UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
SCHEDULE 14A
(Rule 14a-101)
INFORMATION REQUIRED IN PROXY STATEMENT
SCHEDULE 14A INFORMATION
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First Litchfield Financial Corporation
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(Name of Registrant as Specified In Its Charter)
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(Name of Person(s) Filing Proxy Statement, if Other Than the Registrant)
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1) Title of each class of securities to which transaction applies:
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[Logo of First Litchfield Financial Corporation]
MERGER PROPOSED - YOUR VOTE IS VERY IMPORTANT
Dear Stockholder:
The board of directors of First Litchfield Financial Corporation has
unanimously approved a merger of First Litchfield with and into Union Savings
Bank. Under the terms of the proposed merger, First Litchfield stockholders
will receive $15.00 cash for each share of First Litchfield common stock that
they own.
The merger cannot be completed unless the stockholders of First Litchfield
approve the merger agreement. First Litchfield will hold a special meeting of
stockholders at the Litchfield Inn, 432 Bantam Road (Route 202), Litchfield,
Connecticut, on Friday, February 19, 2010 at 3:00 p.m., local time. The board of
directors of First Litchfield unanimously recommends that you vote "FOR" the
merger agreement and "FOR" the adjournment proposal, if necessary.
This document serves as the proxy statement for the special meeting of
stockholders of First Litchfield. This document describes the special meeting,
the merger, the documents related to the merger, and other related matters. WE
URGE YOU TO READ THIS ENTIRE DOCUMENT CAREFULLY. YOU CAN ALSO OBTAIN INFORMATION
ABOUT FIRST LITCHFIELD FROM DOCUMENTS FILED WITH THE SECURITIES AND EXCHANGE
COMMISSION.
YOUR VOTE IS VERY IMPORTANT. Whether or not you plan to attend the special
meeting of First Litchfield, please take the time to vote by completing and
mailing the enclosed proxy card. If you sign, date and mail your proxy card
without indicating how you want to vote, your proxy will be counted as a vote
"FOR" the merger agreement and "FOR" the adjournment proposal, if necessary. If
you do not return the proxy card, it will have the same effect as a vote against
the merger agreement.
Sincerely,
Joseph J. Greco
President and Chief Executive Officer
FIRST LITCHFIELD FINANCIAL CORPORATION
13 NORTH STREET
P.O. BOX 578
LITCHFIELD, CONNECTICUT 06759
(860) 567-8752
NOTICE OF SPECIAL MEETING OF STOCKHOLDERS
TO BE HELD ON FEBRUARY 19, 2010
NOTICE IS HEREBY GIVEN that a special meeting of stockholders of First
Litchfield Financial Corporation will be held on Friday, February 19, 2010 at
3:00 p.m., local time at the Litchfield Inn, 432 Bantam Road (Route 202),
Litchfield, Connecticut, for the following purposes:
1. To consider and vote upon a proposal to approve the Agreement and Plan
of Merger by and among Union Savings Bank, First Litchfield Financial
Corporation and The First National Bank of Litchfield, dated as of
October 25, 2009 and the transactions contemplated therein, pursuant
to which a subsidiary of Union will merge with and into First
Litchfield, with First Litchfield being the surviving corporation, and
First Litchfield will be dissolved and The First National Bank of
Litchfield will merge with and into Union Savings Bank, resulting in
Union Savings Bank being the sole surviving entity;
2. To consider and vote upon a proposal to approve one or more
adjournments of the special meeting, if necessary, to permit further
solicitation of proxies if there are not sufficient votes at the time
of the special meeting, or at any adjournment or postponement of that
meeting, to approve the merger agreement; and
3. To consider and act upon such other matters as may properly come
before the special meeting or any adjournment or postponement of that
meeting.
As of the date of this document, management of First Litchfield is not
aware of any other business to be considered at the special meeting.
The proposed merger of First Litchfield and Union is more fully described
in the attached document, which you should read carefully and in its entirety
before voting. A copy of the merger agreement is included as Annex A to the
attached document.
Only those stockholders of record at the close of business on December 30,
2009, the record date, are entitled to notice of, and to vote at the special
meeting or any adjournment or postponement of that meeting. A list of those
stockholders will be available for inspection by stockholders for ten (10) days
preceding the special meeting at the office of the Assistant Secretary of First
Litchfield at First Litchfield's main office, 13 North Street, Litchfield,
Connecticut, and will also be available for inspection by stockholders at the
special meeting.
The affirmative vote of holders of at least two-thirds of the shares of
First Litchfield common stock outstanding and entitled to vote at the special
meeting is required to approve the merger agreement. THE FIRST LITCHFIELD BOARD
OF DIRECTORS UNANIMOUSLY RECOMMENDS THAT YOU VOTE "FOR" APPROVAL OF THE MERGER
AGREEMENT AND "FOR" THE ADJOURNMENT PROPOSAL, IF NECESSARY.
First Litchfield stockholders are entitled to dissent to the merger and
assert appraisal rights under Section 262 of the Delaware General Corporation
Law. A copy of Section 262 is attached hereto as Annex C.
STOCKHOLDERS ARE REQUESTED TO MARK, DATE, SIGN, AND RETURN THE ENCLOSED PROXY AS
SOON AS POSSIBLE REGARDLESS OF WHETHER THEY PLAN TO ATTEND THE MEETING. ANY
PROXY GIVEN BY A STOCKHOLDER MAY BE REVOKED AT ANY TIME BEFORE IT IS EXERCISED,
AND ANY STOCKHOLDER WHO EXECUTES AND RETURNS A PROXY AND WHO ATTENDS THE
SPECIAL MEETING MAY WITHDRAW THE PROXY AT ANY TIME BEFORE IT IS VOTED AND
VOTE HIS OR HER SHARES IN PERSON. A PROXY MAY BE REVOKED BY GIVING NOTICE
TO MICHELLE QUIGLEY, ASSISTANT SECRETARY OF FIRST LITCHFIELD FINANCIAL
CORPORATION, IN WRITING PRIOR TO THE TAKING OF A VOTE.
By Order of the Board of Directors of First
Litchfield Financial Corporation
George M. Madsen
Secretary
Litchfield, Connecticut
January 6, 2010
PLEASE DO NOT SEND YOUR STOCK CERTIFICATES WITH YOUR PROXY CARD. YOU WILL
RECEIVE SEPARATE INSTRUCTIONS REGARDING THE SURRENDER OF YOUR STOCK
CERTIFICATES.
TABLE OF CONTENTS
QUESTIONS AND ANSWERS ABOUT THE MERGER AND THE SPECIAL MEETING 1
SUMMARY 5
The Companies 5
The Special Meeting of First Litchfield Stockholders 7
The Merger 8
Selected Financial Data 13
Stock Prices and Dividends 13
Number of Holders of Common Stock and Number of Shares Outstanding 14
RISK FACTORS RELATING TO THE MERGER 15
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS 17
THE COMPANIES 18
Union Savings Bank 18
First Litchfield Financial Corporation 18
THE SPECIAL MEETING OF FIRST LITCHFIELD STOCKHOLDERS 22
Date, Time and Place of the Special Meeting 22
Purpose of the Special Meeting 22
Recommendation of the First Litchfield Board of Directors 22
Record Date; Outstanding Shares; Shares Entitled to Vote 22
Quorum; Vote Required 23
Share Ownership of Management 23
Voting of Proxies 23
How to Revoke Your Proxy 24
Voting in Person 24
Abstentions and Broker Non-Votes 24
Proxy Solicitation 25
Appraisal Rights 25
Stock Certificates 30
Proposal to Approve Adjournment of Special Meeting 30
THE MERGER 31
General 31
Background of the Merger 31
First Litchfield's Reasons for the Merger 34
Recommendation of the First Litchfield Board of Directors 35
Fairness Opinion of First Litchfield's Financial Advisor 36
Deregistration of First Litchfield Common Stock Following the Merger 45
INTERESTS OF FIRST LITCHFIELD'S DIRECTORS AND OFFICERS IN THE MERGER 46
General 46
i
Agreements with Executive Officers 46
Directors' and Officers' Insurance 49
Appointment of Three First Litchfield Directors to the Board of Trustees of
Union 49
Stock Ownership and Voting Power 50
THE MERGER AGREEMENT 51
Structure of the Merger 51
Closing of the Merger 51
Merger Consideration 51
Exchange of First Litchfield Stock Certificates for Cash 51
Conditions to the Merger 52
Termination 54
Termination Fee 56
No Solicitation 57
First Litchfield Stockholders Meeting 58
Directors' and Officers' Insurance 59
Conduct of Business Pending the Merger 59
Redemption 63
Employee Benefits 63
Representations and Warranties 64
Expenses 66
Amendments 66
Regulatory Approvals Required for the Merger 66
MATERIAL FEDERAL INCOME TAX CONSEQUENCES 68
Receipt of Merger Consideration 68
Backup Withholding 68
Other Tax Consequences 69
SECURITY OWNERSHIP OF PRINCIPAL STOCKHOLDER 69
SECURITY OWNERSHIP OF EXECUTIVE OFFICERS AND DIRECTORS 69
WHERE YOU CAN FIND MORE INFORMATION 71
PROPOSALS OF STOCKHOLDERS 71
Annex A Agreement and Plan of Merger
Annex B Fairness Opinion of Raymond James & Associates, Inc.
Annex C Section 262 of the Delaware General Corporation Law
Annex D Excerpts from First Litchfield's Form 10-K for the Year Ended
December 31, 2008
Annex E Excerpts from First Litchfield's Form 10-Q for the Quarter Ended
September 30, 2009
ii
QUESTIONS AND ANSWERS ABOUT THE MERGER AND THE SPECIAL MEETING
Q: WHY AM I RECEIVING THIS DOCUMENT?
A: First Litchfield Financial Corporation and Union Savings Bank have agreed
to the acquisition of First Litchfield by Union under the terms of a merger
agreement that is described in this document. A copy of the merger
agreement is attached to this document as Annex A. In order to complete the
merger, the stockholders of First Litchfield must vote to approve the
merger agreement. First Litchfield will hold a special meeting of its
stockholders to obtain this approval. This document contains important
information about the merger, the merger agreement, the special meeting of
First Litchfield stockholders, and other related matters, and you should
read it carefully. The enclosed voting materials allow you to vote your
shares of First Litchfield common stock without attending the special
meeting.
Q: WHAT WILL HAPPEN IN THE MERGER?
A: In the proposed merger, a special purpose subsidiary of Union will merge
with and into First Litchfield, with First Litchfield being the surviving
corporation, and First Litchfield will be dissolved, resulting in Union
owning all the assets and liabilities of First Litchfield. Separately, The
First National Bank of Litchfield will merge into Union, with Union being
the surviving entity.
Q: WHAT WILL FIRST LITCHFIELD STOCKHOLDERS RECEIVE IN THE MERGER?
A: You will receive $15.00 cash in exchange for each share of First Litchfield
common stock that you own immediately prior to the effective time of the
merger.
Q: WHAT ARE THE MATERIAL FEDERAL INCOME TAX CONSEQUENCES OF THE MERGER TO
FIRST LITCHFIELD STOCKHOLDERS?
A: You will generally recognize either a gain or loss for federal income tax
purposes on each share of First Litchfield common stock surrendered in an
amount equal to the difference between your adjusted tax basis in that
share and $15.00 upon completion of the merger. We strongly urge you to
consult your own tax advisor for a full understanding of the tax
consequences of the merger to you.
Q: WHAT ARE THE CONDITIONS TO COMPLETION OF THE MERGER?
A: The obligations of First Litchfield and Union to complete the merger are
subject to the satisfaction or waiver of certain closing conditions
contained in the merger agreement, including the receipt of required
regulatory approvals and approval of the merger agreement by First
Litchfield stockholders.
Q: WHEN DO YOU EXPECT THE MERGER TO BE COMPLETED?
A: We will complete the merger when all of the conditions to completion
contained in the merger agreement are satisfied or waived, including
obtaining the approval of the merger
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agreement by First Litchfield stockholders at the special meeting.
Fulfilling some of these conditions, such as receiving required regulatory
approvals, is not entirely within our control. We currently expect to
complete the merger during the first calendar quarter of 2010 or as soon
thereafter as practicable; however, because the merger is subject to these
conditions, we cannot predict the actual timing.
Q: WHAT STOCKHOLDER APPROVAL IS REQUIRED TO COMPLETE THE MERGER?
A: The affirmative vote of holders of at least two-thirds of the shares of
First Litchfield common stock outstanding and entitled to vote at the First
Litchfield special meeting is required to approve the merger agreement.
Q: WHEN AND WHERE IS THE SPECIAL MEETING OF FIRST LITCHFIELD STOCKHOLDERS?
A: The special meeting of stockholders of First Litchfield will be held at the
Litchfield Inn, 432 Bantam Road (Route 202), Litchfield, Connecticut, on
Friday, February 19, 2010 at 3:00 p.m., local time.
Q: WHAT WILL HAPPEN AT THE SPECIAL MEETING OF FIRST LITCHFIELD STOCKHOLDERS?
A: At the special meeting, you will consider and vote upon a proposal to
approve the merger agreement. If, at the time of the special meeting, there
are not sufficient votes to approve the merger agreement, you may be asked
to consider and vote upon a proposal to adjourn the special meeting, so
that First Litchfield can solicit additional proxies.
Q: DOES THE FIRST LITCHFIELD BOARD OF DIRECTORS RECOMMEND VOTING IN FAVOR OF
THE MERGER AGREEMENT?
A: Yes. After careful consideration, the First Litchfield board of directors
unanimously recommends that First Litchfield stockholders vote "FOR"
approval of the merger agreement and "FOR" the adjournment proposal, if
necessary.
Q: ARE THERE ANY RISKS THAT I SHOULD CONSIDER IN DECIDING WHETHER TO VOTE
FOR APPROVAL OF THE MERGER AGREEMENT?
A: Yes. You should read and carefully consider the risk factors set forth in
the section in this document titled "Risk Factors" beginning on page -.
Q: WHAT DO I NEED TO DO NOW?
A: You should carefully read and consider the information contained or
incorporated by reference into this document, including its annexes. It
contains important information about the merger, the merger agreement and
First Litchfield. After you have read and considered this information, you
should complete and sign your proxy card and return it in the enclosed
postage-paid return envelope as soon as possible. By doing so, you ensure
that your shares of First Litchfield common stock will be represented and
voted at the First Litchfield special meeting.
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Q: IF MY SHARES ARE HELD IN "STREET NAME" BY MY BROKER, BANK OR OTHER NOMINEE,
WILL MY BROKER, BANK OR OTHER NOMINEE AUTOMATICALLY VOTE MY SHARES FOR ME?
A: No. Your broker, bank or other nominee will not vote your shares unless you
provide instructions to your broker, bank or other nominee on how to vote.
You should fill out the voter instruction form sent to you by your broker,
bank or other nominee with this document.
Q: WHAT IF I FAIL TO RETURN MY PROXY CARD OR TO INSTRUCT MY BROKER, BANK OR
OTHER NOMINEE?
A: If you fail to return your proxy card or to instruct your broker, bank or
other nominee to vote your shares, your shares will not be voted and this
will have the same effect as a vote against approval of the merger
agreement.
Q: CAN I ATTEND THE FIRST LITCHFIELD SPECIAL MEETING AND VOTE MY SHARES IN
PERSON?
A: Yes. Although the First Litchfield board of directors requests that you
return the proxy card accompanying this document, all First Litchfield
stockholders are invited to attend the special meeting. First Litchfield
stockholders of record on December 30, 2009 can vote in person at the First
Litchfield special meeting. If your shares are held by a broker, bank or
other nominee, then you are not the stockholder of record and you must
bring to the special meeting appropriate documentation from your broker,
bank or other nominee to enable you to vote at the special meeting.
Q: CAN I CHANGE MY VOTE AFTER I HAVE MAILED MY SIGNED PROXY CARD?
A: Yes. If you have not voted through your broker, bank or other nominee,
there are three ways you can change your vote at any time after you have
sent in your proxy card and before your proxy is voted at the First
Litchfield special meeting.
- You may deliver a written notice bearing a date later than the
date of your proxy card to the secretary of First Litchfield, stating
that you revoke your proxy.
- You may complete and deliver to the secretary of First Litchfield
a new proxy card relating to the same shares and bearing a later date.
- You may attend the special meeting and vote in person, although
attendance at the First Litchfield special meeting will not, by
itself, revoke a proxy.
You should send any notice of revocation or your completed new proxy card,
as the case may be, to First Litchfield at the following address:
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First Litchfield Financial Corporation
13 North Street
P.O. Box 578
Litchfield, Connecticut 06759
Attn: Michelle L. Quigley, Assistant Secretary
If you have instructed a bank, broker or other nominee to vote your shares,
you must follow the directions you receive from your bank, broker or other
nominee to change your vote.
Q: SHOULD FIRST LITCHFIELD STOCKHOLDERS SEND IN THEIR STOCK CERTIFICATES NOW?
A: No. You will receive separate written instructions for surrendering your
shares of First Litchfield common stock in exchange for the merger
consideration promptly following the effective date of the merger. In the
meantime, you should retain your stock certificate(s) because they are
still valid. Please do not send in your stock certificate(s) with your
proxy card.
Q: WHERE CAN I FIND MORE INFORMATION ABOUT FIRST LITCHFIELD?
A: You can find more information about First Litchfield from the various
sources described under the section of this document titled "The
Companies - First Litchfield Financial Corporation" beginning on page - and
"Where You Can Find More Information" beginning on page -.
Q: WHOM SHOULD I CALL WITH QUESTIONS?
A: You may contact First Litchfield at (860) 567-8752. Please ask to speak
with Michelle L. Quigley, Assistant Secretary.
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SUMMARY
This summary highlights selected information from this document and may not
contain all of the information that is important to you. To more fully
understand the merger and for a more complete description of the legal terms of
the merger, you should read this entire document, including the materials
attached as annexes, as well as the other documents to which we have referred
you. See "Where You Can Find More Information" beginning on page -. The page
references in parentheses included in this summary will direct you to a more
detailed description of each topic presented.
Unless the context otherwise requires, throughout this document, "First
Litchfield" refers collectively to First Litchfield Financial Corporation and
its subsidiaries; "FNBL" refers to The First National Bank of Litchfield and its
subsidiaries; and "Union" refers to Union Savings Bank and its subsidiaries.
Also, we refer to the merger between First Litchfield and Union as the "merger"
and the Agreement and Plan of Merger, dated as of October 25, 2009, by and among
First Litchfield, FNBL and Union as the "merger agreement."
THE COMPANIES
UNION SAVINGS BANK
Union Savings Bank was incorporated in 1866 as a Connecticut-chartered
mutual savings bank. The principal business of Union is to provide commercial
banking, retail and small business banking, and wealth management services to
individual, corporate and municipal customers. Banking activities are conducted
primarily within western Connecticut. This full range of financial services is
delivered through a network of 18 offices in northern Fairfield and Litchfield
counties.
At September 30, 2009, Union had total assets of approximately $2.0
billion, loans of approximately $1.5 billion and deposits of approximately $1.1
billion.
Union's principal executive offices are located at 225 Main Street,
Danbury, Connecticut. The mailing address for Union is P.O. Box 647, Danbury,
Connecticut 06813-0647, and its telephone number is (203) 830-4200.
FIRST LITCHFIELD FINANCIAL CORPORATION (PAGE -)
First Litchfield Financial Corporation, a Delaware corporation incorporated
in 1988, is a registered bank holding company under the Bank Holding Company Act
of 1956, as amended. First Litchfield has one banking subsidiary, FNBL,
continually in business since 1814, which provides a broad array of consumer and
commercial banking services to individuals and to small and mid-size businesses
through nine branch locations in Litchfield and Hartford Counties, Connecticut.
At September 30, 2009, First Litchfield had total consolidated assets of
approximately $551 million, loans of approximately $377 million, deposits of
approximately $383 million and stockholders' equity of approximately $31
million.
5
First Litchfield's principal executive offices are located at 13 North
Street, Litchfield, Connecticut 06759, and its telephone number is (860)
567-8752.
6
THE SPECIAL MEETING OF FIRST LITCHFIELD STOCKHOLDERS
TIME, PLACE AND PURPOSE OF THE SPECIAL MEETING (PAGE -)
The special meeting of stockholders of First Litchfield will be held at the
Litchfield Inn, 432 Bantam Road (Route 202), Litchfield, Connecticut, on Friday,
February 19, 2010 at 3:00 p.m., local time. At the special meeting, First
Litchfield's stockholders as of the record date will be asked to vote upon a
proposal to approve the merger agreement with Union.
RECOMMENDATION OF FIRST LITCHFIELD BOARD OF DIRECTORS (PAGE -)
The First Litchfield board of directors unanimously recommends that you
vote "FOR" approval of the merger agreement and "FOR" the adjournment proposal,
if necessary.
RECORD DATE; OUTSTANDING SHARES; SHARES ENTITLED TO VOTE (PAGE -)
Only holders of record of First Litchfield common stock at the close of
business on the record date of December 30, 2009, are entitled to notice of and
to vote at the special meeting. As of the record date, there were 2,356,875
shares of First Litchfield common stock outstanding, held of record by
approximately - stockholders.
QUORUM; VOTE REQUIRED (PAGE -)
A quorum of First Litchfield stockholders is necessary to hold a valid
meeting. If the holders of at least a majority of the total number of the
outstanding shares of First Litchfield common stock entitled to vote are
represented in person or by proxy at the special meeting, a quorum will exist.
First Litchfield will include proxies marked as abstentions and broker non-votes
in determining the number of shares present at the special meeting.
The affirmative vote of the holders of at least two-thirds of the
outstanding shares of First Litchfield common stock is required to approve the
merger agreement. Proxies marked as abstentions and broker non-votes will be
counted as votes against the merger agreement.
SHARE OWNERSHIP OF MANAGEMENT (PAGE -)
As of the record date, the directors and executive officers of First
Litchfield and their affiliates collectively owned 202,052 shares of First
Litchfield common stock, or approximately 8.6% of First Litchfield's outstanding
shares.
PROXIES, VOTING AND REVOCATION (PAGE -)
The First Litchfield board of directors requests that you return the proxy
card accompanying this document for use at the special meeting. Please
complete, date and sign the proxy card and promptly return it in the enclosed
pre-paid envelope. All properly signed proxies received prior to the special
meeting and not revoked before the vote at the special meeting will be voted at
the special meeting according to the instructions indicated on the proxies or,
if no instructions are given, to approve the merger agreement.
7
You may revoke your proxy at any time by taking any of the following
actions before your proxy is voted at the special meeting:
- delivering a written notice bearing a date later than the date of
your proxy card to the secretary of First Litchfield, stating that you
revoke your proxy;
- signing and delivering to the secretary of First Litchfield a new
proxy card relating to the same shares and bearing a later date; or
- attending the special meeting and voting in person, although
attendance at the special meeting will not, by itself, revoke a proxy.
APPRAISAL RIGHTS (PAGE -)
First Litchfield is organized as a Delaware corporation. Pursuant to the
provisions of Section 262 of the Delaware General Corporation Law, First
Litchfield's stockholders are entitled to assert appraisal rights.
THE MERGER
STRUCTURE OF THE MERGER (PAGE -)
First Litchfield, FNBL and Union entered into an Agreement and Plan of
Merger on October 25, 2009. The merger agreement provides for the merger of a
special purpose subsidiary of Union with and into First Litchfield, with First
Litchfield being the surviving corporation, and the dissolution of First
Litchfield, resulting in Union owning all the assets and liabilities of First
Litchfield. The merger agreement also calls for the merger of FNBL with and into
Union, with Union being the sole surviving entity.
The merger will occur following approval of the proposal described in this
document by the stockholders of First Litchfield and satisfaction or waiver of
all other conditions to the merger. The merger agreement is attached to this
document as Annex A. We encourage you to read the merger agreement because it is
the legal document that governs the merger.
MERGER CONSIDERATION (PAGE -)
If the merger is completed, each share of First Litchfield common stock
will be converted into the right to receive $15.00 cash.
TREATMENT OF FIRST LITCHFIELD STOCK OPTIONS (PAGE -)
At the effective time of the merger, each outstanding option and warrant to
purchase First Litchfield common stock, whether vested or unvested, and which
has not been previously exercised or cancelled, will be converted to the right
to receive the difference between $15.00 and the exercise price multiplied by
the number of shares of common stock which the option or warrant entitled the
holder to purchase.
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FAIRNESS OPINION OF FIRST LITCHFIELD'S FINANCIAL ADVISOR (PAGE -)
In deciding to adopt the merger agreement and recommend its approval to
First Litchfield stockholders, the First Litchfield board of directors consulted
with senior management, its financial advisor, Raymond James & Associates, Inc.
("Raymond James"), and its legal counsel, and considered, among other things, an
opinion from its financial advisor. Raymond James has delivered an opinion to
the First Litchfield board of directors that, as of October 25, 2009 and based
on and subject to the matters set forth in its opinion, the merger consideration
was fair, from a financial point of view, to the holders of First Litchfield
common stock. The full text of the written opinion is attached to this document
as Annex B. We encourage you to read the opinion carefully and in its entirety.
The opinion of Raymond James is directed to the First Litchfield board of
directors and is not a recommendation to any stockholder on how to vote on
approval of the merger agreement.
INTERESTS OF FIRST LITCHFIELD'S DIRECTORS AND EXECUTIVE OFFICERS IN THE MERGER
(PAGE -)
Some of First Litchfield's management and board of directors may be deemed
to have interests in the merger that are in addition to or different from their
interests as stockholders of First Litchfield generally. The First Litchfield
board of directors was aware of these interests and considered them in
recommending that First Litchfield stockholders approve the merger agreement.
CONDITIONS TO THE MERGER (PAGE -)
First Litchfield and Union will not complete the merger unless a number of
conditions are satisfied or waived, including:
- the stockholders of First Litchfield must approve the merger
agreement;
- there must be no order, decree or injunction in effect, which
enjoins or prohibits consummation of the merger;
- First Litchfield and Union must receive all required regulatory
approvals, authorizations and consents, any waiting periods required
by law must have passed, and none of the regulatory approvals may
include any condition or requirement that would materially and
adversely affect Union;
- the representations and warranties of each of First Litchfield
and Union in the merger agreement must be true and correct in all
material respects, subject to exceptions that would not have a
material adverse effect;
- First Litchfield and Union must each have performed in all
material respects all obligations required to be performed by it;
- First Litchfield and Union must obtain all material permits,
authorizations, consents, waivers, clearances or approvals for the
consummation of the merger and the related transactions; and
9
- no event or development must have occurred with respect to First
Litchfield that has had, or would reasonably be expected to have, a
material adverse effect.
LIMITATIONS ON CONSIDERING OTHER ACQUISITION PROPOSALS (PAGE -)
The merger agreement restricts First Litchfield's ability to solicit or
otherwise facilitate any inquiries or the making of any proposal or engage in
negotiations with a third party regarding a merger or similar transaction, a
sale or transfer of 25% or more of its assets or the acquisition of 25% or more
of its outstanding stock. However, if First Litchfield receives a bona fide
unsolicited written proposal relating to any of the above from a third party
that, if consummated, would, in the good faith determination of the First
Litchfield board of directors, after consultation with its financial advisor,
result in a transaction that is more favorable to First Litchfield stockholders
from a financial point of view than the merger, and if the First Litchfield
board of directors determines in good faith, after consultation with outside
counsel, that it is required to take such action to comply with its fiduciary
duties to its stockholders under applicable law, First Litchfield may furnish
nonpublic information to that third party, subject to conditions specified in
the merger agreement, engage in negotiations or discussions regarding an
acquisition proposal with that third party, or recommend such proposal to First
Litchfield stockholders. If the First Litchfield board of directors determines
in good faith, after consultation with counsel and its financial advisor, that
it desires to accept such superior proposal, it must provide Union with notice
of such determination and provide Union an opportunity to increase the merger
consideration to an amount at least equal to that of the superior proposal. If
Union does so, First Litchfield may not enter into an agreement with such third
party or recommend acceptance of such proposal to First Litchfield stockholders.
TERMINATION OF THE MERGER AGREEMENT (PAGE -)
First Litchfield and Union can mutually agree to terminate the merger
agreement before the merger has been completed, and either company can terminate
the merger agreement if:
- the other party materially breaches any of its representations,
warranties, covenants or agreements contained in the merger agreement
(provided that the terminating party is not then in material breach of
any representation, warranty, covenant or other agreement contained in
the merger agreement), and the breach cannot be or has not been cured
within 30 days of written notice of the breach;
- if the merger has not occurred on or before June 30, 2010,
provided that such date shall be automatically extended to September
30, 2010 if required regulatory approvals have not been received by
June 1, 2010 and both parties are acting in good faith to obtain such
approvals, unless the failure of the merger to occur on or before such
date was due to the terminating party's breach of any obligations
under the merger agreement;
- the stockholders of First Litchfield do not approve the merger
agreement;
- any required regulatory approval for consummation of the merger
is not obtained;
10
- a court or other governmental authority permanently enjoins or
prohibits the merger; or
- if the conditions precedent to the obligations of such party to
consummate the merger cannot be satisfied or fulfilled by the
termination date of June 30, 2010 or September 30, 2010 as provided
above (provided that the terminating party is not then in material
breach of any representation, warranty, covenant or other agreement
contained in the merger agreement).
Union may terminate the merger agreement if the First Litchfield board of
directors:
- fails to make its recommendation to the First Litchfield
stockholders to vote in favor of the merger agreement or has
withdrawn, modified or changed such recommendation;
- fails to call, give notice of, convene and hold the First
Litchfield special meeting; or
- recommends that First Litchfield stockholders tender their shares
in a tender or exchange offer for 25% or more of the First Litchfield
common stock or otherwise fails to recommend that First Litchfield
stockholders reject such tender or exchange offer.
First Litchfield has the right to terminate the merger agreement if it
decides to enter into a definitive agreement to effect a superior proposal and
Union does not make an offer to First Litchfield that the First Litchfield board
of directors determines is at least as favorable as the superior proposal.
First Litchfield may also terminate the merger agreement if the conditions
precedent to its obligations to consummate the merger cannot be satisfied or
fulfilled by June 1, 2010, provided that if required regulatory approvals have
not been received and both parties are acting in good faith to obtain such
approvals, such date shall automatically be extended to September 1, 2010
(provided that First Litchfield is not then in material breach of any
representation, warranty, covenant or other agreement contained in the merger
agreement).
TERMINATION FEE (PAGE -)
Under the terms of the merger agreement, First Litchfield must pay Union a
termination fee of $1,750,000 if:
- Union terminates the merger agreement if First Litchfield's board
of directors:
- fails to make its recommendation to the First Litchfield
stockholders to vote in favor of the merger agreement or has
withdrawn, modified or changes such recommendation;
- fails to call, give notice of, convene and hold the First
Litchfield special meeting; or
- recommends that First Litchfield stockholders tender their
shares in a tender or exchange offer for 25% or more of the First
Litchfield common stock or
11
otherwise fails to recommend that First Litchfield stockholders
reject such tender or exchange offer.
- The merger agreement is terminated by:
- Union because First Litchfield materially breaches any of
its representations, warranties, covenants or agreements
contained in the merger agreement (provided that Union is not
then in material breach of any representation, warranty, covenant
or other agreement contained in the merger agreement), and the
breach cannot be or has not been cured within 30 days of written
notice of the breach;
- either First Litchfield or Union because the stockholders of
First Litchfield did not approve the merger agreement;
and, in either case, a merger or similar transaction for First
Litchfield, a sale or transfer of 25% or more of First Litchfield's
assets or the acquisition of 25% or more of First Litchfield's
outstanding stock has been announced prior to the termination by Union
or prior to the vote of First Litchfield stockholders.
In each such case, First Litchfield shall pay Union $750,000 upon
termination and, if within 18 months after such termination First
Litchfield enters into any agreement relating to merger or similar
transaction, a sale or transfer of 25% or more of its assets or the
acquisition of 25% or more of its outstanding stock, First Litchfield
shall pay the remainder of the termination fee.
- First Litchfield terminates the merger agreement because it has
entered into a definitive agreement to effect a superior proposal and
Union has not made an offer to First Litchfield that the First
Litchfield board of directors has determined is at least as favorable
as the superior proposal.
If the merger agreement is terminated by either party because of willful
conduct or gross negligence of the other party resulting in a material breach of
any of its representations, warranties, covenants or agreements contained in the
merger agreement, which breach has not been cured within 30 days of written
notice of the breach, then the breaching party shall pay to the non-breaching
party up to $500,000 for documented reasonable out-of pocket costs and expenses
incurred by the other party in connection with the merger agreement, except that
if First Litchfield has paid the termination fee, it shall not be liable for
such costs and expenses.
EFFECTIVE TIME OF THE MERGER (PAGE -)
We expect that the merger will be completed as soon as practicable
following the approval of the merger agreement by the stockholders of First
Litchfield at the First Litchfield special meeting, if all other conditions have
been satisfied or waived. The parties cannot be certain whether or when any of
the conditions to the merger will be satisfied or waived where permissible. We
expect that the merger will close during the first calendar quarter of 2010 or
as soon thereafter as practicable.
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REQUIRED REGULATORY APPROVALS (PAGE -)
To complete the merger, First Litchfield and Union need the prior approval
of the State of Connecticut Department of Banking and the Federal Deposit
Insurance Corporation. First Litchfield and Union have filed all necessary
applications and notices with the applicable regulatory authorities. First
Litchfield and Union cannot predict, however, whether or when the required
regulatory approvals will be obtained or whether any such approvals will impose
any burdensome condition upon Union.
MATERIAL FEDERAL INCOME TAX CONSEQUENCES (PAGE -)
Stockholders of First Litchfield will recognize gain or loss upon the
receipt of the merger consideration.
SELECTED FINANCIAL DATA
Selected balance sheet data of First Litchfield as of December 31, 2008,
2007, 2006, 2005 and 2004 and selected income statement data of First Litchfield
for the years ended December 31, 2008, 2007, 2006, 2005, and 2004 are contained
in Item 6 in Annex D attached to this proxy statement.
STOCK PRICES AND DIVIDENDS
First Litchfield common stock is traded on the Over the Counter ("OTC")
Bulletin Board under the symbol FLFL.OB. The following information sets forth
transactions in First Litchfield's common stock in each of the periods as
reported by Yahoo! Finance, as well as dividends declared per share of First
Litchfield common stock:
Calendar Year 2008 High/Low Dividends
-------- ---------
First Quarter $16.40 $13.25 $ 0.15
Second Quarter 14.45 11.50 0.15
Third Quarter 13.00 10.60 0.15
Fourth Quarter 11.25 5.25 0.15
Calendar Year 2009
First Quarter $11.00 $ 4.25 $ 0.05
Second Quarter 7.59 5.70 0.05
Third Quarter 7.24 5.55 -
Fourth Quarter 14.55 5.45 -
Calendar Year 2010
First Quarter through January - $ - - -
13
The high and low prices per share of First Litchfield common stock on
October 23, 2009, the last trading day before the public announcement of the
merger agreement, were $5.80 and $5.80 and on January -, 2010, the last full
trading day for which prices were available at the time of the printing of this
proxy statement, were $-.- and $-.-.
First Litchfield is prohibited by the merger agreement from declaring any
dividends on First Litchfield common stock until the merger is completed.
NUMBER OF HOLDERS OF COMMON STOCK AND NUMBER OF SHARES OUTSTANDING
As of December 30, 2009, the record date for the special meeting, there
were - stockholders of record of First Litchfield common stock who held an
aggregate of 2,356,875 shares of First Litchfield common stock.
Copies of the governing corporate instruments of First Litchfield are available,
without charge, by following the instructions listed under the section in this
document titled "Where You Can Find More Information" beginning on page -.
14
RISK FACTORS RELATING TO THE MERGER
In addition to the other information included in this document and
incorporated by reference in this document, you should consider carefully the
risk factors described below in deciding how to vote. You should keep these
risk factors in mind when you read forward-looking statements in this document
and in the documents incorporated by reference in this document. Please refer
to the section in this document titled "Special Note Regarding Forward-Looking
Statements" beginning on page -.
IF THE MERGER IS NOT COMPLETED, FNBL WILL CONTINUE TO BE SUBJECT TO THE FORMAL
AGREEMENT AND ENHANCED CAPITAL RATIOS.
FNBL is a party to a formal agreement with the Office of the Comptroller of
the Currency relating to the conduct of its business and subject to enhanced
capital requirements, as more fully described under "The Companies - First
Litchfield Financial Corporation" beginning on page -. If the merger is not
completed, these will inhibit the conduct of FNBL's business and may result in a
reduction of profits of FNBL. This in turn may reduce its ability to pay
dividends to First Litchfield, reducing or eliminating First Litchfield's
ability to pay dividends on its preferred stock and common stock. Further,
among the actions that First Litchfield may be required to take to comply with
the formal agreement and the enhanced capital requirements include obtaining
additional capital, but there can be no assurance that it will be successful in
doing so or if the additional capital is obtained, that it would be on terms
favorable to First Litchfield and not detrimental to the interests of First
Litchfield stockholders.
THE NEED FOR REGULATORY APPROVALS MAY DELAY THE DATE OF COMPLETION OF THE MERGER
OR MAY DIMINISH THE BENEFITS OF THE MERGER.
Union is required to obtain the approvals of several bank regulatory
agencies prior to completing the merger. Satisfying any requirements of these
regulatory agencies may delay the date of completion of the merger. In
addition, it is possible that, among other things, restrictions on the combined
operations of the two companies, including divestitures, may be sought by
governmental agencies as a condition to obtaining the required regulatory
approvals. This may diminish the benefits of the merger to Union. Union has
the right to terminate the merger agreement if a governmental agency, as part of
its authorization or approval, imposes any condition or requirement, excluding
standard conditions that are normally imposed by the regulatory authorities in
bank merger transactions, that would, in the good faith reasonable judgment of
the Board of Trustees of Union, materially and adversely affect the business,
operations, financial condition, property or assets of the combined enterprise
of First Litchfield, FNBL and Union or otherwise materially impair the value of
First Litchfield or FNBL to Union.
THE MERGER MAY DISTRACT MANAGEMENT FROM THEIR OTHER RESPONSIBILITIES.
The merger could cause the management of First Litchfield to focus its time
and energies on matters relating to the merger that otherwise would be directed
to the business and operations of First Litchfield. Any such distraction on the
part of First Litchfield's management, if significant, could affect its ability
to service existing business and develop new business and adversely affect the
business and earnings of First Litchfield if the merger is not consummated.
15
IF THE MERGER IS NOT COMPLETED, FIRST LITCHFIELD WILL HAVE INCURRED SUBSTANTIAL
EXPENSES WITHOUT ITS STOCKHOLDERS REALIZING THE EXPECTED BENEFITS.
First Litchfield has incurred substantial expenses in connection with the
transactions described in this document. If the merger is not completed, First
Litchfield expects to incur approximately $875,000 in merger-related expenses,
exclusive of any termination fee or costs and expenses paid to Union. These
expenses would likely have a material adverse impact on the financial condition
of First Litchfield because it would not have realized the expected benefits of
the merger. There can be no assurance that the merger will be completed.
THE TERMINATION FEE AND THE RESTRICTIONS ON SOLICITATION CONTAINED IN THE MERGER
AGREEMENT MAY DISCOURAGE OTHER COMPANIES FROM TRYING TO ACQUIRE FIRST
LITCHFIELD.
Until the completion of the merger, First Litchfield is prohibited from
soliciting, initiating, encouraging, or with some exceptions, considering any
inquiries or proposals that may lead to a proposal or offer for a merger or
other business combination transaction with any person other than Union. In
addition, First Litchfield has agreed to pay a termination fee of up to
$1,750,000 and to reimburse up to $500,000 of Union's out-of-pocket expenses in
specified circumstances. See "The Merger AgreementTermination Fee" beginning on
page -. These provisions could discourage other companies from trying to
acquire First Litchfield even though those other companies might be willing to
offer greater value to First Litchfield stockholders than Union has offered in
the merger. The payment of the termination fee also could have a material
adverse effect on First Litchfield's financial condition.
16
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This document contains statements that may be considered forward-looking
statements within the meaning of Section 27A of the Securities Act of 1933, as
amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the
"Exchange Act"). You can identify these statements by forward-looking words
such as "may," "could," "should," "would," "intend," "will," "expect,"
"anticipate," "believe," "estimate," "continue" or similar words. First
Litchfield and Union intend these forward-looking statements to be covered by
the safe harbor provisions for forward-looking statements contained in the
Private Securities Litigation Reform Act of 1995 and are including this
statement for purposes of complying with these safe harbor provisions. You
should read statements that contain these words carefully because they discuss
the relevant company's future expectations, contain projections of the relevant
company's future results of operations or financial condition, or state other
"forward-looking" information.
There may be events in the future that First Litchfield is not able to
predict accurately or control and that may cause actual results to differ
materially from the expectations described in these forward-looking statements.
Investors are cautioned that all forward-looking statements involve risks and
uncertainties, and actual results may differ materially from those discussed in
this document, including the documents incorporated by reference in this
document. These differences may be the result of various factors, including
those factors described in the "Risk Factors Relating to the Merger" beginning
on page - and other risk factors identified from time to time in First
Litchfield's periodic filings with the Securities and Exchange Commission (the
"SEC").
The factors referred to above include many, but not all, of the factors
that could impact First Litchfield's ability to achieve the results described in
any forward-looking statements. You should not place undue reliance on
forward-looking statements, which speak only as of the date of this document or
the date of any document incorporated by reference in this document. You should
be aware that the occurrence of the events described above and elsewhere in this
document, including the documents incorporated by reference, could harm First
Litchfield's business, prospects, operating results or financial condition.
First Litchfield undertakes no obligation to update any forward-looking
statements as a result of future events or developments.
17
THE COMPANIES
UNION SAVINGS BANK
Union was incorporated in 1866 as a Connecticut-chartered mutual savings
bank. Union has four subsidiaries including Somers Development, Inc., Juniper
Holdings, Inc., Bancroft Holdings, Inc., and Union Savings Mortgage Corporation.
Union Savings Mortgage Corporation operates as a passive investment company in
accordance with Connecticut law and the three other subsidiaries operate to hold
real property acquired through foreclosure.
The principal business of Union is to provide commercial banking, retail
and small business banking, and wealth management services to individual,
corporate and municipal customers. Traditional banking activities are conducted
primarily within western Connecticut and include extending secured and unsecured
commercial and consumer loans, originating mortgage loans secured by residential
and commercial properties, and accepting consumer, commercial and municipal
deposits. Such deposits include checking and savings accounts, certificate of
deposits, money markets and health savings accounts. In addition to traditional
banking activities, Union provides specialized financial services tailored to
specific markets including cash management and municipal banking services.
This full range of financial services is delivered through a network of 18
offices in northern Fairfield and Litchfield counties. Union's distribution
network also includes online banking and telephone banking services and
participation in a worldwide ATM network.
At September 30, 2009, Union had total assets of approximately $2.0
billion, loans of approximately $1.5 billion and deposits of approximately $1.1
billion.
Union's principal executive offices are located at 225 Main Street,
Danbury, Connecticut. The mailing address for Union is P.O. Box 647, Danbury,
Connecticut 06813-0647, and its telephone number is (203) 830-4200.
FIRST LITCHFIELD FINANCIAL CORPORATION
First Litchfield Financial Corporation, a Delaware corporation, is a
registered bank holding company under the Bank Holding Company Act of 1956, as
amended. First Litchfield was formed in 1988 and has one banking subsidiary,
The First National Bank of Litchfield, a national banking association organized
under the laws of the United States. FNBL and its predecessors have been in
existence since 1814. First Litchfield owns all of the outstanding shares of
FNBL. FNBL has three subsidiaries, Lincoln Corporation and Litchfield Mortgage
Service Corporation, which are Connecticut corporations, and First Litchfield
Leasing Corporation, which is a Delaware corporation. FNBL holds a majority
ownership position in First Litchfield Leasing Corporation. The purpose of
Lincoln Corporation is to hold property such as real estate, personal property,
securities, or other assets, acquired by FNBL through foreclosure or otherwise
to compromise a doubtful claim or collect a debt previously contracted. The
purpose of Litchfield Mortgage Service Corporation is to operate as a passive
investment company in accordance with Connecticut law.
18
FNBL engages in a wide range of commercial and personal banking activities,
including accepting demand deposits (including Money Market Accounts), accepting
savings and time deposit accounts, making secured and unsecured loans and leases
to corporations, individuals, and others, issuing letters of credit, originating
mortgage loans, and providing personal and corporate trust services.
FNBL's lending services include commercial, real estate, and consumer
installment loans and leases. Revenues from FNBL's lending activities constitute
the largest component of FNBL's operating revenues. The loan and lease portfolio
constitutes the major earning asset of FNBL and offers the best alternative for
maximizing interest spread above the cost of funds. FNBL's loan and lease
personnel have the authority to extend credit under guidelines established and
approved by the board of directors. Any aggregate credit which exceeds the
authority of the loan or lease officer is forwarded to the loan committee for
approval. The loan committee is composed of various experienced loan and lease
officers and FNBL directors. All aggregate credits that exceed the loan
committee's lending authority are presented to the full board of directors for
ultimate approval or denial. The loan committee not only acts as an approval
body to ensure consistent application of FNBL's loan and lease policy, but also
provides valuable insight through communication and pooling of knowledge,
judgment, and experience of its members.
FNBL's primary lending area generally includes towns located in Litchfield
and Hartford counties of Connecticut.
FNBL's Trust and Wealth Management Department provides a wide range of
personal and corporate trust and trust-related investment services, including
serving as executor of estates, as trustee under testamentary and intervivos
trusts and various pension and other employee benefit plans, as guardian of the
estates of minors and incompetents, and as escrow agent under various
agreements.
At September 30, 2009, First Litchfield had total consolidated assets of
approximately $551 million, loans of approximately $377 million, deposits of
approximately $383 million, and stockholders' equity of approximately $31
million.
