years Ended
March 31,
------------------------
2008 2007
---------- ----------
Cash flows from operating activities:
Net income $ 1,215 $ 970
Adjustments to reconcile net income to net cash provided by operating activities:
Amortization of fair value adjustments 5 --
Decrease in accrued interest receivable 2 47
Decrease in due from subsidiaries 898 525
Increase in other assets (741) (327)
(Decrease) increase in other liabilities (101) 245
Undistributed net income of subsidiaries (1,232) (654)
---------- ----------
Net cash provided by operating activities 46 806
---------- ----------
Cash flows from investing activities:
Dividends from subsidiaries 19,000 --
Investment in subsidiaries (12,000) --
Cash issued in acquisition (12,424) --
Principal payments received on loans to ESOP 177 164
---------- ----------
Net cash (used in) provided by investing activities (5,247) 164
---------- ----------
Cash flows from financing activities:
Purchase of treasury stock (3,772) --
Purchase of stock for equity incentive plan -- (1,019)
Exercise of stock options 40 --
Payment of cash dividends on common stock (681) (600)
---------- ----------
Net cash used in financing activities (4,413) (1,619)
---------- ----------
Net decrease in cash and cash equivalents (9,614) (649)
Cash and cash equivalents at beginning of year 11,376 12,025
---------- ----------
Cash and cash equivalents at end of year $ 1,762 $ 11,376
========== ==========
77
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A(T). CONTROLS AND PROCEDURES
(a) The Company's management, including the Company's principal
executive officer and principal financial officer, have evaluated the
effectiveness of the Company's "disclosure controls and procedures," as such
term is defined in Rule 13a-15(e) promulgated under the Securities Exchange Act
of 1934, as amended, (the "Exchange Act"). Based upon their evaluation, the
principal executive officer and principal financial officer concluded that, as
of the end of the period covered by this report, the Company's disclosure
controls and procedures were effective for the purpose of ensuring that the
information required to be disclosed in the reports that the Company files or
submits under the Exchange Act with the Securities and Exchange Commission (the
"SEC") (1) is recorded, processed, summarized and reported within the time
periods specified in the SEC's rules and forms, and (2) is accumulated and
communicated to the Company's management, including its principal executive and
principal financial officers, as appropriate to allow timely decisions regarding
required disclosure.
(b) Management's report on internal control over financial reporting.
Management of the Company is responsible for establishing and
maintaining adequate internal control over financial reporting.
The Company's internal control over financial reporting is a process
designed to provide reasonable assurance regarding the reliability of financial
reporting and the preparation of financial statements for external purposes in
accordance with accounting principles generally accepted in the United States of
America. The Company's internal control over financial reporting includes those
policies and procedures that (i) pertain to the maintenance of records that, in
reasonable detail, accurately and fairly reflect the transactions and
dispositions of the assets of the Company; (ii) provide reasonable assurance
that transactions are recorded as necessary to permit preparation of financial
statements in accordance with accounting principles generally accepted in the
United States of America, and that receipts and expenditures of the Company are
being made only in accordance with authorizations of management and directors of
the Company; and (iii) provide reasonable assurance regarding prevention or
timely detection of unauthorized acquisition, use, or disposition of the
Company's assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial
reporting may not prevent or detect misstatements. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that
controls may become inadequate because of changes in conditions, or that the
degree of compliance with the policies or procedures may deteriorate.
Management assessed the effectiveness of the Company's internal control
over financial reporting as of March 31, 2008, based on the framework set forth
by the Committee of Sponsoring Organizations of the Treadway Commission in
Internal Control--Integrated Framework. Based on that assessment, management
concluded that, as of March 31, 2008, the Company's internal control over
financial reporting was effective based on the criteria established in Internal
Control--Integrated Framework.
This annual report does not include an attestation report of the
Company's registered public accounting firm regarding internal control over
financial reporting. Management's report was not subject to attestation by the
Company's registered public accounting firm pursuant to temporary rules of the
Securities and Exchange Commission that permit the company to provide only
management's report in this annual report.
(c) There has been no change in the Company's internal control over
financial reporting during the Company's fourth quarter of fiscal 2008 that has
materially affected, or is reasonably likely to materially affect, the Company's
internal control financial reporting,
78
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Directors
The information relating to the directors of the Company is
incorporated herein by reference to the sections captioned "Corporate
Governance--Committees of the Board of Directors" and "Proposal 1 - Election of
Directors" in the Company's Proxy Statement for the 2008 Annual Meeting of
Stockholders.