On November 9, 2009, FNBL entered into a Formal Agreement with the Office
of the Comptroller of the Currency (the "OCC"). The Formal Agreement is a
remedial supervisory action with provisions intended to improve FNBL's condition
and operations. While not punitive, the Formal Agreement provides a framework
for addressing identified problems, documenting remedial efforts and preventing
the reoccurrence of similar problems so that FNBL's condition will improve and
no longer be considered to be troubled. Management and the Board are of the
opinion that compliance with the Formal Agreement is in the best interest of
FNBL but will require sustained effort and management resources.
To coordinate its compliance efforts pursuant to the Formal Agreement, the
Board of FNBL appointed a Compliance Committee consisting primarily of
independent Directors. The Compliance Committee will meet at least monthly to
monitor and report FNBL's progress to the Board. The Board will review FNBL's
liquidity plans, capital plans, strategic plans and
19
management and staffing plans and provide copies of such plans to the OCC along
with copies of the reports of the Compliance Committee and other relevant
information. The Board will assess the adequacy of FNBL's management and
staffing needs to assure that FNBL is well managed and well staffed. FNBL will
also notify the OCC regarding any proposed changes in the Board, executive
management or staff or changes in their duties or responsibilities.
Pursuant to the Formal Agreement, FNBL will not utilize brokered deposits
without appropriate FDIC and OCC authorization. In this regard, the only
deposits currently utilized by FNBL which could be characterized as "brokered
deposits" are deposits obtained through the Certificate of Deposit Account
Registry System ("CDARS") program. The CDARS program is a program in which
participating banks place large customer deposits into CDs issued by other banks
in the CDARS network in increments of less than the standard FDIC insurance
maximum to ensure that both principal and interest are eligible for full FDIC
insurance. The Formal Agreement with the OCC does not preclude FNBL from
participating in the CDARS program and FNBL has requested authorization from the
FDIC to continue to participate in such program. As of September 30, 2009, FNBL
has approximately $30 million in CDARS deposits, $11 million of which will
mature in January, 2010.
The Formal Agreement further requires FNBL to enhance its credit risk
management program within FNBL's loan and lease functions and to develop and
adhere to policies designed to enhance risk rating and risk monitoring. In
addition, FNBL has agreed to take appropriate action to improve and maintain
asset quality. FNBL will prepare written evaluations of and programs for
collecting any loans greater than $750,000 that are subject to criticism,
regularly review such loans, and only extend additional credit on such loans if
FNBL determines and documents that it is consistent with FNBL's plan to collect
the loan or strengthen the assets underlying the loan and the action is
necessary to protect FNBL's interests. In addition, FNBL will enhance and
document the programs it uses to evaluate, maintain and document the adequacy of
the Allowance for Loan and Lease Losses, which enhanced programs were utilized
in the evaluation of the Allowance for Loan and Lease Losses for the third
quarter of 2009, and provide a copy of such program and documentation to the
OCC.
The Formal Agreement precludes FNBL from growing assets at a rate greater
than 5% on an annual basis. In addition to updating its capital plan with
appropriate contingencies, the Formal Agreement precludes the payment of any
dividends inconsistent with the capital plan or applicable law and without
written non-objection by the OCC. The merger agreement with Union precludes the
payment of dividends to the stockholders of First Litchfield's common stock
pending consummation of the merger.
FNBL understands that the Formal Agreement with the OCC will remain in
place so long as FNBL remains subject to OCC supervision or until such time as
the Formal Agreement is terminated by the OCC, which will generally not occur
until the issues which were the basis of the Formal Agreement have been
corrected and verified through an examination and until there is no basis for
supervisory concern. Failure to comply with the Formal Agreement could result in
more serious supervisory action by the OCC with respect to FNBL, its officers or
directors.
20
In addition to the Formal Agreement, FNBL has been notified that the OCC
will require FNBL to achieve and maintain the following capital ratios by no
later than March 31, 2010:
- Total risk-based capital at least equal to twelve percent (12%) of
risk-weighted assets (as compared with 10.80% maintained by FNBL at September
30, 2009 and 10% generally required of well-capitalized banks);
- Tier 1 capital at least equal to ten percent (10%) of risk weighted
assets (as compared with 9.54% maintained by FNBL at September 30, 2009, and 6%
generally required of well-capitalized banks); and
- Tier 1 capital at least equal to eight percent (8%) of adjusted total
assets (as compared with 6.59% maintained by FNBL at September 30, 2009 and 5%
generally required of well-capitalized banks).
FNBL expects to consummate the merger with and into Union prior to the date
by which it would be required to achieve and maintain such capital ratios.
However, there can be no assurance that the merger will be consummated within
such timeframe. Accordingly, FNBL will develop contingency plans to address
compliance with such capital requirements in the event that the merger is not
consummated by March 31, 2010. Among such contingency plans may be seeking to
raise additional capital, but there can be no assurance that First Litchfield
will be successful in doing so or if the additional capital is obtained, that it
would be on terms favorable to First Litchfield and not detrimental to the
interests of First Litchfield stockholders.
First Litchfield's principal executive offices are located at 13 North
Street, Litchfield, Connecticut 06759, and its telephone number is (860)
567-8752.
You can find additional information about First Litchfield in First
Litchfield's filings with the SEC referenced in the section in this document
titled "Where You Can Find More Information" beginning on page - and in Annexes
D and E.
21
THE SPECIAL MEETING OF FIRST LITCHFIELD STOCKHOLDERS
DATE, TIME AND PLACE OF THE SPECIAL MEETING
The special meeting of stockholders of First Litchfield will be held at the
Litchfield Inn, 432 Bantam Road (Route 202), Litchfield, Connecticut, on Friday,
February 19, 2010 at 3:00 p.m., local time.
PURPOSE OF THE SPECIAL MEETING
At the special meeting, First Litchfield's stockholders as of the record
date will be asked to consider and vote on the following proposals:
1. To approve the merger agreement and the transactions contemplated
thereby, pursuant to which, in a series of transactions, First
Litchfield will be dissolved and FNBL will merge into Union, resulting
in Union being the sole surviving corporation;
2. To approve one or more adjournments of the special meeting, if
necessary, to permit further solicitation of proxies, if there are not
sufficient votes at the time of the special meeting, or at any
adjournment or postponement of that meeting, to approve the merger
agreement; and
3. To act upon such other matters as may properly come before the
special meeting or any adjournment or postponement of that meeting.
RECOMMENDATION OF THE FIRST LITCHFIELD BOARD OF DIRECTORS
THE FIRST LITCHFIELD BOARD OF DIRECTORS HAS UNANIMOUSLY APPROVED THE MERGER
AGREEMENT AND RECOMMENDS THAT YOU VOTE "FOR" APPROVAL OF THE MERGER AGREEMENT
AND "FOR" THE ADJOURNMENT PROPOSAL, IF NECESSARY.
RECORD DATE; OUTSTANDING SHARES; SHARES ENTITLED TO VOTE
Only holders of record of First Litchfield common stock at the close of
business on the record date of December 30, 2009, are entitled to notice of and
to vote at the First Litchfield special meeting. As of the record date, there
were 2,356,875 shares of First Litchfield common stock outstanding, held of
record by approximately - stockholders. A list of First Litchfield stockholders
as of the record date will be available for review by any First Litchfield
stockholder, the stockholder's agent or attorney at First Litchfield's principal
office during regular business hours beginning two business days after notice of
the special meeting is given and continuing through the special meeting. The
list will also be available for inspection at the meeting at any time during the
meeting.
Each holder of First Litchfield common stock is entitled to one vote for
each share of First Litchfield common stock he, she or it owned as of the record
date.
22
QUORUM; VOTE REQUIRED
A quorum of First Litchfield stockholders is necessary to hold a valid
meeting. If the holders of at least a majority of the total number of the
outstanding shares of First Litchfield common stock entitled to vote are
represented in person or by proxy at the special meeting, a quorum will exist.
First Litchfield will include proxies marked as abstentions and broker non-votes
in determining the number of shares present at the special meeting.
The affirmative vote of the holders of at least two-thirds of the
outstanding shares of First Litchfield common stock is required to approve the
merger agreement. If your shares are not voted, either in person or by proxy, as
well as proxies marked as abstentions and broker non-votes, it will have the
same effect as voting against approval of the merger agreement.
First Litchfield expects to seek adjournment of the meeting if a quorum is
not present or, if a quorum is present, the affirmative vote of the holders of
at least two-thirds of the outstanding shares of First Litchfield common stock
has not been obtained.
SHARE OWNERSHIP OF MANAGEMENT
As of the record date, the directors and executive officers of First
Litchfield and their affiliates collectively owned 202,052 shares of First
Litchfield common stock, or approximately 8.6% of First Litchfield's outstanding
shares.
VOTING OF PROXIES
If you are a First Litchfield stockholder, the First Litchfield board of
directors requests that you return the proxy card accompanying this document for
use at the First Litchfield special meeting. Please complete, date and sign the
proxy card and promptly return it in the enclosed pre-paid envelope. All
properly signed proxies received prior to the special meeting and not revoked
before the vote at the special meeting will be voted at the special meeting
according to the instructions indicated on the proxies or, IF NO INSTRUCTIONS
ARE GIVEN, THE SHARES WILL BE VOTED "FOR" APPROVAL OF THE MERGER AGREEMENT,
"FOR" AN ADJOURNMENT OF THE SPECIAL MEETING TO SOLICIT ADDITIONAL PROXIES, IF
NECESSARY, AND IN THE PROXIES' DISCRETION WITH RESPECT TO SUCH OTHER MATTERS AS
MAY PROPERLY COME BEFORE THE SPECIAL MEETING OR ANY ADJOURNMENT OR POSTPONEMENT
OF THAT MEETING.
We do not expect that any matters other than those set forth in the notice
for the special meeting will be brought before the meeting. If other matters are
properly presented and are within the purpose of the special meeting, however,
the persons named as proxies will vote on such matters in such manner as shall
be determined by a majority of the First Litchfield board of directors.
If you have questions or need assistance in completing or submitting your
proxy card, please contact Michelle L. Quigley, Assistant Secretary, at the
following address and telephone number:
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First Litchfield Corporation
13 North Street
P.O. Box 578
Litchfield, Connecticut 06759
(860) 567-8752
HOW TO REVOKE YOUR PROXY
If you are First Litchfield stockholder, you may revoke your proxy at any
time by taking any of the following actions before your proxy is voted at the
special meeting:
- delivering a written notice bearing a date later than the date of
your proxy card to the secretary of First Litchfield, stating that you
revoke your proxy;
- signing and delivering to the secretary of First Litchfield a new
proxy card relating to the same shares and bearing a later date; or
- attending the special meeting and voting in person, although
attendance at the special meeting will not, by itself, revoke a proxy.
You should send any notice of revocation or your completed new proxy card,
as the case may be, to Michelle L. Quigley, Assistant Secretary, at the
following address:
First Litchfield Corporation
13 North Street
P.O. Box 578
Litchfield, Connecticut 06759
If you have instructed a bank, broker or other nominee to vote your shares,
you must follow the directions you receive from your bank, broker or other
nominee to change your vote.
VOTING IN PERSON
If you are a First Litchfield stockholder and plan to attend the First
Litchfield special meeting and wish to vote in person, you will be given a
ballot at the special meeting. Please note, however, that if your shares are
held of record by a broker, bank or other nominee and you wish to vote at the
special meeting, you must bring additional documentation from the broker, bank
or other nominee in order to vote your shares.
ABSTENTIONS AND BROKER NON-VOTES
Only shares affirmatively voted for approval of the merger agreement,
including shares represented by properly executed proxies that do not contain
voting instructions, will be counted as votes "FOR" the merger agreement.
Brokers who hold shares of First Litchfield common stock in street name for
a customer who is the beneficial owner of those shares may not exercise voting
authority on the customer's shares with respect to the actions proposed in this
document without specific instructions from
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the customer. Proxies submitted by a broker that do not exercise this voting
authority are referred to as broker non-votes. If your broker holds your First
Litchfield stock in street name, your broker will vote your shares only if you
provide instructions on how to vote by filling out the voter instruction form
sent to you by your broker with this document.
Accordingly, you are urged to mark and return the enclosed proxy card to
indicate your vote, or fill out the voter instruction form, if applicable.
ABSTENTIONS AND BROKER NON-VOTES WILL BE INCLUDED IN DETERMINING THE
PRESENCE OF A QUORUM AT THE SPECIAL MEETING, BUT WILL HAVE THE SAME EFFECT AS
VOTING AGAINST APPROVAL OF THE MERGER AGREEMENT.
PROXY SOLICITATION
If you are a First Litchfield stockholder, the enclosed proxy is solicited
by and on behalf of the First Litchfield board of directors. First Litchfield
will pay the expenses of soliciting proxies to be voted at the special meeting.
Following the original mailing of the proxies and other soliciting materials,
First Litchfield and its agents also may solicit proxies by mail, telephone,
facsimile or in person. No additional compensation will be paid to directors,
officers or other employees of First Litchfield for making these solicitations.
First Litchfield has retained a proxy solicitation firm, Morrow & Co., LLC, to
aid it in the solicitation process. First Litchfield will pay Morrow a fee of
approximately $6,500, plus a fee of $6.50 for each stockholder solicited by
telephone in addition to reasonable expenses. First Litchfield intends to
reimburse persons who hold First Litchfield common stock of record but not
beneficially, such as brokers, custodians, nominees and fiduciaries, for their
reasonable expenses in forwarding copies of proxies and other soliciting
materials to, and requesting authority for the exercise of proxies from, the
persons for whom they hold the shares.
APPRAISAL RIGHTS
Summary of Appraisal Rights Procedures
The following discussion of the provisions of Section 262 of the Delaware
General Corporation Law is not a complete statement of the law pertaining to
appraisal rights and is qualified in its entirety by reference to the full text
of Section 262 of the Delaware General Corporation Law, a copy of which is
attached to this document as Annex C and is incorporated into this summary by
reference.
First Litchfield is organized under Delaware law. Under Delaware law, any
holder of First Litchfield common stock who does not wish to accept the
consideration contemplated by the merger agreement for the holder's shares of
First Litchfield common stock has the right to dissent from the merger and seek
an appraisal of, and to be paid in cash, the fair cash value (exclusive of any
element of value arising from the accomplishment or expectation of the merger)
for, shares of First Litchfield common stock, as determined by the Delaware
Chancery Court, together with interest, if any. Your entitlement to appraisal
rights is subject in all cases to your compliance with the provisions of Section
262 of the Delaware General Corporation Law.
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Under Section 262, not less than 20 days before First Litchfield special
meeting, First Litchfield must notify each of the holders of record of its
common stock as of the record date for the First Litchfield special meeting that
appraisal rights are available and include in the notice a copy of Section 262.
First Litchfield intends that this proxy statement constitutes that notice.
Ensuring that you actually perfect your appraisal rights can be
complicated. The procedural rules are specific and must be followed precisely.
Your failure to comply with these procedural rules may result in your becoming
ineligible to pursue appraisal rights. If that happens, your shares of First
Litchfield common stock will be converted into the right to receive the merger
consideration payable pursuant to the merger agreement. See "The Merger
Agreement-Consideration To Be Received in the Merger." The following
information is intended as only a brief summary of the material provisions of
the statutory procedures you must follow in order to perfect your appraisal
rights. Please review Section 262 of the Delaware General Corporation Law for a
complete description of the necessary procedures to be followed.
If you are a First Litchfield stockholder and you wish to exercise your
appraisal rights, you must satisfy the provisions of Section 262 of the Delaware
General Corporation Law, including the following:
- YOU MUST MAKE A WRITTEN DEMAND FOR APPRAISAL: You must deliver a
written demand for appraisal to First Litchfield before the vote on
the merger agreement is taken at the First Litchfield special meeting.
This written demand for appraisal must be separate from your proxy
card. A vote against the merger agreement alone will not constitute a
demand for appraisal.
- YOU MUST REFRAIN FROM VOTING FOR ADOPTION OF THE MERGER
AGREEMENT: You must not vote for adoption of the merger agreement. If
you vote, by proxy or in person, in favor of the merger agreement,
this will terminate your right to appraisal. You will also terminate
your right to appraisal if you return a signed proxy card and:
- fail to vote against adoption of the merger agreement; or
- fail to note that you are abstaining from voting.
If you do any of these things, your appraisal rights will terminate even if you
previously filed a written demand for appraisal and your shares of First
Litchfield common stock will be converted into the right to receive the merger
consideration payable pursuant to the merger agreement. See "The Merger
Agreement-Consideration To Be Received in the Merger."
- YOU MUST CONTINUOUSLY HOLD YOUR FIRST LITCHFIELD SHARES: You must
continuously hold your shares of First Litchfield common stock from
the date you make the demand for appraisal through the effective date
of the merger. If you are the record holder of First Litchfield common
stock on the date the written demand for appraisal is made but
thereafter transfer the shares prior to the effective date of the
merger, you will lose any right to appraisal for those shares.
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Description of Appraisal Rights Procedures
A written demand for appraisal of First Litchfield common stock is only
effective if it is signed by, or for, the stockholder of record who owns those
shares at the time the demand is made. The demand must also be signed precisely
as the stockholder's name appears on his or her share certificate. If you are
the beneficial owner of First Litchfield common stock, but not the stockholder
of record, you must have the stockholder of record sign any demand for
appraisal.
If you own First Litchfield common stock in a fiduciary capacity, such as a
trustee, guardian or custodian, you must disclose the fact that you are signing
the demand for appraisal in that capacity.
If you own First Litchfield common stock with more than one person, such as
in a joint tenancy or tenancy in common, all the owners must sign, or have
signed for them, the demand for appraisal. An authorized agent, who could
include one or more of the joint owners, may sign the demand for appraisal for a
stockholder of record; however, the agent must expressly disclose who the
stockholder of record is and that the agent is signing the demand as that
stockholder's agent.
If you are a record owner, such as a broker, who holds First Litchfield
common stock as a nominee for others, you may exercise a right of appraisal with
respect to the shares held for one or more beneficial owners, while not
exercising that right for other beneficial owners. In that case, you should
specify in the written demand the number of shares as to which you wish to
demand appraisal. If you do not expressly specify the number of shares, we will
assume that your written demand covers all the shares of First Litchfield common
stock that are in your name.
If you are a First Litchfield stockholder who elects to exercise appraisal
rights, you should mail or deliver a written demand to:
First Litchfield Financial Corporation
13 North Street
P.O. Box 578
Litchfield, Connecticut 06759
Attention: Corporate Secretary
It is important that First Litchfield receive all written demands before
the vote concerning the merger agreement is taken at the First Litchfield
special meeting. As explained above, this written demand should be signed by, or
on behalf of, the stockholder of record. The written demand for appraisal should
specify the stockholder's name and mailing address, the number of shares of
stock owned, and that the stockholder is demanding appraisal of the
stockholder's shares.
If the merger is completed, each holder of First Litchfield common stock
who has perfected appraisal rights in accordance with Section 262 will be
entitled to be paid for the stockholder's
27
First Litchfield common stock the fair value in cash of those shares. The
Delaware Court of Chancery will appraise the shares, determining their fair
value, exclusive of any element of value arising from the completion or
expectation of the merger, together with interest, if any, to be paid upon the
amount determined to be fair value. In determining the fair value, the Chancery
Court may take into account all relevant factors and upon its determination will
then direct the payment of the fair value of the shares, together with any
interest, to the holders of First Litchfield common stock who have perfected
their appraisal rights. The shares of First Litchfield common stock with
respect to which holders have perfected their appraisal rights in accordance
with Section 262 and have not effectively withdrawn or lost their appraisal
rights are referred to in this document as the dissenting shares.
If you fail to comply with any of these conditions and the merger becomes
effective, you will only be entitled to receive the consideration provided in
the merger agreement for your shares.
Written Notice: Within ten days after the effective date of the merger,
Union, as the surviving corporation in the merger, must give written notice that
the merger has become effective to each stockholder who has fully complied with
the conditions of Section 262.
Petition with the Delaware Chancery Court: Within 120 days after the
merger, either Union or any stockholder who has complied with the conditions of
Section 262 may file a petition in the Delaware Chancery Court. This petition
should request that the Chancery Court determine the value of the shares of
stock held by all the stockholders who are entitled to appraisal rights. If you
intend to exercise your appraisal rights, you should file this petition in the
Chancery Court. Union has no obligation to file this petition, and if you do not
file this petition within 120 days after the effective date of the merger, you
will lose your rights of appraisal.
Request for Appraisal Rights Statement: If you have complied with the
conditions of Section 262, you are entitled to receive a statement from Union.
This statement will set forth the number of shares not voted in favor of the
merger and that have demanded appraisal rights and the number of stockholders
who own those shares. In order to receive this statement you must send a written
request to Union within 120 days after the merger. Union has ten days after
receiving a request to mail you the statement.
Chancery Court Procedures: If you properly file a petition for appraisal in
the Chancery Court and deliver a copy to Union, Union will then have 20 days to
provide the Chancery Court with a list of the names and addresses of all
stockholders who have demanded appraisal rights and have not reached an
agreement with Union as to the value of their shares. The Register in Chancery,
if so ordered by the Court, will give notice of the time and place fixed for the
hearing of that petition to the stockholders on the list. At the hearing, the
Chancery Court will determine the stockholders who have complied with Section
262 and are entitled to appraisal rights. The Chancery Court may also require
you to submit your stock certificates to the Register in Chancery so that it can
note on the certificates that an appraisal proceeding is pending. If you do not
follow the Chancery Court's directions, you may be dismissed from the
proceeding.
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Appraisal of Shares: After the Chancery Court determines which stockholders
are entitled to appraisal rights, the Chancery Court will appraise the shares of
stock that are the subject of the demand for appraisal. To determine the fair
value of the shares, the Chancery Court may consider all relevant factors except
for any appreciation or depreciation due to the accomplishment or expectation of
the merger. After the Chancery Court determines the fair value of the shares, it
will direct Union, as the surviving corporation of the merger, to pay that value
to the stockholders who have successfully sought appraisal rights. Unless the
Chancery Court determines otherwise, Union will pay interest, compounded
quarterly, on that value for the period from the effective date of the merger to
the date of payment. In order to receive payment for your shares under an
appraisal procedure, you must surrender your stock certificates to Union.
FIRST LITCHFIELD STOCKHOLDERS SHOULD BE AWARE THAT THE FAIR VALUE OF THEIR
SHARES AS DETERMINED UNDER SECTION 262 OF THE DELAWARE GENERAL CORPORATION LAW
COULD BE GREATER THAN, THE SAME AS, OR LESS THAN THE MERGER CONSIDERATION. THE
RAYMOND JAMES OPINION DELIVERED TO FIRST LITCHFIELD'S BOARD OF DIRECTORS DOES
NOT IN ANY MANNER ADDRESS FAIR VALUE UNDER SECTION 262 OF THE DELAWARE GENERAL
CORPORATION LAW.
Costs and Expenses of Appraisal Proceeding: The Chancery Court may
determine the costs of the appraisal proceeding and allocate them among the
parties as the Chancery Court deems equitable under the circumstances. Upon
application by a stockholder, the Chancery Court may order all or a portion of
the expenses incurred by any stockholder in connection with the appraisal
proceeding, including reasonable attorneys' fees and the fees and expenses of
experts, to be charged pro rata against the value of all shares entitled to
appraisal. In the absence of that determination or assessment, each stockholder
bears his, her or its own expenses.
Loss of Stockholder's Rights: If you demand appraisal rights, after the
effective date of the merger you will not be entitled:
- to vote the shares of stock for which you have demanded appraisal
rights for any purpose;
- to receive payment of dividends or any other distribution with
respect to the shares of stock for which you have demanded appraisal,
except for dividends or distributions, if any, that are payable to
holders of record as of a record date prior to the effective time of
the merger; or
- to receive the payment of the consideration provided for in the
merger agreement (unless you properly withdraw your demand for
appraisal).
Termination of Appraisal Rights: If you do not file a petition for an
appraisal within 120 days after the effective date of the merger, your right to
an appraisal will terminate. You may withdraw your demand for appraisal and
accept the merger consideration by delivering to Union a written withdrawal of
your demand at any time within 60 days after the effective date of the merger.
After 60 days after the effective date of the merger, any attempt to withdraw
will require the written approval of Union. An appraisal proceeding in the
Chancery Court cannot be dismissed as to any stockholder unless the Chancery
Court approves.
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IF YOU FAIL TO COMPLY STRICTLY WITH THE PROCEDURES DESCRIBED ABOVE YOU WILL
LOSE YOUR APPRAISAL RIGHTS, IN WHICH EVENT YOU WILL BE ENTITLED TO RECEIVE THE
CONSIDERATION WITH RESPECT TO YOUR DISSENTING SHARES IN ACCORDANCE WITH THE
MERGER AGREEMENT. CONSEQUENTLY, IF YOU ARE A HOLDER OF FIRST LITCHFIELD COMMON
STOCK AND WISH TO EXERCISE YOUR APPRAISAL RIGHTS, YOU ARE STRONGLY URGED TO
CONSULT A LEGAL ADVISOR BEFORE ATTEMPTING TO EXERCISE YOUR APPRAISAL RIGHTS.
STOCK CERTIFICATES
If you are a First Litchfield stockholder, you should not send in any
certificates representing First Litchfield common stock at this time. Shortly
after the closing of the merger, you will receive instructions for the exchange
of certificates representing First Litchfield common stock.
PROPOSAL TO APPROVE ADJOURNMENT OF THE SPECIAL MEETING
First Litchfield is also submitting a proposal for consideration at the
special meeting to authorize the named proxies to approve one or more
adjournments of the special meeting if there are not sufficient votes to approve
the merger agreement at the time of the special meeting. Even though a quorum
may be present at the special meeting, it is possible that First Litchfield may
not have received the favorable vote of two-thirds of the outstanding shares
necessary to approve the merger agreement by the time of the special meeting.
In that event, First Litchfield expects to seek adjournment of the special
meeting in order to solicit additional proxies. The adjournment proposal
relates only to an adjournment of the special meeting for purposes of soliciting
additional proxies to obtain the requisite stockholder approval to approve the
merger agreement. Any other adjournment of the special meeting (e.g., an
adjournment required because of the absence of a quorum) would be voted upon
pursuant to the discretionary authority granted by the proxy card in such manner
as determined by a majority of the board of directors. If the special meeting
is adjourned for 30 days or less and the time and place of the adjourned meeting
is announced at the meeting, First Litchfield is not required to give notice of
the time and place of the adjourned meeting unless the board of directors fixes
a new record date for the special meeting.
The proposal to approve one or more adjournments of the special meeting
requires the affirmative vote of holders of a majority of the shares of First
Litchfield common stock present or represented at the special meeting and
entitled to vote on the proposal. The First Litchfield board of directors
retains full authority to the extent set forth in its bylaws and Delaware law to
adjourn the special meeting for any other purpose, or to postpone the special
meeting before it is convened, without the consent of any First Litchfield
stockholders.
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THE MERGER
GENERAL
Under the terms and conditions set forth in the merger agreement, First
Litchfield will be merged with and into Union. At the effective time of the
merger, shares of common stock of First Litchfield, par value $.01 per share,
outstanding immediately prior to the effective time of the merger will, by
virtue of the merger and without any action on the part of a First Litchfield
stockholder, be converted into the right to receive $15.00 cash for each share
of First Litchfield common stock held by the First Litchfield stockholder.
Shares of First Litchfield common stock held by Union or First Litchfield,
other than in a fiduciary capacity or in satisfaction of a debt previously
contracted, will not be converted into the right to receive the merger
consideration upon consummation of the merger.
BACKGROUND OF THE MERGER
First Litchfield's President, Joseph J. Greco, and the President of Union,
John C. Kline, have known each other professionally and socially through
participation in banking associations for more than five years. Through such
industry related functions, they have had the opportunities to interact on a
regular basis. In addition, they have occasionally met socially at which times
they have typically discussed banking and economic issues. On October 15, 2007,
Mr. Greco and Mr. Kline along with Jay C. Lent, Chief Operating Officer of
Union, met for lunch and during the course of that lunch, Mr. Kline inquired
regarding whether there might be potential benefits to an affiliation. Mr.
Greco indicated that while the board of directors of First Litchfield was
confident of First Litchfield's ability to continue to execute its strategic
plan, the board would always consider alternatives if they were in the best
interests of stockholders and other constituencies. On October 24, 2007, Union
sent First Litchfield a letter expressing its preliminary and non-binding
interest in a potential affiliation. The letter and potential benefits of
affiliation were reviewed and discussed by the board of directors of First
Litchfield at a board meeting on October 25, 2007. The board further evaluated
the potential advantages and disadvantages of the potential affiliation
opportunity presented by Union at a meeting on November 29, 2007, at which time
the board determined that it would be in the best interests of First Litchfield,
its stockholders and other constituencies to continue to execute First
Litchfield's strategic plan on an independent basis rather than through an
affiliation. The board's decision was communicated to Union following the
meeting.
Mr. Greco and Mr. Kline continued to maintain a professional and social
relationship and continued to meet professionally and socially on occasions.
On September 7, 2008, the United States Government placed Fannie Mae and
Freddie Mac in conservatorship, which resulted in an other than temporary
impairment ("OTTI") of the Fannie Mae preferred securities owned by First
Litchfield, resulting in a significant reduction of First Litchfield's capital.
The next day, the First Litchfield board held a special meeting to evaluate the
implications of the United States Government's actions on world markets, the
banking industry and First Litchfield. As part of First Litchfield's response to
the financial crisis and the depletion of capital from the OTTI adjustment of
the value of Fannie Mae preferred
31
stock, the board directed management to begin the process of capital planning.
As part of such planning, the Board directed Mr. Greco to contact Union in order
to ascertain their interest in serving as a potential source of capital as part
of the contingency and capital plans of First Litchfield. Mr. Kline and Mr.
Greco discussed these matters and on September 19, 2008, Mr. Kline, Mr. Lent and
Mr. Greco met and discussed the interest of Union in an affiliation.
The First Litchfield board convened a special meeting on September 22, 2008
to discuss the OTTI write-down of the Fannie Mae preferred securities, the world
economic crisis and potential sources of capital. At this meeting, the board
formed an ad hoc Capital Committee to assist the board in the capital planning
initiatives.
In October 2008, the board and its Capital Committee evaluated the benefit
of engaging an adviser to assist First Litchfield in capital planning. After
considering several firms, First Litchfield engaged Raymond James to assist the
board and met with representatives of Raymond James.
On October 14, 2008, the United States Treasury announced the Troubled
Asset Relief Program's Capital Purchase Program (the "CPP") to encourage United
States financial institutions to build capital to increase the flow of financing
to businesses and consumers and to support the United States economy. The board
authorized the application for CPP funds and after receiving approval from the
Treasury, the board took necessary action for First Litchfield to participate in
the CPP. On December 12, 2008, First Litchfield issued $10 million in preferred
stock and a warrant to purchase 199,203 shares of common stock to the Treasury
under the CPP.
While First Litchfield's short term capital needs were addressed through
participation in the CPP, during the first four months of 2009, the board and
its Capital Committee worked with Raymond James to evaluate alternatives to
provide for the long-term capital needs of First Litchfield and FNBL. Various
alternatives were considered, including gradually building capital through
retained earnings, increasing capital through public and private offerings of
securities and potential affiliations. In April 2009, the board decided that
while First Litchfield could continue to execute its strategic mission and
potentially earn and retain sufficient capital to meet the prudent capital needs
of First Litchfield and FNBL, this alternative as well as the anticipated
dilution which would be associated with raising equity in public or private
markets would be disadvantageous to stockholders and would involve significant
risk. In addition, the anticipated dilution which would be associated with
raising equity in public or private markets would be disadvantageous to
stockholders. Therefore, the board determined that its duty to stockholders
warranted consideration of alternatives, including the possible sale or merger
of First Litchfield. Accordingly, the board asked Raymond James to contact two
institutions which had previously expressed interest in exploring a possible
business combination with First Litchfield. Based on publicly available
information, Raymond James indicated that these institutions appeared to have
the financial capacity to consummate a business combination. Additionaly, both
companies maintained a focus on community banking and had expressed interest in
expanding from proximate market areas into the market areas served by FNBL.
Raymond James met separately with representatives of these two institutions
to ascertain their potential interest in an affiliation with First Litchfield.
Informal and preliminary
32
discussions took place and the Capital Committee was informed of these matters
and other capital planning alternatives.
During June of 2009, separate meetings were held between representatives of
First Litchfield and the two institutions. One of these institutions was Union
and the other was an out-of-state bank holding company. On June 30, 2009, the
board met with Raymond James and decided to proceed with discussions with the
two interested institutions who expressed interest in discussing a potential
affiliation. In addition, the board requested that Raymond James provide the
board with additional information regarding potential affiliation opportunities
and deal pricing information while continuing to learn more about affiliation
opportunities and potential structure and pricing with the two interested
institutions.
On July 27 and 28, 2009, representatives of First Litchfield and Raymond
James met separately with representatives of the two institutions following
several conversations which occurred throughout July. First Litchfield had no
desire to engage in the due diligence process and incur the related risks and
expenses unless the suitor was serious and had the potential to consummate a
transaction and pay an attractive premium. At a special meeting on July 30,
2009, the board was informed that, based upon preliminary assessments and
subject to due diligence, each suitor had a significant interest in an
affiliation and the apparent ability to successfully consummate an affiliation
transaction with First Litchfield. Initial interest levels reflected broad price
ranges and contained significant conditions. In communications with Raymond
James, Union expressed interest in a cash transaction while the other suitor
contemplated a stock transaction. Each would require additional reciprocal due
diligence. Following the board's approval, confidentiality agreements were
prepared and executed in early August, 2009 due diligence request lists were
provided.
The potential stock acquirer conducted preliminary due diligence on August
12 and 13, 2009 and Union conducted preliminary due diligence on August 17 and
18, 2009. Each of the interested institutions submitted non-binding confidential
contingent expressions of interest on August 25, 2009. Union expressed interest
in an all cash transaction to acquire First Litchfield at $14.45 per share. The
other suitor expressed interest in an all-stock fixed exchange offer which had
an indicated market value which was lower than the Union price per share.
On August 28, 2009, the board met with Raymond James and reviewed each of
the expressions of interest. The board also discussed additional alternatives.
The board was favorably inclined to proceed with Union's proposal, subject to
due diligence and the successful resolution of various structural issues and
negotiations of proposed terms and conditions. The board added a new member to
its Capital Committee and reformed the Capital Committee as the Negotiating
Committee.
The board instructed Raymond James to proceed with discussions with each
party to obtain a higher price after minimizing or eliminating pricing
contingencies. During September, 2009 additional reciprocal due diligence was
conducted with both interested institutions and each increased their proposed
price levels. Union indicated that its price would likely be $15.00 per share in
cash, while the all-stock proposal from the other institution had a lower price
based upon
33
a to-be-fixed exchange formula and lacked significant protection in the event
the market price of such acquirer's stock declined.
The Negotiating Committee met on September 18, 23 and 25, 2009 to discuss
the status of due diligence, negotiations and the proposed price enhancements.
The full board also discussed these issues on September 23, 2009.
Negotiations regarding the structure and terms of the agreement with Union
continued through October, 2009 along with supplemental reciprocal due
diligence. The Negotiating Committee met with Raymond James and First
Litchfield's legal counsel to discuss and review the proposals, alternatives and
the terms of the transaction on October 5 and 23, 2009. In addition, the full
board reviewed the merger documents on October 23, 2009 and, following the
exchange and review of all disclosure schedules, the board met again with its
legal and financial advisers on the evening of October 25, 2009 to discuss the
final document and all relevant matters and to approve the transaction. The
merger agreement was executed on the evening of October 25, 2009 and announced
prior to the opening of the markets on the morning of October 26, 2009.
FIRST LITCHFIELD'S REASONS FOR THE MERGER
In reaching its decision to approve the merger agreement and related
transactions and recommend their approval to stockholders, the First Litchfield
board of directors consulted with senior management, its financial advisor,
Raymond James, and its legal counsel, Cranmore, FitzGerald & Meaney, and
considered a number of factors, including, among others, the following, which
are not presented in order of priority:
- a review of the historical financial statements of First
Litchfield and certain other internal information, primarily financial
in nature, relating to the respective businesses, earnings and balance
sheets of First Litchfield;
- the business strategy of First Litchfield, prospects for the
future, including expected financial results, and expectations
relating to the proposed merger, based on discussions with management
of First Litchfield;
- the current and prospective regulatory and interest rate environment
in which First Litchfield operates, including the expectation that the
OCC, FNBL's primary supervisory agency, would propose formal
supervisory remedial action, such as the Formal Agreement described in
under "The Companies - First Litchfield Financial Corporation"
beginning on page -;
- the potential advantages and disadvantages of cash consideration
and the amount of the merger consideration offered, its premium to
market and comparability with respect to other premiums;
- the merger consideration which could reasonably be expected from
other potential acquirers located in proximate areas with the apparent
ability to consummate the transaction;
- the ability of Union to pay the merger consideration;
34
- the geographic fit and increased customer convenience of the
branch networks of FNBL and Union;
- the anticipated effect of the acquisition on First Litchfield's
employees (including the fact that Union anticipates offering
employment to all employees of First Litchfield, subject to review of
personnel files and such employment criteria for particular positions
as Union customarily applies, following the consummation of the
merger);
- the effect on First Litchfield's customers and the communities
served by First Litchfield and Union's longstanding history of serving
the customers and communities through its own efforts as well as
through the contributions of its Charitable Foundation;
- the terms of the merger agreement and related transaction,
including the representations and warranties of the parties, the
covenants, the consideration, the benefits to First Litchfield's
employees, the circumstances under which the First Litchfield board of
directors may consider a superior proposal and the absence of
burdensome contingencies in the merger agreement;
- the increased legal lending limit available to borrowers by
reason of the merger;
- the likelihood of expeditiously obtaining the necessary
regulatory approvals without unusual or burdensome conditions; and
- a review of the risks and prospects of First Litchfield remaining
independent, including the likelihood that the OCC would require FNBL
to operate with higher capital ratios which could necessitate an
infusion of additional equity into FNBL or a strategy of significant
deleveraging, as to which there could be no assurance that they could
be successfully achieved and either of which could competitively
disadvantage First Litchfield, FNBL and the interests of stockholders.
Based on the factors described above, the First Litchfield board of
directors determined that the merger with Union would be advisable and in the
best interests of First Litchfield stockholders and other constituencies and
unanimously approved the merger agreement and related transactions contemplated
by those documents. In reaching its determination to approve and recommend the
merger agreement and related transactions, the First Litchfield board of
directors did not assign any specific or relative weights to any of the factors
listed above. The First Litchfield board weighed these factors against the
potential risks of the merger. These risks are discussed in the section of this
document titled "Risk Factors-Risks Relating to the Merger" beginning on page -.
RECOMMENDATION OF THE FIRST LITCHFIELD BOARD OF DIRECTORS
THE FIRST LITCHFIELD BOARD OF DIRECTORS HAS UNANIMOUSLY APPROVED THE MERGER
AGREEMENT AND RECOMMENDS THAT FIRST LITCHFIELD STOCKHOLDERS VOTE "FOR" APPROVAL
OF THE MERGER AGREEMENT AND "FOR" THE ADJOURNMENT PROPOSAL, IF NECESSARY.
35
FAIRNESS OPINION OF FIRST LITCHFIELD'S FINANCIAL ADVISOR
First Litchfield retained Raymond James as financial advisor on September
15, 2009 in connection with the proposed merger. As part of the engagement, the
First Litchfield board of directors requested that Raymond James evaluate the
fairness, from a financial point of view, to the holders of First Litchfield's
outstanding common stock of the merger consideration to be received by such
holders pursuant to the merger agreement.
At the October 25, 2009 meeting of the First Litchfield board of directors,
Raymond James gave its opinion that, as of such date and based upon and subject
to various qualifications and assumptions described with respect to its opinion,
the merger consideration to be received by the stockholders of First Litchfield
pursuant to the merger agreement was fair, from a financial point of view, to
the holders of First Litchfield's outstanding common stock.
The full text of the written opinion of Raymond James, dated October 25,
2009, which sets forth assumptions made, matters considered, and limits on the
scope of review undertaken, is attached as Annex B to this proxy statement. The
summary of the opinion of Raymond James set forth in this proxy statement is
qualified in its entirety by reference to the full text of such opinion.
Holders of First Litchfield common stock are urged to read this opinion in
its entirety. Raymond James's opinion, which is addressed to the First
Litchfield's board of directors, is directed only to the fairness, from a
financial point of view, of the merger consideration to be received by holders
of First Litchfield common stock in connection with the proposed merger. Raymond
James's opinion does not constitute a recommendation to any holder of First
Litchfield common stock as to how such stockholder should vote at the special
meeting of First Litchfield stockholders and does not address any other aspect
of the proposed merger or any related transaction.
In connection with rendering its opinion, Raymond James, among other
things:
- reviewed the financial terms and conditions as stated in the
merger agreement;
- reviewed the Annual and Quarterly Reports on Forms 10-K and 10-Q
of First Litchfield for the years ended December 31, 2008, 2007 and
2006 and for the three month periods ended June 30, 2009, March 31,
2009 and September 30, 2008;
- reviewed certain publicly available financial statements and
other historical financial information of First Litchfield and Union;
- reviewed other financial, corporate, and operating information of
First Litchfield and Union, including certain financial analyses and
forecasts of First Litchfield and Union which were prepared by the
respective managements of First Litchfield and Union;
- reviewed comparative financial and operating data on the banking
industry and certain institutions which it deemed to be comparable to
each of First Litchfield and Union;
36
- reviewed a draft of the remedial supervisory documents between
FNBL and the Comptroller of the Currency;
- reviewed the historical market prices and trading activity for
the common stock of First Litchfield;
- reviewed the pro forma financial impact of the merger on Union,
based on assumptions relating to transaction expenses, purchase
accounting adjustments, and cost savings determined by the senior
management of Union;
- reviewed certain bank mergers and acquisitions on a regional and
nationwide basis for institutions which it deemed to be comparable to
First Litchfield and compared the proposed consideration with the
consideration paid in such other mergers and acquisitions;
- conducted limited discussions with members of senior management
of each of First Litchfield and Union concerning the financial
condition, business and prospects of each respective company; and
- reviewed such other financial studies and analyses and performed
such other investigations and took into account such other matters as
it deemed necessary.
In connection with its review, Raymond James assumed and relied upon the
accuracy and completeness of all information supplied or otherwise made
available to Raymond James by First Litchfield, Union or any other party, and
did not undertake any duty or responsibility to verify independently any of such
information. Raymond James has not made or obtained an independent appraisal of
the assets or liabilities (contingent or otherwise) of First Litchfield. With
respect to financial forecasts and other information and data provided to or
otherwise reviewed by or discussed with Raymond James, Raymond James assumed
that such forecasts and other information and data were reasonably prepared in
good faith on bases reflecting the best currently available estimates and
judgments of management, and relied upon each party to advise Raymond James
promptly if any information previously provided became inaccurate or was
required to be updated during the period of its review.
In rendering its opinion, Raymond James assumed that the merger would be
consummated on the terms described in the merger agreement. Furthermore, Raymond
James assumed, in all respects material to its analysis, that the
representations and warranties of each party contained in the merger agreement
were true and correct, that each party will perform all of the covenants and
agreements required to be performed by it under the merger agreement and that
all conditions to the consummation of the merger will be satisfied without being
waived. Raymond James also assumed that all material governmental, regulatory or
other consents and approvals will be obtained and that, in the course of
obtaining any necessary governmental, regulatory or other consents and
approvals, or any amendments, modifications or waivers to any documents to which
First Litchfield is a party, as contemplated by the merger agreement, no
restrictions will be imposed or amendments, modifications or waivers made that
would have any material adverse effect on First Litchfield. In its financial
analyses, Raymond James assumed the merger consideration had a value of $15.00
per First Litchfield share. Raymond James expressed no opinion as to the
underlying business decision to effect the merger, the structure or tax
consequences of the merger agreement, or the availability or advisability of any
alternatives to the merger. In the capacity of rendering the opinion, Raymond
James reviewed the terms of the merger agreement and offered no judgment as to
the negotiations resulting in such terms.
37
In conducting its investigation and analyses and in arriving at its
opinion, Raymond James took into account such accepted financial and investment
banking procedures and considerations as it deemed relevant, including the
review of: (i) historical and projected revenues, operating earnings, net income
and capitalization of First Litchfield and certain other publicly held companies
in businesses it believes to be comparable to First Litchfield; (ii) the current
and projected financial position and results of operations of First Litchfield;
(iii) the historical market prices and trading activity of the common stock of
First Litchfield; (iv) financial and operating information concerning selected
business combinations which it deemed comparable in whole or in part; and (v)
the general condition of the securities markets.
The following summarizes the material financial analyses presented by
Raymond James to the First Litchfield board of directors at its meeting on
October 25, 2009, which material was considered by Raymond James in rendering
the opinion described below. No company or transaction used in the analyses
described below is directly comparable to First Litchfield, Union or the
contemplated merger.
Trading Analysis. Raymond James analyzed historical closing prices of First
Litchfield and compared them to the value of the proposed merger consideration.
The results of this analysis are summarized below:
Price Per Implied
Share Premium
Merger consideration value $ 15.00 -
First Litchfield Financial, Inc. closing stock price as
of October 23, 2009 5.80 158.6%
52-week high First Litchfield Financial, Inc. stock
price January 15, 2009 11.00 36.4%
52-week low First Litchfield Financial, Inc. stock
price March 6, 2009 4.25 252.9%
Public Companies Analysis. Raymond James analyzed the relative valuation
multiples of 26 publicly-traded New England banks traded on all exchanges with
total assets between $100 million and $1 billion, including:
- Patriot National Bancorp, Inc.
- Cambridge Bancorp
- Northway Financial, Inc.
- Northeast Bancorp
- Centrix Bank & Trust
- Salisbury Bancorp, Inc.
- Katahdin Bankshares Corporation
- Community Bancorp
- Union Bankshares, Inc.
- Ledyard Financial Group, Inc.
- Citizens National Bancorp
- First Ipswitch Bancorp
38
- BNC Financial Group, Inc.
- SBT Bancorp, Inc.
- Middlebury National Corporation
- Grand Bank Corporation
- Connecticut Bank & Trust Company
- Connecticut River Bancorp, Inc.
- People's Trust Company of St. Albans
- Connecticut River Community Bank
- Central Financial Corporation
- Rockport National Bancorp, Inc.
- Damariscotta Bankshares, Inc.
- Hampshire First Bank
- Southern Connecticut Bancorp, Inc.
- Island Bancorp, Inc.
Raymond James calculated various financial multiples for each company,
including (i) market price to June 30, 2009 book value per share, (ii) market
price to June 30, 2009 tangible book value per share, and (iii) market price to
quarter ended June 30, 2009 annualized earnings per share. Raymond James
reviewed the mean, median, minimum and maximum relative valuation multiples of
the selected public companies and compared them to corresponding valuation
multiples for First Litchfield implied by the merger consideration. The results
of the public companies analysis are summarized below:
Market Price/
--------------------------------------
6/30/2009
Tangible Book Earnings
Book Value Value per Share
--------------------------------------
Mean 93.5% 101.5% 18.9x
Median 88.3% 88.3% 15.8x
Minimum 18.9% 18.9% 9.2x
Maximum 183.1% 186.7% 37.2x
Merger consideration 155.7% 155.7% 75.0x
Furthermore, Raymond James applied the mean, median, minimum and maximum
relative valuation multiples for each of the metrics to First Litchfield's
actual June 30, 2009 financial results and determined the implied price per
share of First Litchfield common stock and then compared those implied values
per share to the merger consideration of $15.00 per share. The results of this
are summarized below:
39
Market Price /
-----------------------------------------------
6/30/2009
Tangible Book Earnings per
Book Value Value Share
-----------------------------------------------
Mean $ 9.01 $ 9.77 $ 3.79
Median $ 8.50 $ 8.50 $ 3.15
Minimum $ 1.82 $ 1.82 $ 1.84
Maximum $ 17.63 $ 17.98 $ 7.44
Merger consideration $ 15.00 $ 15.00 $ 15.00
Transaction Analysis. Raymond James analyzed publicly available
information relating to acquisitions of New England bank and thrift companies,
excluding targets that were mutual holding companies, co-operative banks, and
recapitalization transactions, since January 1, 2009 and prepared a summary of
the relative valuation multiples paid in these transactions. The transactions
used in the analysis included:
- United Financial Bancorp, Inc. acquisition of CNB Financial Corp.
- Danvers Bancorp, Inc. acquisition of Beverly National Corporation
- New England Bancshares, Inc. acquisition of Apple Valley Bank &
Trust Company
Raymond James examined valuation multiples of deal value compared to the
target companies' most recently available book value per share and tangible book
value per share and the tangible book premium to core deposits, in each case,
where such information was publicly available. Raymond James reviewed the mean,
median, minimum and maximum relative valuation multiples of the selected
transactions and compared them to corresponding valuation multiples for First
Litchfield implied by the merger consideration. The results of the New England
transactions analysis are summarized below:
Tangible Book Deal Value /
Premium / ---------------------------------
Core Deposits Book Value Tangible Book Value
Mean 3.8% 127.8% 127.8%
Median 3.4% 124.2% 124.2%
Minimum 1.6% 114.7% 114.7%
Maximum 6.3% 144.4% 144.4%
Merger consideration 4.2% 155.7% 155.7%
Furthermore, Raymond James applied the mean, median, minimum and maximum
relative valuation multiples to First Litchfield's June 30, 2009 financials to
determine the implied
40
price per share and then compared those implied values per share to the merger
consideration of $15.00 per share. The results of this are summarized below:
Tangible Book Deal Value /
Premium / -----------------------------------
Core Deposits Book Value Tangible Book Value
Mean $ 14.46 $ 12.30 $ 12.30
Median $ 14.01 $ 11.96 $ 11.96
Minimum $ 11.63 $ 11.04 $ 11.04
Maximum $ 17.74 $ 13.91 $ 13.91
Merger consideration $ 15.00 $ 15.00 $ 15.00
Raymond James further analyzed publicly available information relating to
acquisitions of national bank and thrift companies, excluding targets that were
mutual holding companies, co-operative banks, and recapitalization transactions,
with target total assets between $100 million and $1 billion and target
nonperforming assets as a percentage of total assets less than 5.0% since
January 1, 2009 where deal value was available and prepared a summary of the
relative valuation multiples paid in these transactions. The transactions used
in the analysis included:
- - First Business Bank, N.A. acquisition of 1st Pacific Bancorp
- - First American Financial Management Company acquisition of Community Bank
of Rowan
- - NB&T Financial Group, Inc. acquisition of Community National Corporation
- - BCB Bancorp, Inc. acquisition of Pamrapo Bancorp, Inc.
- - United Financial Bancorp, Inc. acquisition of CNB Financial Corp.
- - Danvers Bancorp, Inc. acquisition of Beverly National Corporation
- - MidAtlantic Bancorp, Inc. acquisition of Greater Atlantic Financial Corp.
- - Carolina Trust Bank acquisition of Carolina Commerce Bank
- - OceanFirst Financial Corp. acquisition of Central Jersey Bancorp
- - First Savings Financial Group, Inc. acquisition of Community First Bank
- - Eastern Virginia Bankshares, Inc. acquisition of First Capital Bancorp,
Inc.
- - First Community Bancshares, Inc. acquisition of TriStone Community Bank
- - Southern Bancorp, Inc. acquisition of Timberland Bank
- - Merchants Bancorp, Incorporated acquisition of CB Bancorp, Incorporated
- - Community Exchange Bancshares acquisition of Hindman Bancshares,
Incorporated
- - Glacier Bancorp, Inc. acquisition of First Company
Raymond James examined valuation multiples of deal value compared to the
target companies' most recently available book value per share and tangible book
value per share and the tangible book premium to core deposits, in each case,
where such information was publicly available. Raymond James reviewed the mean,
median, minimum and maximum relative
41
valuation multiples of the national transactions and compared them to
corresponding valuation multiples for First Litchfield implied by the merger
consideration. The results of the national transactions analysis are summarized
below:
Tangible Book Deal Value /
Premium / ---------------------------------
Core Deposits Book Value Tangible Book Value
Mean -2.1% 93.0% 97.0%
Median -1.1% 86.1% 100.2%
Minimum -8.6% 31.2% 33.1%
Maximum 2.2% 150.0% 150.0%
Merger consideration 4.2% 155.7% 155.7%
Furthermore, Raymond James applied the mean, median, minimum and maximum
relative valuation multiples to First Litchfield's June 30, 2009 financials to
determine the implied price per share and then compared those implied values per
share to the merger consideration of $15.00 per share. The results of this are
summarized below:
Tangible Book Deal Value /
Premium / -------------------------------------
Core Deposits Book Value Tangible Book Value
Mean $ 6.93 $ 8.96 $ 9.34
Median $ 8.20 $ 8.29 $ 9.65
Minimum $ 0.00 $ 3.00 $ 3.19
Maximum $ 12.50 $ 14.45 $ 14.45
Merger consideration $ 15.00 $ 15.00 $ 15.00
Transaction Premium Analysis. Raymond James analyzed the stock price
premiums paid in nine merger and acquisition transactions announced since
January 1, 2009 with target total assets between $100 million and $1 billion and
target nonperforming assets as a percentage of total assets less than 5.0% where
deal value was available. Raymond James measured each transaction price per
share relative to each target's closing price per share one day, one month and
three months prior to announcement of the transaction. Raymond James compared
the mean, median, minimum and maximum premiums paid from this set of
transactions to the First Litchfield merger consideration expressed as a premium
relative to the closing stock price of First Litchfield on October 22, 2009,
September 23, 2009, and July 25, 2009. The results of the transaction premium
analysis are summarized below:
42
Implied
Premium
-----------------------------
1-day 1-month 3-month
-----------------------------
Mean 34.5% 45.3% 53.5%
Median 20.6% 17.5% 38.5%
Minimum -2.7% -2.3% -20.0%
Maximum 173.8% 175.8% 257.3%
Merger consideration $15.00 $ 15.00 $ 15.00
First Litchfield closing stock price per share $ 5.80 $ 6.38 $ 6.10
Implied Transaction premium 158.6% 135.1% 145.9%
Furthermore, Raymond James applied the mean, median, minimum and maximum
premiums for each of the metrics to First Litchfield's actual corresponding
closing stock prices to determine the implied equity price per share and then
compared those implied equity values per share to the merger consideration of
$15.00 per share. The results of this are summarized below:
Implied Equity Price Per Share
----------------------------------------
1-day 1-month 3-month
----------------------------------------
Mean $ 7.80 $ 9.26 $ 9.36
Median $ 6.99 $ 7.49 $ 8.44
Minimum $ 5.65 $ 6.23 $ 4.88
Maximum $ 15.88 $ 17.58 $ 21.78
Merger consideration $ 15.00 $ 15.00 $ 15.00
Discounted Cash Flow Analysis. Raymond James analyzed the discounted
present value of First Litchfield's projected free cash flows for the years
ending December 31, 2009 through 2013 on a standalone basis. Raymond James used
free cash flows, defined as capital excess or shortfall of total regulatory
capital beyond what is required to maintain a minimum Total Risk Based Capital
ratio of 12.0% in each period.
The discounted cash flow analysis was based on projections of the financial
performance of First Litchfield that represented the best available estimates
and judgment of management. Consistent with the periods included in the
financial projections, Raymond James used calendar year 2013 as the final year
for the analysis and applied multiples, ranging from 10.0x to 20.0x, to calendar
2013 net income in order to derive a range of terminal values for First
Litchfield in 2013.
The projected free cash flows and terminal values were discounted using
rates ranging from 10.0% to 14.0%, which reflected the weighted average
after-tax cost of debt and equity
43
capital associated with executing First Litchfield's business plan. The
resulting range of present values was divided by First Litchfield's number of
diluted shares outstanding in order to arrive at a range of present values per
First Litchfield share. Raymond James reviewed the range of per share prices
derived in the discounted cash flow analysis and compared them to the merger
price consideration of $15.00 per share. The results of the discounted cash flow
analysis are summarized below:
--------------
Implied Value
Per Share
--------------
Minimum $ 6.00
Maximum $ 18.87
Merger consideration $ 15.00
Additional Considerations. The preparation of a fairness opinion is a
complex process and is not necessarily susceptible to a partial analysis or
summary description. Raymond James believes that its analyses must be considered
as a whole and that selecting portions of its analyses, without considering the
analyses taken as a whole, would create an incomplete view of the process
underlying the analyses set forth in its opinion. In addition, Raymond James
considered the results of all such analyses and did not assign relative weights
to any of the analyses, but rather made qualitative judgments as to significance
and relevance of each analysis and factor, so the ranges of valuations resulting
from any particular analysis described above should not be taken to be Raymond
James's view of the actual value of First Litchfield.
In performing its analyses, Raymond James made numerous assumptions with
respect to industry performance, general business, economic and regulatory
conditions and other matters, many of which are beyond the control of First
Litchfield. The analyses performed by Raymond James are not necessarily
indicative of actual values, trading values or actual future results which might
be achieved, all of which may be significantly more or less favorable than
suggested by such analyses. Such analyses were provided to the First Litchfield
board of directors and were prepared solely as part of Raymond James's analysis
of the fairness, from a financial point of view, to the holders of First
Litchfield common stock of the consideration to be received by such holders in
connection with the proposed merger. The analyses do not purport to be
appraisals or to reflect the prices at which companies may actually be sold, and
such estimates are inherently subject to uncertainty. The opinion of Raymond
James was one of many factors taken into consideration by the First Litchfield
board of directors in making its determination to approve the merger agreement.
Consequently, the analyses described above should not be viewed as determinative
of the First Litchfield board of directors' or First Litchfield management's
opinion with respect to the value of First Litchfield. First Litchfield placed
no limits on the scope of the analysis performed, or opinion expressed, by
Raymond James.
Raymond James's opinion was necessarily based upon market, economic,
financial and other circumstances and conditions existing and disclosed to it on
October 25, 2009, and any material change in such circumstances and conditions
may affect Raymond James's opinion, but Raymond James does not have any
obligation to update, revise or reaffirm that opinion.
44
For services rendered in connection with the delivery of its opinion, First
Litchfield paid Raymond James an investment banking fee of $125,000 upon
delivery of its opinion. First Litchfield will also pay Raymond James a
transaction fee for advisory services in connection with the merger, which fee
is contingent upon the closing of the merger, of $354,000; of this amount,
$75,000 has been paid to date which is not contingent upon the closing of the
merger but will be applied to the advisory services if the merger closes. First
Litchfield also agreed to reimburse Raymond James for its expenses incurred in
connection with its services, including the fees and expenses of its counsel,
and will indemnify Raymond James against certain liabilities arising out of its
engagement.
Raymond James is actively involved in the investment banking business and
regularly undertakes the valuation of investment securities in connection with
public offerings, private placements, business combinations and similar
transactions. In the ordinary course of business, Raymond James may trade in the
securities of First Litchfield for its own account and for the accounts of its
customers and, accordingly, may at any time hold a long or short position in
such securities. Raymond James has provided certain services to First Litchfield
in the previous two years, including strategic advisory services for which it
has been paid a fee of $25,000 plus expenses, which fee will be applied to the
fee for advisory services in connection with the merger upon the closing of the
merger.
DEREGISTRATION OF FIRST LITCHFIELD COMMON STOCK FOLLOWING THE MERGER
If the merger is completed, First Litchfield's common stock will be
deregistered under the Exchange Act.
45
INTERESTS OF FIRST LITCHFIELD'S DIRECTORS AND EXECUTIVE OFFICERS IN THE MERGER
Some of the members of First Litchfield's management and board of directors
may be deemed to have interests in the merger that are in addition to their
interests as stockholders of First Litchfield generally. The board of directors
was aware of these interests and considered them in recommending that First
Litchfield stockholders approve the merger agreement and the transactions
contemplated by the merger agreement.
GENERAL
Under the terms of the merger agreement, Union anticipates offering
employment to all employees of FNBL, subject to review of personnel files and
such employment criteria for particular positions as Union customarily applies.
This includes the executive officers of First Litchfield, including Joseph J.
Greco, President and Chief Executive Officer of First Litchfield.
AGREEMENTS WITH EXECUTIVE OFFICERS
There are no employment contracts between the Company and any of its
executive officers.
EXECUTIVE CHANGE IN CONTROL AGREEMENTS
There are Change in Control Agreements between FNBL and certain executive
officers, namely Mr. Greco, Carroll A. Pereira, Treasurer of First Litchfield
and Senior Vice President and Chief Financial Officer of FNBL, Frederick F.
Judd, III, Senior Vice President and Senior Trust and Wealth Management Officer
of FNBL, Joelene A. Smith, Senior Vice President and Operations Officer of FNBL,
Robert E. Teittinen, Senior Vice President and Senior Loan Officer of FNBL, and
Matthew R. Robison, Senior Vice President, Retail Banking of FNBL. Pursuant to
the Change in Control Agreements, each executive officer is eligible to receive
payments and other benefits, described below, in the event the executive officer
is terminated, involuntarily reassigned more than fifty (50) miles from
Litchfield, Connecticut, or has an involuntary reduction in compensation, duties
or responsibilities during the twenty-four (24) month period following a change
in control, such as the merger.
- If, within twenty-four (24) months after the merger, the
executive officer's employment with FNBL terminates or is reassigned
(except by an agency acting with proper jurisdiction, or by a board of
directors for cause or as a result of death, retirement or
disability), then FNBL and/or its successor shall pay the executive
officer within five (5) days after the date of termination an amount
equal to the sum of:
(i) two (2) years of the executive officer's annual compensation based
upon the most recent aggregate base salary paid to the executive
officer in the twelve (12) month period immediately preceding his/her
termination or reassignment less amounts previously paid to the
executive officer from the date of the Change in Control; plus
46
(ii) reasonable legal fees and expenses incurred by the executive
officer as a result of such termination or reassignment (including all
such fees and expenses, if any, incurred in contesting or disputing
any such termination or reassignment or in seeking to obtain or
enforce any right or benefit provided for by the Change in Control
Agreement).
- FNBL and/or its successors shall maintain in full force and
effect for the executive officer's continued benefit, for the two (2)
year period beginning upon a Change in Control, all life insurance,
medical, health and accident and disability policies, plans, programs
or arrangements which were in effect immediately prior to the Change
in Control.
- If by reason of the operation of Section 280G of the Internal
Revenue Code (the "Code") any such payments exceed the amount that can
be deducted by FNBL, the amount of such payments shall be reduced to
the maximum that can be deducted by FNBL. To the extent that payments
in excess of the amount that can be deducted by FNBL have been made to
and for the executive officer's benefit, they shall be refunded with
interest.
First Litchfield participated in the CPP. Notwithstanding the provisions
of the Change in Control Agreements, so long as CPP funds are outstanding, First
Litchfield is precluded from making a payment which constitutes a "Golden
Parachute" payment as defined in the American Recovery and Reinvestment Act of
2009 to the executive officers (other than Mr. Robison). After the merger,
Union will not be subject to such limitations.
ACCELERATION OF RESTRICTED STOCK AWARDS
The 2007 Restricted Stock Plan provides that awards of First Litchfield
common stock under the plan immediately vest upon a change in control, such as
the merger. The following table identifies for each First Litchfield executive
officer and director as of December 31, 2009, the number of unvested shares of
restricted stock held by such officer or director that will accelerate in
connection with the transaction.
NAME NUMBER OF SHARES
- ---------------------- ----------------
Joseph J. Greco 1,200
Frederick F. Judd, III 400
Carroll A. Pereira 400
Joelene A. Smith 400
Robert E. Teittinen 400
EMPLOYEE STOCK OWNERSHIP PLAN
Participants in FNBL's Employee Stock Ownership Plan (the "ESOP") have been
awarded shares of First Litchfield common stock in proportion to their
compensation. Participants in the ESOP, including all executive officers, will
receive $15.00 per share of First Litchfield common stock allocated to their
accounts in the ESOP upon the merger.
47
NONCONTRIBUTORY DEFINED BENEFIT PENSION PLAN
FNBL has a noncontributory defined benefit pension plan (the "Pension
Plan") that covers substantially all employees who have completed one year of
service and have attained age 21. The benefits are based on years of service
and the employee's compensation during the last five (5) years of employment.
The Pension Plan was frozen effective May 1, 2005. No new employees thereafter
were eligible for the Pension Plan and no further benefits were earned
thereafter. Benefits payable at normal retirement age (generally age 65) to an
existing participant will be based on service and participation credit and
earnings history through May 1, 2005. Pension benefits are based upon average
salary (determined as of each November 15th) during the highest five (5)
consecutive plan years of services prior to the date the Pension Plan was
frozen. The amount of the annual benefit is 1.55% of average salary per year of
service (to a maximum of 25 years). Benefits under the Pension Plan will be
paid in accordance with the terms of the Pension Plan after the merger.
EXECUTIVE INCENTIVE RETIREMENT AGREEMENTS
FNBL has entered into Executive Incentive Retirement Agreements "Executive
Incentive Agreements") with its executive officers to encourage the executive
officers to remain employees of FNBL. The Executive Incentive Agreements
provide for the award of deferred bonuses of from 4.6% to 16.1% of the executive
officer's base salary if FNBL's earnings growth is at least 5% and its return on
equity is at least 11%. Amounts are awarded after the end of each fiscal year.
It is anticipated that no awards will be earned with respect to First
Litchfield's 2009 performance. Tax-deferred earnings on prior awards accrue
annually at a rate equivalent to the rate of appreciation on First Litchfield's
stock price in the preceding year, with a guaranteed minimum of 4% and a maximum
of 15%. Such awards are immediately vested upon a change in control, such as
the merger. Upon retirement, the executive officer's total deferred
compensation, including earnings thereon, may be paid out in one lump sum, or
paid in equal annual installments over fifteen (15) years, during which payout
period earnings continue to accrue at the rate in effect at the date of
retirement; in the case of early retirement, the executive officer may elect to
defer commencement of the payment of benefits, during which period earnings
continue to accrue at the rate in effect at the date of early retirement.
Deferred amounts will be paid by Union in accordance with the terms of the
Executive Incentive Agreements after the merger.
SUPPLEMENTAL EXECUTIVE RETIREMENT AGREEMENTS
FNBL has entered into Supplemental Executive Retirement Agreements with Mr.
Greco, Ms. Pereira and Ms. Smith. At December 31, 2009, accrued supplemental
retirement benefits of $531,000 are recognized in First Litchfield's balance
sheet related to the Supplement Executive Retirement Agreement for these
executive officers. Upon retirement, the Supplemental Retirement Agreements
provide for payments to these individuals ranging from 10% to 25% of the
three-year average of the executive officer's compensation prior to retirement
for the life expectancy of the executive officer at the retirement date. After
the merger, these obligations will be assumed by Union.
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DIRECTOR INCENTIVE RETIREMENT AGREEMENTS
FNBL has entered into Long Term Incentive Retirement Agreements with each
of its directors (the "Director Incentive Agreements") to reward past service
and encourage continued service of each director.
The Director Incentive Agreements award a director with the right to earn
and defer the receipt of a bonus in an amount or percentage ranging from 14.5%
to 50% of the director's retainer, meeting fees and committee fees, depending on
the return on equity and earnings growth in the preceding year, provided that
there is no award if the return on equity in the preceding year is less than 11%
and earnings growth in the preceding year is less than 5%. Earnings accrue
annually on such amounts at a rate equivalent to the appreciation in First
Litchfield's stock price in the preceding year, with a guaranteed minimum of 4%
and a maximum of 15%. It is anticipated that no awards will be earned with
respect to First Litchfield's 2009 performance. Such awards are immediately
vested upon a change in control, such as the merger. Upon retirement, the
director's total deferred compensation, including earnings thereon, may be paid
out in one lump sum, or paid in equal annual installments over ten (10) years,
during which payout period earnings continue to accrue as stated above. Deferred
amounts will be paid by Union in accordance with the terms of the Director
Incentive Agreements after the merger.
INDEMNIFICATION
Pursuant to the merger agreement, Union has agreed to indemnify the
officers and directors of First Litchfield and FNBL to the fullest extent
provided in First Litchfield's articles of organization and bylaws or FNBL's
charter and bylaws, as the case may be, for a period of six years after the
effective date of the merger.
DIRECTORS' AND OFFICERS' INSURANCE
Union has agreed to purchase an extension of its current directors' and
officers' liability insurance coverage that will provide First Litchfield's
officers and directors with coverage for six years following the effective date
of the merger for errors and omissions committed by an officer or director in
his or her capacity as such and that occurred prior to the effective date of the
merger. Under the terms of the merger agreement, the aggregate cost of the
insurance extension must be less than $200,000.
APPOINTMENT OF THREE FIRST LITCHFIELD DIRECTORS TO THE BOARD OF TRUSTEES OF
UNION
As of the closing of the merger, three members of the current board of
directors of First Litchfield mutually agreed upon by the board of directors of
First Litchfield and the board of trustees of Union will be appointed to the
Union board of trustees. These trustees will receive compensation commensurate
with his or her duties and responsibilities in the same amounts and subject to
the same conditions as paid to the other members of the board of trustees of
Union. The members of the First Litchfield board of directors who will be
appointed to the Union board of trustees have not been dertermined as of the
date of this proxy statement.
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STOCK OWNERSHIP AND VOTING POWER
As of the record date, the directors and officers of First Litchfield
beneficially owned approximately 8.6% of the total outstanding shares of common
stock of First Litchfield entitled to vote at the special meeting.
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THE MERGER AGREEMENT
The following is a brief summary of the significant provisions of the
merger agreement between First Litchfield and Union. The summary is not
complete and is qualified in its entirety by reference to the merger agreement,
which is attached to this document as Annex A and is incorporated into this
document by reference. You should read the entire merger agreement carefully
and in its entirety.
STRUCTURE OF THE MERGER
The merger agreement provides for the merger of a subsidiary of Union with
and into First Litchfield, with First Litchfield being the surviving
corporation, and the dissolution of First Litchfield. This will result in Union
owning all the assets and liabilities of First Litchfield. Separately, FNBL
will merge with and into Union, with Union being the surviving entity.
CLOSING OF THE MERGER
The closing of the merger will occur on a date determined in the sole
discretion of Union upon five business day's prior written notice to First
Litchfield, but in no event later than 30 days after the last condition
precedent to the merger has been fulfilled or waived, or such other date as
First Litchfield and Union shall mutually agree. The merger will become
effective upon the filing of articles of merger with the Secretary of State of
Delaware and the Secretary of the State of Connecticut.
We currently expect that the merger will become effective during the first
quarter of 2010 or as soon thereafter as practicable; however, because the
merger is subject to a number of conditions, we cannot predict the actual
timing.
MERGER CONSIDERATION
In the merger, each outstanding share of First Litchfield common stock will
be converted into the right to receive $15.00 cash.
EXCHANGE OF FIRST LITCHFIELD STOCK CERTIFICATES FOR CASH
On or before the closing date of the merger, Union will cause to be
delivered to the exchange agent (which will be a bank or trust company selected
by Union and reasonably satisfactory to First Litchfield), an amount of cash
sufficient to pay the aggregate amount of cash payable to all holders of First
Litchfield common stock and options.
As soon as practicable following the effective time of the merger, the
exchange agent will mail to each First Litchfield stockholder of record at the
effective time of the merger a letter of transmittal and instructions for use in
surrendering the stockholder's First Litchfield stock certificates. When such
First Litchfield stockholders deliver their First Litchfield stock certificates
to the exchange agent along with a properly completed and duly executed letter
of transmittal and any other required documents, their First Litchfield stock
certificates will be cancelled and in exchange they will receive a check
representing the amount of cash that they are entitled to receive in respect of
the certificates surrendered.
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The surrendered stock certificates will then be cancelled.
A check will be issued in a name other than the name in which a surrendered
First Litchfield stock certificate is registered only if the exchange agent is
presented with all documents required to show and effect the unrecorded transfer
of ownership, together with evidence that any applicable stock transfer taxes
have been paid.
CONDITIONS TO THE MERGER
The obligations of First Litchfield and Union to complete the merger are
subject to the fulfillment of the following conditions:
- the merger agreement has been approved by the requisite vote of
the stockholders of First Litchfield;
- Neither Union or First Litchfield shall be subject to any order,
decree or injunction which enjoins or prohibits the consummation of
the transactions contemplated by the merger agreement; and
- All necessary approvals, authorizations and consents of all
governmental authorities required to consummate the transactions
contemplated by the merger agreement have been obtained and all
waiting periods have expired, and none of the approvals,
authorizations or consents shall include any condition or requirement
that would, in the good faith reasonable judgment of the Board of
Trustees of Union, materially and adversely affect the business,
operations, financial condition, property or assets of the combined
enterprise of First Litchfield, FNBL and Union or otherwise materially
impair the value of First Litchfield or FNBL to Union.
In addition, the obligation of Union to complete the merger is subject to
the fulfillment or written waiver, where permissible, of the following
conditions:
- each of the representations and warranties of First Litchfield
contained in the merger agreement shall be true and correct in all
material respects as of the date of the merger agreement and as of the
closing date of the merger, unless the failure of those
representations and warranties to be true and correct does not
constitute, individually or in the aggregate, a material adverse
effect on First Litchfield and FNBL, taken as a whole;
- First Litchfield and FNBL shall have performed in all material
respects all obligations and complied in all material respects with
all agreements and covenants of First Litchfield and FNBL required to
be performed under the merger agreement at or prior to the closing
date of the merger, unless the failure to perform or comply does not,
individually or in the aggregate, have a material adverse effect on
First Litchfield and FNBL, taken as a whole, or materially adversely
affect consummation of the merger and the other transaction
contemplated by the merger agreement;
- First Litchfield and FNBL shall have obtained any and all
material permits, authorizations, consents, waivers, clearances or
approvals required for the lawful
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consummation of the merger and the bank merger, respectively, unless
the failure to obtain these would not have a material adverse effect
on First Litchfield and FNBL, taken as a whole; and
- since June 30, 2009, no event has occurred or circumstance has
arisen that, individually or in the aggregate, has had or is
reasonably likely to have a material adverse effect on First
Litchfield and FNBL, taken as a whole.
The obligations of First Litchfield to complete the merger are subject to
the fulfillment or written waiver, where permissible, of the following
additional conditions:
- each of the representations and warranties of Union contained in
the merger agreement shall be true and correct in all material
respects as of the date of the merger agreement and as of the closing
date of the merger, unless the failure of those representations and
warranties to be true and correct does not constitute, individually or
in the aggregate, a material adverse effect on Union;
- Union shall have performed in all material respects all
obligations and complied in all material respects with all agreements
and covenants of Union required to be performed under the merger
agreement at or prior to the closing date of the merger, unless the
failure to perform or comply does not, individually or in the
aggregate, have a material adverse effect on Union or materially
adversely affect consummation of the merger and the other transaction
contemplated by the merger agreement;
- Union shall have obtained any and all material permits,
authorizations, consents, waivers, clearances or approvals required
for the lawful consummation of the merger and the bank merger, unless
the failure to obtain these would not have a material adverse effect
on Union; and
- Union shall have delivered to the exchange agent an amount of
cash sufficient to pay the aggregate amount of cash payable to all
holders of First Litchfield common stock and options.
"Material adverse effect" when used in reference to First Litchfield or
Union, means any effect that (i) is material and adverse to the financial
condition, results of operations or business of First Litchfield as a whole or
Union, or (ii) materially impairs the ability of either First Litchfield or
Union to consummate the transactions contemplated by the merger agreement.
However, "material adverse effect" shall not be deemed to include the impact of:
- changes in laws and regulations affecting banks and their holding
companies generally;
- changes in Generally Accepted Accounting Principles or regulatory
accounting principles generally applicable to banks and their holding
companies;
- actions and omissions of either party taken with the prior
written consent of the other party;
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- changes in economic conditions affecting financial institutions
generally, including but not limited to changes in market interest
rates or the projected future interest rate environment; and
- the direct effects of compliance with this Agreement on the
operating performance of the parties.
TERMINATION
The merger agreement may be terminated at any time prior to the closing and
the transactions contemplated by the merger agreement abandoned as follows:
- by mutual written consent of the parties;
- by Union or First Litchfield if the other party has breached any
of its representations or warranties contained in the merger agreement
(provided that the terminating party is not then in material breach of
any representation, warranty, covenant or other agreement contained in
the merger agreement), and the breach cannot be cured prior to the
closing or has not been cured within 30 days of written notice of the
breach;
- by Union or First Litchfield if the other party has failed to
perform or comply with any of its covenants or agreements contained in
the merger agreement (provided that the terminating party is not then
in material breach of any representation, warranty, covenant or other
agreement contained in the merger agreement), and the failure cannot
be cured prior to the closing or has not been cured within 30 days of
written notice of the breach;
- by Union or First Litchfield if the merger has not occurred on or
before June 30, 2010, provided that such date shall be automatically
extended to September 30, 2010 if required regulatory approvals have
not been received by June 1, 2010 and both parties are acting in good
faith to obtain such approvals, unless the failure of the merger to
occur on or before such date was due to the terminating party's breach
of any obligations under the merger agreement;
- by Union or First Litchfield if First Litchfield stockholders
have voted at the Special Meeting and the required approval of the
merger agreement has not been obtained;
- by Union or First Litchfield if final action has been taken by
any regulatory authority whose approval or non-objection is required
for connection with the merger agreement or the transactions
contemplated by the merger agreement, which final action has become
nonappealable action and does not approve or state a non-objection to
the merger agreement or the transactions contemplated by the merger
agreement; if any regulatory authority whose approval or non-objection
is required in connection with the merger agreement or the
transactions contemplated by the merger agreement has stated in
writing that it will not issue the required approval or non-objection;
or if any court or governmental entity has issued a final
nonappealable
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order, decree, ruling or taken any other action restraining, enjoining
or otherwise prohibiting the merger and the transactions contemplated
by the merger agreement;
- by First Litchfield if the conditions precedent to its
obligations to consummate the merger or the transactions contemplated
by the merger agreement cannot be satisfied or fulfilled by June 1,
2010, provided that if required regulatory approvals have not been
received and both parties are acting in good faith to obtain such
approvals, such date shall automatically be extended to September 1,
2010 (provided that First Litchfield is not then in material breach of
any representation, warranty, covenant or other agreement contained in
the merger agreement);
- by Union or First Litchfield if any of the conditions precedent
to the obligations of such party to consummate the merger or the
transactions contemplated by the merger agreement cannot be satisfied
or fulfilled by the June 30, 2010 or September 30, 2010 if required
regulatory approvals have not been received and both parties are
acting in good faith to obtain such approvals (provided that the
terminating party is not then in material breach of any
representation, warranty, covenant or other agreement contained in the
merger agreement);
- By Union if at any time prior to the Special Meeting the First
Litchfield board fails to recommend approval of the merger agreement,
withdraws such recommendation or changes such recommendation in a
manner adverse to Union or has failed to call or hold the Special
Meeting;
- By Union if a tender or exchange offer for 25% or more of the
First Litchfield common stock is commenced and the First Litchfield
board recommends that First Litchfield stockholders tender their
shares in such tender or exchange offer or otherwise fails to
recommend in a timely manner that First Litchfield stockholders reject
such tender or exchange offer; and
- by First Litchfield in connection with entering into an
acquisition agreement with respect to a superior proposal, but only
if, after five business days after Union's receipt of written notice
from First Litchfield advising Union that it is prepared to enter an
agreement with respect to the superior proposal, Union does not make
an offer to First Litchfield that the First Litchfield board
determines is at least as favorable as the superior proposal. A
"superior proposal" means any offer or proposal involving First
Litchfield in (i) any merger, consolidation, business combination or
similar transaction, (ii) any sale, lease or other disposition of 25%
or more of its consolidated assets, (iii) any tender or exchange offer
for 25% or more of the First Litchfield common stock or (iv) any
public announcement of a proposal, plan or intention to do any of the
foregoing that the First Litchfield board determines in good faith is
at least as likely to be consummated, and if consummated, would result
in a transaction more favorable to First Litchfield stockholders from
a financial point of view than the merger.
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TERMINATION FEE
Under the terms of the merger agreement, First Litchfield must pay Union a
termination fee if:
- Union terminates the merger agreement as a result of:
- First Litchfield's board of directors' failure at any time
prior to the Special Meeting to recommend approval of the merger
agreement, withdrawal of such recommendation or changing such
recommendation in a manner adverse to Union or failure to call or
hold the Special Meeting; or
- The commencement of a tender or exchange offer for 25% or
more of the First Litchfield common stock and the recommendation
of the First Litchfield board that First Litchfield stockholders
tender their shares in such tender or exchange offer or otherwise
fails to recommend in a timely manner that First Litchfield
stockholders reject such tender or exchange offer.
- an acquisition proposal is publicly announced or otherwise
communicated to First Litchfield and prior to the termination of the
merger agreement, Union terminates the merger agreement as a result
of:
- the breach by First Litchfield of any of its representations or
warranties contained in the merger agreement (provided that Union
is not then in material breach of any representation, warranty,
covenant or other agreement contained in the merger agreement),
and the breach cannot be cured prior to the closing or has not
been cured within 30 days of written notice of the breach; or
- the failure by First Litchfield to perform or comply with any of
its covenants or agreements contained in the merger agreement
(provided that Union is not then in material breach of any
representation, warranty, covenant or other agreement contained
in the merger agreement), and the failure cannot be cured prior
to the closing or has not been cured within 30 days of written
notice of the breach; or
- prior to the Special Meeting, Union or First Litchfield terminates the
merger agreement because the First Litchfield stockholders have voted
at the Special Meeting and the required approval of the merger
agreement has not been obtained.
An "acquisition proposal" means any proposal or offer with respect to (i)
any merger, consolidation, business combination or similar transaction, (ii) any
sale lease or other disposition of 25% or more of its consolidated assets, (iii)
any tender or exchange offer for 25% or more of the First Litchfield common
stock or (iv) any public announcement of a proposal, plan or intention to do any
of the foregoing or any agreement to engage in any of the foregoing.
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In any of the above circumstances, First Litchfield shall pay Union a
termination fee of $750,000 within three business days of the termination and,
if within 18 months of such termination First Litchfield enters into an
agreement with respect to, or consummates, an acquisition transaction, First
Litchfield shall pay Union a termination fee of an additional $1,000,000 on the
date of execution or consummation of the acquisition agreement. An "acquisition
transaction" means any (i) merger, consolidation, business combination or
similar transaction, (ii) any sale, lease or other disposition of 25% or more of
its consolidated assets or (iii) any tender or exchange offer for 25% or more of
the First Litchfield common stock.
In addition, First Litchfield must pay Union a termination fee of
$1,750,000 within three business days of the termination if First Litchfield
terminates the merger agreement in connection with entering into an acquisition
agreement with respect to a superior proposal, but only if, after five business
days after Union's receipt of written notice from First Litchfield advising
Union that it is prepared to enter an agreement with respect to the superior
proposal, Union does not make an offer to First Litchfield that the First
Litchfield board determines is at least as favorable as the superior proposal.
Also, in the event of a termination by Union or First Litchfield if the
other party has:
- breached any of its representations or warranties contained in
the merger agreement (provided that the terminating party is not then
in material breach of any representation, warranty, covenant or other
agreement contained in the merger agreement), and the breach cannot be
cured prior to the closing or has not been cured within 30 days of
written notice of the breach; or
- failed to perform or comply with any of its covenants or
agreements contained in the merger agreement (provided that the
terminating party is not then in material breach of any
representation, warranty, covenant or other agreement contained in the
merger agreement), and the failure cannot be cured prior to the
closing or has not been cured within 30 days of written notice of the
breach,
as a result of the willful conduct or gross negligence of the breaching party,
the breaching party shall pay to the other party up to $500,000 of documented
reasonable out-of-pocket costs and expenses incurred in connection with entering
the merger agreement and the carrying out of the acts contemplated by the merger
agreement. However, if First Litchfield has paid any termination fee described
above, it shall not be obligated to make this payment.
NO SOLICITATION
First Litchfield has agreed that neither it nor its subsidiaries, and has
agreed to use its best efforts in good faith to cause its and any subsidiaries'
respective officers, directors, employees, investment bankers, financial
advisors, attorneys, accountants, affiliates and other of its agents (which
First Litchfield sometimes refers to as its representatives), not to, directly
or indirectly:
- initiate, solicit, knowingly encourage or otherwise facilitate
any inquiries or the making of any proposal or offer with respect to
an acquisition proposal; or
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- engage in any negotiations concerning, or provide any
confidential information or data to, or have any discussions with, any
person relating to an acquisition proposal.
However, neither First Litchfield nor its board of directors is prohibited
from (i) providing information in response to a request from a person who has
made an unsolicited bona fide written acquisition proposal if the person enters
a confidentiality agreement; (ii) engaging in any negotiations or discussions
with any person or (iii) recommending such an acquisition proposal to First
Litchfield stockholders if:
- the First Litchfield board of directors determines in good faith,
after consultation with outside counsel, that such action is required
for the directors to comply with their fiduciary duties under
applicable law; and
- the First Litchfield board of directors determines in good faith,
after consultation with its financial advisor, that such acquisition
proposal, if accepted, is at least as reasonably likely to be
consummated as the merger and if consummated, would result in a
transaction more favorable to First Litchfield's stockholders from a
financial point of view than the merger (a "superior proposal").
First Litchfield has agreed to immediately, within 24 hours, notify Union
if any such inquiries, proposals or offers are received by, any information is
requested from, or any negotiations or discussions are sought to be initiated or
continued with First Litchfield or any of its representatives. Any such notice
will identify the person making such inquiry, proposal or offer and the
substance thereof. First Litchfield is also required to keep Union informed of
any material developments with respect thereto immediately upon the occurrence
thereof.
If the First Litchfield board of directors determines in good faith, after
consultation with its financial advisor and upon advice from outside counsel,
that it desires to accept a superior proposal, it shall notify Union in writing
that it intends to terminate the merger agreement in order to enter into an
agreement with respect to, or recommend acceptance of, the superior proposal,
identifying all the material terms and conditions of the superior proposal and
identifying the person making the superior proposal. Union shall have 5
business days to respond to the notice. If Union, within such 5 business days,
notified First Litchfield in writing that it shall increase the merger
consideration to an amount at least equal to that of the superior proposal, then
First Litchfield may not enter into an acquisition agreement with respect to the
superior proposal nor may the First Litchfield board of directors recommend to
First Litchfield stockholders acceptance of the superior proposal. However, if
the First Litchfield board of directors determines in good faith, upon the
advice of its financial advisor and outside counsel, that the Union proposal is
not at least equal to the superior proposal, First Litchfield may terminate the
merger agreement in order to execute an acquisition agreement with respect to,
or recommend to First Litchfield stockholders acceptance of, the superior
proposal.
FIRST LITCHFIELD STOCKHOLDERS MEETING
First Litchfield has agreed, in accordance with Delaware law and its
certificate of incorporation and bylaws, as promptly as reasonably practicable,
to call, give notice of, convene and hold a meeting of its stockholders to
approve the merger agreement and the transactions
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contemplated thereby. First Litchfield also has agreed, subject to the
fiduciary duty of the First Litchfield board of directors, as advised by
counsel, to recommend to First Litchfield stockholders approval of the merger
agreement and the transactions contemplated thereby and oppose any third party
proposal or other action that is inconsistent with the merger agreement and the
transactions contemplated thereby.
DIRECTORS' AND OFFICERS' INSURANCE
Union has agreed to maintain in effect for six years after the effective
time of the merger the current directors' and officers' liability insurance
policies maintained by First Litchfield, subject to Union's right to substitute
policies with at least the same coverage, with regard to matters occurring
before the effective time of the merger. Alternatively, Union may purchase
"tail coverage" for a period of six years with coverage no less favorable than
in First Litchfield's current policies. However, Union is not required to
expend in excess of $200,000 for such coverage.
In addition, Union has agreed to indemnify, defend and hold harmless each
director of First Litchfield against all losses, claims, damages, costs,
expenses (including reasonable attorney's fees), liabilities or judgments or
amounts that are paid in settlement of or in connection with any claim, action,
suit, proceeding or investigation, whether civil, criminal, investigative or
administrative, in which such a director is, or is threatened to be made, a
party or witness in whole or in part on or arising in whole or in part out of
the fact that such person was a director of First Litchfield if such matter
pertains to any fact arising, existing or occurring at or before the merger, as
provided under applicable state or federal law and under First Litchfield's
certificate of incorporation and bylaws. Union shall pay expenses in advance of
the final disposition of any such action or proceeding to the full extent
permitted by applicable state or federal law upon receipt of an undertaking to
repay such advance payments if the director shall be adjudicated or determined
not to be entitled to indemnification.
CONDUCT OF BUSINESS PENDING THE MERGER
Pursuant to the merger agreement, First Litchfield has agreed that, until
the effective time of the merger, First Litchfield and its subsidiaries will:
- operate its business in the usual, regular and ordinary;
- use reasonable best efforts in good faith to preserve intact its
business organization and assets, keep available the present services
of its employees, maintain its rights and franchises, and preserve the
goodwill of its customers and others with whom business relationships
exist; or
- voluntarily take any action that would or be reasonably likely to
(i) adversely affect the ability of either First Litchfield or FNBL to
obtain any necessary regulatory approvals required for the
transactions contemplated by the merger agreement or increase the
period of time necessary to obtain such approvals or (ii) adversely
affect its ability to perform any of its covenants or agreements under
the merger agreement.