Executive Officers
Certain executive officers of the Association and Bank also serve as
executive officers of the Company. The day-to-day management duties of the
executive officers of the Company, Association and Bank relate primarily to
their duties as to the Association and Bank. The executive officers are elected
annually and hold office until their successors have been elected and qualified
or until they are removed or replaced. The executive officers of the Company
currently are as follows:
Name Age(1) Position(s)
- ----------- ------- ------------------------------------------------------------------
David J. O'Connor 61 Chief Executive Officer and Director of New England
Bancshares and Chief Executive Officer, President and
Director of Enfield Federal
Robert L. Messier, Jr. 65 President and Director of New England Bancshares and
Chief Executive Officer and Director of Valley Bank
Scott D. Nogles 38 Executive Vice President and Chief Financial Officer
of New England Bancshares and Enfield Federal
John F. Parda 59 Executive Vice President and Chief Loan Officer of Enfield Federal
- ----------------------------
(1) As of March 31, 2008.
David J. O'Connor. Mr. O'Connor has been the Chief Executive Officer,
President and Director of Enfield Federal since 1999 and of New England
Bancshares since 2002. Mr. O'Connor also served as the Company's and Enfield
Federal's Chief Financial Officer from 1999 to April 2004. Mr. O'Connor has over
30 years of banking experience in New England. Before joining Enfield Federal,
he was the Executive Vice President, Treasurer and Chief Financial Officer of
The Berlin City Bank, a community bank in New Hampshire.
Robert L. Messier, Jr. is the President of New England Bancshares, Inc.
and the Chief Executive Officer of Valley Bank. He was the President and Chief
Executive Officer of First Valley Bancorp, the former holding company of Valley
Bank, since its inception in 1999. Mr. Messier served as Vice President and
regional commercial banking officer with Eagle Bank from 1996 until its merger
with Webster Bank in 1998. From 1992 to 1996, Mr. Messier was a Vice President,
with corporate/small business lending regional manager responsibilities of
BankBoston Connecticut. He is Director Emeritus and Past Chairman of the Greater
Bristol Health Care, Inc., a Past Director of St. Francis Hospital and Medical
Center and Past Director of Central Connecticut Medical Management. He has been
the President of the Business Education Foundation since 1990 and Former
Chairman of the Central Connecticut Revolving Loan Fund from 1995 to 2006. Age
65. Director since 2007.
Scott D. Nogles. Mr. Nogles joined New England Bancshares and Enfield
Federal in 2004 as Senior Vice President and Chief Financial Officer. He was
named Executive Vice President and Chief Financial Officer in 2008. Before
joining Enfield Federal, he was Vice President and Chief Financial Officer of
Luzerne National Bank in Luzerne, Pennsylvania from 2003 to 2004. Mr. Nogles has
an MBA from the University of Connecticut.
79
John F. Parda. Mr. Parda joined Enfield Federal in 1999 as Vice
President and Senior Loan Officer. He was named Senior Vice President and Senior
Loan Officer in 2001and Executive Vice President and Senior Loan Officer in
2008. Mr. Parda has over 30 years of diversified banking experience with
Connecticut financial institutions. Before joining Enfield Federal, he was a
Vice President and Commercial Loan Officer with the former First International
Bank, now a subsidiary of UPS Capital, a lender specializing in government
guaranteed loans.
Compliance with Section 16(a) of the Exchange Act
Reference is made to the cover page of this report and to the section
captioned "Section 16(a) Beneficial Ownership Reporting Compliance" in the
Company's Proxy Statement for the 2008 Annual Meeting of Stockholders.
Disclosure of Code of Ethics and Business Conduct
For information concerning the Company's code of ethics, the
information contained under the section captioned "Corporate Governance--Code of
Ethics and Business Conduct" in the Company's Proxy Statement for the 2008
Annual Meeting of Stockholders is incorporated by reference. A copy of the code
of ethics and business conduct is available, without charge, upon written
request to Nancy L. Grady, Corporate Secretary, New England Bancshares, Inc.,
855 Enfield Street, Enfield, Connecticut 06082.
Corporate Governance
For information regarding the audit committee and its composition and
the audit committee financial expert, the section captioned "Corporate
Governance - Committees of the Board of Directors - Audit Committee" in the
Company's Proxy Statement for the 2008 Annual Meeting of Stockholders is
incorporated by reference.