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Also pursuant to the merger agreement, First Litchfield has agreed that,
until the effective time of the merger, except as specifically permitted or
required by the merger agreement or any governmental entity, or consented to in
writing by Union, First Litchfield and its subsidiaries will not:
- change or waive any provision of First Litchfield's certificate
of incorporation or FNBL's charter or their bylaws, except as required
by law;
- change the number of shares of its authorized capital stock;
- issue any capital stock or issue or grant any option, restricted
stock award, warrant, call, commitment, subscription, right to
purchase or agreement of any character relating to its authorized or
issued capital stock or any securities convertible into shares of such
stock; except that First Litchfield may issue shares of First
Litchfield common stock or permit treasury shares to become
outstanding to satisfy currently outstanding restricted stock awards
in accordance with the terms of the First Litchfield stock plan;
- effect any recapitalization, reclassification, stock dividend,
stock split or like change in capitalization, or redeem, repurchase or
otherwise acquire any shares of its capital stock;
- declare or pay any dividends or other distributions with respect
to First Litchfield common stock;
- enter into or terminate any contract or agreement (including
without limitation any settlement agreement with respect to
litigation) except in the ordinary course of business;
- incur any liabilities or obligations (excluding customer deposit
accounts and retail repurchase agreements) in excess of $50,000
individually or $250,000 in the aggregate, whether directly or by way
of guaranty, including any obligation for borrowed money whether or
not evidenced by a note, bond, debenture or similar instrument;
- make any capital expenditures (excluding third party leasing
transactions through First Litchfield Leasing Corporation consistent
with past practice) in excess of $50,000 individually or $250,000 in
the aggregate, except pursuant to binding commitments existing on the
date of the merger agreement and except for expenditures reasonable
and necessary to maintain assets in good repair;
- except for commitments issued prior to the date of the merger
agreement which have not expired, make any new loan (including leasing
transactions) or other credit facility commitment or increase any loan
or other credit facility commitment to any borrower or group of
affiliated borrowers in excess of the following limitations without
prior consultation with approval from Union's Chief Lending Officer:
- residential first mortgage loan in excess of $500,000;
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- owner occupied and/or "under contract" residential
construction loan in excess of $500,000;
- commercial and industrial loan in excess of $250,000;
- commercial real estate loan in excess of $1,000,000 for
owner-occupied and in excess of $500,000 for non-owner occupied;
- commercial construction loan in excess of $500,000;
- consumer loan (including home equity loan) in excess of
$250,000 for secured and in excess of $25,000 unsecured;
- residential development, acquisition, and construction loan
in excess of $250,000;
- renewal of existing lines of credit to OAEM or higher risk
rating; and
- loans of new monies to borrowers or borrowing relationships
with OAEM-rated credits or higher shall not be made in any
amount;
- grant any increase in rates of compensation to its non-officer
employees other than in the ordinary course of business consistent
with past practice provided that no such increase shall result in an
annual adjustment of more than 3% without prior consultation with and
approval from Union's Senior Vice President of Human Resources; grant
any increase in rates of compensation to, or pay or agree to pay any
bonus or severance to, or provide any other new employee benefit or
incentive to its directors or to its officers except for
non-discretionary payments required by agreements existing as of the
date of the merger agreement without prior consultation with and
approval from Union; grant any increases in compensation or bonuses to
its non-officer employees other than in the ordinary course of
business consistent with past practice and bonuses that are reasonable
and necessary to compensate employees in lieu of option grants through
the effective date of the merger, in consultation with Union's Senior
Vice President of Human Resources; enter into any employment,
severance or similar agreements or arrangements with any director or
employee; adopt or amend or terminate any employee benefit plan,
pension plan or incentive plan except as required by law or the terms
of such plan, or permit the vesting of any material amount of benefits
under any such plan other than pursuant to the provisions thereof as
in effect on the date of the merger agreement; make any contributions
to any First Litchfield employee plan not in the ordinary course of
business consistent with past practice; or make any contributions to
First Litchfield Employee Stock Ownership Plan (the "ESOP") other than
as required by the terms of the ESOP currently in effect on the date
of the merger agreement;
- increase the number of (i) non-officer personnel employed by
First Litchfield over the staffing level previously authorized or (ii)
officers employed by First Litchfield over the number of such officers
employed at the time of the merger agreement, without the prior
consent of Union's Senior Vice President of Human Resources;
- make application for the opening or closing of any, or open or
close any, branch or automated banking facility;
61
- make any equity investment or commitment to make such an
investment in real estate or in any real estate development project
including foreclosures, settlements in lieu of foreclosure or troubled
loan or debt restructuring;
- merge into, consolidate with, affiliate with, or be purchased or
acquired by, any other person, or permit any other person to be
merged, consolidated or affiliated with it or be purchased or acquired
by it, or, except to realize upon collateral in the ordinary course of
its business, acquire a significant portion of the assets of any other
person, or sell a significant portion of its assets;
- make any change in its accounting methods or practices, except
changes as may be required by Generally Accepted Accounting Principles
("GAAP") or by law or regulatory requirements;
- enter into any off-balance sheet transaction involving interest
rate and currency swaps, options and futures contracts, or any other
similar derivative transactions;
- except for commitments outstanding as of June 30, 2009, invest in
or commit to invest in, or otherwise increase, decrease or alter its
investment in, any existing or new joint venture;
- make any material change in policies in existence as of the date
of the merger agreement with regard to the extension of credit, the
establishment of reserves with respect to the possible loss thereon or
the charge off of losses incurred thereon, investment, asset/liability
management or other material banking policies, except as may be
required by changes in applicable law or regulations or by GAAP;
- waive, release, grant or transfer any rights of value or modify
or change any existing agreement or indebtedness to which First
Litchfield is a party, other than in the ordinary course of business,
consistent with past practice;
- purchase any debt securities or any equity securities, or
purchase any security for its investment portfolio, or otherwise take
any action that would materially alter the mix, maturity, credit or
interest rate risk profile of its portfolio of investment securities;
- enter into, renew, extend or modify any other transaction with
any affiliate;
- take any action that would give rise to a right of payment to any
individual under any employment or severance agreement or similar
agreement;
- take any action that would give rise to an acceleration of the
right to payment to any individual under any First Litchfield employee
plan;
- without the prior consultation and consent of Union's Chief
Financial Officer, sell any participation interest in any existing or
newly originated loan or acquire a participation in any loan;
62
- enter into any new or depart from any existing line of business;
- without prior consultation with Union's Chief Financial Officer,
increase or decrease the rate of interest paid on deposits, except
within 25 basis points of rates paid by Union for comparable deposits;
- take any action that (i) would, or is reasonably likely to,
prevent or impede the merger from qualifying as a qualified stock
purchase within the meaning of Section 338 of the Code or (ii) is
intended or is reasonably likely to result in (x) any of its
representations and warranties set forth in the merger agreement being
or becoming untrue in any material respect at or prior to the
effective time of the merger, (y) any of the conditions to the merger
not being satisfied or (z) a material violation of any provision of
the merger agreement or the bank merger agreement, except, in each
case, as may be required by applicable law or regulation; or
- elect to participate in, or fail to opt out of participation in,
the Transaction Account Guarantee Program established by the FDIC or
any other similar program; or
- agree to do any of the foregoing.
The agreements relating to the conduct of First Litchfield's business
contained in the merger agreement are complicated and not easily summarized.
You are urged to carefully read Article VI of the merger agreement attached to
this document as Annex A.
REDEMPTION
First Litchfield has agreed to use its best efforts to, immediately before
or contemporaneously with the merger, redeem at par value the trust preferred
securities issued in 2003 by First Litchfield's subsidiary First Litchfield
Statutory Trust I and in 2006 by First Litchfield's subsidiary First Litchfield
Statutory Trust II and redeem all of the 10,000 outstanding shares of First
Litchfield preferred stock and the warrant to purchase 199,203 shares of First
Litchfield common stock issued to the United States Department of the Treasury
under the CPP and satisfy all obligations related thereto. First Litchfield has
agreed to use its best efforts, in coordination with Union, to obtain all
necessary approvals and non-objections of governmental entities and any counter
party and third party consents necessary for the foregoing. Union has agreed to
advance the funds to First Litchfield for redemption of any one or more of the
foregoing immediately before or contemporaneously with the merger to enable
First Litchfield to effectuate the redemptions. The completion of the
redemptions is not a condition precedent to completion of the merger and if the
merger is consummated without the redemptions having occurred, the trust
preferred securities and the preferred stock will become the obligations of
Union.
EMPLOYEE BENEFITS
Under the terms of the merger agreement, Union anticipates offering
employment to all employees of FNBL, subject to review of personnel files and
such employment criteria for particular positions as Union customarily applies.
63
Each employee of FNBL who remains employed by Union following the merger
will be entitled to participate, at the option of Union, in (i) such of the
employee benefit plans, deferred compensation arrangements, bonus or incentive
plans and other compensation and benefit plans of FNBL that Union may continue,
and (ii) whatever employee benefit plans and other compensation and benefit
plans that Union may maintain for the benefit of its similarly situated
employees if the former FNBL employee is not otherwise then participating in a
similar FNBL plan that Union continues.
Each former FNBL employee will be credited with service as a FNBL employee
for purposes of determining his or her status under Union's policies with
respect to vacation, sick and other leave. With respect to the Union defined
benefit pension plan, each former FNBL employee will be credited with hours of
service as a FNBL employee for the prior employment period with FNBL in order to
determine when the employee would be eligible to participate in the plan, but
not for purposes of calculating benefits under the plan. With respect to the
Union defined contribution plan, each former FNBL employee will be eligible to
participate, but will not be credited with prior years of service as a FNBL
employee for purposes of vesting. With respect to any Union plan which is a
health, life or disability insurance plan, each former FNBL employee will not be
subject to any pre-existing condition limitation for conditions covered under
such plans and each such plan which provides health insurance benefits.
After the merger, Union may in its discretion maintain, terminate, merge or
dispose of any FNBL employee plan. Union will assume all obligations under
deferred compensation plans of First Litchfield or FNBL, but has the right to
terminate such plans following the merger. Union will honor the terms of all
employment, change in control or other agreements with any director or employee
of First Litchfield or FNBL unless Union and the affected employee or director
agree otherwise.
REPRESENTATIONS AND WARRANTIES
The merger agreement contains reciprocal representations and warranties of
First Litchfield and Union and their subsidiaries relating to:
- capital structure;
- due organization, existence and good standing;
- corporate power and authority to conduct its business;
- subsidiaries;
- deposit insurance;
- corporate power and authority to enter the merger agreement and
to consummate the transactions contemplated thereby;
- the merger agreement and the transactions contemplated do not
violate or breach organizational documents, agreements and
governmental orders;
64
- financial statements;
- no material adverse change since December 31, 2009;
- legal proceedings;
- compliance with applicable laws;
- off-balance sheet transactions;
- environmental matters;
- employee benefit plans; and
- brokers and finders.
The merger agreement contains additional representations and warranties by
First Litchfield and its subsidiaries relating to:
- due registration as a bank holding company;
- SEC documents and filings;
- tax matters:
- certain contracts;
- insurance;
- properties;
- labor matters;
- fairness opinion;
- loans and nonperforming and classified assets;
- required vote and inapplicability of takeover laws;
- material interests of certain persons;
- joint ventures; and
- intellectual property.
The merger agreement also contains additional representations and
warranties by Union relating to:
- Community Reinvestment Act rating;
65
- absence of certain changes; and
- financial ability and sufficiency of funds to complete the merger.
None of the representations and warranties by either party survives the
effective time of the merger. The representations and warranties in the merger
agreement are complicated and not easily summarized. You are urged to carefully
read Articles IV and V of the merger agreement attached to this document as
Annex A.
EXPENSES
Each party will pay all fees and expenses it incurs in the merger.
AMENDMENTS
First Litchfield and Union may amend the merger agreement by executing a
written amendment approved by the boards of First Litchfield and Union.
However, after approval of the merger agreement by the stockholders of First
Litchfield, no amendment of the merger agreement may be made which reduces the
amount, value or changes the form of consideration to be delivered to First
Litchfield stockholders without obtaining their approval.
REGULATORY APPROVALS REQUIRED FOR THE MERGER
First Litchfield and Union must obtain a number of regulatory approvals
from, or give notices to, federal and state bank regulators, before the merger
of First Litchfield and Union and the merger of FNBL into Union can be
completed.
FDIC. On December 23, 2009, Union filed with the FDIC the required
application under the Bank Merger Act to obtain approval of the merger of FNBL
with and into Union. The FDIC is required to consider the financial and
managerial resources and future prospects of the banks concerned, as well as the
convenience and needs of the communities to be served. In addition, the FDIC
must consider the effectiveness of FNBL and Union in combating money laundering
activities in connection with its determination whether to approve the bank
merger.
OFFICE OF COMPTROLLER OF THE CURRENCY. FNBL will provide the OCC with a
notice of termination as a national bank as a result the bank merger. No OCC
approval of the bank merger is required because Union, the survivor of the bank
merger, is a state nonmember bank whose principal federal regulator is the FDIC.
CONNECTICUT DEPARTMENT OF BANKING. On December 23, 2009, Union filed an
application seeking the permission of the Connecticut Department of Banking to
acquire FNBL. In determining whether to approve the merger, the Connecticut
Department of Banking must consider whether the merger will promote the public
convenience, whether the benefits to the public clearly outweigh possible
adverse effects and whether the terms of the merger are reasonable and in
accordance with law and sound public policy.
First Litchfield and Union are not aware of any governmental approvals or
actions that may be required for consummation of the merger other than as
described above. Should any
66
other approval or action be required, First Litchfield and Union currently
contemplate that such approval or action would be sought.
67
MATERIAL FEDERAL INCOME TAX CONSEQUENCES
The following is a general summary of material United States federal income
tax consequences of the merger of First Litchfield and Union. The federal
income tax laws are complex and the tax consequences of the merger may vary
depending upon each stockholder's individual circumstances or tax status. The
following discussion is based upon current provisions of the Internal Revenue
Code of 1986, as amended, (the "Code"), existing temporary and final regulations
under the Code and current administrative rulings and court decisions, all of
which are subject to change, possibly on a retroactive basis. No attempt has
been made to comment on all United States federal income tax consequences of the
merger that may be relevant to stockholders of First Litchfield. The tax
discussion set forth below is included for general information only. It is not
intended to be, nor should it be construed to be, legal or tax advice to a
particular stockholder of First Litchfield.
The following discussion may not apply to particular categories of holders
of shares of First Litchfield common stock subject to special treatment under
the Code, such as insurance companies, financial institutions, broker-dealers,
tax-exempt organizations, individual retirement and other tax-deferred accounts,
banks, persons subject to the alternative minimum tax, persons who hold First
Litchfield capital stock as part of a straddle, hedging or conversion
transaction, persons whose functional currency is other than the United States
dollar, persons eligible for tax treaty benefits, foreign corporations, foreign
partnerships and other foreign entities, individuals who are not citizens or
residents of the United States and holders whose shares were acquired pursuant
to the exercise of an employee stock option or otherwise as compensation. This
discussion assumes that holders of shares of First Litchfield common stock hold
their shares as capital assets. The following discussion does not address state,
local or foreign tax consequences of the merger. You are urged to consult your
tax advisors to determine the specific tax consequences of the merger to you,
including any state, local or foreign tax consequences of the merger.
RECEIPT OF MERGER CONSIDERATION
Each First Litchfield stockholder who receives the merger consideration of
$15.00 cash will generally recognize capital gain or loss in an amount
determined by the excess of the amount of cash received and the stockholder's
tax basis in the shares. Any capital gain or loss will be long-term capital
gain or loss if the First Litchfield common stock exchanged was held for more
than one year.
BACKUP WITHHOLDING
Non-corporate holders of First Litchfield common stock may be subject to
information reporting and backup withholding on the cash payments they receive.
First Litchfield stockholders will not be subject to backup withholding,
however, if they:
- furnish a correct taxpayer identification number and certify that
they are not subject to backup withholding on the IRS Form W-9 or
successor form included in the election form/letter of transmittal you
will receive; or
68
- are otherwise exempt from backup withholding.
If withholding results in an overpayment of taxes, a refund or credit
against a First Litchfield stockholder's United States federal income tax
liability may be obtained from the IRS, provided the stockholder furnishes the
required information to the IRS. Holders that do not furnish their correct
Taxpayer Identification Numbers may be subject to penalties imposed by the IRS.
OTHER TAX CONSEQUENCES
The state and local tax treatment of the merger may not conform to the
federal income tax consequences discussed above. Consequently, you should
consult your own tax advisors regarding the treatment of the merger under state
and local tax laws.
SECURITY OWNERSHIP OF PRINCIPAL STOCKHOLDER
The following table includes certain information as of December 30, 2009,
the record date for the special meeting, regarding the only stockholder (the
"Principal Stockholder") of the First Litchfield known to be a beneficial owner
of five percent (5%) or more of the First Litchfield's common stock.
Percentages are based on 2,356,875 shares of First Litchfield common stock
issued and outstanding as of December 30, 2009.
Name and Address Number of Shares and Nature Percent of Outstanding
of Beneficial Owner of Beneficial Ownership (1) Common Stock
- -------------------- ---------------------------- -----------------------
William J. Sweetman 123,568 (2) 5.2%
101 Talmadge Lane
Litchfield, CT 06759
________________________________________________________________________________
1. The definition of beneficial owner includes any person who, directly or
indirectly, through any contract, agreement or understanding, relationship
or otherwise, has or shares voting power or investment power with respect
to such security or has the right to acquire such voting or investment
power within 60 days.
2. As reported in the amendment to Schedule 13G filed with the SEC on February
13, 2009. Includes 14,347 shares owned by an estate as to which Mr.
Sweetman has shared voting and investment power as fiduciary of said
estate.
SECURITY OWNERSHIP OF EXECUTIVE OFFICERS AND DIRECTORS
The following table sets forth the number of shares and percentage of
common stock beneficially owned by each director, each of the executive
officers, and the directors and executive officers as a group at December 30,
2009, the record date for the special meeting. Percentages are based on
2,356,875 shares of First Litchfield common stock issued and outstanding as of
December 30, 2009.
69
Name of Common Shares Beneficially Owned
Beneficial Owner at December 30, 2009(1) Percent of Class
- -------------------------------- --------------------------------- -----------------
Joseph J. Greco 7,494 (2), (3) *
Patrick J. Boland 2,021 *
John A. Brighenti 220 *
Perley H. Grimes, Jr. 15,559 *
George M. Madsen 13,985 *
Alan B. Magary 266 (4) *
Gregory S. Oneglia 23,749 (4) 1.0%
Richard E. Pugh 54 *
William J. Sweetman 123,568 (5) 5.2%
H. Ray Underwood 6,500 *
Patricia D. Werner 4,866 *
Frederick F. Judd, III 762 (6) *
Carroll A. Pereira 1,645 (4),(6),(7) *
Matthew R. Robison 0 *
Joelene E. Smith 853 (6),(8) *
Robert E. Teittinen 510 (6) *
All Directors and Executives
Officers as a group (16 persons) 202,052 8.6%
______________________________________________________________________________________
* Less than 1%.
1. The definition of beneficial owner includes any person who, directly or
indirectly, through any contract, agreement or understanding, relationship
or otherwise has or shares voting power or investment power with respect to
such security or has the right to acquire such voting or investment power
within 60 days.
2. Includes 1,500 shares of restricted common stock.
3. Includes 162 shares held in FNBL's ESOP.
4. Includes shares owned by, or as to which voting power is shared with,
spouse or children.
5. Includes 14,347 shares owned by an estate as to which Mr. Sweetman has
shared voting and investment power as fiduciary of said estate.
6. Includes 500 shares of restricted common stock.
7. Includes 95 shares held in FNBL's ESOP.
8. Includes 71 shares held in FNBL's ESOP.
70
WHERE YOU CAN FIND MORE INFORMATION
First Litchfield files annual, quarterly and current reports, proxy
statements and other information with the SEC. You may read and copy any
reports, statements or other information that First Litchfield files with the
SEC at the SEC's Public Reference Room at 100 F Street, NE, Washington, DC
20549.
You may obtain information on the operation of the Public Reference Room by
calling the SEC at 1-800-SEC-0330. The SEC filings of First Litchfield are also
available to the public from commercial document retrieval services and at the
web site maintained by the SEC at www.sec.gov. First Litchfield's SEC file
number is 0-28815.
You should rely only on the information contained in this document. Union
has supplied all information contained in this document relating to Union, and
First Litchfield has supplied all information contained in this document
relating to First Litchfield. We have not authorized anyone to provide you with
information that is different from what is contained in this document. This
document is dated January __, 2010. You should not assume that the information
contained in this document is accurate as of any date other than that date.
Neither the mailing of this document to First Litchfield stockholders nor the
issuance of the merger consideration in the merger creates any implication to
the contrary.
PROPOSALS OF STOCKHOLDERS
If the merger occurs, there will be no future First Litchfield annual
meetings of stockholders. If the merger does not occur, there will be a 2010
Annual Meeting of Stockholders of First Litchfield.
Under First Litchfield's bylaws, for business proposed by a stockholder
(other than director nomination) to be a proper subject for action at an annual
meeting of stockholders, in addition to any requirement of law, the stockholder
must submit the proposal. Any proposal for consideration by stockholders at an
annual meeting of stockholders of First Litchfield's must be delivered to, or
mailed to and received by, the Secretary of First Litchfield not less than 45
days nor more than 90 days prior to the date of the meeting if First Litchfield
gives at least 30 days notice or prior public disclosure of the meeting date to
stockholders. Stockholder proposals should be mailed to: George M. Madsen,
Secretary, First Litchfield Financial Corporation, P.O. Box 578, 13 North
Street, Litchfield, Connecticut 06759.
In order to be included in First Litchfield's proxy statement and form of
proxy for the 2010 Annual Meeting of Stockholders and in order to be a proper
subject for action at that meeting, proposals of stockholders must have been
received at First Litchfield's principal executive offices by December 17, 2009,
pursuant to proxy soliciting regulations of the SEC. The SEC's rules contain
standards as to what stockholder proposals are required to be in the proxy
statement. Any such proposal will be subject to Rule 14a-8 of the rules and
regulations promulgated by the SEC. Nothing in this paragraph shall be deemed to
require First Litchfield to include in its proxy statement and form of proxy for
such meeting any stockholder proposal which does not meet the requirements of
the SEC in effect at the time.
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In addition, under First Litchfield's bylaws, stockholders who wish to
nominate a director or bring other business before an annual meeting must comply
with the following:
- You must be a stockholder of record and must have given timely
notice in writing to the Secretary of First Litchfield.
- Your notice must contain specific information required in First
Litchfield's bylaws.
72
Annex A
AGREEMENT AND PLAN OF MERGER
BY AND AMONG
UNION SAVINGS BANK
AND
FIRST LITCHFIELD FINANCIAL CORPORATION
AND
THE FIRST NATIONAL BANK OF LITCHFIELD
DATED AS OF
OCTOBER 25, 2009
A - 1
TABLE OF CONTENTS
AGREEMENT AND PLAN OF MERGER
PAGE
----
ARTICLE I..................................................................A - 6
1.1 Certain Definitions.............................................A - 6
ARTICLE II................................................................A - 12
2.1 The Merger.....................................................A - 12
2.2 The Bank Merger................................................A - 12
2.3 Effective Time.................................................A - 13
2.4 Certificate of Incorporation and Bylaws........................A - 13
2.5 Directors and Officers of Surviving Corporation................A - 13
2.6 Directors and Officers of Surviving Bank.......................A - 13
2.7 Additional Actions.............................................A - 13
2.8 Effects Of The Merger..........................................A - 13
2.9 Possible Alternative Structures................................A - 14
ARTICLE III...............................................................A - 14
3.1 Merger Consideration...........................................A - 14
3.2 Dissenters' Rights.............................................A - 15
3.3 Procedures for Exchange of FLFC Common Stock and Options.......A - 15
ARTICLE IV................................................................A - 18
4.1 Capital Structure..............................................A - 18
4.2 Organization, Standing and Authority of FLFC...................A - 18
4.3 Ownership of FLFC Subsidiaries.................................A - 19
4.4 Organization, Standing and Authority of FLFC Subsidiaries......A - 19
4.5 Authorized and Effective Agreement.............................A - 19
4.6 Securities Documents and Regulatory Reports....................A - 21
4.7 Financial Statements...........................................A - 21
4.8 Material Adverse Change........................................A - 22
4.9 Environmental Matters..........................................A - 22
4.10 Tax Matters....................................................A - 24
4.11 Legal Proceedings..............................................A - 26
4.12 Compliance with Laws...........................................A - 26
4.13 Certain Information............................................A - 27
4.14 Employee Benefit Plans.........................................A - 27
4.15 Certain Contracts..............................................A - 30
4.16 Brokers and Finders............................................A - 31
4.17 Insurance......................................................A - 31
4.18 Properties.....................................................A - 31
4.19 Labor..........................................................A - 32
A - 2
4.20 Certain Transactions...........................................A - 32
4.21 Fairness Opinion...............................................A - 32
4.22 Loan Portfolio.................................................A - 32
4.23 Required Vote; Inapplicability of Anti-takeover Statutes.......A - 33
4.24 Material Interests of Certain Persons..........................A - 34
4.25 Joint Ventures.................................................A - 34
4.26 Intellectual Property..........................................A - 34
4.27 Disclosures....................................................A - 34
ARTICLE V.................................................................A - 35
5.1 Capital Structure..............................................A - 35
5.2 Organization, Standing and Authority of USB....................A - 35
5.3 Authorized and Effective Agreement.............................A - 36
5.4 Financial Statements...........................................A - 37
5.5 Material Adverse Change........................................A - 38
5.6 Certain Information............................................A - 38
5.7 Legal Proceedings..............................................A - 38
5.8 Compliance with Laws...........................................A - 38
5.9 Brokers and Finders............................................A - 40
5.10 Disclosures....................................................A - 40
5.11 Financial Ability..............................................A - 41
5.12 Employee Benefit Plans.........................................A - 41
ARTICLE VI................................................................A - 42
6.1 Conduct of Business............................................A - 42
6.2 Current Information............................................A - 46
6.3 Access to Properties and Records...............................A - 46
6.4 Financial and Other Statements.................................A - 47
6.5 Maintenance of Insurance.......................................A - 47
6.6 Disclosure Supplements.........................................A - 48
6.7 Consents and Approvals of Third Parties........................A - 48
6.8 Reasonable Best Efforts........................................A - 48
6.9 Failure to Fulfill Conditions..................................A - 48
6.10 Acquisition Proposals..........................................A - 48
6.11 Board of Directors and Committee Meetings......................A - 50
6.12 Reserves and Merger-Related Costs..............................A - 50
6.13 Transaction Expenses of FLFC...................................A - 51
ARTICLE VII...............................................................A - 51
7.1 Disclosure Supplements.........................................A - 51
7.2 Consents and Approvals of Third Parties........................A - 51
7.3 Reasonable Best Efforts........................................A - 51
7.4 Failure to Fulfill Conditions..................................A - 52
7.5 Acquisition Corporation Organizational Documents...............A - 52
7.6 Employees and Employee Benefits................................A - 52
7.7 Directors and Officers Indemnification and Insurance...........A - 53
A - 3
ARTICLE VIII..............................................................A - 54
8.1 FLFC Special Meeting...........................................A - 54
8.2 Proxy Statement................................................A - 54
8.3 Intentionally Omitted..........................................A - 55
8.4 Regulatory Approvals...........................................A - 55
8.5 Compliance with Anti-Trust Laws................................A - 55
8.6 Execution of Bank Merger Agreement.............................A - 56
8.7 Redemption Condition...........................................A - 56
ARTICLE IX................................................................A - 56
9.1 Conditions to Each Party's Obligations under this Agreement....A - 56
9.2 Conditions to the Obligations of USB under this Agreement......A - 57
9.3 Conditions to the Obligations of FLFC under this Agreement.....A - 58
ARTICLE X.................................................................A - 58
10.1 Time and Place.................................................A - 58
10.2 Deliveries at the Closing......................................A - 59
ARTICLE XI................................................................A - 59
11.1 Termination....................................................A - 59
11.2 Effect of Termination..........................................A - 61
11.3 Amendment, Extension and Waiver................................A - 62
ARTICLE XII...............................................................A - 63
12.1 Confidentiality...................................................A - 63
12.2 Public Announcements.............................................A - 63
12.3 Survival.........................................................A - 63
12.4 Notices..........................................................A - 63
12.5 Parties in Interest..............................................A - 64
12.6 Complete Agreement...............................................A - 64
12.7 Counterparts.....................................................A - 64
12.8 Severability.....................................................A - 64
12.9 Governing Law....................................................A - 65
12.10 Interpretation..................................................A - 65
12.11 Specific Performance............................................A - 65
A - 4
AGREEMENT AND PLAN OF MERGER
This AGREEMENT AND PLAN OF MERGER (the "Agreement") dated as of October
25, 2009 is by and among UNION SAVINGS BANK, a Connecticut-chartered mutual
savings bank ("USB"), FIRST LITCHFIELD FINANCIAL CORPORATION, a Delaware
corporation ("FLFC"), and THE FIRST NATIONAL BANK OF LITCHFIELD, a national bank
and wholly-owned subsidiary of FLFC ("FNB").
W I T N E S S E T H:
- - - - - - - - - -
WHEREAS, the Boards of Trustees of USB and the Boards of Directors of
FLFC and FNB have determined that it is in the best interest of their respective
companies and shareholders or depositors, as the case may be, to consummate the
business combination transactions provided for herein, subject to the terms and
conditions set forth herein;
WHEREAS, USB will form a wholly-owned subsidiary, a Connecticut stock
corporation (the "Acquisition Corporation");
WHEREAS, the Acquisition Corporation will merge with and into FLFC with
FLFC being the surviving entity (the "Surviving Corporation") (the "Merger");
WHEREAS, prior to the consummation of the Merger, USB and FNB will
enter into a merger agreement, in form and substance substantially similar to
that attached hereto as Exhibit A (the "Bank Merger Agreement") pursuant to
which FNB will merge with and into USB, with USB being the surviving entity (the
"Bank Merger"), which Bank Merger shall be consummated immediately following the
Merger;
WHEREAS, immediately following the merger and simultaneously with the
Bank Merger FLFC shall be liquidated in accordance with a Plan of Liquidation,
in the form attached hereto as Exhibit B;
---------
WHEREAS, immediately following the above there will remain one entity;
and
WHEREAS, the parties hereto desire to make certain representations,
warranties and agreements in connection with the business combination
transactions described in this Agreement and to prescribe certain conditions
thereto.
NOW, THEREFORE, in consideration of the mutual covenants,
representations, warranties and agreements herein contained, and for other good
and valuable consideration, the receipt and sufficiency of which are hereby
acknowledged, the parties hereto hereby agree as follows:
A - 5
ARTICLE I
CERTAIN DEFINITIONS
1.1 Certain Definitions. As used in this Agreement, the following terms
have the following meanings, unless the context otherwise requires (both here
and throughout this Agreement, references to Articles and Sections refer to
Articles and Sections of this Agreement).
"2003 TruPS" shall have the meaning set forth in Section 8.7 hereof.
"2006 TruPS" shall have the meaning set forth in Section 8.7 hereof.
"Acquisition Agreement" shall have the meaning set forth in Section
11.1.11 hereof.
"Acquisition Corporation" shall have the meaning set forth in the
recitals hereto.
"Acquisition Proposal" means any proposal or offer with respect to any
of the following (other than the transactions contemplated hereunder) involving
FLFC or any FLFC Subsidiaries: (i) any merger, consolidation, share exchange,
business combination or other similar transaction; (ii) any sale, lease,
exchange, mortgage, pledge, transfer or other disposition of 25% or more of its
consolidated assets in a single transaction or series of transactions; (iii) any
tender offer or exchange offer for 25% or more of the outstanding shares of its
capital stock or the filing of a registration statement under the Securities Act
in connection therewith; or (iv) any public announcement of a proposal, plan or
intention to do any of the foregoing or any agreement to engage in any of the
foregoing.
"Acquisition Transaction" means any of the following (other than the
transaction contemplated hereunder) involving FLFC or any FLFC Subsidiaries: (i)
any merger, consolidation, share exchange, business combination or other similar
transaction; (ii) any sale, lease, exchange, mortgage, pledge, transfer or other
disposition of 25% or more of its consolidated assets in a single transaction or
series of transactions; or (iii) any tender offer or exchange offer for 25% or
more of the outstanding shares of its capital stock or the filing of a
registration statement under the Securities Act in connection therewith.
"Affiliate" shall mean, with respect to a Person, any Person that
directly, or indirectly through one or more intermediaries, controls, or is
controlled by, or is under common control with, such Person.
"BHCA" shall mean the Bank Holding Company Act of 1956, as amended.
"Banking Law" shall mean the Banking Law of Connecticut, Connecticut
General Statutes ss. 36a-1 et seq., as amended.
"Bank Merger" shall have the meaning set forth in the recitals hereto.
"Bank Merger Agreement" shall have the meaning set forth in the
recitals hereto.
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"Bank Regulator" shall mean any federal or state banking regulator that
regulates USB or FNB, or any of their respective holding companies or
subsidiaries, as the case may be, including but not limited to the FDIC, the
Department, the FRB, and the OCC.
"Benefit Agreement" shall have the meaning set forth in Section 7.6.3
hereof.
"Business Day" means Monday through Friday of each week, except a legal
holiday recognized as such by the U.S. Government or any day on which banking
institutions in the State of Connecticut are authorized or obligated to close.
"CBCA" shall mean the Connecticut Business Corporation Act.
"Certificate" shall mean certificates evidencing shares of FLFC Common
Stock.
"Claim" shall have the meaning set forth in Section 7.7.2 hereof.
"Closing" shall have the meaning set forth in Section 2.3 hereof.
"Closing Date" shall have the meaning set forth in Section 2.3 hereof.
"Code" shall mean the Internal Revenue Code of 1986, as amended.
"Company Restricted Share" shall have the meaning set forth in Section
3.1.4 hereof.
"Confidentiality Agreement" shall mean the confidentiality agreement
referred to in Section 12.1 of this Agreement.
"Continuing Employee" shall have the meaning set forth in Section 7.6.2
hereof.
"Costs" shall have the meaning set forth in Section 11.2.3 hereof.
"DGCL" shall mean the Delaware General Corporation Law, as amended.
"Department" shall mean the Connecticut Department of Banking.
"DIF" shall mean the Deposit Insurance Fund administered by the FDIC.
"Dissenting Shares" shall have the meaning set forth in Section 3.2.1
hereof.
"Dissenting Shareholder" shall have the meaning set forth in Section
3.2.1 hereof.
"DOJ" shall mean the United States Department of Justice.
"Effective Date" shall mean the date on which the Effective Time
occurs.
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"Effective Time" shall mean the date and time specified pursuant to
Section 2.3 hereof as the effective time of the Merger.
"Environmental Laws" means any applicable federal, state or local law,
statute, ordinance, rule, regulation, code, license, permit, authorization,
approval, consent, order, judgment, decree, injunction or agreement with any
governmental entity relating to (1) the protection, preservation or restoration
of the environment (including, without limitation, air, water vapor, surface
water, groundwater, drinking water supply, surface soil, subsurface soil, plant
and animal life or any other natural resource), and/or (2) the use, storage,
recycling, treatment, generation, transportation, processing, handling,
labeling, production, release or disposal of Materials of Environment Concern.
The term Environmental Law includes without limitation (a) the Comprehensive
Environmental Response, Compensation and Liability Act, as amended, 42 U.S.C.
ss. 9601, et seq.; the Resource Conservation and Recovery Act, as amended, 42
U.S.C. ss. 6901, et seq.; the Clean Air Act, as amended, 42 U.S.C. ss. 7401, et
seq.; the Federal Water Pollution Control Act, as amended, 33 U.S.C. ss. 1251,
et seq.; the Toxic Substances Control Act, as amended, 15 U.S.C. ss. 9601, et
seq.; the Emergency Planning and Community Right to Know Act, 42 U.S.C. ss.
ll0l, et seq.; the Safe Drinking Water Act, 42 U.S.C. ss. 300f, et seq.; the
Connecticut Transfer Act, Connecticut General Statutes ss. 22a-134 et seq.; and
all applicable comparable state and local laws, and (b) any common law
(including without limitation common law that may impose strict liability) that
may impose liability or obligations for injuries or damages due to the presence
of or exposure to any Materials of Environmental Concern.
"ERISA" shall mean the Employee Retirement Income Security Act of 1974,
as amended.
"ERISA Affiliate" shall have the meaning set forth in Section 4.14.3
hereof.
"ESOP" shall have the meaning set forth in Section 6.1.2(j) hereof.
"Exchange Act" shall mean the Securities Exchange Act of 1934, as
amended.
"Exchange Agent" shall mean Register and Transfer Company or another
registered transfer agent designated by USB and reasonably acceptable to FLFC,
which shall act as agent for USB in connection with the exchange procedures for
converting FLFC Common Stock and Options into the Merger Consideration.
"Exchange Fund" shall have the meaning set forth in Section 3.3.1
hereof.
"FDIA" shall mean the Federal Deposit Insurance Act, as amended.
"FDIC" shall mean the Federal Deposit Insurance Corporation or any
successor thereto.
"FLFC" shall mean First Litchfield Financial Corporation, a Delaware
corporation with its principal address located at 13 North Street, Litchfield,
Connecticut.
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"FLFC Common Stock" shall mean the common stock, par value $.01 per
share, of FLFC.
"FLFC Defined Benefit Plan" shall have the meaning set forth in Section
4.14.3 hereof.
"FLFC Disclosure Schedule" shall mean a written, signed disclosure
schedule delivered by FLFC to USB specifically referring to the appropriate
section of this Agreement and describing in reasonable detail the matters
contained therein.
"FLFC Employee Plan(s)" shall mean all stock option, employee stock
purchase, stock bonus and any other stock-based plans, qualified pension or
profit-sharing plans, any deferred compensation, non-qualified plan or
arrangement, supplemental retirement, consultant, bonus or group insurance
contract or any other incentive, health and welfare or employee benefit plan or
agreement maintained for the benefit of any of the employees or former employees
or directors of FLFC or any FLFC Subsidiary, whether written or oral.
"FLFC Financial Statements" shall mean (i) the audited consolidated
balance sheets (including related notes and schedules, if any) of FLFC as of
December 31, 2008, 2007 and 2006 and the consolidated statements of operations,
changes in shareholders' equity and cash flows (including related notes and
schedules, if any) of FLFC for each of the three (3) years ended 2008, 2007 and
2006 as filed by FLFC in its Securities Documents, and (ii) the unaudited
interim and audited annual consolidated financial statements of FLFC as of the
end of each calendar quarter and fiscal year, respectively, following December
31, 2008 as filed by FLFC in its Securities Documents.
"FLFC Pension Plan" shall have the meaning set forth in Section 4.14.4
hereof.
"FLFC Shareholders Meeting" shall have the meaning set forth in Section
8.1 hereof.
"FLFC Stock Plan" shall mean the FLFC 2007 Restricted Stock Plan.
"FLFC Termination Fee" shall have the meaning set forth in Section
11.2.2.
"FLFC Welfare Plan" shall have the meaning set forth in Section 4.14.11
hereof.
"FRB" shall mean the Board of Governors of the Federal Reserve System
or any successor thereto.
"FNB" shall mean The First National Bank of Litchfield, a national bank
with its principal offices at 13 North Street, Litchfield, Connecticut.
"GAAP" shall mean United States generally accepted accounting
principles.
"Governmental Entity" shall mean any federal or state court,
administrative agency or commission or other governmental authority or
instrumentality.
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"Indemnified Liabilities" shall have the meaning set forth in Section
7.7.2 hereof.
"Indemnified Parties" shall have the meaning set forth in Section 7.7.2
hereof.
"Intellectual Property" shall have the meaning set forth in Section
4.26 hereof.
"Joint Venture" shall mean any limited partnership, joint venture,
corporation, or venture capital investment.
"Loan Property" shall have the meaning set forth in Section 4.9.2
hereof.
"Material Adverse Effect" shall mean, with respect to FLFC or USB,
respectively, any effect that (i) is material and adverse to the financial
condition, results of operations or business of FLFC and its Subsidiaries taken
as a whole, or USB and its Subsidiaries taken as a whole, respectively, or (ii)
materially impairs the ability of either FLFC, on the one hand, or USB, on the
other hand, to consummate the transactions contemplated by this Agreement;
provided that "Material Adverse Effect" shall not be deemed to include the
impact of (a) changes in laws and regulations affecting banks and their holding
companies generally, (b) changes in GAAP or regulatory accounting principles
generally applicable to banks and their holding companies, (c) actions and
omissions of a party (or any of its Subsidiaries) taken with the prior written
consent of the other party, (d) changes in economic conditions affecting
financial institutions generally, including but not limited to changes in market
interest rates or the projected future interest rate environment, and (e) the
direct effects of compliance with this Agreement on the operating performance of
the parties.
"Materials Of Environmental Concern" shall mean petroleum and petroleum
products, byproducts or breakdown products, radioactive materials,
asbestos-containing materials and polychlorinated biphenyls and any other
chemicals, materials or substances regulated as toxic or hazardous or as a
pollutant, contaminant or waste under any applicable Environmental Laws.
"Merger" shall have the meaning set forth in the recitals hereto.
"Merger Consideration" shall mean the cash paid by Acquisition
Corporation to holders of FLFC Common Stock and Options under Section 3.1
hereof.
"OCC" shall mean the Office of the Comptroller of the Currency.
"Option Consideration" shall have the meaning set forth in Section
3.1.3 hereof.
"Option Price" shall have the meaning set forth in Section 3.1.3
hereof.
"Options" shall mean options to purchase shares of FLFC Common Stock
granted pursuant to the FLFC Stock Plan as set forth in Section 4.1 of the FLFC
Disclosure Schedule and include the Warrants to purchase 199,203 shares of FLFC
Common Stock issued December 12, 2008 to the United States Department of the
Treasury, if exercised by the United States Department of the Treasury effective
as of the Closing.
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"Participation Facility" shall have the meaning set forth in Section
4.9.2 hereof.
"PBGC" shall mean the Pension Benefit Guaranty Corporation, or any
successor thereto.
"Person" shall mean any individual, corporation, partnership, joint
venture, association, trust or "group" (as that term is defined under the
Exchange Act).
"Per Share Merger Consideration" shall have the meaning set forth in
Section 3.1 hereof.
"Proxy Statement" shall have the meaning set forth in Section 8.2.1
hereof.
"Rights" shall mean warrants, options, rights, convertible securities,
stock appreciation rights and other arrangements or commitments that obligate an
entity to issue or dispose of any of its capital stock or other ownership
interests or that provide for compensation based on the equity appreciation of
its capital stock.
"SEC" shall mean the Securities and Exchange Commission.
"Securities Act" shall mean the Securities Act of 1933, as amended.
"Securities Documents" shall mean all reports, offering circulars,
proxy statements, registration statements and all similar documents filed, or
required to be filed, pursuant to the Securities Laws.
"Securities Laws" shall mean the Securities Act; the Exchange Act; the
Investment Company Act of 1940, as amended; the Investment Advisers Act of 1940,
as amended; the Trust Indenture Act of 1939, as amended; and the rules and
regulations of the SEC promulgated thereunder.
"Subsidiary" shall have the meaning set forth in Rule 1-02 of
Regulation S-X of the SEC.
"Superior Proposal" shall have the meaning set forth in Section 6.10
hereof.
"Surviving Bank" shall mean USB as the resulting institution of the
Bank Merger.
"Surviving Corporation" shall have the meaning set forth in the
recitals hereof.
"TARP Obligations" shall have the meaning set forth in Section 8.7.
"Tax" shall have the meaning set forth in Section 4.10.6 hereof.
"Tax Return" shall have the meaning set forth in Section 4.10.6 hereof.
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"Termination Date" shall mean June 30, 2010, provided that such date
shall be automatically extended until September 30, 2010 if required regulatory
approvals and non-objections of Governmental Entities have not been received by
June 1, 2010 and the parties are acting in good faith to obtain such approvals
and non-objections.
"USB" shall mean Union Savings Bank, a Connecticut-chartered mutual
savings bank with its principal offices located at 225 Main Street, Danbury,
Connecticut.
"USB Disclosure Schedule" shall mean a written, signed disclosure
schedule delivered by USB to FLFC specifically referring to the appropriate
section of this Agreement and describing in reasonable detail the matters
contained therein.
"USB Employee Plan" shall mean all qualified pension or profit-sharing
plans, and health and welfare benefit plans maintained for the benefit of all
employees of USB or any USB Subsidiary, whether written or oral.
"USB Financial Statements" shall mean the audited consolidated balance
sheets (including related notes and schedules, if any) of USB as of December 31,
2008, 2007 and 2006 and the consolidated statements of income and cash flows
(including related notes and schedules, if any) of USB for each of the three (3)
years ended December 31, 2008, 2007 and 2006, and the USB call reports for each
quarter subsequent to December 31, 2008.
"USB Proposal" shall have the meaning set forth in Section 6.10 hereof.
Other terms used herein are defined in the preamble and elsewhere in
this Agreement.
ARTICLE II
THE MERGER
2.1 The Merger. As promptly as practicable following the satisfaction
or waiver of the conditions to each party's respective obligations hereunder,
and subject to the terms and conditions of this Agreement, at the Effective Time
Acquisition Corporation shall merge with and into FLFC with FLFC as the
Surviving Corporation in accordance with the provisions of the CBCA and the
DGCL, immediately following the Merger and simultaneously with the Bank Merger,
the Surviving Corporation shall be liquidated in accordance with a Plan of
Liquidation, in the form attached hereto as Exhibit B. At the Effective Time of
the Merger, each share of FLFC Common Stock and each Option (including the
Warrants, if exercised) will be converted into the right to receive the Merger
Consideration pursuant to the terms of Article III hereof.
2.2 The Bank Merger. The Bank Merger shall be consummated immediately
following the Merger in accordance with a Bank Merger Agreement substantially in
the form attached hereto as Exhibit A.
---------
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2.3 Effective Time. The Merger shall be effected by the filing of a
certificate of merger with the Delaware Office of the Secretary of State on the
day of the closing ("Closing Date"), in accordance with the DGCL (the
"Closing"). The "Effective Time" of the Merger shall be the date and time upon
which the certificate of merger as to the Merger is filed with the Delaware
Office of the Secretary of State, or as otherwise stated in such certificate of
merger.
2.4 Certificate of Incorporation and Bylaws. (a) The Certificate of
Incorporation and Bylaws of FLFC shall be amended and restated to be the same as
Acquisition Corporation's immediately prior to the Effective Time, and shall be
the Certificate of Incorporation and Bylaws of the Surviving Corporation until
thereafter amended as provided therein and by applicable law.
(b) The Certificate of Incorporation and Bylaws of USB as in effect
immediately prior to the Effective Time shall be the Certificate of
Incorporation and Bylaws of the Surviving Bank until thereafter amended as
provided therein and by applicable law.
2.5 Directors and Officers of Surviving Corporation. The directors of
the Surviving Corporation immediately after the Effective Time shall be the
Chief Executive Officer and Chief Financial Officer of USB. The officers of the
Surviving Corporation immediately after the Effective Time shall also be those
individuals.
2.6 Trustees and Officers of Surviving Bank. The trustees of the
Surviving Bank immediately after the Effective Time shall be the trustees of USB
prior to the Effective Time plus three (3) directors of FLFC immediately prior
to the Effective Time who shall be mutually agreed upon by the Board of Trustees
of USB and the Board of Directors of FLFC, each to meet the qualifications of
and hold office in accordance with the Certificate of Incorporation and Bylaws
of the Surviving Bank. The officers of USB immediately prior to the Effective
Time shall be the officers of the Surviving Bank supplemented by those officers
of FNB who accept employment from USB, in each case until their respective
successors are duly elected or appointed and qualified.
2.7 Additional Actions. If, at any time after the Effective Time, the
Surviving Corporation or the Surviving Bank shall consider or be advised that
any further assignments or assurances in law or any other acts are necessary or
desirable (a) to vest, perfect or confirm, of record or otherwise, in the
Surviving Corporation or the Surviving Bank, title to and possession of any
property or right of FLFC (or FNB) acquired or to be acquired by reason of, or
as a result of, the Merger, or (b) otherwise to carry out the purposes of this
Agreement, FLFC, FNB and their officers and directors shall be deemed to have
granted to the Surviving Corporation and the Surviving Bank an irrevocable power
of attorney to execute and deliver all such proper deeds, assignments and
assurances in law and to do all acts necessary or proper to vest, perfect or
confirm title to and possession of such property or rights in the Surviving
Corporation or the Surviving Bank and otherwise to carry out the purposes of
this Agreement; and the officers and directors of the Surviving Corporation and
the Surviving Bank are fully authorized in the name of FLFC, FNB or otherwise to
take any and all such action.
2.8 Effects Of The Merger. At and after the Effective Time, the Merger
shall have the effects set forth in the CBCA and the DGCL with respect to
Acquisition Corporation and
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FLFC, and the Bank Merger shall have the effects set forth in the Banking Law
with respect to USB and FNB.
2.9 Possible Alternative Structures. Notwithstanding anything to the
contrary contained in this Agreement, prior to the Effective Time USB shall be
entitled to revise the structure of the Merger described in Section 2.1 hereof,
provided that (i) there are no adverse federal or state income tax consequences
to FLFC and its shareholders as a result of the modification; (ii) the
consideration to be paid to the holders of FLFC Common Stock and Options under
this Agreement is not thereby changed in kind or value or reduced in amount;
(iii) there are no adverse changes to the benefits and other arrangements
provided to or on behalf of FLFC's directors, officers and other employees; and
(iv) such modification will not delay materially or jeopardize receipt of any
required regulatory approvals or non-objection of Governmental Entities. USB,
FLFC and FNB agree to amend this Agreement and any related documents
appropriately in order to reflect any such revised structure.
ARTICLE III
CONVERSION OF SHARES AND OPTIONS
3.1 Merger Consideration.
--------------------
3.1.1 At the Effective Time, by virtue of the Merger and without any
action on the part of USB, FLFC or the holders of any of the shares of FLFC
Common Stock, each share of FLFC Common Stock issued and outstanding immediately
prior to the Effective Time (other than any shares to be cancelled pursuant to
Section 3.1.2 hereof and any Dissenting Shares) shall be converted into the
right to receive a cash payment in an amount equal to $15.00 (the "Per Share
Merger Consideration").
3.1.2 Each share of FLFC Common Stock (i) held in the treasury of
FLFC, (ii) owned by USB or any direct or indirect wholly owned subsidiary of
FLFC immediately prior to the Effective Time (other than shares held in a
fiduciary capacity or in connection with debts previously contracted), or (iii)
reserved for issuance under the FLFC Stock Plan which has not been granted or
allocated, shall, at the Effective Time, cease to exist, and the certificates
for such shares shall be cancelled as promptly as practicable thereafter, and no
payment or distribution shall be made in consideration therefor.
3.1.3 Each Option issued and outstanding immediately prior to the
Effective Time, including the Options, if exercised by the United States
Department of the Treasury, shall, by virtue of the Merger and without any
action on the part of the holder thereof and without regard to any future
vesting date thereof, be cancelled and converted into the right to receive a
cash payment in an amount determined by multiplying (i) the positive difference,
if any, between the Per Share Merger Consideration, and the exercise price of
such Option, for each share of FLFC Common Stock covered by such Option (the
"Option Price") by (ii) the number of shares of FLFC Common Stock subject to
such Option (the "Option Consideration"). The payment of the Option
Consideration referred to in the immediately preceding sentence to each holder
of an
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Option shall be subject to such holder executing such instruments of
cancellation as USB may reasonably deem appropriate. FLFC or FNB shall make
necessary tax withholdings from the Option Consideration as they deem
appropriate.
3.1.4 At the Effective Time, each unvested restricted share of FLFC
Common Stock granted under the FLFC Stock Plan (each a "Company Restricted
Share"), as set forth in FLFC Disclosure Schedule Section 3.1.4, which is
outstanding immediately prior to the Effective Time and which vests at the
Effective Time under the terms of the FLFC Stock Plan shall vest and become free
of restrictions to the extent provided by the terms thereof, and each holder
thereof shall have the same rights to receive the Merger Consideration as are
provided to other holders of FLFC Common Stock pursuant to Section 3.1.
3.2 Dissenters' Rights.
------------------
3.2.1 Each outstanding share of FLFC Common Stock the
holder of which has perfected his right to dissent under the DGCL and has not
effectively withdrawn or lost such right as of the Effective Time (the
"Dissenting Shares") shall not be converted into or represent a right to receive
the Merger Consideration hereunder, and the holder thereof shall be entitled
only to such rights as are granted by the DGCL. FLFC shall give USB notice upon
receipt by FLFC of any such demands for payment of the fair value of such shares
of FLFC Common Stock and of withdrawals of such notice and any other instruments
provided pursuant to applicable law (any shareholder duly making such demand
being hereinafter called a "Dissenting Shareholder"), and USB shall have the
right to participate in all negotiations and proceedings with respect to any
such demands. FLFC shall not, except with the prior written consent of USB,
voluntarily make any payment with respect to, or settle or offer to settle, any
such demand for payment, or waive any failure to timely deliver a written demand
for appraisal or the taking of any other action by such Dissenting Shareholder
as may be necessary to perfect appraisal rights under the DGCL. Any payments
made in respect of Dissenting Shares shall be made by USB.
3.2.2 If any Dissenting Shareholder shall effectively withdraw or
lose (through failure to perfect or otherwise) his right to such fair value
payment at or prior to the Effective Time, such holder's shares of FLFC Common
Stock shall be converted into a right to receive the Merger Consideration in
accordance with the applicable provisions of this Agreement. If such holder
shall effectively withdraw or lose (through failure to perfect or otherwise) his
right to such fair value payment after the Effective Time, each share of FLFC
Common Stock of such holder shall be converted into the right to receive the
Merger Consideration.
3.2.3 After the Effective Time, shares of FLFC Common Stock other
than Dissenting Shares shall be no longer outstanding and shall automatically be
cancelled and shall cease to exist, and shall thereafter by operation of this
section be the right to receive the Merger Consideration as set forth in Section
3.3.4.
3.3 Procedures for Exchange of FLFC Common Stock and Options.
--------------------------------------------------------
3.3.1 USB and Acquisition Corporation to Make Cash Available. Prior
to the Effective Time, USB shall designate the Exchange Agent. USB and
Acquisition Corporation
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shall take all steps necessary on or prior to Closing Date to deliver to the
Exchange Agent, for the benefit of the holders of shares of FLFC Common Stock
and Options, for exchange in accordance with this Section 3.3, an amount of cash
sufficient to pay the aggregate amount of cash payable in accordance with
Article III hereof (such cash for shares of FLFC Common Stock and Options being
hereinafter referred to as the "Exchange Fund") to be paid in exchange for
outstanding FLFC Common Stock and Options in accordance with this Agreement.
3.3.2 Exchange of Certificates. FLFC shall cause to be delivered to
the Exchange Agent all information which is necessary for the Exchange Agent to
perform its obligations specified herein. USB shall, within five (5) Business
Days after the Effective Time, take all steps necessary to cause the Exchange
Agent to mail to each holder of a Certificate or Certificates a form letter of
transmittal for return to the Exchange Agent and instructions for use in
effecting the surrender of the Certificates for cash into which the FLFC Common
Stock represented by such Certificates shall have been converted as a result of
the Merger. The letter of transmittal (which shall be subject to the reasonable
approval of FLFC) shall specify that delivery shall be effected, and risk of
loss and title to the Certificates shall pass, only upon delivery of the
Certificates to the Exchange Agent. Upon surrender of a Certificate for exchange
and cancellation to the Exchange Agent together with such letter of transmittal,
duly executed, the holder of such Certificate shall be entitled to receive in
exchange therefor a check representing the amount of cash that such holder has
the right to receive in respect of Certificates surrendered pursuant to the
provisions of Section 3.1, and the Certificates so surrendered shall forthwith
be cancelled.
3.3.3 Payment of Option Price. At the Effective Time, if not
previously paid by FLFC immediately prior to the Effective Time (to which USB
has no objection) or unless otherwise required by the United States Department
of the Treasury in connection with the exercise of its Warrants, FLFC and USB
shall take all steps necessary to cause the Exchange Agent to issue and deliver
within five (5) Business Days a check representing the amount of the Option
Price to the holders of the Options, all of which shall have been cancelled in
connection with the Merger Agreement.
3.3.4 Rights of Certificate or Option Holders after the Effective
Time. The holder of (i) a Certificate (other than a Certificate with respect to
Dissenting Shares) that prior to the Merger represented issued and outstanding
FLFC Common Stock, or (ii) an Option, including the Warrants if exercised by the
United States Department of the Treasury, shall have no rights, after the
Effective Time, with respect to such FLFC Common Stock or Option except to
surrender the Certificate and receive in exchange for the Merger Consideration
as provided in this Agreement.
3.3.5 Surrender by Persons Other than Record Holders. If the Person
surrendering a Certificate and signing the accompanying letter of transmittal is
not the record holder thereof, then it shall be a condition of the payment of
the Merger Consideration that: (i) such Certificate is properly endorsed to such
Person or is accompanied by appropriate stock powers, in either case signed
exactly as the name of the record holder appears on such Certificate, and is
otherwise in proper form for transfer, or is accompanied by appropriate evidence
of the authority of the Person surrendering such Certificate and signing the
letter of
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transmittal to do so on behalf of the record holder; and (ii) the person
requesting such exchange shall pay to the Exchange Agent in advance any transfer
or other taxes required by reason of the payment to a person other than the
registered holder of the Certificate surrendered, or required for any other
reason, or shall establish to the satisfaction of the Exchange Agent that such
tax has been paid or is not payable.
3.3.6 Closing of Transfer Books. From and after the Effective Time,
there shall be no transfers on the stock transfer books of FLFC of the FLFC
Common Stock which were outstanding immediately prior to the Effective Time. If,
after the Effective Time, Certificates representing such shares are presented
for transfer to the Exchange Agent, they shall be exchanged for the Merger
Consideration and cancelled as provided in this Section 3.3.
3.3.7 Return of Exchange Fund. At any time following the six (6)
month period after the Effective Time, USB shall be entitled to require the
Exchange Agent to deliver to it any portions of the Exchange Fund that had been
made available to the Exchange Agent and not disbursed to holders of
Certificates and Options (including, without limitation, all interest and other
income received by the Exchange Agent in respect of all funds made available to
it), and thereafter such holders shall be entitled to look to USB (subject to
abandoned property, escheat and other similar laws) with respect to any Merger
Consideration that may be payable upon due surrender of the Certificates or
Options held by them. Notwithstanding the foregoing, neither USB, FLFC nor the
Exchange Agent shall be liable to any holder of a Certificate or any Merger
Consideration delivered in respect of such Certificate to a public official
pursuant to any abandoned property, escheat or other similar law.
3.3.8 Lost, Stolen or Destroyed Certificates. In the event any
Certificate shall have been lost, stolen or destroyed, upon the making of an
affidavit of that fact by the person claiming such Certificate to be lost,
stolen or destroyed and, if required by USB, the posting by such person of a
bond in such amount as USB may reasonably direct as indemnity against any claim
that may be made against it with respect to such Certificate, the Exchange Agent
will issue in exchange for such lost, stolen or destroyed Certificate the Merger
Consideration deliverable in respect thereof.
3.3.9 Withholding. USB or the Exchange Agent will be entitled to
deduct and withhold from the consideration otherwise payable pursuant to this
Agreement or the transactions contemplated hereby to any holder of FLFC Common
Stock or Options such amounts as USB or the Exchange Agent are required to
deduct and withhold with respect to the making of such payment under the Code,
or any applicable provision of U.S. federal, state, local or non-U.S. tax law.
To the extent that such amounts are properly withheld by USB or the Exchange
Agent, such withheld amounts will be treated for all purposes of this Agreement
as having been paid to the holder of the FLFC Common Stock or Options in respect
of whom such deduction and withholding were made by USB or the Exchange Agent.
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ARTICLE IV
REPRESENTATIONS AND WARRANTIES OF
FLFC AND FNB
FLFC and FNB represent and warrant to USB that the statements contained
in this Article IV are correct and complete as of the date of this Agreement and
will be correct and complete as of the Closing Date (as though made then and as
though the Closing Date were substituted for the date of this Agreement
throughout this Article IV), except as set forth in the FLFC Disclosure Schedule
delivered by FLFC to USB on the date hereof, and except as to any representation
or warranty which specifically relates to an earlier date. No representation or
warranty of FLFC or FNB contained herein shall be deemed untrue or incorrect,
and neither FLFC nor FNB shall be deemed to have breached a representation or
warranty, on account of the existence of any fact, circumstance or event,
unless, as a direct or indirect consequence of such fact, circumstance or event,
individually or taken together with all other facts, circumstances or events
inconsistent with any paragraph in this Article IV, as applicable, there is
reasonably likely to exist a Material Adverse Effect. The mere inclusion of an
item in the FLFC Disclosure Schedule as an exception to a representation or
warranty shall not be deemed an admission by FLFC that such item represents a
material exception or fact, event or circumstance or that, absent such inclusion
in the FLFC Disclosure Schedule, such item is or would be reasonably likely to
result in a Material Adverse Effect.
4.1 Capital Structure. The authorized capital stock of FLFC consists of
5,000,000 shares of common stock, par value $0.01 per share, and 1,000,000
shares of preferred stock, par value $0.00001 per share. As of the date of this
Agreement, 2,356,875 shares of FLFC Common Stock, including shares of FLFC
Common Stock issued subject to restrictions as to vesting pursuant to the FLFC
Stock Plan, are issued and outstanding, 149,747 shares of FLFC Common Stock are
directly or indirectly held by FLFC as treasury stock, and 10,000 shares of FLFC
preferred stock, par value $0.00001 per share, are issued and outstanding. All
outstanding shares of FLFC Common Stock have been duly authorized and validly
issued and are fully paid and nonassessable, and none of the outstanding shares
of FLFC Common Stock has been issued in violation of the preemptive rights of
any person, firm or entity. Except for the FLFC Stock Plan pursuant to which
there are outstanding 3,500 shares of FLFC Common Stock, a schedule of which is
set forth in Section 4.1 of the FLFC Disclosure Schedule and the Warrant to
purchase 199,203 shares of FLFC Common Stock issued December 12, 2008 to the
United States Department of the Treasury, there are no Rights authorized, issued
or outstanding with respect to or relating to the capital stock of FLFC.
4.2 Organization, Standing and Authority of FLFC. FLFC is a corporation
duly organized, validly existing and in good standing under the laws of the
State of Delaware with full corporate power and authority to own or lease all of
its properties and assets and to carry on its business as now conducted, and is
duly licensed or qualified to do business and is in good standing in each
jurisdiction in which its ownership or leasing of property or the conduct of its
business requires such licensing or qualification, except where the failure to
be so licensed or qualified would not have a Material Adverse Effect. FLFC is
duly registered as a bank holding company under the BHCA. FLFC has heretofore
delivered to USB and has included as Section
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4.2 of the FLFC Disclosure Schedule true, complete and correct copies of the
Certificate of Incorporation and Bylaws of FLFC as in effect as of the date
hereof.
4.3 Ownership of FLFC Subsidiaries. Set forth in Section 4.3 of the
FLFC Disclosure Schedule is the name, jurisdiction of incorporation and
percentage ownership of each direct or indirect FLFC Subsidiary. Except for (a)
capital stock of the FLFC Subsidiaries, (b) securities and other interests held
in a fiduciary capacity and beneficially owned by third parties or taken in
consideration of debts previously contracted, and (c) securities and other
interests which are set forth in the FLFC Disclosure Schedule, FLFC does not own
or have the right or obligation to acquire, directly or indirectly, any
outstanding capital stock or other voting securities or ownership interests of
any corporation, bank, savings association, partnership, joint venture or other
organization, other than investment securities representing not more than five
percent (5%) of the outstanding capital stock of any entity. The outstanding
shares of capital stock or other ownership interests of each FLFC Subsidiary
that are owned by FLFC or any FLFC Subsidiary have been duly authorized and
validly issued, are fully paid and nonassessable and are directly or indirectly
owned by FLFC free and clear of all liens, claims, encumbrances, charges,
pledges, restrictions or rights of third parties of any kind whatsoever. Except
as set forth on Section 4.3 of the FLFC Disclosure Schedule, there are no Rights
authorized, issued or outstanding with respect to the capital stock or other
ownership interests of any FLFC Subsidiary and there are no agreements,
understandings or commitments relating to the right of FLFC to vote or to
dispose of such capital stock or other ownership interests.
4.4 Organization, Standing and Authority of FLFC Subsidiaries. Each
FLFC Subsidiary is a national bank, corporation, partnership or business trust
duly organized, validly existing and in good standing or legal existence, as
appropriate, under the laws of the jurisdiction in which it is organized. Each
FLFC Subsidiary (i) has full power and authority to own or lease all of its
properties and assets and to carry on its business as now conducted, and (ii) is
duly licensed or qualified to do business and is in good standing or legal
existence, as appropriate, in each jurisdiction in which its ownership or
leasing of property or the conduct of its business requires such qualification,
except where the failure to be so licensed or qualified would not have a
Material Adverse Effect. FLFC is authorized to own each FLFC Subsidiary under
the BHCA. The deposit accounts of FNB are insured by the FDIC through the DIF to
the maximum extent permitted by the FDIA. FNB has paid all premiums and
assessments required by the FDIC. FLFC has heretofore delivered or made
available to USB and has included as Section 4.4 of the FLFC Disclosure Schedule
true, complete and correct copies of the Certificate of Incorporation and Bylaws
of FNB and each other FLFC Subsidiary as in effect as of the date hereof.
4.5 Authorized and Effective Agreement.
----------------------------------
4.5.1 Each of FLFC and FNB has all requisite corporate power and
authority to enter into this Agreement and the Bank Merger Agreement, as
applicable, and (subject to receipt of all necessary governmental approvals and
the approval of FLFC's shareholders of this Agreement) to perform all of its
obligations under this Agreement and the Bank Merger Agreement, as applicable.
The execution and delivery of this Agreement and the Bank Merger Agreement and
the consummation of the transactions contemplated hereby and thereby have been
duly and validly authorized by all necessary corporate action in respect thereof
on the part
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of FLFC and FNB, except for the approval of this Agreement by FLFC's
shareholders. This Agreement has been duly and validly executed and delivered by
FLFC and FNB and, assuming due authorization, execution and delivery by USB,
constitutes the legal, valid and binding obligations of FLFC and FNB,
enforceable against FLFC and FNB in accordance with its terms, subject, as to
enforceability, to bankruptcy, insolvency, and other laws of general
applicability relating to or affecting creditors' rights and to general equity
principles. The Bank Merger Agreement, upon execution and delivery by FNB, will
have been duly and validly executed and delivered by FNB and, assuming due
authorization, execution and delivery by USB, will constitute the legal, valid
and binding obligation of FNB, enforceable against FNB in accordance with its
terms, subject, as to enforceability, to bankruptcy, insolvency, and other laws
of general applicability relating to or affecting creditors' rights and to
general equity principles.
4.5.2 Neither the execution and delivery of this Agreement by FLFC
or FNB, nor the execution and delivery of the Bank Merger Agreement by FNB, nor
consummation of the transactions contemplated hereby or thereby, nor compliance
by FLFC and FNB with any of the provisions hereof or thereof (i) does or will
conflict with or result in a breach of any provisions of the Certificate of
Incorporation or Bylaws of FLFC or the equivalent documents of any FLFC
Subsidiary, (ii) violate, conflict with or result in a breach of any term,
condition or provision of, or constitute a default (or an event which, with
notice or lapse of time, or both, would constitute a default) under, or give
rise to any right of termination, cancellation or acceleration with respect to,
or result in the creation of any lien, charge or encumbrance upon any property
or asset of FLFC or any FLFC Subsidiary pursuant to, any material note, bond,
mortgage, indenture, deed of trust, license, lease, agreement or other
instrument or obligation to which FLFC or any FLFC Subsidiary is a party, or by
which any of their respective properties or assets may be bound or affected, or
(iii) subject to receipt of all required governmental, Board of Director and
shareholder approvals, violate any order, writ, injunction, decree, statute,
rule or regulation applicable to FLFC or any FLFC Subsidiary.
4.5.3 Except for (i) the filing of applications and notices with,
and the consents and approvals of, as applicable, the Bank Regulators, (ii) the
filing of the Proxy Statement with the SEC, (iii) the approval of this Agreement
by the requisite vote of the shareholders of FLFC, (iv) the filing of
certificates of merger with respect to the merger of Acquisition Corporation
with and into FLFC with the Secretary of State of the State of Delaware pursuant
to the DGCL and with the Secretary of the State of the State of Connecticut
pursuant to the CBCA in connection with the Merger, and (v) the filing of a copy
of the Bank Merger Agreement and a copy of the approval of the commissioner of
the Connecticut Department of Banking with the Connecticut Secretary of the
State with respect to the Bank Merger, no consents or approvals of or filings or
registrations with any Governmental Entity or with any third party are necessary
on the part of FLFC or FNB in connection with the execution and delivery by FLFC
and FNB of this Agreement, the execution and delivery by FNB of the Bank Merger
Agreement, the consummation of the Merger by FLFC, and the consummation of the
Bank Merger by FNB.
4.5.4 As of the date hereof, neither FLFC nor FNB is aware of any
reasons relating to FLFC or FNB (including without limitation Community
Reinvestment Act compliance) why all consents and approvals shall not be
procured from all regulatory agencies having jurisdiction over the Merger or the
Bank Merger as shall be necessary for (i)
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consummation of the Merger and the Bank Merger, and (ii) the continuation by USB
after the Effective Time of the business of FLFC and FNB as such business is
carried on immediately prior to the Effective Time, free of any conditions or
requirements which could have a Material Adverse Effect on the business of FLFC
or FNB.
4.6 Securities Documents and Regulatory Reports.
-------------------------------------------
4.6.1 Except as set forth in Section 4.6.1 of the FLFC Disclosure
Schedule, since December 31, 2006 FLFC has timely filed, including those filed
within the period permitted by Rule 12b-25 of the Exchange Act, with the SEC all
Securities Documents required by the Securities Laws and such Securities
Documents, as the same may have been amended, complied as to form in all
material respects with the Securities Laws and did not contain any untrue
statement of a material fact or omit to state any material fact required to be
stated therein or necessary in order to make the statements therein, in light of
the circumstances under which they were made, not misleading.
4.6.2 Except as set forth in Section 4.6.2 of the FLFC Disclosure
Schedule, since December 31, 2006, each of FLFC and FNB, has duly filed with the
Bank Regulators in correct form the reports required to be filed under
applicable laws and regulations and such reports were complete and accurate in
all material respects and in compliance in all material respects with the
requirements of applicable laws and regulations. In connection with the most
recent federal and state Bank Regulator examinations of FLFC and FNB, neither
FLFC nor FNB was required to correct or change any action, procedure or
proceeding which FLFC or FNB believes has not been corrected or changed as
required as of the date hereof.
4.7 Financial Statements.
--------------------
4.7.1 FLFC has previously delivered or made available to USB
accurate and complete copies of the FLFC Financial Statements which, in the case
of audited FLFC Financial Statements, are accompanied by the audit reports of
its independent public accountants. The FLFC Financial Statements referred to
herein, as well as the FLFC Financial Statements to be delivered pursuant to
Section 6.4 hereof, fairly present or will fairly present, as the case may be,
in all material respects (including the related notes in each case where
applicable) the consolidated financial condition of FLFC as of the respective
dates set forth therein, and the consolidated results of operations,
shareholders' equity and cash flows of FLFC for the respective periods or as of
the respective dates set forth therein.
4.7.2 Each of the FLFC Financial Statements referred to in Section
4.7.1 has been prepared in accordance with GAAP during the periods involved,
except as stated therein or, in the case of unaudited interim FLFC Financial
Statements, the absence of footnotes and customary year-end adjustments. The
audits of FLFC and FLFC Subsidiaries have been conducted in accordance with
generally accepted auditing standards. The books and records of FLFC and the
FLFC Subsidiaries are being maintained in compliance with applicable legal and
accounting requirements, and such books and records accurately reflect in all
material respects all dealings and transactions in respect of the business,
assets, liabilities and affairs of FLFC and its Subsidiaries. The minute books
of FLFC and each FLFC Subsidiary contain complete and
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accurate records of all meetings and other corporate actions of their respective
shareholders and Boards of Directors (including all committees) authorized at
such meetings held or taken since December 31, 2006 through the date of this
Agreement.
4.7.3 Except as set forth in Section 4.7.3 of the FLFC Disclosure
Schedule, at the date of each balance sheet included in the FLFC Financial
Statements, neither FLFC or any FLFC Subsidiary had any liabilities, obligations
or loss contingencies of any nature (whether absolute, accrued, contingent or
otherwise) of a type required to be reflected in such FLFC Financial Statements
or in the footnotes thereto which are not fully reflected or reserved against
therein or fully disclosed in a footnote thereto, except for liabilities,
obligations and loss contingencies which are not material individually or in the
aggregate or which are incurred in the ordinary course of business, consistent
with past practice, and except for liabilities, obligations and loss
contingencies which are within the subject matter of a specific representation
and warranty herein and subject, in the case of any unaudited statements, to
normal, recurring audit adjustments and the absence of footnotes.
4.8 Material Adverse Change. Since December 31, 2008 to the date
hereof (i) FLFC and each FLFC Subsidiary has conducted its respective business
in the ordinary and usual course (excluding the incurrence of expenses in
connection with this Agreement, and excluding the transactions contemplated
hereby), and (ii) no event has occurred or circumstance arisen that,
individually or in the aggregate, has had or is reasonably likely to have a
Material Adverse Effect on FLFC.
4.9 Environmental Matters.
---------------------
4.9.1 Except as set forth in Section 4.9.1 of the FLFC Disclosure
Schedule, with respect to FLFC and each FLFC Subsidiary:
(a) Each of FLFC and the FLFC Subsidiaries, the Participation
Facilities, and the Loan Properties are, and at all times have been, in
compliance with, and are not in violation of or liable under, any Environmental
Laws;
(b) There is no suit, claim, action, demand, executive or
administrative order, directive, investigation or proceeding pending and there
is no such action threatened, before any court, governmental agency or other
forum against it or any of the FLFC Subsidiaries or any Participation Facility
(x) for alleged noncompliance (including by any predecessor) with, or liability
under, any Environmental Law or (y) relating to the presence of or release (as
defined herein) into the environment of any Materials of Environmental Concern
(as defined herein), whether or not occurring at or on a site currently or
formerly owned, leased or operated by it or any of the FLFC Subsidiaries or any
Participation Facility or (z) with respect to any property at or to which
Material of Environmental Concern were generated, manufactured, refined,
transported, transferred, imported, used, disposed, treated, or processed by
FLFC or any FLFC Subsidiary or any Participation Facility or from which
Materials of Environmental Concern have been transported, treated, stored,
handled, transferred, disposed, recycled, or received;
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(c) There is no suit, claim, action, demand, executive or
administrative order, directive, investigation or proceeding pending and no such
action is threatened before any court, governmental agency or other forum
relating to or against any Loan Property (or FLFC or any of the FLFC
Subsidiaries in respect of such Loan Property) (x) relating to alleged
noncompliance (including by any predecessor) with, or liability under, any
Environmental Law or (y) relating to the presence of or release into the
environment of any Materials of Environmental Concern;
(d) The real properties, leasehold or other interest in real
property currently or formerly owned or operated by FLFC or any FLFC Subsidiary
(including, without limitation, soil, groundwater or surface water on, under or
geologically or hydrologically adjacent to the properties, and buildings
thereon) are not contaminated with and do not otherwise contain any Materials of
Environmental Concern;
(e) Neither FLFC nor any FLFC Subsidiary has received any written
notice, demand letter, executive or administrative order, directive or request
for information from any federal, state, local or foreign governmental entity or
any third party indicating that it may be in violation of, or liable under, any
Environmental Law;
(f) There are no underground storage tanks on, in or under any
properties currently or formerly owned or operated by FLFC or any of the FLFC
Subsidiaries or any Participation Facility, and no underground storage tanks
have been closed or removed from any properties currently or formerly owned or
operated by FLFC or any of the FLFC Subsidiaries or any Participation Facility;
and
(g) During the period of (i) FLFC's or any of the FLFC Subsidiaries'
ownership or operation of any of their respective currently or formerly owned or
operated properties or (ii) FLFC's or any of the FLFC Subsidiaries'
participation in the management of any Participation Facility, there has been no
contamination by or release of Materials of Environmental Concern in, on, under
or affecting such properties. Prior to the period of (i) FLFC's or any of the
FLFC Subsidiaries' ownership or operation of any of their respective currently
or formerly owned or operated properties or (ii) FLFC's or any of FLFC
Subsidiaries' participation in the management of any Participation Facility,
there was no known contamination by or release of Materials of Environmental
Concern in, on, under or affecting such properties.
4.9.2 "Loan Property" means any property (including a leasehold
interest therein) in which the applicable party (or a Subsidiary of it)
currently holds a security interest or has held a security interest within the
past five (5) years. "Participation Facility" means any facility in which the
applicable party (or a Subsidiary of it) currently participates or formerly
participated in the management (including all property held as trustee or in any
other fiduciary capacity) and, where required by the context, includes the owner
or operator of such property, but only with respect to such property.
4.9.3 Except as set forth in Section 4.9.3 of the FLFC Disclosure
Schedule, FLFC does not possess and has not conducted or arranged for the
conduct of any environmental studies, reports, analyses, tests or monitoring
during the past ten (10) years with respect to any properties currently or
formerly owned or leased by FLFC or any FLFC Subsidiary or any
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Participation Facility. FLFC has delivered to USB true and complete copies and
results of any and all such schedules, reports, analyses, tests or monitoring.
4.9.4 Except as set forth in Section 4.9.4 of the FLFC Disclosure
Schedule, no real property currently or formerly owned or leased by FLFC or any
FLFC Subsidiary, no Loan Property, and no Participation Facility meets the
statutory criteria of an "Establishment" as such term is defined pursuant to the
Connecticut Transfer Act, Connecticut General Statutes Section 22a-134 et seq.
No condition exists at any real property currently or formerly owned or leased
by FLFC or any FLFC Subsidiary, any Loan Property or any Participation Facility
that would require investigation, remediation, or post-remediation or natural
attenuation monitoring under the Connecticut Department of Environmental
Protection's Remediation Standard Regulations, Regulations of Connecticut State
Agencies Sections 22a-133k-1 et seq.
4.10 Tax Matters.
-----------
4.10.1 FLFC and each FLFC Subsidiary (taking into account any
extension of time within which to file which has not expired) has timely filed
all Tax Returns required by applicable law to be filed by them in respect of all
applicable Taxes required to be paid through the date hereof and will timely
file any such Tax Returns required to be filed prior to the Effective Time with
respect to Taxes required to be paid through the Effective Time. FLFC and each
FLFC Subsidiary have paid, or where payment is not required to have been made,
have set up an adequate reserve or accrual for the payment of, all Taxes
required to be paid in respect of the periods covered by such Tax Returns and,
as of the Effective Time, will have paid, or where payment is not required to
have been made, will have set up an adequate reserve or accrual for the payment
of, all Taxes for any subsequent periods ending on or prior to the Effective
Time. Neither FLFC nor any FLFC Subsidiary will have any liability for any such
Taxes in excess of the amounts so paid or reserves or accruals so established.
As of the date hereof, except as disclosed in Section 4.10.1 of the FLFC
Disclosure Schedule, no audit, examination or deficiency or refund litigation
with respect to any Tax Returns filed by FLFC or any FLFC Subsidiary is pending
or threatened and there is no basis for any Tax authority to assess any
additional Taxes for any period for which Tax Returns have been filed.
4.10.2 FLFC and each FLFC Subsidiary has withheld and paid all Taxes
required to be paid in connection with amounts paid to any employee, independent
contractor, creditor, stockholder or other third party.
4.10.3 All Tax Returns filed by FLFC and its Subsidiaries are
complete and accurate in all material respects. Neither FLFC nor any FLFC
Subsidiary is delinquent in the payment of any Tax, assessment or governmental
charge, or has requested any extension of time within which to file any Tax
Returns in respect of any fiscal year or portion thereof which have not since
been filed. Except as set forth in Section
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4.10.3 of the FLFC Disclosure Schedule, the Tax Returns of FLFC and its
Subsidiaries have been examined by the applicable tax authorities (or are closed
to examination due to the expiration of the applicable statute of limitations)
and no deficiencies for any Tax, assessment or governmental charge have been
proposed, asserted or assessed (tentatively or otherwise) against FLFC or any
FLFC Subsidiary as a result of such examinations or otherwise which have not
been settled and paid. Except as set forth in Section 4.10.3.1 of the FLFC
Disclosure Schedule, the Tax Returns of FLFC and its Subsidiaries filed within
six years prior to the date of this Agreement have not been examined by the
applicable tax authorities. There are currently no agreements in effect with
respect to FLFC or any FLFC Subsidiary to extend the period of limitations for
the assessment or collection of any Tax and no power of attorney has been
granted by FLFC and its Subsidiaries with respect to any Tax matter currently in
force. No claim has ever been made by an authority in a jurisdiction where FLFC
or its subsidiaries do not file Tax Returns that FLFC or its Subsidiaries are or
may be subject to taxation by that jurisdiction. There are no liens for Taxes
(other than Taxes not yet due and payable) upon any of the assets of FLFC or its
Subsidiaries.
4.10.4 Except as set forth in Section 4.10.4 of the FLFC Disclosure
Schedule, neither FLFC nor any FLFC Subsidiary is a party to any agreement,
contract, arrangement or plan that has resulted or could result, separately or
in the aggregate, in the payment of (i) any "excess parachute payment" within
the meaning of Code ss.280G (or any corresponding provision of state, local or
foreign Tax law) and (ii) any amount that will not be fully deductible as a
result of Code ss.162(m) (or any corresponding provision of state, local or
foreign Tax law). Neither FLFC nor any FLFC Subsidiary has been a United States
real property holding corporation within the meaning of Code ss.897(c)(2) during
the applicable period specified in Code ss.897(c)(1)(A)(ii). Each of FLFC and
any FLFC Subsidiary have disclosed on their federal income Tax Returns all
positions taken therein that could give rise to a substantial understatement of
federal income Tax within the meaning of Code ss.6662. Neither FLFC nor any FLFC
Subsidiary is a party to or bound by any Tax allocation or sharing agreement.
Except as set forth in Section 4.10.4 of the FLFC Disclosure Schedule, neither
FLFC nor any FLFC Subsidiary (A) has been a member of an Affiliated Group filing
a consolidated federal income Tax Return (other than a group the common parent
of which was FLFC or a FLFC Subsidiary) or (B) has any Liability for the Taxes
of any Person (other than FLFC or any FLFC Subsidiary) under Reg. ss.1.1502-6
(or any similar provision of state, local, or foreign law), as a transferee or
successor, by contract, or otherwise.
4.10.5 Except as set forth in Section 4.10.5 of the FLFC Disclosure
Schedule, neither FLFC nor any FLFC Subsidiary (i) is a party to any agreement
providing for the allocation or sharing of taxes (ii) is required to include in
income any adjustment pursuant to Section 481(a) of the Code by reason of a
voluntary change in accounting method initiated by FLFC or any FLFC Subsidiary
(nor does FLFC have any knowledge that the Internal Revenue Service has proposed
any such adjustment or change of accounting method) or (iii) has filed a consent
pursuant to Section 341(f) of the Code or agreed to have Section 341(f)(2) of
the Code apply. Neither FLFC nor any FLFC Subsidiary will be required to include
any item of income in, or exclude any item of deduction from, taxable income for
any taxable period (or portion thereof) ending after the Closing Date as a
result of any: (A) change in method of accounting for a taxable period ending on
or prior to the Closing Date; (B) "closing agreement" as described in Code
ss.7121 (or any corresponding or similar provision of state, local or foreign
income Tax law) executed on or prior to the Closing Date; (C) intercompany
transaction or excess loss account described in Treasury Regulations under Code
ss.1502 (or any corresponding or similar provision of state, local or foreign
income Tax law); (D) installment sale or open transaction disposition made on or
prior to the Closing Date; or (E) prepaid amount received on or prior to the
Closing Date.
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4.10.6 As used in this Agreement, "Tax" means any federal, state,
local or foreign income, gross receipts, license, payroll, employment, excise,
severance, stamp, occupation, premium, windfall profits, environmental, customs
duties, capital stock, franchise, profits, withholding, social security (or
similar), unemployment, disability, real property, personal property, sales,
use, transfer, registration, value added, highway, estimated or other tax of any
kind whatsoever, including any interest, penalties or addition thereto, whether
disputed or not, imposed by any government or quasi-government authority; and
"Tax Return" means any return, declaration, report, claim for refund, or
information return or statement relating to Taxes, including any schedule or
attachment thereto, and including any amendment thereof.
4.10.7 Neither FLFC nor any FLFC Subsidiary has distributed stock of
another Person, or has had its stock distributed by another Person, in a
transaction that was purported or intended to be governed in whole or in party
by Code ss.355 or Code ss.361.
4.10.8 Neither FLFC nor any FLFC Subsidiary owns an interest that is
on the Closing Date treated as a partnership for purposes of Subchapter K of the
Code, a "controlled foreign corporation" within the meaning of Code section 957,
a "passive foreign investment company" within the meaning of Code section 1297,
or any other entity that under the Code allocates items of income, gain,
deduction and expense among its owners whether or not distributed.
4.11 Legal Proceedings. Except as set forth in Section 4.11 of the
FLFC Disclosure Schedule, there are no actions, suits, claims, governmental
investigations or proceedings instituted, pending or, to the best knowledge of
FLFC or any FLFC Subsidiary, threatened against FLFC or any FLFC Subsidiary or
against any asset, interest or right of FLFC or any FLFC Subsidiary, or to the
best of FLFC's knowledge, against any officer, director or employee of any of
them, and neither FLFC nor any FLFC Subsidiary is a party to any order, judgment
or decree.
4.12 Compliance with Laws.
--------------------
4.12.1 Each of FLFC and the FLFC Subsidiaries has all material
permits, licenses, certificates of authority, orders and approvals of, and has
made all filings, applications and registrations with, federal, state, local and
foreign governmental or regulatory bodies that are required in order to permit
it to carry on its business in all material respects as it is currently being
conducted; all such permits, licenses, certificates of authority, orders and
approvals are in full force and effect; and to the best knowledge of FLFC, no
suspension or cancellation of any of the same is threatened.
4.12.2 Except as set forth in Section 4.12.2 of the FLFC Disclosure
Schedule, neither FLFC nor any FLFC Subsidiary is in violation of its respective
Certificate of Incorporation, Charter or other chartering instrument or Bylaws,
or to the best of its knowledge, in violation of any applicable federal, state
or local law or ordinance or any order, rule or regulation of any federal,
state, local or other governmental agency or body (including, without
limitation, all banking (including without limitation all regulatory capital
requirements),
A - 26
municipal securities, insurance, safety, health, zoning, anti-discrimination,
antitrust, and wage and hour laws, ordinances, orders, rules and regulations),
or in default with respect to any order, writ, injunction or decree of any
court, or in default under any order, license, regulation or demand of any
governmental agency and, to the best knowledge of FLFC, FLFC along with its
executive officers and directors is not in violation of any Securities Laws; and
neither FLFC nor any FLFC Subsidiary has received any written notice or
communication from any federal, state or local governmental authority asserting
that FLFC or any FLFC Subsidiary is in violation of any of the foregoing, which
violation has not been corrected on a prospective basis in all material
respects. Neither FLFC nor any FLFC Subsidiary is subject to any regulatory or
supervisory cease and desist order, agreement, written directive, memorandum of
understanding or written commitment (other than those of general applicability
to all banks or holding companies), and, except as set forth in Section 4.12.2
of the FLFC Disclosure Schedule, none of them has received any written
communication requesting that it enter into any of the foregoing. Since December
31, 2008, no regulatory agency has initiated any proceeding or, to the best
knowledge of FLFC, investigation into the business or operations of FLFC or any
FLFC Subsidiary. Except as set forth in Section 4.12.2 of the FLFC Disclosure
Schedule, FLFC has not received any objection from any regulatory agency to
FLFC's response to any violation, criticism or exception with respect to any
report or statement relating to any examination of FLFC or any of the FLFC
Subsidiaries.
4.13 Certain Information. None of the information supplied by FLFC or
FNB relating to FLFC and its Subsidiaries to be included or incorporated by
reference in the Proxy Statement, as of the date(s) such Proxy Statement is
mailed to shareholders of FLFC, and up to and including the date of the meeting
of shareholders to which such Proxy Statement relates, will contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements therein, in light of the circumstances under which they were
made, not misleading, provided that information as of a later date shall be
deemed to modify information as of an earlier date. The Proxy Statement mailed
by FLFC to its shareholders in connection with the meeting of shareholders at
which this Agreement will be considered by such shareholders will comply as to
form in all material respects with the Exchange Act and the rules and
regulations promulgated thereunder.
4.14 Employee Benefit Plans.
----------------------
4.14.1 FLFC has set forth in Section 4.14.1 of the FLFC Disclosure
Schedule all FLFC Employee Plans, and FLFC has previously furnished or made
available to USB accurate and complete copies of the same together with (i)
Schedule B forms and the actuarial and audited financial reports prepared with
respect to any qualified plans for the last two (2) plan years, (ii) the annual
reports filed with any governmental agency for any qualified or non-qualified
plans for the last two (2) plan years, (iii) the Summary Annual Report provided
to Participants for the last two (2) plan years; and (iv) all rulings and
determination letters and any open requests for rulings or letters that pertain
to any qualified plan.
4.14.2 None of FLFC, any FLFC Subsidiary, any pension plan
maintained by any of them and qualified under Section 401 of the Code or, to the
best of FLFC's knowledge, any fiduciary of such plan has incurred any liability
to the PBGC (except for premiums payable in
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the ordinary course) or the Internal Revenue Service with respect to any
employees of FLFC or any FLFC Subsidiary. No reportable event under Section
4043(b) of ERISA has occurred with respect to any such pension plan, other than
the transactions contemplated by this Agreement.
4.14.3 Except as set forth in Section 4.14.3 of the FLFC Disclosure
Schedule: (a) neither FLFC nor any FLFC Subsidiary participates in or has
incurred any liability under Section 4201 of ERISA for a complete or partial
withdrawal from a multi-employer plan (as such term is defined in ERISA); (b) no
liability under Title IV of ERISA has been incurred by FLFC or any FLFC
Subsidiary with respect to any FLFC Employee Plan which is subject to Title IV
of ERISA, or with respect to any "single-employer plan" (as defined in Section
4001(a) of ERISA) ("FLFC Defined Benefit Plan") currently or formerly maintained
by FLFC or any entity which is considered an affiliated employer with FLFC under
Section 4001(b) (1) of ERISA or Section 414 of the Code (an "ERISA Affiliate")
since the effective date of ERISA that has not been satisfied to the extent
required by ERISA from time to time; (c) no FLFC Defined Benefit Plan had an
"accumulated funding deficiency" (as defined in Section 302 of ERISA), whether
or not waived, as of the last day of the end of the most recent plan year ending
prior to the date hereof that has not or will not be funded within the time
provided under Section 302(c) (10) of ERISA; (d) the fair market value of the
assets of each FLFC Defined Benefit Plan exceeds the present value of the
"benefit liabilities" (as defined in Section 4001(a) (16) of ERISA) under such
FLFC Defined Benefit Plan as of the end of the most recent plan year with
respect to the respective FLFC Defined Benefit Plan ending prior to the date
hereof, calculated on the basis of the actuarial assumptions used in the most
recent actuarial valuation for such FLFC Defined Benefit Plan as of the date
hereof; (e) neither FLFC nor any ERISA Affiliate has provided, or is required to
provide, security to any FLFC Defined Benefit Plan or to any single-employer
plan of an ERISA Affiliate pursuant to Section 401(a) (29) of the Code; (f)
neither FLFC nor any ERISA Affiliate has contributed to any "multiemployer
plan," as defined in Section 3(37) of ERISA, on or after September 26, 1980; (g)
neither FLFC, nor any ERISA Affiliate, nor any FLFC Employee Plan, including any
FLFC Defined Benefit Plan, nor any trust created thereunder has engaged in a
transaction in connection with which FLFC, any ERISA Affiliate, and any FLFC
Employee Plan, including any FLFC Defined Benefit Plan, any such trust or any
trustee or administrator thereof, is subject to either a civil liability or
penalty pursuant to Section 409, 502(i) or 502(1) of ERISA or a tax imposed
pursuant to Chapter 43 of the Code.
4.14.4 Except as set forth in Section 4.14.4 of the FLFC Disclosure
Schedule, a favorable determination letter has been issued by the Internal
Revenue Service, with respect to each FLFC Employee Plan which is an "employee
pension benefit plan" (as defined in Section 3(2) of ERISA) (a "FLFC Pension
Plan") which is intended to qualify under Section 401 of the Code, to the effect
that such plan is qualified under Section 401 of the Code and the trust
associated with such employee pension plan is tax exempt under Section 501 of
the Code. No such letter has been revoked or, to the best of FLFC's knowledge,
is threatened to be revoked, and FLFC does not know of any ground on which such
revocation may be based. Except as set forth in Section 4.14.4 of the FLFC
Disclosure Schedule, neither FLFC nor any FLFC Subsidiary has any current
liability under any such plan that was required to be reflected as a liability
on the Financial Statements as of June 30, 2009 under GAAP, which was not
reflected on the consolidated statement of financial condition of FLFC at June
30, 2009 included in the FLFC Financial Statements.
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4.14.5 No prohibited transaction (which shall mean any transaction
prohibited by Section 406 of ERISA and not exempt under Section 408 of ERISA or
Section 4975 of the Code) has occurred with respect to any FLFC Employee Plan
which would result in the imposition, directly or indirectly, of a material
excise tax on FLFC under Section 4975 of the Code.
4.14.6 Except as specifically identified in Section 4.14.6 of the
FLFC Disclosure Schedule, neither FLFC nor any FLFC Subsidiary has any
obligations for post-retirement or post-employment benefits under any FLFC
Employee Plan that cannot be amended or terminated upon sixty (60) or fewer days
notice without incurring any liability thereunder, except for coverage required
by Part 6 of Title I of ERISA or Section 4980B of the Code, or similar state
law, the cost of which is borne by the insured individual. Full payment has been
made (or proper accruals have been established) of all contributions which are
required for periods prior to the date hereof, and full payment will be so made
(or proper accruals will be so established) of all contributions which are
required for periods after the date hereof and prior to the Effective Time,
under the terms of each FLFC Employee Plan or ERISA; no accumulated funding
deficiency (as defined in Section 302 of ERISA or Section 412 of the Code),
whether or not waived, exists with respect to any FLFC Pension Plan, and there
is no "unfunded current liability" (as defined in Section 412 of the Code) with
respect to any FLFC Pension Plan.