ITEM 11. EXECUTIVE COMPENSATION
The information regarding executive compensation is incorporated herein
by reference to the sections captioned "Corporate Governance - Directors'
Compensation" and "Executive Compensation" in the Company's Proxy Statement for
the 2008 Annual Meeting of Stockholders.
80
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
AND RELATED STOCKHOLDER MATTERS
(a) Security Ownership of Certain Beneficial Owners
Information required by this item is incorporated herein by
reference to the section captioned "Stock Ownership" in the
Company's Proxy Statement for the 2008 Annual Meeting of
Stockholders.
(b) Security Ownership of Management
Information required by this item is incorporated herein by
reference to the section captioned "Stock Ownership" in the
Company's Proxy Statement for the 2008 Annual Meeting of
Stockholders.
(c) Changes in Control
Management of New England Bancshares knows of no arrangements,
including any pledge by any person of securities of New
England Bancshares, the operation of which may at a subsequent
date result in a change in control of the registrant.
(d) Equity Compensation Plan Information
The following table provides information as of March 31, 2008 for
compensation plans under which equity securities may be issued.
- ------------------------------------------------------------------------------------------------------------------
Plan category Number of Securities to be Weighted-average exercise Number of securities
issued upon exercise of price of outstanding remaining available for
outstanding options, options, warrants and future issuance under
warrants and rights rights equity compensation plans
(excluding securities
reflected in column (a))
(a) (b) (c)
- ------------------------------------------------------------------------------------------------------------------
Equity compensation plans
approved by security holders 349,997 $8.84 193,989
- ------------------------------------------------------------------------------------------------------------------
Equity compensation plans not
approved by security holders --- --- ---
- ------------------------------------------------------------------------------------------------------------------
Total 349,997 $8.84 193,989
- ------------------------------------------------------------------------------------------------------------------
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS AND DIRECTOR
INDEPENDENCE
Certain Relationships and Related Transactions
For information regarding certain relationships and related
transactions, the section captioned "Transactions with Related Persons" in the
Company's Proxy Statement for the 2008 Annual Meeting of Stockholders is
incorporated by reference.
Corporate Governance
For information regarding director independence, the section captioned
"Proposal 1 - Election of Directors" in the Company's Proxy Statement for the
2008 Annual Meeting of Stockholders is incorporated by reference.
81
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information relating to the Company's principal accountant fees and
services is incorporated herein by reference to the section captioned "Proposal
2--Ratification of Independent Auditors" in the Company's Proxy Statement for
the 2008 Annual Meeting of Stockholders.
PART IV
ITEM 15. EXHIBITS AND FINANCIAL SATEMENT SCHEDULES
2.1 Agreement and Plan of Merger, dated November 21, 2006, by and
among, New England Bancshares, Inc., New England Bancshares
Acquisition, Inc. and First Valley Bancorp, Inc. (1)
3.1 Articles of Incorporation of New England Bancshares, Inc.
((2))
3.2 Bylaws of New England Bancshares, Inc. ((2))
4.0 Specimen stock certificate of New England Bancshares, Inc.
((2))
10.1 Form of Enfield Federal Savings and Loan Association Employee
Stock Ownership Plan and Trust((3))
10.2 Employment Agreement by and between Enfield Federal Savings
and Loan Association and David J. O'Connor ((4))
10.3 Employment Agreement by and between New England Bancshares,
Inc. and David J. O'Connor ((4))
10.4 Form of Enfield Federal Savings and Loan Association Employee
Severance Compensation Plan((3))
10.5 Enfield Federal Savings and Loan Association Employee Savings
& Profit-Sharing Plan and Adoption Agreement ((3))
10.6 Enfield Federal Savings and Loan Association Executive
Supplemental Retirement Plan, as amended and restated (5)
10.7 Form of Enfield Federal Savings and Loan Association
Supplemental Executive Retirement Plan((3))
10.8 Form of Enfield Federal Savings and Loan Association Director
Fee Continuation Plan ((3))
10.9 Split Dollar Arrangement with David J. O'Connor ((3))
10.10 New England Bancshares, Inc. 2003 Stock-Based Incentive Plan,
as amended and restated (7)
10.11 Change in Control Agreement by and among Enfield Federal
Savings and Loan Association, New England Bancshares, Inc. and
John F. Parda, as amended and restated ((8))
10.12 Change in Control Agreement by and among Enfield Federal
Savings and Loan Association, New England Bancshares, Inc. and
Scott D. Nogles, as amended and restated ((8))
10.13 Lease agreement with Troiano Professional Center, LLC ((6))
10.14 Employment Agreement by and between New England Bancshares,
Inc. and Robert L. Messier, Jr.(9)