4.14.7 The FLFC Employee Plans have been operated in compliance in
all material respects with the applicable provisions of ERISA, the Code, all
regulations, rulings and announcements promulgated or issued thereunder and all
other applicable governmental laws and regulations.
4.14.8 There are no pending or, to the best knowledge of FLFC,
threatened claims (other than routine claims for benefits) by, on behalf of or
against any of the FLFC Employee Plans or any trust related thereto or any
fiduciary thereof.
4.14.9 Section 4.14.9 of the FLFC Disclosure Schedule sets forth (i)
the maximum amount that could be paid to each executive officer of FLFC or any
FLFC Subsidiary as a result of the transactions contemplated by this Agreement
under all employment, severance, and termination agreements, other compensation
arrangements and FLFC Employee Plans currently in effect; and (ii) the estimated
"base amount" (as such term is defined in section 280G(b) (3) of the Code) for
each such individual calculated as of the date of this Agreement based on
estimated 2009 compensation.
4.14.10 Except as set forth in Section 4.14.10 of the FLFC
Disclosure Schedule, no compensation payable by FLFC or any FLFC Subsidiary to
any of their employees under any FLFC Employee Plan (including by reason of the
transactions contemplated hereby) will be subject to disallowance under Section
162(m) of the Code.
4.14.11 Except as set forth in Section 4.14.11 of the FLFC
Disclosure Schedule, with respect to any FLFC Employee Plan which is an employee
welfare benefit plan (within the meaning of ERISA Section 3(1) (a "FLFC Welfare
Plan"): (i) each such FLFC Welfare Plan which is intended to meet the
requirements for tax-favored treatment under Subchapter B of
A - 29
Chapter 1 of the Code meets such requirements; (ii) there is no disqualified
benefit (as such term is defined in Code Section 4976(b)) which would subject
FLFC to a tax under Code Section 4976(a); (iii) each and every FLFC Welfare Plan
which is a group health plan (as such term is defined in Code Sections
5000(b)(1)) complies and in each and every case has complied with the applicable
requirements of Code Section 4980B; and (iv) each such FLFC Welfare Plan
(including any such plan covering former employees of FLFC or any FLFC
Subsidiary) may be amended or terminated by FLFC or USB on or at any time after
the Effective Date without incurring liability thereunder except as required to
satisfy the terms of such FLFC Welfare Plan.
4.15 Certain Contracts.
-----------------
4.15.1 Neither FLFC nor any FLFC Subsidiary is in default or
non-compliance under any contract, agreement, commitment, arrangement, lease,
insurance policy or other instrument to which it is a party or by which its
assets, business or operations may be bound or affected, whether entered into in
the ordinary course of business or otherwise and whether written or oral, and
there has not occurred any event that with the lapse of time or the giving of
notice, or both, would constitute such a default or non-compliance.
4.15.2 Except as set forth in Section 4.15.2 of the FLFC Disclosure
Schedule, neither FLFC nor any FLFC Subsidiary is a party to, is bound or
affected by, receives, or is obligated to pay benefits under:
(a) any agreement, arrangement, policy or commitment, including
without limitation any agreement, indenture or other instrument, relating to the
borrowing of money by FLFC or any FLFC Subsidiary (other than in the case of FNB
deposits, Federal Reserve or Federal Home Loan Bank advances, federal funds
purchased and securities sold under agreements to repurchase in the ordinary
course of business) or the guarantee by FLFC or any FLFC Subsidiary of any
obligation;
(b) any agreement, arrangement, policy or commitment relating to the
employment of a consultant or the employment, election or retention in office of
any present or former director, officer or employee of FLFC or any FLFC
Subsidiary;
(c) any agreement, arrangement, policy or understanding pursuant to
which any payment (whether of severance pay or otherwise) became or may become
due to any director, officer or employee of FLFC or any FLFC Subsidiary upon
execution of this Agreement or the Bank Merger Agreement or upon or following
consummation of the transactions contemplated by this Agreement or the Bank
Merger Agreement (either alone or in connection with the occurrence of any
additional acts or events);
(d) any agreement, arrangement, policy or understanding pursuant to
which FLFC or any FLFC Subsidiary is obligated to indemnify any director,
officer, employee or agent of FLFC or any FLFC Subsidiary;
A - 30
(e) any agreement, arrangement, policy or understanding to which
FLFC or any FLFC Subsidiary is a party or by which any of the same is bound
which limits the freedom of FLFC or any FLFC Subsidiary to compete in any line
of business or with any person;
(f) any assistance agreement, supervisory agreement, memorandum of
understanding, consent order, cease and desist order or condition of any
regulatory order or decree with or by any Bank Regulator;
(g) any agreement (other than any agreement with a banking customer
for the provision of banking services entered into by any FLFC Subsidiary in the
ordinary course of business) that involves a payment or series of payments of
more than $50,000 in any one (1) year from or to FLFC or any FLFC Subsidiary;
(h) any agreement, arrangement or understanding any of the benefits
of which will be increased, or the vesting of the benefits of which will be
accelerated, by the occurrence of any of the transactions contemplated by this
Agreement or the Bank Merger Agreement, or the value of any of the benefits of
which will be calculated on the basis of any of the transactions contemplated by
this Agreement or the Bank Merger Agreement; or
(i) any other agreement, arrangement or understanding that would be
required to be filed as an exhibit to FLFC's Annual Report on Form 10-K under
the Exchange Act and which has not been so filed.
4.16 Brokers and Finders. Except as set forth in Section 4.16 of the
FLFC Disclosure Schedule, neither FLFC nor any FLFC Subsidiary nor any of their
respective directors, officers or employees, has employed any broker or finder
or incurred any liability for any broker or finder fees or commissions in
connection with the transactions contemplated hereby.
4.17 Insurance. FLFC and each FLFC Subsidiary are insured for
reasonable amounts with reputable insurance companies against such risks as
management of FLFC and any FLFC Subsidiary reasonably has determined to be
prudent for companies engaged in a similar business would, in accordance with
good business practice, customarily be insured and has maintained all insurance
required by contracts currently in effect and applicable laws and regulations.
Section 4.17 of the FLFC Disclosure Schedule sets forth all policies of
insurance maintained by FLFC or any FLFC Subsidiary as of the date hereof and
any claims thereunder in excess of $25,000 since December 31, 2007. Since
December 31, 2008, neither FLFC nor any FLFC Subsidiary has received any notice
of termination of any such insurance coverage or increase in the premiums
therefor or has any reason to believe that any such insurance coverage will be
terminated or the premiums therefor increased (except for increases in premiums
in the ordinary course of business).
4.18 Properties. Section 4.18 of the FLFC Disclosure Schedule sets
forth the street address of all real property in which FLFC or any FLFC
Subsidiary has an ownership or leasehold interest (specifying, as to each,
whether owned or leased) and identifies all properties on which any FLFC
Subsidiary operates a bank branch. All real and personal property owned by FLFC
or any FLFC Subsidiary or presently used by any of them in its respective
business are in
A - 31
good condition (ordinary wear and tear excepted) and are sufficient to carry on
its business in the ordinary course of business consistent with their past
practices. Each of FLFC and each FLFC Subsidiary has good and marketable title
free and clear of all material liens, encumbrances, charges, defaults or
equities (other than equities of redemption under applicable foreclosure laws)
to all of the properties and assets, real and personal, reflected on the
consolidated statement of financial condition of FLFC contained in the FLFC
Financial Statements dated June 30, 2009 or acquired, through merger or
otherwise, after such date (other than those disposed of for fair value after
such date), except (i) liens for current taxes not yet due or payable, (ii)
pledges to secure deposits and other liens incurred in the ordinary course of
its banking business, (iii) such imperfections of title, easements and
encumbrances, if any, as are not material in character, amount or extent, and
(iv) as reflected on the consolidated statement of financial condition of FLFC
contained in the FLFC Financial Statements dated June 30, 2009. Except as
disclosed in Section 4.18 of the FLFC Disclosure Schedule, all real and personal
property leased or licensed by FLFC or any FLFC Subsidiary are held pursuant to
leases or licenses that are valid and enforceable in accordance with their
respective terms subject, as to enforceability, to bankruptcy, insolvency,
reorganization, moratorium, fraudulent transfer and similar laws of general
applicability relating to or affecting creditors' rights and to general equity
principles, each such real property lease is transferable to USB and no such
real property lease will terminate or lapse prior to March 31, 2010.
4.19 Labor. No work stoppage involving FLFC or any FLFC Subsidiary is
pending or threatened. Neither FLFC nor any FLFC Subsidiary is involved in,
threatened with or affected by, any labor dispute, arbitration, lawsuit or
administrative proceeding involving its employees. Employees of FLFC and the
FLFC Subsidiaries are not represented by any labor union nor are any collective
bargaining agreements otherwise in effect with respect to such employees, and to
the best of FLFC's knowledge there have been no efforts to unionize or organize
any employees of FLFC or any FLFC Subsidiary.
4.20 Certain Transactions. Neither FLFC nor any FLFC Subsidiary has
been a party to any off-balance-sheet transactions involving interest rate and
currency swaps, options and futures contracts, or any other similar derivative
transactions, except as set forth in Section 4.20 of the FLFC Disclosure
Schedule.
4.21 Fairness Opinion. FLFC has received an opinion from Raymond James
& Associates, Inc. to the effect that, subject to the terms, conditions and
qualifications set forth therein, as of the date thereof, the Merger
Consideration to be received by the shareholders of FLFC pursuant to this
Agreement is fair to such shareholders from a financial point of view, and
Raymond James & Associates, Inc. has consented to the inclusion of such written
opinion in the Proxy Statement.
4.22 Loan Portfolio.
--------------
4.22.1 The allowance for possible losses reflected in FLFC's audited
consolidated statement of financial condition contained in the FLFC Financial
Statements dated June 30, 2009 was, and the allowance for possible losses shown
on the balance sheets in FLFC's Securities
A - 32
Documents for dates after June 30, 2009 will be, adequate in all material
respects, as of the dates thereof, under GAAP.
4.22.2 Section 4.22.2 of the FLFC Disclosure Schedule sets forth a
listing, as of August 30, 2009 by account, of: (A) all loans, (1) that are
contractually past due ninety (90) days or more in the payment of principal
and/or interest, (2) that are on non-accrual status, (3) that as of the date of
this Agreement are classified as "Impaired" (as contemplated under FAS 114),
"Other Loans Specially Mentioned", "Special Mention", "Substandard", "Doubtful",
"Loss", "Classified", "Criticized", "Watch list", or words of similar import,
together with the principal amount of and accrued and unpaid interest on each
such loan and the identity of the obligor thereunder, (4) where a reasonable
doubt exists as to the timely future collectibility of principal and/or
interest, whether or not interest is still accruing or the loans are less than
ninety (90) days past due, (5) where the interest rate terms have been reduced
and/or the maturity dates have been extended subsequent to the agreement under
which the loan was originally created due to concerns regarding the borrower's
ability to pay in accordance with such initial terms, or (6) where a specific
reserve allocation exists in connection therewith, and (B) all assets classified
by FLFC or any FLFC Subsidiary as real estate acquired through foreclosure or in
lieu of foreclosure, including in-substance foreclosures, and all other assets
currently held that were acquired through foreclosure or in lieu of foreclosure.
4.22.3 All loans receivable (including discounts) and accrued
interest entered on the books of FLFC and the FLFC Subsidiaries arose out of
bona fide arm's-length transactions, were made for good and valuable
consideration in the ordinary course of FLFC's or the appropriate FLFC
Subsidiary's respective business, and the notes or other evidences of
indebtedness with respect to such loans (including discounts) are, in all
material respects, valid, true and genuine and are what they purport to be,
except as set forth in Section 4.22.3 of the FLFC Disclosure Schedule. The
loans, discounts and the accrued interest reflected on the books of FLFC and the
FLFC Subsidiaries are subject to no defenses, set-offs or counterclaims
(including, without limitation, those afforded by usury or truth-in-lending
laws), except as may be provided by bankruptcy, insolvency or similar laws
affecting creditors' rights generally or by general principles of equity. Except
as set forth in Section 4.22.3 of the FLFC Disclosure Schedule, all such loans
are owned by FLFC or the appropriate FLFC Subsidiary free and clear of any
liens.
4.22.4 All pledges, mortgages, deeds of trust and other collateral
documents or security instruments relating to all notes or other evidences of
indebtedness referred to in Section 4.22.3 are, in all material respects, valid,
true and genuine, and what they purport to be.
4.23 Required Vote; Inapplicability of Anti-takeover Statutes.
--------------------------------------------------------
4.23.1 The affirmative vote of the holders of two-thirds of the
outstanding shares of FLFC Common Stock outstanding and entitled to vote is
necessary to approve this Agreement and the transactions contemplated hereby
(including the Bank Merger) on behalf of FLFC.
A - 33
4.23.2 No "fair price," "moratorium," "control share acquisition" or
other form of anti-takeover statute or regulation or provision of FLFC's
Certificate of Incorporation or By-Laws is applicable to this Agreement and the
transactions contemplated hereby.
4.24 Material Interests of Certain Persons. Except as set forth in
Section 4.24 of the FLFC Disclosure Schedule, no officer or director of FLFC or
a FLFC Subsidiary, or any "associate" (as such term is defined in Rule 14a-l
under the Exchange Act) of any such officer or director, (i) has any material
interest in any contract or property (real or personal), tangible or intangible,
used in or pertaining to the business of FLFC or any of the FLFC Subsidiaries,
or (ii) is indebted to, or has the right under a line of credit to borrow from,
FLFC or any FLFC Subsidiary in an amount greater than $100,000.
4.25 Joint Ventures. Section 4.25 of the FLFC Disclosure Schedule sets
forth (i) the identities of all Joint Ventures in which FLFC or any FLFC
Subsidiary is participating, (ii) a list of agreements relating to such Joint
Ventures, (iii) the identities of the other participants in the Joint Venture,
(iv) the percentage of the Joint Venture owned by each participant, (v) copies
of the most recent available financial statements (on an audited basis if
available) of such Joint Ventures, and (vi) the amount of the investment or
contractually binding commitment of FLFC or any FLFC Subsidiary to invest in
such Joint Venture.
4.26 Intellectual Property. FLFC and each FLFC Subsidiary own or
possess valid and binding licenses and other rights to use without payment of
any material amount all material patents, trademarks, trade names, service
marks, copyrights and any applications therefor, schematics, technology,
know-how, trade secrets, inventory, ideas, algorithms, processes, computer
programs and applications (in both source code and object code form) and
tangible and intangible proprietary information or material that are used in
their businesses ("Intellectual Property"), and all such Intellectual Property
is described in Section 4.26 of the FLFC Disclosure Schedule. Neither FLFC nor
any FLFC Subsidiary has any material undisclosed liability with respect to (i)
the Intellectual Property or (ii) licenses, sublicenses and other agreements as
to which FLFC or any FLFC Subsidiary is a party and pursuant to which FLFC or
any FLFC Subsidiary is authorized to use any third party patents, trademarks or
copyrights, including software which are incorporated in, or form a part of any
FLFC or any FLFC Subsidiary product.
4.27 Disclosures. None of the representations and warranties of FLFC
and FNB or any of the written information or documents furnished or to be
furnished by FLFC or FNB to USB in connection with or pursuant to this Agreement
or the consummation of the transactions contemplated hereby (including the Bank
Merger), when considered as a whole, contains or will contain any untrue
statement of a material fact, or omits or will omit to state any material fact
required to be stated or necessary to make any such information or document, in
light of the circumstances, not misleading.
A - 34
ARTICLE V
REPRESENTATIONS AND WARRANTIES OF USB
USB represents and warrants to FLFC and FNB that the statements
contained in this Article V are correct and complete as of the date of this
Agreement and will be correct and complete as of the Closing Date (as though
made then and as though the Closing Date were substituted for the date of this
Agreement throughout this Article V), except as set forth in the USB Disclosure
Schedule delivered by USB to FLFC and FNB on the date hereof. No representation
or warranty of USB contained herein shall be deemed untrue or incorrect, and USB
shall not be deemed to have breached a representation or warranty, on account of
the existence of any fact, circumstance or event, unless, as a direct or
indirect consequence of such fact, circumstance or event, individually or taken
together with all other facts, circumstances or events inconsistent with any
paragraph in this Article V, as applicable, there is reasonably likely to exist
a Material Adverse Effect. The mere inclusion of an item in the USB Disclosure
Schedule as an exception to a representation or warranty shall not be deemed an
admission by USB that such item represents a material exception or fact, event
or circumstance or that, absent such inclusion in the USB Disclosure Schedule,
such item is or would be reasonably likely to result in a Material Adverse
Effect.
5.1 Capital Structure. USB is a Connecticut-chartered savings bank in
mutual form and, as a result, has no authorized or
outstanding capital stock.
5.2 Organization, Standing and Authority of USB.
-------------------------------------------
5.2.1 USB is a mutual savings bank duly organized and in legal
existence under the laws of the State of Connecticut with full corporate power
and authority to own or lease all of its properties and assets and to carry on
its business as now conducted, and is duly licensed or qualified to do business
and is in good standing or legal existence, as appropriate, in each jurisdiction
in which its ownership or leasing of property or the conduct of its business
requires such licensing or qualification. The deposit accounts of USB are
insured by the FDIC through the DIF to the maximum extent permitted by the FDIA.
USB has paid all premiums and assessments required by the FDIC. USB has
heretofore delivered or made available to FLFC, true and complete copies of the
Certificate of Incorporation and Bylaws of USB as in effect on the date hereof.
5.2.2 Set forth in Section 5.2.2 of the USB Disclosure Schedule is
the name, jurisdiction of incorporation and percentage ownership of each direct
and indirect USB Subsidiary. Except for (a) capital stock of the USB
Subsidiaries, (b) securities and other interests held in a fiduciary capacity
and beneficially owned by third parties or taken in consideration of debts
previously contracted, and (c) securities and other interests which are set
forth in the USB Disclosure Schedule, USB does not own or have the right or
obligation to acquire, directly or indirectly, any outstanding capital stock or
other voting securities or ownership interests of any corporation, bank, savings
association, partnership, joint venture or other organization, other than
investment securities representing not more than five percent (5%) of the
outstanding capital stock of any entity. The outstanding shares of capital stock
or other
A - 35
ownership interests of each USB Subsidiary that are owned by USB have been duly
authorized and validly issued, are fully paid and nonassessable and are directly
owned by USB free and clear of all liens, claims, encumbrances, charges,
pledges, restrictions or rights of third parties of any kind whatsoever. Except
as set forth on Section 5.2.2 of the USB Disclosure Schedule, there are no
Rights authorized, issued or outstanding with respect to the capital stock or
other ownership interests of any USB Subsidiary and there are no agreements,
understandings or commitments relating to the right of USB to vote or to dispose
of such capital stock or other ownership interests.
5.2.3 Organization, Standing and Authority of USB Subsidiaries. Each
USB Subsidiary is a corporation, partnership or business trust duly organized,
validly existing and in good standing or legal existence, as appropriate, under
the laws of the jurisdiction in which it is organized. Each USB Subsidiary (i)
has full power and authority to own or lease all of its properties and assets
and to carry on its business as now conducted, and (ii) is duly licensed or
qualified to do business and is in good standing or legal existence, as
appropriate, in each jurisdiction in which its ownership or leasing of property
or the conduct of its business requires such qualification, except where the
failure to be so licensed or qualified would not have a Material Adverse Effect.
USB is authorized to own each USB Subsidiary under applicable law. USB has
heretofore delivered or made available to FLFC and has included as Section 5.2.3
of the USB Disclosure Schedule true, complete and correct copies of the
Certificate of Incorporation and Bylaws of each USB Subsidiary as in effect as
of the date hereof.
5.3 Authorized and Effective Agreement.
----------------------------------
5.3.1 USB has all requisite corporate power and authority to enter
into this Agreement and the Bank Merger Agreement and (subject to receipt of all
necessary governmental approvals) to perform all of its obligations under this
Agreement and the Bank Merger Agreement. The execution and delivery of this
Agreement and the Bank Merger Agreement and the consummation of the transactions
contemplated hereby and thereby have been duly and validly authorized by all
necessary corporate action in respect thereof on the part of USB. This Agreement
has been duly and validly executed and delivered by USB and, assuming due
authorization, execution and delivery by FLFC and FNB, constitutes the legal,
valid and binding obligation of USB, enforceable against USB in accordance with
its terms, subject, as to enforceability, to bankruptcy, insolvency and other
laws of general applicability relating to or affecting creditors' rights and to
general equity principles. The Bank Merger Agreement, upon execution and
delivery by USB, will have been duly and validly executed and delivered by USB
and, assuming due authorization, execution and delivery by FLFC and FNB,
constitutes the legal, valid and binding obligation of USB, enforceable against
USB in accordance with its terms, subject, as to enforceability, to bankruptcy,
insolvency and other laws of general applicability relating to or affecting
creditors' rights and to general equity principles.
5.3.2 Neither the execution and delivery of this Agreement or the
Bank Merger Agreement, nor consummation of the transactions contemplated hereby
or thereby, nor compliance by USB with any of the provisions hereof or thereof
(i) does or will conflict with or result in a breach of any provisions of the
Certificate of Incorporation or Bylaws of USB, (ii) violate, conflict with or
result in a breach of any term, condition or provision of, or constitute a
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default (or an event which, with notice or lapse of time, or both, would
constitute a default) under, or give rise to any right of termination,
cancellation or acceleration with respect to, or result in the creation of any
lien, charge or encumbrance upon any property or asset of USB pursuant to, any
material note, bond, mortgage, indenture, deed of trust, license, lease,
agreement or other instrument or obligation to which USB is a party, or by which
any of its properties or assets may be bound or affected, or (iii) subject to
receipt of all required governmental and Board of Director approvals, violate
any order, writ, injunction, decree, statute, rule or regulation applicable to
USB.
5.3.3 Except for (i) the filing of applications and notices with,
and the consents and approvals, as applicable, of the Bank Regulators, (ii) the
filing of certificates of merger with the Secretary of State of the State of
Delaware pursuant to the DGCL and the Secretary of State of the State of
Connecticut pursuant to the CBCA in connection with the Merger, and (iii) the
filing of a copy of the Bank Merger Agreement and the approval of the
commissioner of the Department with the Connecticut Secretary of the State in
connection with the Bank Merger pursuant to the Connecticut Revised Nonstock
Corporation Act and other applicable law, no consents or approvals of or filings
or registrations with any Governmental Entity or with any third party are
necessary on the part of USB in connection with the execution and delivery of
this Agreement or the Bank Merger Agreement, the consummation of the Merger by
Acquisition Corporation, and the consummation of the Bank Merger by USB.
5.3.4 As of the date hereof, USB is not aware of any reasons
relating to USB why all consents and approvals shall not be procured from all
regulatory agencies having jurisdiction over the transactions contemplated by
this Agreement and the Bank Merger Agreement as shall be necessary for
consummation of the transactions contemplated by this Agreement and the Bank
Merger Agreement.
5.4 Financial Statements.
--------------------
5.4.1 USB has previously delivered or made available to FLFC
accurate and complete copies of the USB Financial Statements which, in the case
of audited USB Financial Statements, are accompanied by the audit reports of its
independent public accountants. The USB Financial Statements have been prepared
in accordance with GAAP and (including the related notes where applicable)
fairly present in each case in all material respects (subject in the case of the
unaudited interim statements to normal year-end adjustments) the consolidated
financial position, results of operations and cash flows of USB and the USB
Subsidiaries on a consolidated basis as of and for the respective periods ending
on the dates thereof, in accordance with GAAP during the periods involved,
except as indicated in the notes thereto.
5.4.2 Each of the USB Financial Statements referred to in Section
5.4.1 has been prepared in accordance with GAAP during the periods involved,
except as stated therein or, in the case of unaudited interim USB Financial
Statements, the absence of footnotes and customary year-end adjustments. The
audits of USB have been conducted in accordance with generally accepted auditing
standards. The books and records of USB and the USB Subsidiaries are being
maintained in compliance with applicable legal and accounting requirements, and
such books and records accurately reflect in all material respects all dealings
and transactions in
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respect of the business, assets, liabilities and affairs of USB and its
Subsidiaries. The minute books of USB and each USB Subsidiary contain complete
and accurate records of all meetings and other corporate actions of their
respective shareholders and Boards of Trustees (including all committees)
authorized at such meetings held or taken since December 31, 2006 through the
date of this Agreement.
5.4.3 At the date of each balance sheet included in the USB
Financial Statements, USB did not have any liabilities, obligations or loss
contingencies of any nature (whether absolute, accrued, contingent or otherwise)
of a type required to be reflected in such USB Financial Statements or in the
footnotes thereto which are not fully reflected or reserved against therein or
fully disclosed in a footnote thereto, except for liabilities, obligations and
loss contingencies which are not material individually or in the aggregate or
which are incurred in the ordinary course of business, consistent with past
practice, and except for liabilities, obligations and loss contingencies which
are within the subject matter of a specific representation and warranty herein
and subject, in the case of any unaudited statements, to normal, recurring audit
adjustments and the absence of footnotes.
5.5 Material Adverse Change. Since December 31, 2008 to the date hereof
(i) USB has conducted its business in the ordinary and usual course (excluding
the incurrence of expenses in connection with this Agreement, and excluding the
incurrence of expenses in connection with the transactions contemplated hereby),
and (ii) no event has occurred or circumstance arisen that, individually or in
the aggregate, has had or is reasonably likely to have a Material Adverse Effect
on USB.
5.6 Certain Information. None of the information supplied by USB
relating to USB and its Subsidiaries to be included or incorporated by reference
in the Proxy Statement, as of the date(s) such Proxy Statement is mailed to
shareholders of FLFC, and up to and including the date of the meeting of
shareholders to which such Proxy Statement relates, will contain any untrue
statement of a material fact or omit to state a material fact necessary to make
the statements therein, in light of the circumstances under which they were
made, not misleading, provided that information as of a later date shall be
deemed to modify information as of an earlier date.
5.7 Legal Proceedings. Except as set forth in Section 5.7 of the USB
Disclosure Schedule, there are no actions, suits, claims, governmental
investigations or proceedings instituted, pending or, to the best knowledge of
USB, threatened against USB or against any asset, interest or right of USB, or
against any officer, director or employee of any of them, and USB is not a party
to any order, judgment or decree.
5.8 Compliance with Laws.
--------------------
5.8.1 USB has all material permits, licenses, certificates of
authority, orders and approvals of, and has made all filings, applications and
registrations with, federal, state, local and foreign governmental or regulatory
bodies that are required in order to permit it to carry on its business in all
material respects as it is currently being conducted; all such permits,
licenses, certificates of authority, orders and approvals are in full force and
effect; and to the best knowledge of USB, no suspension or cancellation of any
of the same is threatened.
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5.8.2 Except as set forth in Section 5.8.2 of the USB Disclosure
Schedule, USB is not in violation of its respective Certificate of
Incorporation, Charter or other chartering instrument or Bylaws, or to its
knowledge, in violation of any applicable federal, state or local law or
ordinance or any order, rule or regulation of any federal, state, local or other
governmental agency or body (including, without limitation, all banking
(including without limitation all regulatory capital requirements), municipal
securities, insurance, safety, health, zoning, anti-discrimination, antitrust,
and wage and hour laws, ordinances, orders, rules and regulations), or in
default with respect to any order, writ, injunction or decree of any court, or
in default under any order, license, regulation or demand of any governmental
agency and, to the best knowledge of USB, USB along with its executive officers
and directors, is not in violation of any Securities Laws; and USB has not
received any written notice or communication from any federal, state or local
governmental authority asserting that USB is in violation of any of the
foregoing, which violation has not been corrected on a prospective basis in all
material respects. USB is not subject to any regulatory or supervisory cease and
desist order, agreement, written directive, memorandum of understanding or
written commitment (other than those of general applicability to all savings
banks), and it has not received any written communication requesting that it
enter into any of the foregoing. Since December 31, 2008 no regulatory agency
has initiated any proceeding or, to the best knowledge of USB, investigation
into the business or operations of USB. USB has not received any objection from
any regulatory agency to USB's response to any violation, criticism or exception
with respect to any report or statement relating to any examination of USB.
5.8.3 Certain Transactions. USB has not been a party to any
off-balance sheet transactions involving interest rate and currency swaps,
options and futures contracts, or any other similar derivative transactions,
except as set forth in Section 5.8.3 of the USB Disclosure Schedule.
5.8.4 Absence of Certain Changes or Events.
(a) Except as set forth in Section 5.8.4 of the USB Disclosure
Schedule, since December 31, 2008, there has not been:
(1) to the best of USB's knowledge, any material adverse
change in the business, operations, properties, assets or financial condition to
USB and no fact or condition exists which USB believes will cause such a
material adverse change in the future;
(2) to the best of USB's knowledge, any loss (for purposes of
this subsection 5.8.4(a)(2), "loss" shall not mean a loan loss), damage,
destruction or other casualty materially and adversely affecting any of the
significant properties, assets or business of USB (whether or not covered by
insurance);
(3) any change in any method of accounting or accounting
practice of USB; or
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(4) any material change to any of the employee benefit plans
provided by USB to its employees.
5.8.5 Environmental Matters. Except as set forth in Section 5.8.5 of
the USB Disclosure Schedule:
(a) To the best knowledge and belief of USB, USB is in material
compliance, and has in the last three years been in material compliance, with
all Environmental Laws, except where such noncompliance or violations could not
reasonably be expected to have a Material Adverse Effect on USB.
(b) There is no suit, claim, action or proceeding pending before
any court or Governmental Entity (and, to the best of USB's knowledge, no basis
exists for the assertion or commencement thereof) in which USB has been named as
defendant(s) for alleged noncompliance with any Environmental Law or relating to
contamination or the release of Materials of Environmental Concern at or on a
site presently or formerly owned, leased, or operated by USB or to USB's
knowledge, on a site with respect to which USB has made a commercial real estate
loan and has a mortgage or security interest in, except where such noncompliance
or release would not have a material adverse effect on USB taken as a whole.
5.8.6 Insurance. USB is insured for reasonable amounts with
reputable insurance companies against such risks as management of USB reasonably
has determined to be prudent for companies engaged in a similar business would,
in accordance with good business practice, customarily be insured and has
maintained all insurance required by contracts currently in effect and
applicable laws and regulations. Since December 31, 2008, USB has not received
any notice of termination of any such insurance coverage nor has USB any reason
to believe that any such insurance coverage will be terminated.
5.8.7 CRA Rating. USB was rated "Outstanding" following its most
recent Community Reinvestment Act examination by the regulatory agency
responsible for its supervision. USB has not received any notice of and has no
knowledge of any planned or threatened objection by any community group to the
transactions contemplated hereby.
5.9 Brokers and Finders. Neither USB nor any of its trustees, officers
or employees, has employed any broker or finder or incurred any liability for
any broker or finder fees or commissions in connection with the transactions
contemplated hereby.
5.10 Disclosures. None of the representations and warranties of USB or
any of the written information or documents furnished or to be furnished by USB
to FLFC in connection with or pursuant to this Agreement or the consummation of
the transactions contemplated hereby (including the Bank Merger), when
considered as a whole, contains or will contain any untrue statement of a
material fact, or omits or will omit to state any material fact required to be
stated or necessary to make any such information or document, in light of the
circumstances, not misleading.
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5.11 Financial Ability. As of the date of the Agreement USB has the
financial ability and on the Effective Date and through the date of payment of
the aggregate amount of cash payable pursuant to Article III hereof, USB or
Acquisition Corporation will have the funds necessary to consummate the Merger
and pay the aggregate amount of cash to be paid to holders of FLFC Common Stock
and Options pursuant to Section 3.3 hereof.
5.12 Employee Benefit Plans.
----------------------
5.12.1 USB has set forth in Section 5.12.1 of the USB Disclosure
Schedule all USB Employee Plans, and USB has previously furnished or made
available to FLFC accurate and complete copies of the same together with (i)
Schedule B forms and the actuarial and audited financial reports prepared with
respect to any qualified plans for the last two (2) plan years, (ii) the annual
reports filed with any governmental agency for any qualified or non-qualified
plans for the last two (2) plan years, (iii) the Summary Annual Report provided
to Participants for the last two (2) plan years; and (iv) all rulings and
determination letters and any open requests for rulings or letters that pertain
to any qualified plan.
5.12.2 None of USB, any USB Subsidiary, any pension plan maintained
by any of them and qualified under Section 401 of the Code or, to the best of
USB's knowledge, any fiduciary of such plan has incurred any liability to the
PBGC (except for premiums payable in the ordinary course) or the Internal
Revenue Service with respect to any employees of USB or any USB Subsidiary. No
reportable event under Section 4043(b) of ERISA has occurred with respect to any
such pension plan, other than the transactions contemplated by this Agreement.
5.12.3 Except as set forth in Section 5.12.3 of the USB Disclosure
Schedule, a favorable determination letter has been issued by the Internal
Revenue Service, with respect to each USB Employee Plan which is an "employee
pension benefit plan" (as defined in Section 3(2) of ERISA) (a "USB Pension
Plan") which is intended to qualify under Section 401 of the Code, to the effect
that such plan is qualified under Section 401 of the Code and the trust
associated with such employee pension plan is tax exempt under Section 501 of
the Code. No such letter has been revoked or, to the best of USB's knowledge, is
threatened to be revoked, and USB does not know of any ground on which such
revocation may be based. Except as set forth in Section 5.12.3 of the USB
Disclosure Schedule, neither USB nor any USB Subsidiary has any current
liability under any such plan that was required to be reflected as a liability
on the Financial Statements as of June 30, 2009 under GAAP, which was not
reflected on the consolidated statement of financial condition of USB at June
30, 2009 included in the USB Financial Statements.
5.12.4 No prohibited transaction (which shall mean any transaction
prohibited by Section 406 of ERISA and not exempt under Section 408 of ERISA or
Section 4975 of the Code) has occurred with respect to any USB Employee Plan
which would result in the imposition, directly or indirectly, of a material
excise tax on USB under Section 4975 of the Code.
5.12.5 To the best knowledge of USB, the USB Employee Plans have
been operated in compliance in all material respects with the applicable
provisions of ERISA, the
A - 41
Code, all regulations, rulings and announcements promulgated or issued
thereunder and all other applicable governmental laws and regulations.
5.12.6 There are no pending or, to the best knowledge of USB,
threatened claims (other than routine claims for benefits) by, on behalf of or
against any of the USB Employee Plans or any trust related thereto or any
fiduciary thereof.
ARTICLE VI
COVENANTS OF FLFC AND FNB
6.1 Conduct of Business.
-------------------
6.1.1 Affirmative Covenants. Except with the written consent of USB,
during the period from the date of this Agreement to the Effective Time FLFC
will operate its business, and it will cause each of the FLFC Subsidiaries to
operate its business, only in the usual, regular and ordinary course of
business; use its reasonable best efforts in good faith to preserve intact its
business organization and assets, keep available the present services of the
employees, maintain its rights and franchises, and preserve the goodwill of its
customers and others with whom business relationships exist; and voluntarily
take no action which would or be reasonably likely to (i) adversely affect the
ability of FLFC or FNB to obtain any necessary approvals of Governmental
Entities required for the transactions contemplated hereby or under the Bank
Merger Agreement or increase the period of time necessary to obtain such
approvals, or (ii) adversely affect its ability to perform its covenants and
agreements under this Agreement or the Bank Merger Agreement;
6.1.2 Negative Covenants. FLFC agrees that from the date of this
Agreement to the Effective Time, except as otherwise specifically permitted or
required by this Agreement and except to the extent required by law or
regulation or any Governmental Entity, or consented to by USB in writing, FLFC
will not, and will cause each of the FLFC Subsidiaries not to:
(a) change or waive any provision of its Certificate of
Incorporation, Charter or Bylaws, except as required by law;
(b) change the number of shares of its authorized capital stock;
(c) issue any capital stock or issue or grant any option,
restricted stock award, warrant, call, commitment, subscription, right to
purchase or agreement of any character relating to the authorized or issued
capital stock of FLFC or any of the FLFC Subsidiaries, or any securities
convertible into shares of such stock; except that FLFC may issue shares of FLFC
Common Stock or permit treasury shares to become outstanding to satisfy
currently outstanding Company Restricted Stock awards and in accordance with the
terms of the FLFC Stock Plan described in Section 4.1 hereof;
A - 42
(d) effect any recapitalization, reclassification, stock
dividend, stock split or like change in capitalization, or redeem, repurchase or
otherwise acquire any shares of its capital stock;
(e) declare or pay any dividends or other distributions with
respect to FLFC Common Stock;
(f) enter into or terminate any contract or agreement (including
without limitation any settlement agreement with respect to litigation) except
in the ordinary course of business or except as set forth in Section 6.1.2(f) of
the FLFC Disclosure Schedule;
(g) incur any liabilities or obligations (excluding customer
deposit accounts and retail repurchase agreements) in excess of $50,000
individually or $250,000 in the aggregate, whether directly or by way of
guaranty, including any obligation for borrowed money whether or not evidenced
by a note, bond, debenture or similar instrument;
(h) make any capital expenditures (excluding third party leasing
transactions through First Litchfield Leasing Corporation consistent with past
practice) in excess of $50,000 individually or $250,000 in the aggregate, except
pursuant to binding commitments existing on the date hereof and as set forth in
Section 6.1.2(h) of the FLFC Disclosure Schedule and except for expenditures
reasonable and necessary to maintain assets in good repair;
(i) except for commitments issued prior to the date of
this Agreement which have not yet expired and which have been disclosed in
Section 6.1.2(i) of the FLFC Disclosure Schedule, make any new loan (including
leasing transactions) or other credit facility commitment or increase any loan
or other credit facility commitment to any borrower or group of affiliated
borrowers in excess of the following limitations without prior consultation with
and approval from USB's Chief Lending Officer, which approval shall be deemed to
be given unless USB provides written objection to FLFC or the FLFC Subsidiary by
the end of the third Business Day after USB receives a written request from FLFC
or the FLFC Subsidiary for approval:
(i) residential first mortgage loan in
excess of $500,000;
(ii) owner occupied and/or "under contract"
residential construction loan in excess of $500,000;
(iii) commercial and industrial loan in
excess of $250,000;
(iv) commercial real estate loan in excess
of $1,000,000 for owner-occupied and in excess of $500,000 for
non-owner occupied;
(v) commercial construction loan in excess
of $500,000;
(vi) consumer loan (including home equity
loan) in excess of $250,000 for secured and in excess of
$25,000 unsecured;
(vii) residential development, acquisition,
and construction loan in excess of $250,000;
(viii) renewal of existing lines of credit
to OAEM or higher risk rating; and
(ix) loans of new monies to borrowers or
borrowing relationships with OAEM-rated credits or higher
shall not be made in any amount.
A - 43
(j) (i) grant any increase in rates of compensation to its
non-officer employees other than in the ordinary course of business consistent
with past practice provided that no such increase shall result in an annual
adjustment of more than 3% without prior consultation with and approval from
USB's Senior Vice President of Human Resources; grant any increase in rates of
compensation to, or pay or agree to pay any bonus or severance to, or provide
any other new employee benefit or incentive to its directors or to its officers
except for non-discretionary payments required by agreements existing as of the
date hereof and set forth on Schedule 6.1.2(j)(i) of the FLFC Disclosure
Schedule without prior consultation with and approval from USB; grant any
increases in compensation or bonuses to its non-officer employees other than in
the ordinary course of business consistent with past practice and bonuses that
are reasonable and necessary to compensate FLFC or FNB employees in lieu of
option grants between the date hereof through the Effective Date, in
consultation with the Senior Vice President of Human Resources of USB; enter
into any employment, severance or similar agreements or arrangements with any
director or employee; adopt or amend or terminate any employee benefit plan,
pension plan or incentive plan except as required by law or the terms of such
plan or as provided in Section 6.1.2(j)(i) of the FLFC Disclosure Schedule, or
permit the vesting of any material amount of benefits under any such plan other
than pursuant to the provisions thereof as in effect on the date of this
Agreement; or make any contributions to any FLFC Employee Plan not in the
ordinary course of business consistent with past practice; or make any
contributions to FLFC's Employee Stock Ownership Plan (the "ESOP") other than as
required by the terms of the ESOP currently in effect on the date hereof; or
(ii) increase the number of (A) non-officer personnel employed by
FLFC or any FLFC Subsidiary over the staffing level previously authorized as set
forth in Section 6.1.2(j)(ii) of the FLFC Disclosure Schedule, or (B) officers
employed by FLFC or any FLFC Subsidiary over the number of such officers
currently so employed, without the prior consent of USB's Senior Vice President
of Human Resources.
(k) make application for the opening or closing of any, or open or
close any, branch or automated banking facility;
(l) make any equity investment or commitment to make such an
investment in real estate or in any real estate development project including
foreclosures, settlements in lieu of foreclosure or troubled loan or debt
restructuring;
(m) subject to Section 6.10 hereof, merge into, consolidate with,
affiliate with, or be purchased or acquired by, any other Person, or permit any
other Person to be merged, consolidated or affiliated with it or be purchased or
acquired by it, or, except to realize upon collateral in the ordinary course of
its business, acquire a significant portion of the assets of any other Person,
or sell a significant portion of its assets;
(n) make any change in its accounting methods or practices, except
changes as may be required by GAAP or by law or regulatory requirements;
A - 44
(o) enter into any off-balance sheet transaction involving interest
rate and currency swaps, options and futures contracts, or any other similar
derivative transactions;
(p) except for commitments outstanding as of June 30, 2009 invest in
or commit to invest in, or otherwise increase, decrease or alter its investment
in, any existing or new Joint Venture;
(q) except as set forth in Section 6.1.2(q) of the FLFC Disclosure
Schedule, make any material change in policies in existence as of the date of
this Agreement with regard to the extension of credit, the establishment of
reserves with respect to the possible loss thereon or the charge off of losses
incurred thereon, investment, asset/liability management or other material
banking policies, except as may be required by changes in applicable law or
regulations or by GAAP;
(r) waive, release, grant or transfer any rights of value or modify
or change any existing agreement or indebtedness to which FLFC or any FLFC
Subsidiary is a party, other than in the ordinary course of business, consistent
with past practice;
(s) purchase any debt securities or any equity securities, or
purchase any security for its investment portfolio, or otherwise take any action
that would materially alter the mix, maturity, credit or interest rate risk
profile of its portfolio of investment securities;
(t) enter into, renew, extend or modify any other transaction with
any Affiliate;
(u) except for the execution of this Agreement, and actions taken or
which will be taken in accordance with the provisions of this Agreement and
performance thereunder, take any action that would give rise to a right of
payment to any individual under any employment or severance agreement or similar
agreement;
(v) except for the execution of this Agreement, and actions taken or
which will be taken in accordance with the provisions of this Agreement, take
any action that would give rise to an acceleration of the right to payment to
any individual under any FLFC Employee Plan;
(w) without the prior consultation and consent of USB's Chief
Financial Officer, sell any participation interest in any existing or newly
originated loan other than as permitted under Section 6.1.2(i), or acquire a
participation in any loan except as set forth in and subject to the restrictions
of Section 6.1.2(i) hereof;
(x) enter into any new or depart from any existing line of business;
(y) without prior consultation with USB's Chief Financial Officer,
increase or decrease the rate of interest paid on deposits, except within 25
basis points of rates paid by USB for comparable deposits;
A - 45
(z) take any action that (i) would, or is reasonably likely to,
prevent or impede the Merger from qualifying as a qualified stock purchase
within the meaning of Section 338 of the Code or (ii) is intended or is
reasonably likely to result in (x) any of its representations and warranties set
forth in this Agreement being or becoming untrue in any material respect at or
prior to the Effective Time, (y) any of the conditions to the Merger set forth
in Article IX not being satisfied or (z) a material violation of any provision
of this Agreement or the Bank Merger Agreement, except, in each case, as may be
required by applicable law or regulation; or
(aa) elect to participate in, or fail to opt out of participation
in, the Transaction Account Guarantee Program established by the FDIC or any
other similar program; or
(bb) agree to do any of the foregoing.
6.2 Current Information. During the period from the date of this
Agreement to the Effective Time, FLFC will cause one or more of its
representatives to confer with representatives of USB and report on the general
status of its ongoing operations at such times as USB may reasonably request,
which reports shall include, but not be limited to, discussion of the possible
termination by FLFC or FNB of third-party service provider arrangements
effective at the Effective Time or at a date thereafter, non-renewal of personal
and real property leases and software licenses used by FLFC or any of its
Subsidiaries in connection with its systems operations, retention of outside
consultants and additional employees to assist with transactions contemplated by
this Agreement, and outsourcing, as appropriate, of proprietary or self-provided
system services, it being understood that FLFC shall not be obligated to take
any such action prior to the Effective Time and, unless FLFC otherwise agrees,
no conversion shall take place prior to the Effective Time. FLFC will promptly
notify USB of any material change from the normal course of the business of FLFC
or any FLFC Subsidiary or in the operation of the properties of FLFC or any FLFC
Subsidiary and, to the extent permitted by applicable law, of any governmental
complaints, investigations or hearings (or communications indicating that the
same may be contemplated), or the institution or the threat of litigation
involving FLFC or any FLFC Subsidiary. With respect to such events, FLFC will
also provide USB such information as USB may reasonably request from time to
time. Within fifteen (15) calendar days after the end of each month, FLFC will
deliver to USB an unaudited consolidated balance sheet and an unaudited
consolidated statement of operations, without related notes, for such month
prepared in accordance with FLFC's current financial reporting practices.
6.3 Access to Properties and Records. In order to facilitate the
consummation of the Merger and the Bank Merger and the integration of the
business and operations of the parties, subject to Section 12.1 hereof and
subject to applicable laws relating to exchange of information, FLFC will permit
USB and its officers, employees, counsel, accountants and other authorized
representatives, access, upon reasonable notice, to its personnel and properties
and those of the FLFC Subsidiaries, and shall disclose and make available to USB
during normal business hours throughout the period prior to the Effective Time
all of the books, papers and records of FLFC or any FLFC Subsidiary relating to
the assets, properties, operations, obligations and liabilities, including, but
not limited to, all books of account (including the general ledger), tax
records, minute books of directors' (other than minutes that discuss any of the
transactions contemplated by this Agreement or other strategic alternatives) and
shareholders' meetings, organizational
A - 46
documents, Bylaws, material contracts and agreements, filings with any
regulatory authority, litigation files, plans affecting employees, and any other
business activities or prospects in which USB may have a reasonable interest;
provided, however, that FLFC shall not be required to take any action that would
provide access to or to disclose information where such access or disclosure
would violate or prejudice the rights or business interests or confidences of
any customer or other person or would result in the waiver by it of the
privilege protecting communications between it and any of its counsel. FLFC
shall provide and shall request its auditors to provide USB with such historical
financial information regarding FLFC and any FLFC Subsidiary (and related audit
reports and consents) as USB may reasonably request for securities disclosure
purposes. USB shall use reasonable efforts to minimize any interference with
FLFC's and any FLFC Subsidiary's regular business operations during any such
access to FLFC's or any FLFC Subsidiary's personnel, property, books or records.