23.1 Consent of Shatswell, MacLeod & Company, P.C.
31.1 Rule 13a-14(a) /15d-14(a) Certification of Chief Executive
Officer
31.2 Rule 13a-14(a) /15d-14(a) Certification of Chief Financial
Officer
32.1 Section 1350 Certification of Chief Executive Officer
32.2 Section 1350 Certification of Chief Financial Officer
--------------------
(1) Incorporated by reference into this document from the exhibits to the
Current Report on Form 8-K filed on November 28, 2006.
(2) Incorporated by reference into this document from the Company's Form
SB-2, Registration Statement filed under the Securities Act of 1933,
Registration No. 333-128277.
(3) Incorporated by reference into this document from the Company's Form
SB-2, Registration Statement filed under the Securities Act of 1933,
Registration No. 333-82856.
(4) Incorporated herein by reference into this document from the exhibits
to the Quarterly Report on Form 10-QSB for the quarter ended December
31, 2005.
(5) Incorporated by reference into this document from the exhibits to the
Annual Report on Form 10-K for the year ended March 31, 2006.
(6) Incorporated by reference into this document from the exhibits to the
Annual Report on Form 10-K for the year ended March 31, 2005.
(7) Incorporated by reference from the Proxy Statement for the 2003 Special
Meeting of Stockholders.
(8) Incorporated by reference into this document from the exhibits to the
Annual Report on Form 10-K for the year ended March 31, 2007.
(9) Incorporated by reference into this document from the exhibits to the
Quarterly Report on Form 10-QSB filed November 14, 2007.
82
SIGNATURES
In accordance with Section 13 or 15(d) of the Exchange Act, the
registrant caused this report to be signed on its behalf by the undersigned,
thereunto duly authorized.
New England Bancshares, Inc.
Date: June 27, 2008 By: /s/ David J. O'Connor
--------------------------------------
David J. O'Connor
Chief Executive Officer
and Director
In accordance with the Exchange Act, this report has been signed below
by the following persons on behalf of the registrant in the capacities and on
the dates indicated.
/s/ David J. O'Connor /s/ Scott D. Nogles
- ----------------------------------------------- ---------------------------------------
David J. O'Connor, Chief Executive Scott D. Nogles, Executive Vice President and Chief
Officer and Director (principal executive officer) Financial Officer (principal financial and
accounting officer)
Date: June 27, 2008 Date: June 27, 2008
/s/ Thomas O. Barnes /s/ Lucien P. Bolduc
- ----------------------------------------------- ---------------------------------------
Thomas O. Barnes, Director Lucien P. Bolduc, Director
Date: June 27, 2008 Date: June 27, 2008
/s/ Edmund D. Donovan /s/ Peter T. Dow
- ----------------------------------------------- ---------------------------------------
Edmund D. Donovan, Director Peter T. Dow, Chairman of the Board
Date: June 27, 2008 Date: June 27, 2008
/s/ William C. Leary /s/ Myron J. Marek
- ----------------------------------------------- ---------------------------------------
William C. Leary, Director Myron J. Marek, Director
Date: June 27, 2008 Date: June 27, 2008
/s/ Dorothy K. McCarty /s/ Robert L. Messier, Jr.
- ----------------------------------------------- ---------------------------------------
Dorothy K. McCarty, Director Robert L. Messier, Jr., President and Director
Date: June 27, 2008 Date: June 27, 2008
/s/ James J. Pryor /s/ Richard K. Stevens
- ----------------------------------------------- ---------------------------------------
James J. Pryor, Director Richard K. Stevens, Director
Date: June 27, 2008 Date: June 27, 2008
/s/ Richard M. Tatoian, Esq.
- -----------------------------------------------
Richard M. Tatoian, Esq., Director
Date: June 27, 2008
83