FLFC and its Subsidiaries shall permit USB, at USB's expense, to cause so-called
"Phase I Environmental Site Assessments" and/or "Phase II Environmental Site
Assessments" to be performed at any physical location owned or operated by FLFC
or any FLFC Subsidiary and, to the extent FLFC or the applicable FLFC Subsidiary
has the contractual right to do so, at any Loan Property or Participation
Facility.
6.4 Financial and Other Statements.
------------------------------
6.4.1 Promptly upon receipt thereof, FLFC will furnish to USB copies
of each annual, interim or special audit of the books of FLFC and the FLFC
Subsidiaries made by its independent accountants and/or its internal auditors
and copies of all internal control reports submitted to FLFC by such accountants
and/or internal auditors in connection with each annual, interim or special
audit of the financial statements of FLFC and the FLFC Subsidiaries made by such
accountants and/or internal auditors.
6.4.2 As soon as reasonably available, but in no event later than
the date such documents are filed with the SEC, FLFC will deliver to USB any and
all Securities Documents filed by it with the SEC under the Securities Laws. As
soon as practicable, FLFC will furnish to USB copies of all such financial
statements and reports as it or any FLFC Subsidiary shall send to its
shareholders, the FDIC, the FRB, the Department or any other regulatory
authority, except as legally prohibited thereby.
6.4.3 FLFC will advise USB promptly of the receipt of any
examination report of any Bank Regulator with respect to the condition or
activities of FLFC or any of the FLFC Subsidiaries.
6.4.4 FLFC will promptly furnish to USB such additional financial
data as USB may reasonably request, including without limitation, detailed
routine monthly loan reports and other reports that FLFC routinely produces.
6.5 Maintenance of Insurance. FLFC shall maintain, and shall cause its
Subsidiaries to maintain, such insurance in such amounts as are reasonable to
cover such risks management of FLFC and any FLFC Subsidiary reasonably has
determined to be prudent and as are customary
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in relation to the character and location of its and their respective properties
and the nature of its and their respective businesses consistent with past
practices.
6.6 Disclosure Supplements. From time to time prior to the Effective
Time, FLFC and FNB will promptly supplement or amend the FLFC Disclosure
Schedule delivered in connection herewith with respect to any matter hereafter
arising which, if existing, occurring or known at the date of this Agreement,
would have been required to be set forth or described in such FLFC Disclosure
Schedule or which is necessary to correct any information in such FLFC
Disclosure Schedule which has been rendered inaccurate thereby. No supplement or
amendment to any FLFC Disclosure Schedule shall be deemed to be an admission by
FLFC or FNB that such FLFC Disclosure Schedule was materially inaccurate prior
to such supplement or amendment or that such supplement or amendment constitutes
a material change. No supplement or amendment to such FLFC Disclosure Schedule
shall be deemed to have modified the representation, warranties and covenants
for the purpose of determining satisfaction of the conditions set forth in
Article IX.
6.7 Consents and Approvals of Third Parties. FLFC shall use all
reasonable best efforts in good faith to obtain as soon as practicable all
consents and approvals of any other persons necessary or desirable for the
consummation of the transactions contemplated by this Agreement and the Bank
Merger Agreement. Without limiting the generality of the foregoing, FLFC shall
utilize the services of a professional proxy soliciting firm to help obtain the
shareholder vote required to be obtained by it hereunder.
6.8 Reasonable Best Efforts. Subject to the terms and conditions herein
provided, FLFC shall use its reasonable best efforts in good faith to take, or
cause to be taken, all action and to do, or cause to be done, all things
necessary, proper or advisable under applicable laws and regulations to
consummate and make effective the transactions contemplated by this Agreement
and the Bank Merger Agreement.
6.9 Failure to Fulfill Conditions. In the event that FLFC determines
that a condition to its obligation to complete the Merger or the Bank Merger
cannot be fulfilled and that it will not waive that condition, it will
immediately so notify USB.
6.10 Acquisition Proposals. (a) From and after the date of this
Agreement and until the termination of this Agreement, FLFC agrees that neither
it nor any of FLFC's Subsidiaries shall, and that it shall direct and use its
best efforts in good faith to cause its and each such Subsidiary's directors,
officers, employees, agents and representatives not to, directly or indirectly,
initiate, solicit, knowingly encourage or otherwise facilitate any inquiries or
the making of any proposal or offer with respect to an Acquisition Proposal.
FLFC further agrees that neither it nor any of its Subsidiaries shall, and that
it shall direct and use its reasonable best efforts in good faith to cause its
and each such Subsidiary's directors, officers, employees, agents and
representatives not to, directly or indirectly, engage in any negotiations
concerning, or provide any confidential information or data to, or have any
discussions with, any Person relating to an Acquisition Proposal, or otherwise
knowingly facilitate any effort or attempt to make or implement an Acquisition
Proposal; provided, however, that nothing contained in this Agreement shall
prevent FLFC or its Board of Directors from (A) complying with its disclosure
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obligations under federal or state law; (B) providing information in response to
a request therefore by a Person who has made an unsolicited bona fide written
Acquisition Proposal if the FLFC Board of Directors receives from the Person so
requesting such information an executed confidentiality agreement substantially
similar to that entered into with USB; (C) engaging in any negotiations or
discussions with any Person who has made an unsolicited bona fide written
Acquisition Proposal or (D) recommending such an Acquisition Proposal to the
shareholders of FLFC, if and only to the extent that, in each such case referred
to in clause (B), (C) or (D) above, (i) the FLFC Board of Directors determines
in good faith (after consultation with outside legal counsel) that such action
would be required in order for its directors to comply with their respective
fiduciary duties under applicable law, and (ii) the FLFC Board of Directors
determines in good faith (after consultation with its financial advisor) that
such Acquisition Proposal, if accepted, is at least as reasonably likely to be
consummated, taking into account all legal, financial and regulatory aspects of
the proposal and the Person making the proposal and, if consummated, would
result in a transaction more favorable to FLFC's shareholders from a financial
point of view than the Merger. An Acquisition Proposal which is received and
considered by FLFC in compliance with this Section 6.10 and which meets the
requirements set forth in clause (D) of the preceding sentence is herein
referred to as a "Superior Proposal." FLFC agrees that it will immediately cease
and cause to be terminated any existing activities, discussions or negotiations
with any parties conducted heretofore with respect to any Acquisition Proposals.
FLFC agrees that it will notify USB immediately (within 24 hours) if any such
inquiries, proposals or offers are received by, any such information is
requested from, or any such discussions or negotiations are sought to be
initiated or continued with FLFC or any of its representatives after the date
hereof, and the identity of the person making such inquiry, proposal or offer
and the substance thereof and will keep USB informed of any material
developments with respect thereto immediately upon the occurrence thereof.
(b) In the event that the Board of Directors of FLFC determines in good faith,
after consultation with its financial advisor and upon advice from outside
counsel, that it desires to accept a Superior Proposal, it shall notify USB in
writing of its intent to terminate this Agreement in order to enter into an
acquisition agreement with respect to, or recommend acceptance of, the Superior
Proposal. Such notice shall specify all of the material terms and conditions of
such Superior Proposal and identify the Person making such Superior Proposal.
USB shall have five Business Days to evaluate and respond to FLFC's notice. If
USB notifies FLFC in writing prior to the expiration of the five Business Day
period provided above that it shall increase the Merger Consideration to an
amount at least equal to that of such Superior Proposal (the "USB Proposal"),
then FLFC shall not be permitted to enter into an acquisition agreement with
respect to, or permit its Board to recommend acceptance to its shareholders of,
such Superior Proposal. Such notice by USB shall specify the new Merger
Consideration. FLFC shall have five Business Days to evaluate the USB Proposal.
(c) In the event the Superior Proposal involves consideration to FLFC's
shareholders consisting of securities, in whole or in part, a USB Proposal shall
be deemed to be at least equal to the Superior Proposal, if the USB Proposal
offers Merger Consideration that equals or exceeds the consideration being
offered to FLFC's shareholders in the Superior Proposal valuing any securities
forming a part of the Superior Proposal at its cash equivalent based upon (a)
the average trading price of such securities for the 30 trading days immediately
preceding the date of
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the USB Proposal, or (b) the written valuation of such securities by a
nationally recognized investment banking firm selected if such securities are
not traded on a nationally recognized exchange or will be newly issued
securities that are not of a class then trading on a nationally recognized
exchange. Any written valuation shall be attached as an exhibit to the USB
Proposal.
(d) In the event that the Board of Directors of FLFC determines in good faith,
upon the advice of its financial advisor and outside counsel, that the USB
Proposal is not at least equal to the Superior Proposal, FLFC can terminate this
Agreement in order to execute an acquisition agreement with respect to, or to
allow its Board to adopt a resolution recommending acceptance to FLFC's
shareholders of, the Superior Proposal as provided in Section 11.1.11.
6.11 Board of Directors and Committee Meetings. FLFC shall provide to
USB (a) notice of any and all regular and special meetings of the Board of
Directors and all Committees of FLFC or FNB, which notice shall be no less
timely than the notice required to be provided to FLFC's or FNB's directors, and
(b) at such time as customarily provided to FLFC's and FNB's directors, copies
of all written materials (i) accompanying any such notices, (ii) presented to
the participants of any and all such meetings, and (iii) copies of drafts of
meeting minutes and credit memoranda produced with respect to such meeting
excluding, however, any materials pertaining to USB, the transactions
contemplated by this Agreement, and any third party proposal to acquire a
controlling interest in FLFC or FNB.USB shall be entitled to send one
representative to observe, but not participate as a voting member in, all such
meetings provided he/she shall not be allowed to observe any discussions
regarding the transactions contemplated by this Agreement, and any third party
proposal to acquire a controlling interest in FLFC or FNB.
6.12 Reserves and Merger-Related Costs. On or before the Effective
Time, FLFC shall use its reasonable best efforts in good faith to establish such
additional accruals and reserves as may be necessary to conform the accounting
reserve practices and methods (including credit loss practices and methods) of
FLFC and FNB to those of USB (as such practices and methods are to be applied to
FLFC and FNB from and after the Closing Date) and USB's plans with respect to
the conduct of the business of FLFC and FNB following the Merger and otherwise
to reflect Merger-related expenses and costs incurred by FLFC, provided,
however, that FLFC shall not be required to take such action unless USB agrees
in writing that all conditions to Closing set forth in Article IX have been
satisfied or waived (including the expiration of any applicable waiting periods
but excluding the delivery of certificates and other documents to be delivered
at the Closing); prior to the delivery by USB of the writing referred to in the
preceding clause, FLFC shall, upon USB's request, provide USB a written
statement that the representation made in Section 4.22.1, hereof with respect to
FLFC's allowance for possible loan losses is true as of such date or,
alternatively, setting forth in detail the circumstances that prevent such
representation from being true as of such date; and no accrual or reserve made
by FLFC or any FLFC Subsidiary pursuant to this subsection, or any litigation or
regulatory proceeding arising out of any such accrual or reserve, shall
constitute a breach of this Agreement within the meaning of Section 11.1.2
hereof. No action shall be required to be taken by FLFC pursuant to this Section
6.12 if, in the opinion of FLFC's independent auditors, such action would
contravene GAAP.
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6.13 Transaction Expenses of FLFC.
----------------------------
6.13.1 For planning purposes, FLFC shall, within thirty (30) days
from the date hereof, provide USB with FLFC's estimated budget of
transaction-related expenses reasonably anticipated to be payable by FLFC in
connection with this transaction, including the fees and expenses of counsel,
accountants, investment bankers and other professionals. FLFC shall promptly
notify USB if or when it determines that it expects to exceed its budget.
6.13.2 Promptly after the execution of this Agreement, FLFC shall
ask all of its attorneys and other professionals to render current and correct
invoices for all unbilled time and disbursements. FLFC shall accrue and/or pay
all of such amounts that are actually due and owing as soon as possible.
6.13.3 FLFC shall advise USB monthly of all out-of-pocket expenses
that FLFC has incurred in connection with the transactions contemplated by this
Agreement (including the Bank Merger).
ARTICLE VII
COVENANTS OF USB
7.1 Disclosure Supplements. From time to time prior to the Effective
Time, USB will promptly supplement or amend the USB Disclosure Schedule
delivered in connection herewith with respect to any material matter hereafter
arising which, if existing, occurring or known at the date of this Agreement,
would have been required to be set forth or described in such USB Disclosure
Schedule or which is necessary to correct any information in such USB Disclosure
Schedule which has been rendered inaccurate thereby. No supplement or amendment
to any USB Disclosure Schedule shall be deemed to be an admission by USB that
such USB Disclosure Schedule was materially inaccurate prior to such supplement
or amendment or that such supplement or amendment constitutes a material change.
No supplement or amendment to such USB Disclosure Schedule shall be deemed to
have modified the representation, warranties and covenants the purpose of
determining satisfaction of the conditions set forth in Article IX.
7.2 Consents and Approvals of Third Parties. USB shall use all
reasonable best efforts in good faith to obtain as soon as practicable all
consents and approvals of any other Persons necessary or desirable for the
consummation of the transactions contemplated by this Agreement and the Bank
Merger Agreement.
7.3 Reasonable Best Efforts. Subject to the terms and conditions herein
provided, USB agrees to use its reasonable best efforts in good faith to take,
or cause to be taken, all action and to do, or cause to be done, all things
necessary, proper or advisable under applicable laws and regulations to
consummate during the first calendar quarter of 2010 or as soon thereafter as
practicable and make effective the transactions contemplated by this Agreement
and the Bank Merger Agreement.
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7.4 Failure to Fulfill Conditions. In the event that USB determines
that a condition to its obligation to complete the Merger or the Bank Merger
Agreement cannot be fulfilled and that it will not waive that condition, it will
immediately so notify FLFC.
7.5 Acquisition Corporation Organizational Documents. Prior to the
Effective Time, Acquisition Corporation will be a corporation duly organized and
in good standing or legal existence, as appropriate, under the laws of the
jurisdiction in which it is organized with full corporate power and authority to
own or lease all of its properties and assets and to carry on its business as
then conducted and shall be duly licensed or qualified to do business and be in
good standing or legal existence, as appropriate, in each jurisdiction in which
its ownership or leasing of property or the conduct of its business requires
such licensing or qualification. Promptly following the organization of
Acquisition Corporation, the Board of Directors thereof shall approve this
Agreement and the transactions contemplated hereby, and USB shall cause
Acquisition Corporation to execute and deliver an appropriate instrument of
accession to this Agreement, whereupon Acquisition Corporation shall become a
party to, and be bound by, this Agreement.
7.6 Employees and Employee Benefits.
-------------------------------
7.6.1 USB anticipates offering employment to all employees of FNB,
subject to review of personnel files and such employment criteria for particular
positions as USB customarily applies, following the Effective Time.
7.6.2 Each employee of FNB who remains employed by USB following the
Effective Time (each, a "Continuing Employee") shall be entitled to participate,
at the option of USB, in (i) such of the employee benefit plans, deferred
compensation arrangements, bonus or incentive plans and other compensation and
benefit plans of FLFC that USB may continue for the benefit of Continuing
Employees following the Effective Time, and (ii) whatever employee benefit plans
and other compensation and benefit plans that USB may maintain for the benefit
of its similarly situated employees, if such Continuing Employee is not
otherwise then participating in a similar plan under subsection (i).
Each Continuing Employee shall be credited with service as a FNB
employee for purposes of determining his or her status under USB's policies with
respect to vacation, sick and other leave. With respect to the USB defined
benefit pension plan, each Continuing Employee shall be credited with hours of
service as a FNB employee for the prior employment period with FNB in order to
determine when the employee would be eligible to participate in the plan, but
not for purposes of calculating benefits under the plan. With respect to the USB
defined contribution plan, each Continuing Employee shall be eligible to
participate, but will not be credited with prior years of service as a FNB
employee for purposes of vesting. With respect to any USB plan which is a
health, life or disability insurance plan, each Continuing Employee shall not be
subject to any pre-existing condition limitation for conditions covered under
such plans and each such plan which provides health insurance benefits. Nothing
herein shall limit the ability of USB to amend or terminate any of the USB
Employee Plans in accordance with their terms at any time.
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After the Effective Time, USB may in its discretion maintain,
terminate, merge or dispose of any FLFC Employee Plan; provided however, that
any action taken by USB shall comply with ERISA and any other applicable laws,
including laws regarding the preservation of employee benefit plan benefits.
USB assumes all obligations under deferred compensation plans of
FLFC or any FLFC Subsidiary but shall have the right to terminate such plans
following the Effective Time.
7.6.3 Section 7.6.3 of the FLFC Disclosure Schedule contains all
employment and change of control, severance and similar agreements,
arrangements, policies or programs with any employee or director of FLFC or any
FLFC Subsidiary ("Benefit Agreements"). USB shall honor the terms of all Benefit
Agreements unless USB and the affected employee, officer or director shall agree
otherwise.
7.7 Directors and Officers Indemnification and Insurance.
----------------------------------------------------
7.7.1 USB shall maintain in effect for six (6) years following the
Effective Time, the current directors' and officers' liability insurance
policies maintained by FLFC and the FLFC Subsidiaries (provided, that USB may
substitute therefore policies of at least the same coverage containing terms and
conditions which are not materially less favorable) with respect to matters
occurring prior to the Effective Time. In connection with the foregoing, FLFC
agrees to provide such insurer or substitute insurer with such representations
as such insurer may request with respect to the reporting of any prior claims.
Alternatively, USB may purchase "tail coverage" for a period of six (6) years
following the Effective Time for FLFC's and FLFC Subsidiaries' current directors
and officers, which coverage in amount and scope, and containing terms and
conditions, which are not less favorable than FLFC's current policy. The
foregoing notwithstanding, in no event shall USB be required to expend on tail
coverage in excess of $200,000 and if the annual premium exceeds such amount,
USB shall provide the maximum amount of coverage that can be obtained for such
amount.
7.7.2 From and after the Effective Time, USB shall indemnify, defend
and hold harmless each person who is now, or who has been at any time before the
date hereof or who becomes before the Effective Time, a director of FLFC or FNB
(the "Indemnified Parties") against all losses, claims, damages, costs, expenses
(including reasonable attorney's fees), liabilities or judgments or amounts that
are paid in settlement (which settlement shall require the prior written consent
of USB, which consent shall not be unreasonably withheld) of or in connection
with any claim, action, suit, proceeding or investigation, whether civil,
criminal, investigative or administrative (each a "Claim"), in which an
Indemnified Party is, or is threatened to be made, a party or witness in whole
or in part on or arising in whole or in part out of the fact that such person is
or was a director of FLFC or a FLFC Subsidiary if such Claim pertains to any
matter of fact arising, existing or occurring at or before the Effective Time
(including, without limitation, the Merger and the other transactions
contemplated hereby), regardless of whether such Claim is asserted or claimed
before, or after, the Effective Time (the "Indemnified Liabilities"), as
provided under applicable state or federal law and under FLFC's Certificate of
Incorporation and Bylaws. USB shall pay expenses in advance of the final
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disposition of any such action or proceeding to each Indemnified Party to the
full extent permitted by applicable state or federal law upon receipt of an
undertaking to repay such advance payments if he or she shall be adjudicated or
determined not to be entitled to indemnification.
ARTICLE VIII
REGULATORY AND OTHER MATTERS
8.1 FLFC Special Meeting.
--------------------
FLFC will, in accordance with applicable law and FLFC's Certificate of
Incorporation and Bylaws, (i) as promptly as reasonably practicable take all
steps necessary to duly call, give notice of, convene and hold a meeting of its
shareholders (the "FLFC Shareholders Meeting") for the purpose of approving the
transactions contemplated by this Agreement, and for such other purposes as may
be, in FLFC's and USB's reasonable judgment, necessary or desirable, (ii)
subject to the fiduciary responsibility of the Board of Directors of FLFC as
advised by counsel, recommend to its shareholders the approval of the
aforementioned matters to be submitted by it to its shareholders and oppose any
third party proposal or other action that is inconsistent with this Agreement or
the consummation of the transactions contemplated herein (including the Bank
Merger), and (iii) cooperate and consult with USB with respect to each of the
foregoing matters. Except with the prior approval of USB, no other matters shall
be submitted for approval of the FLFC shareholders at the FLFC Shareholders
Meeting.
8.2 Proxy Statement.
---------------
8.2.1 For the purposes of holding the FLFC Shareholders Meeting,
FLFC shall draft and prepare, and USB shall cooperate in the preparation of, a
proxy statement or statements satisfying all applicable requirements of the
Exchange Act and the rules and regulations thereunder (such proxy statement in
the form mailed by FLFC to the FLFC shareholders, together with any and all
amendments or supplements thereto, being herein referred to as the "Proxy
Statement"). FLFC shall file the Proxy Statement with the SEC in accordance with
its Regulation 14A under the Exchange Act. FLFC shall upon expiration of the
period of time within which the SEC may comment on the preliminary Proxy
Statement or upon satisfaction of any SEC comments, thereafter promptly mail the
Proxy Statement to its shareholders.
8.2.2 USB shall provide FLFC with any information concerning USB
that FLFC may reasonably request in connection with the drafting and preparation
of the Proxy Statement, and FLFC shall notify USB promptly of the receipt of any
comments of the SEC with respect to the Proxy Statement and of any requests by
the SEC for any amendment or supplement thereto or for additional information
and shall provide to USB promptly copies of all correspondence between FLFC or
any of its representatives and the SEC. FLFC shall give USB and its counsel the
opportunity to review and comment on the Proxy Statement prior to its being
filed with the SEC and shall give USB and its counsel the opportunity to review
and comment on all amendments and supplements to the Proxy Statement and all
responses to requests for additional information and replies to comments prior
to their being filed with, or sent to, the SEC. Each of USB and FLFC agrees to
use all reasonable efforts, after consultation with the other party hereto,
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to respond promptly to all such comments of and requests by the SEC and to cause
the Proxy Statement and all required amendments and supplements thereto to be
mailed to the holders of FLFC Common Stock entitled to vote at the FLFC
Shareholders Meeting at the earliest practicable time.
8.2.3 USB and FLFC each shall promptly notify the other party if at
any time either of them, respectively, becomes aware that the Proxy Statement
contains any untrue statement of a material fact or omits to state a material
fact about themselves required to be stated therein or necessary to make the
statements contained therein, in light of the circumstances under which they
were made, not misleading. In such event, USB shall cooperate with FLFC in the
preparation of a supplement or amendment to such Proxy Statement which corrects
such misstatement or omission, and FLFC shall mail an amended Proxy Statement to
FLFC's shareholders.
8.3 Intentionally Omitted.
---------------------
8.4 Regulatory Approvals. Each of FLFC, FNB and USB will cooperate with
the other and use all reasonable efforts to prepare and file within forty-five
(45) days of execution of this Agreement all necessary documentation, to effect
all necessary filings and to obtain all necessary permits, consents, approvals
and authorizations of all third parties and governmental bodies necessary to
consummate the transactions contemplated by this Agreement, including without
limitation the Merger and the Bank Merger. FLFC and USB will furnish each other
and each other's counsel with all information concerning themselves, their
subsidiaries, directors, officers and shareholders and such other matters as may
be necessary or advisable in connection with the Proxy Statement and any
application, petition or any other statement or application made by or on behalf
of USB, FLFC or FNB to any Governmental Entity in connection with the Merger,
the Bank Merger, and the other transactions contemplated by this Agreement. Each
party hereto shall have the right to review and approve in advance all
characterizations of the information relating to such party and any of its
Subsidiaries that appear in any filing made in connection with the transactions
contemplated by this Agreement with any Governmental Entity. In addition, USB,
FLFC and FNB shall each furnish to the other for review a copy of each such
filing made in connection with the transactions contemplated by this Agreement
with any Governmental Entity prior to its filing.
8.5 Compliance with Anti-Trust Laws. Each of USB and FLFC shall use
reasonable best efforts in good faith to resolve objections, if any, which may
be asserted with respect to the Merger under anti-trust laws. In the event a
suit is threatened or instituted challenging the Merger as violative of
anti-trust laws, each of USB and FLFC shall use reasonable best efforts in good
faith to avoid the filing of, or resist or resolve such suit, USB and FLFC shall
use reasonable best efforts in good faith to take such action as may be
required: (a) by the FRB, the Connecticut Banking Commissioner, and the
Antitrust Division of the DOJ or the United States Federal Trade Commission in
order to resolve such objections as any of them may have to the Merger under
antitrust laws, or (b) by any federal or state court of the United States, in
any suit brought by a private party or Governmental Entity challenging the
Merger as violative of antitrust laws, in order to avoid the entry of, or to
effect the dissolution of, any injunction, temporary restraining order, or other
order which has the effect of preventing the consummation of the Merger.
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Reasonable best efforts in good faith shall not include, among other things and
only to the extent USB so desires, the willingness of USB to accept an order
agreeing to the divestiture, or the holding separate, of any assets of USB or
FLFC.
8.6 Execution of Bank Merger Agreement. Prior to the Effective Time,
FNB and USB each shall execute and deliver the Bank Merger Agreement,
substantially in the form attached hereto as Exhibit A.
8.7 Redemption. FLFC shall use its best efforts to immediately before
or contemporaneously with Closing: (i) redeem at par value the trust preferred
securities issued in 2003 by FLFC's subsidiary First Litchfield Statutory Trust
I (the "2003 TruPS"); (ii) redeem at par value the trust preferred securities
issued in 2006 by FLFC's subsidiary First Litchfield Statutory Trust II (the
"2006 TruPS"); (iii) redeem all of the 10,000 outstanding shares of FLFC
preferred stock and the warrant to purchase 199,203 shares of FLFC Common Stock
issued by FLFC to the United States Department of the Treasury under the United
States Department of the Treasury's Troubled Assets Relief Program Capital
Purchase Program (the "TARP Obligations") and satisfy all obligations related
thereto. Accordingly, FLFC shall use its best efforts, in coordination with USB,
to obtain all necessary approvals and non-objections of Governmental Entities
and any counter party and third party consents necessary for the foregoing. USB
shall advance the funds to FLFC for redemption of any one or more of the
foregoing immediately before or contemporaneously with Closing to enable FLFC to
effectuate the redemptions.
ARTICLE IX
CLOSING CONDITIONS
9.1 Conditions to Each Party's Obligations under this Agreement. The
respective obligations of each party under this Agreement shall be subject to
the fulfillment at or prior to the Closing Date of the following conditions,
none of which may be waived:
9.1.1 Stockholder Approval. This Agreement shall have been approved
by the requisite vote of shareholders of FLFC.
9.1.2 Injunctions. None of the parties hereto shall be subject to
any order, decree or injunction of a court or agency of competent jurisdiction
which enjoins or prohibits the consummation of the transactions contemplated by
this Agreement.
9.1.3 Regulatory Approvals. All necessary approvals, authorizations
and consents of all Governmental Entities required to consummate the
transactions contemplated by this Agreement, including the Merger and the Bank
Merger shall have been obtained and shall remain in full force and effect and
all waiting periods relating to such approvals, authorizations or consents shall
have expired; and no such approval, authorization or consent shall include any
condition or requirement, excluding standard conditions that are normally
imposed by the regulatory authorities in bank merger transactions, that would,
in the good faith reasonable judgment of the Board of Trustees of USB,
materially and adversely affect the business,
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operations, financial condition, property or assets of the combined enterprise
of FLFC, FNB and USB or otherwise materially impair the value of FLFC or FNB to
USB.
9.2 Conditions to the Obligations of USB under this Agreement. The
obligations of USB under this Agreement shall be further subject to the
satisfaction or waiver of the conditions set forth in Sections 9.2.1 through
9.2.6 at or prior to the Closing:
9.2.1 Representations and Warranties. Except as otherwise
contemplated by this Agreement or consented to in writing by USB, the
representations and warranties of FLFC and FNB set forth in this Agreement shall
be true and correct in all material respects as of the date of this Agreement
and as of the Effective Time as though made on and as of the Effective Time (or
on the date when made in the case of any representation and warranty which
specifically relates to an earlier date), except as otherwise contemplated by
this Agreement or consented to in writing by USB; provided, however, that (i) in
determining whether or not the condition contained in this Section 9.2.1 shall
be satisfied, no effect shall be given to any exceptions in such representations
and warranties relating to materiality or Material Adverse Effect and (ii) the
condition contained in this Section 9.2.1 shall be deemed to be satisfied unless
the failure of such representations and warranties to be so true and correct
constitute, individually or in the aggregate, a Material Adverse Effect on FLFC
and FNB, taken as a whole; and FLFC shall have delivered to USB a certificate of
FLFC to such effect signed by the Chief Executive Officer and the Chief
Financial Officer of FLFC as of the Effective Time.
9.2.2 Agreements and Covenants. As of the Closing Date, FLFC and
each FLFC Subsidiary shall have performed in all material respects all
obligations and complied in all material respects with all agreements or
covenants of FLFC and such FLFC Subsidiary to be performed or complied with by
each of them at or prior to the Effective Date under this Agreement, except to
the extent that any failure to perform or comply shall not individually, or in
the aggregate, have a Material Adverse Effect on FLFC and the FLFC Subsidiaries,
taken as a whole, or materially adversely affect consummation of the Merger and
other transactions contemplated hereby, and USB shall have received a
certificate signed on behalf of FLFC by the Chief Executive Officer and Chief
Financial Officer of FLFC to such effect dated as of the Effective Time.
9.2.3 Permits, Authorizations, Etc. FLFC and the FLFC Subsidiaries
shall have obtained any and all material permits, authorizations, consents,
waivers, clearances or approvals required for the lawful consummation of the
Merger by FLFC and the Bank Merger by FNB, the failure to obtain which would
have a Material Adverse Effect on FLFC and the FLFC Subsidiaries, taken as a
whole.
9.2.4 Intentionally Omitted.
---------------------
9.2.5 No Material Adverse Effect. Since June 30, 2009, no event has
occurred or circumstance has arisen that, individually or in the aggregate, has
had or is reasonably likely to have a Material Adverse Effect on FLFC.
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9.3 Conditions to the Obligations of FLFC under this Agreement. The
obligations of FLFC under this Agreement shall be further subject to the
satisfaction of the conditions set forth in Sections 9.3.1 through 9.3.4 at or
prior to the Closing:
9.3.1 Representations and Warranties. Except as otherwise
contemplated by this Agreement or consented to in writing by FLFC, the
representations and warranties of USB set forth in this Agreement shall be true
and correct in all material respects as of the date of this Agreement and as of
the Effective Time as though made on and as of the Effective Time (or on the
date when made in the case of any representation and warranty which specifically
relates to an earlier date), except as otherwise contemplated by this Agreement
or consented to in writing by FLFC; provided, however, that (i) in determining
whether or not the condition contained in this Section 9.3.1 shall be satisfied,
no effect shall be given to any exceptions in such representations and
warranties relating to materiality or Material Adverse Effect and (ii) the
condition contained in this Section 9.3.1 shall be deemed to be satisfied unless
the failure of such representations and warranties to be so true and correct
constitute, individually or in the aggregate, a Material Adverse Effect on USB;
and USB shall have delivered to FLFC a certificate of USB to such effect signed
by the Chief Executive Officer and the Chief Financial Officer of USB as of the
Effective Time.
9.3.2 Agreements and Covenants. As of the Closing Date, USB shall
have performed in all material respects all obligations and complied in all
material respects with all agreements or covenants of USB to be performed or
complied with by them at or prior to the Effective Date under this Agreement
except to the extent that any failure to perform or comply shall not
individually, or in the aggregate, have a Material Adverse Effect on USB or
materially adversely affect consummation of the Merger and other transactions
contemplated hereby; and FLFC shall have received a certificate signed on behalf
of USB by the Chief Executive Officer and Chief Financial Officer of USB to such
effect dated as of the Effective Time.
9.3.3 Permits, Authorizations, Etc. Acquisition Corporation and USB
shall have obtained any and all material permits, authorizations, consents,
waivers, clearances or approvals required for the lawful consummation of the
Merger and the Bank Merger by Acquisition Corporation and USB, the failure to
obtain which would have a Material Adverse Effect on Acquisition Corporation,
USB, and its Subsidiaries, taken as a whole.
9.3.4 Payment of Merger Consideration. USB shall have delivered the
Exchange Fund to the Exchange Agent on or before the Closing Date and the
Exchange Agent shall provide FLFC with a certificate evidencing such delivery.
ARTICLE X
THE CLOSING
10.1 Time and Place. Subject to the provisions of Articles IX and XI
hereof, the Closing of the transactions contemplated hereby shall take place at
the offices of Hinckley, Allen & Snyder LLP, 20 Church Street, Hartford,
Connecticut at 10:00 a.m. on the date determined by USB, in its sole discretion,
upon five (5) Business Days prior written notice to FLFC, but in no
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event later than thirty (30) days after the last condition precedent pursuant to
this Agreement has been fulfilled or waived (including the expiration of any
applicable waiting period), or at such other place, date or time upon which USB
and FLFC mutually agree.
10.2 Deliveries at the Closing. At the Closing there shall be delivered
(i) to USB and FLFC the certificates and other documents and instruments
required to be delivered at the Closing under Article IX hereof and (ii) to the
Exchange Agent on behalf of FLFC the Merger Consideration required to be
delivered at the Closing under Section 9.3.4 hereof.
ARTICLE XI
TERMINATION, AMENDMENT AND WAIVER
11.1 Termination. This Agreement may be terminated at any time prior to
the Closing Date, whether before or after approval of the Merger by the
stockholders of FLFC:
11.1.1 By the mutual written agreement of USB and FLFC;
11.1.2 By either USB or FLFC (provided that the terminating party is
not then in material breach of any representation, warranty, covenant or other
agreement contained herein) if there shall have been a breach of any of the
representations or warranties set forth in this Agreement on the part of the
other party such that the conditions set forth in Sections 9.2.1 or 9.3.1, as
the case may be, would not be satisfied and such breach by its nature cannot be
cured prior to the Closing Date or shall not have been cured within thirty (30)
days after written notice by USB to FLFC (or by FLFC to USB) of such breach;
11.1.3 By either USB or FLFC (provided that the terminating party is
not then in material breach of any representation, warranty, covenant or other
agreement contained herein) if there shall have been a failure to perform or
comply with any of the covenants or agreements set forth in this Agreement on
the part of the other party such that the conditions set forth in Sections 9.2.2
or 9.3.2, as the case may be, would not be satisfied and such failure by its
nature cannot be cured prior to the Closing Date or shall not have been cured
within thirty (30) days after written notice by USB to FLFC (or by FLFC to USB)
of such failure;
11.1.4 If the Closing shall not have occurred by the Termination
Date, or such later date as shall have been agreed to in writing by USB and
FLFC; provided, that no party may terminate this Agreement pursuant to this
Section 11.1.4 if the failure of the Closing to have occurred on or before said
date was due to such party's breach of any of its obligations under this
Agreement;
11.1.5 By either USB or FLFC if (a) the shareholders of FLFC shall
have voted at the FLFC Shareholders Meeting on the Agreement and such vote shall
not have been sufficient to approve the Agreement; (b) any other party as may be
required to vote on the Merger or the Bank Merger shall have voted at a meeting
of such party and such vote shall not have been sufficient to approve the Merger
or the Bank Merger;
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11.1.6 By either USB or FLFC (a) if final action has been taken by a
Government Entity whose approval or non-objection is required in connection with
this Agreement or the Bank Merger Agreement and the transactions contemplated
hereby or thereby, which final action (i) has become unappealable and (ii) does
not approve or state a non-objection to this Agreement or the Bank Merger
Agreement or the transactions contemplated hereby or thereby, (b) if any
regulatory authority whose approval or non-objection is required in connection
with this Agreement or the Bank Merger Agreement and the transactions
contemplated hereby or thereby has stated in writing that it will not issue the
required approval or non-objection, or (c) if any court of competent
jurisdiction or other governmental authority shall have issued an order, decree,
ruling or taken any other action restraining, enjoining or otherwise prohibiting
the Merger or the Bank Merger and such order, decree, ruling or other action
shall have become final and nonappealable;
11.1.7 Intentionally Omitted.
11.1.8 By (a) FLFC (provided that FLFC is not then in material
breach of any representation, warranty, covenant or other agreement contained
herein) in the event that any of the conditions precedent to the obligations of
FLFC to consummate the Merger or the Bank Merger, as set forth in Article IX,
cannot be satisfied or fulfilled by June 1, 2010, provided, however, that if
required regulatory approvals and non-objections of Governmental Entities have
not been received by such date and the parties are acting in good faith to
obtain such approvals and non-objections such date shall be automatically
extended until September 1, 2010, or (b) either USB or FLFC (provided that the
terminating party is not then in material breach of any representation,
warranty, covenant or other agreement contained herein) in the event that any of
the conditions precedent to the obligations of such party to consummate the
Merger or the Bank Merger, as set forth in Article IX, cannot be satisfied or
fulfilled by the Termination Date;
11.1.9 By USB if (a) at any time prior to the FLFC Shareholder
meeting, the FLFC Board of Directors shall have failed for any reason to make
its recommendation referred to in Section 8.1, withdrawn such recommendation or
modified or changed such recommendation in a manner adverse in any respect to
the interests of USB, or (ii) the FLFC Board of Directors shall have failed for
any reason to call, give notice of, convene and hold the FLFC Shareholder
Meeting;
11.1.10 By USB if a tender offer or exchange offer for 25% or more
of the outstanding shares of FLFC Common Stock is commenced (other than by USB),
and the FLFC Board of Directors recommends that the shareholders of FLFC tender
their shares in such tender or exchange offer or otherwise fails to recommend
that such shareholders reject such tender offer or exchange offer within the
ten-Business Day period specified in Rule 14e-2(a) under the Exchange Act;
11.1.11 At any time prior to the FLFC Shareholders Meeting, by FLFC
in order to concurrently enter into an acquisition agreement or similar
agreement (each, an "Acquisition Agreement") with respect to a Superior Proposal
which has been received and considered by FLFC and the FLFC Board of Directors
in compliance with Section 6.10 hereof, provided, however, that this Agreement
may be terminated by FLFC pursuant to this Section 11.1.11 only
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after the fifth Business Day following USB's receipt of written notice from FLFC
advising USB that FLFC is prepared to enter into an Acquisition Agreement with
respect to a Superior Proposal, and only if, during such five-Business Day
period, USB does not, in its sole discretion, make an offer to FLFC that the
FLFC's Board of Directors determines in good faith, after consultation with its
financial and legal advisors, is at least as favorable as the Superior Proposal.
For purposes of this Section 11.1, termination of this Agreement by USB
shall be deemed to constitute a termination on behalf of Acquisition
Corporation.
11.2 Effect of Termination.
---------------------
11.2.1 In the event of termination of this Agreement pursuant to any
provision of Section 11.1, this Agreement shall forthwith become void and have
no further force, except that (i) the provisions of Sections 11.1, 11.3, 12.1,
12.2, 12.6, 12.9, 12.10, this Section 11.2, and (ii) any other Section which, by
its terms, relates to post-termination rights or obligations, shall survive such
termination of this Agreement and remain in full force and effect.
11.2.2 In recognition of the efforts, expenses and other
opportunities foregone by USB while structuring and pursuing the Merger, the
parties hereto agree that FLFC shall pay to USB a termination fee of One Million
Seven Hundred Fifty Thousand Dollars ($1,750,000) (the "FLFC Termination Fee")
in the manner and subject to the conditions set forth below only if:
(i) this Agreement is terminated by USB
pursuant to Section 11.1.9 or 11.1.10;
(ii) this Agreement is terminated by (A) USB
pursuant to Sections 11.1.2 or 11.1.3, or (B) by either USB or
FLFC pursuant to Section 11.1.5(a), and in the case of any
termination pursuant to clause (A) or (B) an Acquisition
Proposal shall have been publicly announced or otherwise
communicated or made known to the senior management of FLFC or
the FLFC Board of Directors (or any Person shall have publicly
announced, communicated or made known an intention, whether or
not conditional, to make an Acquisition Proposal) at any time
after the date of this Agreement and prior to the taking of
the vote of the shareholders of FLFC contemplated by this
Agreement at the FLFC Shareholder Meeting, in the case of
clause (B), or the date of termination of this Agreement, in
the case of clause (A); or
(iii) this Agreement is terminated by FLFC
pursuant to Section 11.1.11.
In the event the FLFC Termination Fee shall become payable pursuant
to Section 11.2.2(i) or (ii), (x) FLFC shall pay to USB an amount equal to Seven
Hundred Fifty Thousand Dollars ($750,000) on or before the third Business Day
following termination of this Agreement, and (y) if within 18 months after such
termination FLFC or a FLFC Subsidiary enters into any agreement with respect to,
or consummates, any Acquisition Transaction, FLFC shall pay to USB the FLFC
Termination Fee (net of any payment made pursuant to clause (x) above) on the
date of execution of such agreement or consummation of the Acquisition
Transaction. In the
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event the FLFC Termination Fee shall become payable pursuant to Section
11.2.2(iii), FLFC shall pay to USB the entire FLFC Termination Fee within three
Business Days following the date of termination of this Agreement. Any amount
that becomes payable pursuant to this Section 11.2.2 shall be paid by wire
transfer of immediately available funds to an account designated by USB.
11.2.3 In the event of a termination of this Agreement pursuant to
Section 11.1.2 or 11.1.3 hereof resulting from the willful conduct or gross
negligence of a party, such party shall be obligated to reimburse the other
party for up to Five Hundred Thousand Dollars ($500,000) of documented
reasonable out-of-pocket costs and expenses, including, without limitation,
reasonable legal, accounting and investment banking fees and expenses, incurred
by such other party in connection with the entering into of this Agreement and
the carrying out of any and all acts contemplated hereunder (collectively
referred to as "Costs"). The payment of Costs is not an exclusive remedy, but is
in addition to any other rights or remedies available to the parties hereto at
law or in equity or as is contemplated herein. Notwithstanding anything to the
contrary herein, if FLFC makes the payment contemplated in Section 11.2.2 of
this Agreement FLFC shall not have any further liability to USB (or its
Subsidiaries), whether for Costs, breach or otherwise.
11.2.4 Except as provided in Sections 11.2.2 and 11.2.3 whether or
not the Merger is consummated, all Costs incurred in connection with this
Agreement and the transactions contemplated hereby shall be borne by the party
incurring such Costs.
11.2.5 In no event shall any officer, agent or director of FLFC, any
FLFC Subsidiary, USB or any USB Subsidiary, be personally liable thereunder for
any default by any party in any of its obligations hereunder unless any such
default was intentionally caused by such officer, agent or director.
11.3 Amendment, Extension and Waiver. Subject to applicable law, at any
time prior to the Effective Time (whether before or after approval thereof by
the shareholders of FLFC), the parties hereto by action of their respective
Boards of Directors, may (a) amend this Agreement, (b) extend the time for the
performance of any of the obligations or other acts of any other party hereto,
(c) waive any inaccuracies in the representations and warranties contained
herein or in any document delivered pursuant hereto, or (d) waive compliance
with any of the agreements or conditions contained herein; provided, however,
that after any approval of this Agreement and the transactions contemplated
hereby by the shareholders of FLFC, there may not be, without further approval
of such shareholders, any amendment of this Agreement which reduces the amount,
value or changes the form of consideration to be delivered to FLFC's
shareholders or Option holders pursuant to this Agreement. This Agreement may
not be amended except by an instrument in writing signed on behalf of each of
the parties hereto. Any agreement on the part of a party hereto to any extension
or waiver shall be valid only if set forth in an instrument in writing signed on
behalf of such party, but such waiver or failure to insist on strict compliance
with such obligation, covenant, agreement or condition shall not operate as a
waiver of, or estoppel with respect to, any subsequent or other failure.
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ARTICLE XII
MISCELLANEOUS
12.1 Confidentiality. Except as specifically set forth herein, USB and
FLFC mutually agree to be bound by the terms of the confidentiality agreement
dated as of August 7, 2009 (the "Confidentiality Agreement") previously executed
by the parties hereto, which Confidentiality Agreement is hereby incorporated
herein by reference. The parties hereto agree that such Confidentiality
Agreement shall continue in accordance with its terms, notwithstanding the
termination of this Agreement.
12.2 Public Announcements. FLFC and USB shall cooperate with each other
in the development and distribution of all news releases and other public
information disclosures with respect to this Agreement, except as may be
otherwise required by law, and neither FLFC nor USB shall issue any joint news
releases with respect to this Agreement unless such news releases have been
mutually agreed upon in writing by the parties hereto, except as required by
law.
12.3 Survival. All representations, warranties and covenants in this
Agreement or in any instrument delivered pursuant hereto or thereto shall expire
on and be terminated and extinguished at the Effective Date, other than those
covenants set forth in Sections 2.4, 2.5, 2.6, 2.7, 7.6, and 7.7, or any other
covenant that by its terms is to survive or be performed after the Effective
Date.
12.4 Notices. All notices or other communications hereunder shall be in
writing and shall be deemed given if delivered by receipted hand delivery or
mailed by prepaid registered or certified mail (return receipt requested) or by
cable, telegram, telex or fax addressed as follows:
If to FLFC or FNB, to:
13 North Street
P.O. Box 578
Litchfield, CT 06759
Attention: Joseph Greco, President and Chief Executive Officer
Fax: (860) 567-5231
With required copies to:
Cranmore, FitzGerald & Meaney
47 Wethersfield Avenue
Hartford, CT 06114
Attention: J.J. Cranmore, Esq.
Fax: (860) 522-3379
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If to USB, to:
225 Main Street
P.O. Box 647
Danbury, CT 06813-0647
Attention: John C. Kline, President and Chief Executive Officer
Fax: (203) 792-1169
With required copies to:
Hinckley, Allen & Snyder LLP
20 Church Street
Hartford, Connecticut 06103
Attention: William W. Bouton III, Esq.
Fax: (860) 278-3802
or such other address as shall be furnished in writing by any party, and any
such notice or communication shall be deemed to have been given as of the date
so mailed.
12.5 Parties in Interest. This Agreement shall be binding upon and
shall inure to the benefit of the parties hereto and their respective successors
and assigns; provided, however, that neither this Agreement nor any of the
rights, interests or obligations hereunder shall be assigned by any party hereto
without the prior written consent of the other party, and that (except as
otherwise expressly provided in this Agreement) nothing in this Agreement is
intended to confer upon any other person any rights or remedies under or by
reason of this Agreement.
12.6 Complete Agreement. This Agreement, including the Exhibits and
Disclosure Schedules hereto and the documents and other writings referred to
herein or therein or delivered pursuant hereto or thereto, together with the
Confidentiality Agreements referred to in Section 12.1, contains the entire
agreement and understanding of the parties with respect to its subject matter.
There are no restrictions, agreements, promises, warranties, covenants or
undertakings between the parties other than those expressly set forth herein or
therein. This Agreement supersedes all prior agreements and understandings
(other than the Confidentiality Agreements referred to in Section 12.1 hereof)
between the parties, both written and oral, with respect to its subject matter.
12.7 Counterparts. This Agreement may be executed in counterparts all
of which shall be considered one and the same agreement and each of which shall
be deemed an original.
12.8 Severability. In the event that any one or more provisions of this
Agreement shall for any reason be held invalid, illegal or unenforceable in any
respect, by any court of competent jurisdiction, such invalidity, illegality or
unenforceability shall not affect any other provisions of this Agreement and the
parties shall use their reasonable efforts to substitute a valid, legal and
enforceable provision which, insofar as practical, implements the purposes and
intents of this Agreement.
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12.9 Governing Law. This Agreement shall be governed by the laws of the
State of Connecticut, without giving effect to conflicts of laws principles that
would require the application of any other law.
12.10 Interpretation. When a reference is made in this Agreement to
Sections or Exhibits, such reference shall be to a Section of or Exhibit to this
Agreement unless otherwise indicated. The recitals hereto constitute an integral
part of this Agreement. References to Sections include subsections, which are
part of the related Section (e.g., a section numbered Section 5.5.1" would be
part of "Section 5.5" and references to "Section 5.5" would also refer to
material contained in the subsection described as "Section 5.5.1"). The table of
contents, index and headings contained in this Agreement are for reference
purposes only and shall not affect in any way the meaning or interpretation of
this Agreement. Whenever the words "include", "includes" or "including" are used
in this Agreement, they shall be deemed to be followed by the words "without
limitation". The phrases "the date of this Agreement", "the date hereof" and
terms of similar import, unless the context otherwise requires, shall be deemed
to refer to the date set forth in the Recitals to this Agreement.
12.11 Specific Performance. The parties hereto agree that irreparable
damage would occur in the event that the provisions contained in this Agreement
were not performed in accordance with its specific terms or was otherwise
breached. It is accordingly agreed that the parties shall be entitled to an
injunction or injunctions to prevent breaches of this Agreement and to enforce
specifically the terms and provisions thereof in any court of the United States
or any state having jurisdiction, this being in addition to any other remedy to
which they are entitled at law or in equity.
[SIGNATURES APPEAR ON THE FOLLOWING PAGE]
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IN WITNESS WHEREOF, USB, FLFC and FNB have caused this Agreement to be
executed under seal by their duly authorized officers as of the date first set
forth above.
UNION SAVINGS BANK
By: /S/ JOHN C. KLINE
---------------------------------------------
Name: John C. Kline
---------------------------------------------
Title: President & Chief Executive Officer
----------------------------------------------
FIRST LITCHFIELD FINANCIAL CORPORATION
By: /S/ JOSEPH J. GRECO
----------------------------------------------
Name: Joseph J. Greco
----------------------------------------------
Title: President & Chief Executive Officer
----------------------------------------------
THE FIRST NATIONAL BANK OF LITCHFIELD
By: /S/ JOSEPH J. GRECO
----------------------------------------------
Name: Joseph J. Greco
----------------------------------------------
Title: President & Chief Executive Officer
----------------------------------------------
A - 66
Annex B
RAYMOND JAMES(R)
----------------
October 25, 2009
Board of Directors
First Litchfield Financial Corporation
13 North Street
Litchfield, Connecticut 06759-0578
Members of the Board:
You have requested our opinion as to the fairness, from a financial point of
view, to the shareholders of the outstanding common stock, par value $0.01 (the
"Common Stock") of First Litchfield Financial Corporation (the "Company") of the
consideration to be received by such holders in connection with the proposed
merger with and into Union Savings Bank ("Union Savings") through a series of
transactions (the "Merger") pursuant and subject to the Agreement and Plan of
Merger between the Company and Union Savings dated as of October 25, 2009 (the
"Agreement"). The consideration to be offered by Union Savings in exchange for
all the outstanding Common Stock of the Company will be $15.00 per share payable
in cash.
In connection with our review of the proposed Merger and the preparation of our
opinion herein, we have, among other things:
1. reviewed the financial terms and conditions as stated in the
Agreement;
2. reviewed the Annual and Quarterly Reports on Forms 10-K and 10-Q of
the Company for the years ended December 31, 2008, 2007 and 2006 and
for the three month periods ended June 30, 2009, March 31, 2009 and
September 30, 2008;
3. reviewed certain publicly available financial statements and other
historical financial information of the Company and Union Savings;
4. reviewed other financial, corporate, and operating information of
the Company and Union Savings, including certain financial analyses
and forecasts of the Company and Union Savings which were prepared
by the respective managements of the Company and Union Savings;
5. reviewed comparative financial and operating data on the banking
industry and certain institutions which we deemed to be comparable
to each of the Company and Union Savings;
Raymond James & Associates, Inc.
Member New York Stock Exchange/SIPC
277 Park Avenue o New York, NY 10172
212-297-5600 o 212-885-1808 Fax
www.RaymondJames.com
--------------------
B - 1
RAYMOND JAMES(R)
----------------
Board of Directors
First Litchfield Financial Corporation
October 25, 2009
Page 2
6. reviewed a draft of the remedial supervisory documents between The
First National Bank of Litchfield and the Comptroller of the
Currency;
7. reviewed the historical market prices and trading activity for the
common stock of the Company;
8. reviewed the pro forma financial impact of the merger on Union
Savings, based on assumptions relating to transaction expenses,
purchase accounting adjustments, and cost savings determined by the
senior management of Union Savings;
9. reviewed certain bank mergers and acquisitions on a regional and
nationwide basis for institutions which we deemed to be comparable
to the Company and compared the proposed consideration with the
consideration paid in such other mergers and acquisitions;
10. conducted limited discussions with members of senior management of
each of the Company and Union Savings concerning the financial
condition, business and prospects of each respective company; and
11. reviewed such other financial studies and analyses and performed
such other investigations and took into account such other matters
as we deemed necessary.
With your consent, we have assumed and relied upon the accuracy and completeness
of all information supplied or otherwise made available to us by the Company,
Union Savings or any other party, and we have undertaken no duty or
responsibility to verify independently any of such information. We have not made
or obtained an independent appraisal of the assets or liabilities (contingent or
otherwise) of the Company. With respect to financial forecasts and other
information and data provided to or otherwise reviewed by or discussed with us,
we have, with your consent, assumed that such forecasts and other information
and data have been reasonably prepared in good faith on a basis reflecting the
best currently available estimates and judgments of management, and we have
relied upon each party to advise us promptly if any information previously
provided became inaccurate or was required to be updated during the period of
our review. We have assumed that the final form of the Agreement will be
substantially similar to the draft reviewed by us, and that the Merger will be
consummated in accordance with the terms of the Agreement without waiver of any
conditions thereof.
Our opinion is based upon market, economic, financial and other circumstances
and conditions existing and disclosed to us as of October 25, 2009 and any
material change in such circumstances and conditions would require a
reevaluation of this opinion, which we are under no obligation to undertake.
Our opinion is limited to the fairness, from a financial point of view, of the
Merger to the Company. We express no opinion with respect to any reasons, legal,
business, or
B - 2
RAYMOND JAMES(R)
----------------
Board of Directors
First Litchfield Financial Corporation
October 25, 2009
Page 3
otherwise, that may support the decision of the Board of Directors to approve or
consummate the Merger. In formulating our opinion, we have considered only what
we understand to be the consideration to be received by the Shareholders as is
described above, and we have not considered, and this opinion does not address,
any other payments that may be made in connection to Company employees or other
shareholders in connection with the Transaction.
In conducting our investigation and analyses and in arriving at our opinion
expressed herein, we have taken into account such accepted financial and
investment banking procedures and considerations as we have deemed relevant,
including the review of (i) historical and projected revenues, operating
earnings, net income and capitalization of the Company and certain other
publicly held companies in businesses we believe to be comparable to the
Company; (ii) the current and projected financial position and results of
operations of the Company; (iii) the historical market prices and trading
activity of the Common Stock of the Company; (iv) financial and operating
information concerning selected business combinations which we deemed comparable
in whole or in part; and (v) the general condition of the securities markets.
The delivery of this opinion was approved by our fairness opinion committee.
In arriving at this opinion, we did not attribute any particular weight to any
analysis or factor considered by us, but rather made qualitative judgments as to
the significance and relevance of each analysis and factor. Accordingly, we
believe that our analyses must be considered as a whole and that selecting
portions of our analyses, without considering all analyses, would create an
incomplete view of the process underlying this opinion.
Raymond James & Associates, Inc. ("Raymond James") is actively engaged in the
investment banking business and regularly undertakes the valuation of investment
securities in connection with public offerings, private placements, business
combinations and similar transactions. Raymond James has been engaged to render
financial advisory services to the Company in connection with the proposed
Merger and will receive a fee for such services, which fee is contingent upon
consummation of the Merger. Raymond James will also receive a fee upon the
delivery of this opinion. In addition, the Company has agreed to indemnify us
against certain liabilities arising out of our engagement.
In the ordinary course of our business, Raymond James may trade in the
securities of the Company for our own account or for the accounts of our
customers and, accordingly, may at any time hold a long or short position in
such securities. Raymond James has provided certain services to the Company in
the previous two years, including strategic advisory, for which it has been paid
a fee.
It is understood that this letter is for the information of the Board of
Directors of the Company in evaluating the proposed Merger and does not
constitute a recommendation to any shareholder of the Company regarding how said
shareholder should vote on the proposed Merger. Furthermore, this letter should
not be construed as creating any
B - 3
RAYMOND JAMES(R)
----------------
Board of Directors
First Litchfield Financial Corporation
October 25, 2009
Page 4
fiduciary duty on the part of Raymond James to any such party. This opinion is
not to be quoted or referred to, in whole or in part, without our prior written
consent, which will not be unreasonably withheld.
Based upon and subject to the foregoing, it is our opinion that, as of October
25, 2009, the consideration to be received by the shareholders of the Company
pursuant to the Agreement is fair, from a financial point of view, to the
holders of the Company's outstanding Common Stock.
Very truly yours,
/S/ Raymond James & ASSOCIATES, Inc.
RAYMOND JAMES & ASSOCIATES, INC.
B - 4
Annex C
SECTION 262 OF THE DELAWARE GENERAL CORPORATION LAW
ss. 262. Appraisal rights.
(a) Any stockholder of a corporation of this State who holds shares of
stock on the date of the making of a demand pursuant to subsection (d) of this
section with respect to such shares, who continuously holds such shares through
the effective date of the merger or consolidation, who has otherwise complied
with subsection (d) of this section and who has neither voted in favor of the
merger or consolidation nor consented thereto in writing pursuant to ss. 228 of
this title shall be entitled to an appraisal by the Court of Chancery of the
fair value of the stockholder's shares of stock under the circumstances
described in subsections (b) and (c) of this section. As used in this section,
the word "stockholder" means a holder of record of stock in a stock corporation
and also a member of record of a nonstock corporation; the words "stock" and
"share" mean and include what is ordinarily meant by those words and also
membership or membership interest of a member of a nonstock corporation; and the
words "depository receipt" mean a receipt or other instrument issued by a
depository representing an interest in one or more shares, or fractions thereof,
solely of stock of a corporation, which stock is deposited with the depository.
(b) Appraisal rights shall be available for the shares of any class or
series of stock of a constituent corporation in a merger or consolidation to be
effected pursuant to ss. 251 (other than a merger effected pursuant to ss.
251(g) of this title), ss. 252, ss. 254, ss. 257, ss. 258, ss. 263 or ss. 264 of
this title:
(1) Provided, however, that no appraisal rights under this section
shall be available for the shares of any class or series of stock,
which stock, or depository receipts in respect thereof, at the record
date fixed to determine the stockholders entitled to receive notice of
the meeting of stockholders to act upon the agreement of merger or
consolidation, were either (i) listed on a national securities exchange
or (ii) held of record by more than 2,000 holders; and further provided
that no appraisal rights shall be available for any shares of stock of
the constituent corporation surviving a merger if the merger did not
require for its approval the vote of the stockholders of the surviving
corporation as provided in subsection (f) of ss. 251 of this title.
(2) Notwithstanding paragraph (1) of this subsection, appraisal
rights under this section shall be available for the shares of any
class or series of stock of a constituent corporation if the holders
thereof are required by the terms of an agreement of merger or
consolidation pursuant to ss.ss. 251, 252, 254, 257, 258, 263 and 264
of this title to accept for such stock anything except:
a. Shares of stock of the corporation surviving or resulting
from such merger or consolidation, or depository receipts in
respect thereof;
b. Shares of stock of any other corporation, or depository
receipts in respect thereof, which shares of stock (or
C - 1
depository receipts in respect thereof) or depository receipts
at the effective date of the merger or consolidation will be
either listed on a national securities exchange or held of
record by more than 2,000 holders;
c. Cash in lieu of fractional shares or fractional depository
receipts described in the foregoing subparagraphs a. and b. of
this paragraph; or
d. Any combination of the shares of stock, depository receipts
and cash in lieu of fractional shares or fractional depository
receipts described in the foregoing subparagraphs a., b. and
c. of this paragraph.
(3) In the event all of the stock of a subsidiary Delaware
corporation party to a merger effected under ss. 253 of this title is
not owned by the parent corporation immediately prior to the merger,
appraisal rights shall be available for the shares of the subsidiary
Delaware corporation.
(c) Any corporation may provide in its certificate of incorporation
that appraisal rights under this section shall be available for the shares of
any class or series of its stock as a result of an amendment to its certificate
of incorporation, any merger or consolidation in which the corporation is a
constituent corporation or the sale of all or substantially all of the assets of
the corporation. If the certificate of incorporation contains such a provision,
the procedures of this section, including those set forth in subsections (d) and
(e) of this section, shall apply as nearly as is practicable.
(d) Appraisal rights shall be perfected as follows:
(1) If a proposed merger or consolidation for which appraisal
rights are provided under this section is to be submitted for approval
at a meeting of stockholders, the corporation, not less than 20 days
prior to the meeting, shall notify each of its stockholders who was
such on the record date for notice of such meeting with respect to
shares for which appraisal rights are available pursuant to subsection
(b) or (c) hereof that appraisal rights are available for any or all of
the shares of the constituent corporations, and shall include in such
notice a copy of this section. Each stockholder electing to demand the
appraisal of such stockholder's shares shall deliver to the
corporation, before the taking of the vote on the merger or
consolidation, a written demand for appraisal of such stockholder's
shares. Such demand will be sufficient if it reasonably informs the
corporation of the identity of the stockholder and that the stockholder
intends thereby to demand the appraisal of such stockholder's shares. A
proxy or vote against the merger or consolidation shall not constitute
such a demand. A stockholder electing to take such action must do so by
a separate written demand as herein provided. Within 10 days after the
effective date of such merger or consolidation, the surviving or
resulting corporation shall notify each stockholder of each constituent
corporation who has complied with this subsection and has not voted in
favor of or consented to the merger or consolidation of the date that
the merger or consolidation has become effective; or
C - 2
(2) If the merger or consolidation was approved pursuant to ss.
228 or ss. 253 of this title, then either a constituent corporation
before the effective date of the merger or consolidation or the
surviving or resulting corporation within 10 days thereafter shall
notify each of the holders of any class or series of stock of such
constituent corporation who are entitled to appraisal rights of the
approval of the merger or consolidation and that appraisal rights are
available for any or all shares of such class or series of stock of
such constituent corporation, and shall include in such notice a copy
of this section. Such notice may, and, if given on or after the
effective date of the merger or consolidation, shall, also notify such
stockholders of the effective date of the merger or consolidation. Any
stockholder entitled to appraisal rights may, within 20 days after the
date of mailing of such notice, demand in writing from the surviving or
resulting corporation the appraisal of such holder's shares. Such
demand will be sufficient if it reasonably informs the corporation of
the identity of the stockholder and that the stockholder intends
thereby to demand the appraisal of such holder's shares. If such notice
did not notify stockholders of the effective date of the merger or
consolidation, either (i) each such constituent corporation shall send
a second notice before the effective date of the merger or
consolidation notifying each of the holders of any class or series of
stock of such constituent corporation that are entitled to appraisal
rights of the effective date of the merger or consolidation or (ii) the
surviving or resulting corporation shall send such a second notice to
all such holders on or within 10 days after such effective date;
provided, however, that if such second notice is sent more than 20 days
following the sending of the first notice, such second notice need only
be sent to each stockholder who is entitled to appraisal rights and who
has demanded appraisal of such holder's shares in accordance with this
subsection. An affidavit of the secretary or assistant secretary or of
the transfer agent of the corporation that is required to give either
notice that such notice has been given shall, in the absence of fraud,
be prima facie evidence of the facts stated therein. For purposes of
determining the stockholders entitled to receive either notice, each
constituent corporation may fix, in advance, a record date that shall
be not more than 10 days prior to the date the notice is given,
provided, that if the notice is given on or after the effective date of
the merger or consolidation, the record date shall be such effective
date. If no record date is fixed and the notice is given prior to the
effective date, the record date shall be the close of business on the
day next preceding the day on which the notice is given.
(e) Within 120 days after the effective date of the merger or
consolidation, the surviving or resulting corporation or any stockholder who has
complied with subsections (a) and (d) of this section hereof and who is
otherwise entitled to appraisal rights, may commence an appraisal proceeding by
filing a petition in the Court of Chancery demanding a determination of the
value of the stock of all such stockholders. Notwithstanding the foregoing, at
any time within 60 days after the effective date of the merger or consolidation,
any stockholder who has not commenced an appraisal proceeding or joined that
proceeding as a named party shall have the right to withdraw such stockholder's
demand for appraisal and to accept the terms offered upon the merger or
consolidation. Within 120 days after the effective date of the merger or
consolidation, any stockholder who has complied with the requirements of
subsections (a) and (d) of this section hereof, upon written request, shall be
entitled to receive from the corporation surviving the merger or resulting from
the consolidation a statement setting forth the aggregate number of
C - 3
shares not voted in favor of the merger or consolidation and with respect to
which demands for appraisal have been received and the aggregate number of
holders of such shares. Such written statement shall be mailed to the
stockholder within 10 days after such stockholder's written request for such a
statement is received by the surviving or resulting corporation or within 10
days after expiration of the period for delivery of demands for appraisal under
subsection (d) of this section hereof, whichever is later. Notwithstanding
subsection (a) of this section, a person who is the beneficial owner of shares
of such stock held either in a voting trust or by a nominee on behalf of such
person may, in such person's own name, file a petition or request from the
corporation the statement described in this subsection.
(f) Upon the filing of any such petition by a stockholder, service of a
copy thereof shall be made upon the surviving or resulting corporation, which
shall within 20 days after such service file in the office of the Register in
Chancery in which the petition was filed a duly verified list containing the
names and addresses of all stockholders who have demanded payment for their
shares and with whom agreements as to the value of their shares have not been
reached by the surviving or resulting corporation. If the petition shall be
filed by the surviving or resulting corporation, the petition shall be
accompanied by such a duly verified list. The Register in Chancery, if so
ordered by the Court, shall give notice of the time and place fixed for the
hearing of such petition by registered or certified mail to the surviving or
resulting corporation and to the stockholders shown on the list at the addresses
therein stated. Such notice shall also be given by 1 or more publications at
least 1 week before the day of the hearing, in a newspaper of general
circulation published in the City of Wilmington, Delaware or such publication as
the Court deems advisable. The forms of the notices by mail and by publication
shall be approved by the Court, and the costs thereof shall be borne by the
surviving or resulting corporation.
(g) At the hearing on such petition, the Court shall determine the
stockholders who have complied with this section and who have become entitled to
appraisal rights. The Court may require the stockholders who have demanded an
appraisal for their shares and who hold stock represented by certificates to
submit their certificates of stock to the Register in Chancery for notation
thereon of the pendency of the appraisal proceedings; and if any stockholder
fails to comply with such direction, the Court may dismiss the proceedings as to
such stockholder.
(h) After the Court determines the stockholders entitled to an
appraisal, the appraisal proceeding shall be conducted in accordance with the
rules of the Court of Chancery, including any rules specifically governing
appraisal proceedings. Through such proceeding the Court shall determine the
fair value of the shares exclusive of any element of value arising from the
accomplishment or expectation of the merger or consolidation, together with
interest, if any, to be paid upon the amount determined to be the fair value. In
determining such fair value, the Court shall take into account all relevant
factors. Unless the Court in its discretion determines otherwise for good cause
shown, interest from the effective date of the merger through the date of
payment of the judgment shall be compounded quarterly and shall accrue at 5%
over the Federal Reserve discount rate (including any surcharge) as established
from time to time during the period between the effective date of the merger and
the date of payment of the judgment. Upon application by the surviving or
resulting corporation or by any stockholder entitled to participate in the
appraisal proceeding, the Court may, in its discretion, proceed to trial upon
C - 4
the appraisal prior to the final determination of the stockholders entitled to
an appraisal. Any stockholder whose name appears on the list filed by the
surviving or resulting corporation pursuant to subsection (f) of this section
and who has submitted such stockholder's certificates of stock to the Register
in Chancery, if such is required, may participate fully in all proceedings until
it is finally determined that such stockholder is not entitled to appraisal
rights under this section.
(i) The Court shall direct the payment of the fair value of the shares,
together with interest, if any, by the surviving or resulting corporation to the
stockholders entitled thereto. Payment shall be so made to each such
stockholder, in the case of holders of uncertificated stock forthwith, and the
case of holders of shares represented by certificates upon the surrender to the
corporation of the certificates representing such stock. The Court's decree may
be enforced as other decrees in the Court of Chancery may be enforced, whether
such surviving or resulting corporation be a corporation of this State or of any
state.
(j) The costs of the proceeding may be determined by the Court and
taxed upon the parties as the Court deems equitable in the circumstances. Upon
application of a stockholder, the Court may order all or a portion of the
expenses incurred by any stockholder in connection with the appraisal
proceeding, including, without limitation, reasonable attorney's fees and the
fees and expenses of experts, to be charged pro rata against the value of all
the shares entitled to an appraisal.
(k) From and after the effective date of the merger or consolidation,
no stockholder who has demanded appraisal rights as provided in subsection (d)
of this section shall be entitled to vote such stock for any purpose or to
receive payment of dividends or other distributions on the stock (except
dividends or other distributions payable to stockholders of record at a date
which is prior to the effective date of the merger or consolidation); provided,
however, that if no petition for an appraisal shall be filed within the time
provided in subsection (e) of this section, or if such stockholder shall deliver
to the surviving or resulting corporation a written withdrawal of such
stockholder's demand for an appraisal and an acceptance of the merger or
consolidation, either within 60 days after the effective date of the merger or
consolidation as provided in subsection (e) of this section or thereafter with
the written approval of the corporation, then the right of such stockholder to
an appraisal shall cease. Notwithstanding the foregoing, no appraisal proceeding
in the Court of Chancery shall be dismissed as to any stockholder without the
approval of the Court, and such approval may be conditioned upon such terms as
the Court deems just; provided, however that this provision shall not affect the
right of any stockholder who has not commenced an appraisal proceeding or joined
that proceeding as a named party to withdraw such stockholder's demand for
appraisal and to accept the terms offered upon the merger or consolidation
within 60 days after the effective date of the merger or consolidation, as set
forth in subsection (e) of this section.
(l) The shares of the surviving or resulting corporation to which the
shares of such objecting stockholders would have been converted had they
assented to the merger or consolidation shall have the status of authorized and
unissued shares of the surviving or resulting corporation.
C - 5
Annex D
FIRST LITCHFIELD FINANCIAL CORPORATION
EXCERPTS FROM FORM 10-K FOR THE YEAR ENDED DECEMBER 31, 2008
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION
PART I
ITEM 1. BUSINESS
Business of the Company
First Litchfield Financial Corporation, a Delaware corporation (the "Company")
is a registered bank holding company under the Bank Holding Company Act of 1956,
as amended. The Company was formed in 1988 and has one banking subsidiary, The
First National Bank of Litchfield (the "Bank"), a national banking association
organized under the laws of the United States. The Bank and its predecessors
have been in existence since 1814. The principal executive office of the Company
is located at 13 North Street, Litchfield, CT 06759, and the telephone number is
(860) 567-8752. The Company owns all of the outstanding shares of the Bank. The
Bank has three subsidiaries, Lincoln Corporation and Litchfield Mortgage Service
Corporation, which are Connecticut corporations, and First Litchfield Leasing
Corporation which is a Delaware corporation. The Bank holds a majority ownership
position in First Litchfield Leasing Corporation. The purpose of Lincoln
Corporation is to hold property such as real estate, personal property,
securities, or other assets, acquired by the Bank through foreclosure or
otherwise to compromise a doubtful claim or collect a debt previously
contracted. The purpose of Litchfield Mortgage Service Corporation is to operate
as a passive investment company in accordance with Connecticut law. On June 26,
2003, the Company formed First Litchfield Statutory Trust I for the purpose of
issuing trust preferred securities and investing the proceeds in subordinated
debentures issued by the Company, and on June 26, 2003, the first series of
trust preferred securities were issued. During the second quarter of 2006, the
Company formed a second statutory trust, First Litchfield Statutory Trust II
("Trust II"). Trust II exists for the sole purpose of issuing trust securities
and investing the proceeds in subordinated debentures issued by the Company. In
June 2006, Trust II issued its first series of trust preferred securities. The
Company owns 100% of each Trust's common stock.
During the fourth quarter of 2006, The Bank formed First Litchfield Leasing
Corporation for the purpose of providing equipment financing and leasing
products. The Company considers First Litchfield Leasing Corporation as an
operating segment for reporting business line results.
The Bank engages in a wide range of commercial and personal banking activities,
including accepting demand deposits (including Money Market Accounts), accepting
savings and time deposit accounts, making secured and unsecured loans and leases
to corporations, individuals, and others, issuing letters of credit, originating
mortgage loans, and providing personal and corporate trust services. The
business of the Bank is not significantly affected by seasonal factors.
The Bank's lending services include commercial, real estate, and consumer
installment loans and leases. Revenues from the Bank's lending activities
constitute the largest component of the Bank's operating revenues. The loan and
lease portfolio constitutes the major earning asset of the Bank and offers the
best alternative for maximizing interest spread above the cost of funds. The
Bank's loan and lease personnel have the authority to extend credit under
guidelines established and approved by the Board of Directors. Any aggregate
credit which exceeds the authority of the loan or lease officer is
D-1
forwarded to the loan committee for approval. The loan committee is composed of
various experienced loan and lease officers and Bank directors. All aggregate
credits that exceed the loan committee's lending authority are presented to the
full Board of Directors for ultimate approval or denial. The loan committee not
only acts as an approval body to ensure consistent application of the Bank's
loan and lease policy, but also provides valuable insight through communication
and pooling of knowledge, judgment, and experience of its members.
The Bank's primary lending area generally includes towns located in Litchfield
and Hartford counties.
The Bank's Trust and Wealth Management Department provides a wide range of
personal and corporate trust and trust-related investment services, including
serving as executor of estates, as trustee under testamentary and intervivos
trusts and various pension and other employee benefit plans, as guardian of the
estates of minors and incompetents, and as escrow agent under various
agreements.
The Bank introduces new products and services as permitted by the regulatory
authorities or desired by the public. The Bank remains committed to meeting the
challenges that require technology. In addition to providing its customers with
access to the latest technological products, such as telephone banking, which
allows customers to handle routine transactions using a standard touch tone
telephone, the Bank is accessible via a home page on the Internet. The Bank also
offers PC banking and bill paying via the Internet at its Website. The Bank also
offers a cash management product; e-Business Advantage, which is geared toward
commercial businesses, municipal and nonprofit customers and provides 24-hour
online account management including real-time account monitoring, managing cash
flow, collecting and making payments electronically, as well as transferring
idle cash.
Competition
In Connecticut generally, and in the Bank's primary service area specifically,
there is intense competition in the commercial banking industry. The Bank's
market area consists principally of towns located in Litchfield County and
Hartford County, although the Bank also competes with other financial
institutions in surrounding counties in Connecticut in obtaining deposits and
providing many types of financial services. The Bank competes with larger
regional and national banks for the business of companies located in the Bank's
market area. The Bank also competes with savings and loan associations, credit
unions, finance companies, personal loan companies, money market funds and other
non-depository financial intermediaries. Many of these financial institutions
have resources many times greater than those of the Bank. In addition, new
financial intermediaries such as money-market mutual funds and large retailers
are not subject to the same regulations and laws that govern the operation of
traditional depository institutions.
Changes in federal and state law have resulted in, and are expected to continue
to result in, increased competition. The reductions in legal barriers to the
acquisition of banks by out-of-state bank holding companies resulting from
implementation of the Riegle-Neal Interstate Banking and Branching Efficiency
Act of 1994 and other recent and proposed changes are expected to continue to
further stimulate competition in the markets in which the Bank operates,
although it is not possible to predict the extent or timing of such increased
competition.
Lending Activities
The Bank's lending policy is designed to correspond with its mission of
remaining a community-oriented bank. The loan and lease policy sets forth
accountability for lending functions in addition to standardizing the
underwriting, credit and documentation procedures. The Bank's target market
regarding lending is in the towns in which a Bank office is located and
contiguous towns. The typical
D-2
loan and lease customer is an individual or small business which has a deposit
relationship with the Bank. The Bank strives to provide an appropriate mix in
its loan and lease portfolio of commercial loans leases and loans and leases to
individual consumers.
Loan and Lease Portfolio
- ------------------------
The Bank's loan and lease portfolio at December 31, 2008 - 2004 was comprised of
the following categories:
(Dollar Amounts in Thousands)
December 31,
------------------------------------------------
2008 2007 2006 2005 2004
-------- -------- -------- -------- --------
Commercial loans $ 46,250 $ 33,642 $ 26,950 $ 21,151 $ 17,911
Commercial leases 19,786 8,634 -- -- --
Real Estate
Construction 38,153 34,809 30,606 28,549 11,597
Residential 193,574 189,557 177,082 145,927 148,662
Commercial 67,455 55,752 53,318 42,145 33,655
Installment 5,113 6,520 7,168 4,334 6,315
Others 129 99 172 47 80
-------- -------- -------- -------- --------
Total Loans and Leases $370,460 $329,013 $295,296 $242,153 $218,220
======== ======== ======== ======== ========
The following table reflects the maturity and sensitivities of the Bank's loan
and lease portfolio at December 31, 2008.
(Dollar Amounts in Thousands)
After one Total
One Year year through Due after loans
or less five years five years and leases
-------- -------- -------- ----------
Commercial loans $ 24,172 $ 10,126 $ 11,952 $ 46,250
Commercial leases -- 15,949 3,837 19,786
Real Estate
Construction 21,927 4,207 12,019 38,153
Residential 56,932 36,681 99,961 193,574
Commercial 9,422 30,633 27,400 67,455
Installment 641 2,661 1,811 5,113
Others 129 -- -- 129
-------- -------- -------- --------
Total Loans and Leases $113,223 $100,257 $156,980 $370,460
======== ======== ======== ========
At December 31, 2008, loans maturing after one year included approximately:
$164,801,000 in fixed rate loans; and $92,436,000 in variable rate loans.
Investment Securities
The primary objectives of the Bank's investment policy are to provide a stable
source of interest income, to provide adequate liquidity necessary to meet short
and long-term changes in the mix of its assets and liabilities, to provide a
means to achieve goals set forth in the Bank's interest rate risk policy and to
provide a balance of quality and diversification to its assets. The
available-for-sale portion of the investment portfolio is expected to provide
funds when demand for acceptable loans and leases increases and is expected to
absorb funds when loan and lease demand decreases.
D-3
At December 31, 2008 the carrying value of the Bank's investment portfolio was
$113,502,751 or 21% of total assets. There were no Federal Funds Sold as of
December 31, 2008.
The table below presents the amortized cost and fair values of investment
securities held by the Bank at December 31, 2008, 2007 and 2006.
(Dollar Amounts in Thousands)
2008 2007 2006
-------------------- -------------------- --------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
-------- -------- -------- -------- -------- --------
Available-for-sale $113,246 $113,486 $130,145 $128,980 $150,895 $147,780
Held-to-maturity 17 17 34 34 41 40
-------- -------- -------- -------- -------- --------
$113,263 $113,503 $130,179 $129,014 $150,936 $147,820
======== ======== ======== ======== ======== ========
The following tables present the maturity distribution of investment securities
at December 31, 2008, and the weighted average yields of such securities. The
weighted average yields were calculated based on the amortized cost and
tax-effective yields to maturity of each security. The maturity distribution
shown below will differ from the contractual maturities because the issuer has
the ability to prepay or call the security.
(Dollar Amounts in Thousands)
Held-to-maturity
Over One Over Five Weighted
One Year Through Through Over Ten No Average
or Less Five Years Ten Years Years Maturity Total Yield
---------- ----------- ---------- ----------- ---------- ---------- ----------
Mortgage-Backed Securities $ -- $ -- $ -- $ -- $ 17 $ 17 2.02%
========== =========== ========== =========== ========== ========== ==========
Weighted Average Yield -- -- -- -- 2.02% 2.02%
========== =========== ========== =========== ========== ==========
Available-for-sale (1)
U.S. Treasury Securities $ -- $ 3,111 $ -- $ -- $ -- $ 3,111 2.34%
U.S. Government Agency Securities 22,500 4,000 -- -- -- 26,500 3.56%
State and Municipal Obligations -- -- 19,931 -- -- 19,931 6.02%
Trust Preferred Securities -- -- -- 493 -- 493 5.73%
Mortgage-Backed Securities -- -- -- -- 60,166 60,166 4.17%
Marketable Equity Securities 1,000 -- 2,000 -- 45 3,045 1.49%
---------- ----------- ---------- ----------- ---------- ----------
Total $ 23,500 $ 7,111 $ 21,931 $ 493 $ 60,211 $ 113,246 4.88%
========== =========== ========== =========== ========== ==========
Weighted Average Yield 3.98% 2.10% 5.84% 5.73% 4.17% 4.33%
========== =========== ========== =========== ========== ==========
Total Portfolio $ 23,500 $ 7,111 $ 21,931 $ 493 $ 60,228 $ 113,263 4.33%
========== =========== ========== =========== ========== ========== ==========
Total Weighted Average Yield 3.98% 2.10% 5.84% 5.73% 4.17% 4.33%
========== =========== ========== =========== ========== ==========
(1) Dollars shown at amortized cost amounts.
D-4
Deposits
The following table summarizes average deposits and interest rates of the Bank
for the years ended December 31, 2008, 2007 and 2006.
(Dollar Amounts in Thousands)
2008 2007 2006
-------------------------- -------------------------- ---------------------------
Average Average Average Average Average Average
Balance Rate Balance Rate Balance Rate
------------ ------------ ------------ ------------ ------------ -------------
Non-interest bearing
demand deposits $ 68,864 0.00% $ 68,278 0.00% $ 65,047 0.00%
Money market deposits 83,116 1.88% 75,832 2.96% 74,200 2.20%
Savings deposits 58,788 1.04% 55,026 1.37% 48,141 0.67%
Time deposits 132,813 3.69% 136,764 4.59% 115,559 4.05%
------------ ------------ ------------ ------------ ------------ -------------
$ 343,581 2.06% $ 335,900 2.76% $ 302,947 2.19%
============ ============ ============ ============ ============ =============
Fixed rate certificates of deposit in amounts of $100,000 or more at December
31, 2008 are scheduled to mature as follows:
(Dollar Amounts in Thousands)
- -------------------------------------------------
Three months or less $ 12,657
Over three, through six months 7,357
Over six, through twelve months 14,433
Over twelve months 6,557
------------
Total $ 41,004
============
Return on Equity and Assets
The following table summarizes various operating ratios of the Company for the
past two years:
2008 2007
-------------------
Return on average total
assets (net (loss) income divided by average total assets) (0.85)% 0.39%
Return on average shareholders' equity (net
(loss) income divided by average shareholders' equity) (17.10)% 7.25%
Equity to assets (average shareholders' equity as a
percent of average total assets) 4.98% 5.43%
Dividend payout ratio N/A 70.63%
Asset/Liability Management
A principal objective of the Bank is to reduce and manage the exposure of
changes in interest rates on its results of operations and to maintain an
approximate balance between the interest rate sensitivity of its assets and
liabilities within acceptable limits. While interest-rate risk is a normal part
of the commercial banking activity, the Bank desires to minimize its effect upon
operating results. Managing the rate sensitivity embedded in the balance sheet
can be accomplished in several ways. By managing the origination of new assets
and liabilities, or the rollover of the existing balance sheet assets,
D-5
incremental change towards the desired sensitivity position can be achieved.
Hedging activities, such as the use of interest rate caps, can be utilized to
create immediate change in the sensitivity position.
The Bank monitors the relationship between interest earning assets and interest
bearing liabilities by examining the extent to which such assets and liabilities
are "interest rate sensitive" and by monitoring the Bank's interest rate
sensitivity "gap". 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 interest rate sensitivity gap is defined as the difference between
the amount of interest-bearing liabilities maturing or repricing and the amount
of interest-earning assets maturing or repricing for the same period of time.
During a period of falling interest rates, a positive gap would tend to
adversely affect net interest income, while a negative gap would tend to
increase net interest income. During a period of rising interest rates, a
positive gap would tend to increase net interest income, while a negative gap
would tend to adversely affect net interest income.
The information presented in the interest sensitivity table is based upon a
combination of maturities, call provisions, repricing frequencies, prepayment
patterns and management judgment. The distribution of variable rate assets and
liabilities is based upon the repricing interval of the instrument. Management
estimates that less than 25% of savings products are sensitive to interest rate
changes based upon analysis of historic and industry data for these types of
accounts.
The following table summarizes the repricing schedule for the Bank's assets and
liabilities and provides an analysis of the Bank's periodic and cumulative GAP
positions.
(Dollar Amounts in Thousands)
As of December 31, 2008
Repriced Within
--------------------------------------------------
Under 3 4 to 12 1 to 5 Over 5
Months Months Years Years
--------- --------- --------- ---------
Securities available-for-sale $ 16,783 $ 33,756 $ 39,377 $ 23,330
Securities held-to-maturity -- 17 -- --
Loan and Lease Portfolio 107,636 84,384 141,657 36,783
Other -- -- -- 5,753
--------- --------- --------- ---------
Total interest earning assets 124,419 118,157 181,034 65,866
Interest-bearing liabilities
Money Market 93,085 -- -- --
Savings 8,521 -- -- 50,061
Time 35,061 62,931 24,119 --
--------- --------- --------- ---------
Total interest-bearing deposits 136,667 62,931 24,119 50,061
Borrowed funds 33,906 26,000 39,914 39,006
--------- --------- --------- ---------
Total interest-bearing liabilities 170,573 88,931 64,033 89,067
Periodic gap $ (46,154) $ 29,226 $ 117,001 $ (23,201)
========= ========= ========= =========
Cumulative gap $ (46,154) $ (16,928) $ 100,073 $ 76,872
========= ========= ========= =========
Cumulative gap as a percentage of
total earning assets (9.43)% (3.46)% 20.44% 15.70%
========= ========= ========= =========
D-6
Supervision and Regulation
The Bank is chartered under the National Bank Act and is subject to the
supervision of, and is regularly examined by, the Office of the Comptroller of
the Currency (the "OCC") and the Federal Deposit Insurance Corporation ("FDIC").
The Company is a bank holding company within the meaning of the Bank Holding
Company Act ("BHC Act"), is registered as such with and is subject to the
supervision of, and the Bank Holding Company laws, of the Federal Reserve Board
("FRB"). The Company, as a bank holding company, is also subject to the
Connecticut Bank Holding Company laws. In addition, the Company's securities are
registered pursuant to Section 12(g) of the Securities Exchange Act of 1934, as
amended (the "Exchange Act") and, therefore, is subject to rules and regulations
of the Securities and Exchange Commission (the "SEC"). Certain legislation and
regulations affecting the business of the Company and the Bank are discussed
below.
General
As a bank holding company, the Company is subject to the BHC Act. The Company
reports to, registers with, and is examined by the FRB. The FRB also has the
authority to examine the Company's subsidiaries, which includes the Bank.
The FRB requires the Company to maintain certain levels of capital. See "Capital
Standards" herein. The FRB also has the authority to take enforcement action
against any bank holding company that commits any unsafe or unsound practice,
violates certain laws, regulations, or conditions imposed in writing by the FRB.
See "Prompt Corrective Action and Other Enforcement Mechanisms" herein.
Under the BHC Act, a company generally must obtain the prior approval of the FRB
before it exercises a controlling influence over, or acquires, directly or
indirectly, more than 5% of the voting shares or substantially all of the assets
of, any bank or bank holding company. Thus, the Company is required to obtain
the prior approval of the FRB before it acquires merges or consolidates with any
bank, or bank holding company. Any company seeking to acquire, merge or
consolidate with the Company also would be required to obtain the FRB's
approval.
The FRB generally prohibits a bank holding company from declaring or paying a
cash dividend which would impose undue pressure on the capital of subsidiary
banks or would be funded only through borrowing or other arrangements that might
adversely affect a bank holding company's financial position. The FRB's policy
is that a bank holding company should not continue its existing rate of cash
dividends on its common stock unless its net income is sufficient to fully fund
each dividend and its prospective rate of earnings retention appears consistent
with its capital needs, asset quality and overall financial condition.
Transactions between the Company, the Bank and any future subsidiaries of the
Company are subject to a number of other restrictions. FRB policies forbid the
payment by bank subsidiaries of management fees, which are unreasonable in
amount or exceed the fair market value of the services rendered (or, if no
market exists, actual costs plus a reasonable profit). Additionally, a bank
holding company and its subsidiaries are prohibited from engaging in certain
tie-in arrangements in connection with the extension of credit, sale or lease of
property, or furnishing of services. Subject to certain limitations, depository
institution subsidiaries of bank holding companies may extend credit to, invest
in the securities of, purchase assets from, or issue a guarantee, acceptance, or
letter of credit on behalf of, an affiliate, provided that the aggregate of such
transactions with affiliates may
D-7
not exceed 10% of the capital stock and surplus of the institution, and the
aggregate of such transactions with all affiliates may not exceed 20% of the
capital stock and surplus of such institution. The Company may only borrow from
depository institution subsidiaries if the loan is secured by marketable
obligations with a value of a designated amount in excess of the loan. Further,
the Company may not sell a low-quality asset to a depository institution
subsidiary.
The Emergency Economic Stabilization Act of 2008 and the American Recovery and
Reinvestment Act of 2009 and programs thereunder in which the Company
participates, including the Capital Purchase Program ("CPP") of the Troubled
Asset Relief Program ("TARP") and the Temporary Liquidity Guarantee Program
("TLGP"), contain limitations on increasing dividends on the Common Stock during
the first three years of participation in the CPP and allow the U.S. Government
to unilaterally modify any term or provision of contracts executed under the
CPP. For discussion of these programs and the acts see "Recent Legislation and
Regulatory Initiatives to Address Difficult Market and Economic Conditions"
below.
Capital Standards
The FRB, OCC and other federal banking agencies have adopted risk-based minimum
capital adequacy guidelines intended to provide a measure of capital adequacy
that reflects the degree of risk associated with a banking organization's
operations for both transactions reported on the balance sheet as assets, and
transactions, such as letters of credit and recourse arrangements, which are
reported as off- balance sheet items. Under these guidelines, nominal dollar
amounts of assets and credit equivalent amounts of off-balance sheet items are
multiplied by one of several risk adjustment percentages, which range from 0%
for assets with low credit risk, such as certain U.S. government securities, to
100% for assets with relatively higher credit risk, such as business loans.
A banking organization's risk-based capital ratios are obtained by dividing its
qualifying capital by its total risk-adjusted assets and off-balance sheet
items. The regulators measure risk-adjusted assets and off-balance sheet items
against both total qualifying capital (the sum of Tier 1 capital and limited
amounts of Tier 2 capital) and Tier 1 capital. Tier 1 capital consists of common
stock, retained earnings, noncumulative perpetual preferred stock and minority
interests in certain subsidiaries, less most other intangible assets. Trust
preferred securities are currently considered regulatory capital for purposes of
determining the Company's Tier I capital ratios. Tier 2 capital may consist of
limited amounts of the allowance for loan and lease losses, unrealized gains on
equity securities and certain other instruments with some characteristics of
equity. The inclusion of elements of Tier 2 capital are subject to certain other
requirements and limitations of the federal banking agencies. The federal
banking agencies require a minimum ratio of qualifying total capital to
risk-adjusted assets and off-balance sheet items of 8%, and a minimum ratio of
Tier 1 capital to risk-adjusted assets and off-balance sheet items of 4%.
In addition to the risk-based guidelines, federal banking regulators require
banking organizations to maintain a minimum amount of Tier 1 capital to total
assets, referred to as the leverage ratio. For a banking organization rated in
the highest of the five categories used by regulators to rate banking
organizations, the minimum leverage ratio of Tier 1 capital to total assets is
3%. It is improbable; however, that an institution with a 3% leverage ratio
would receive the highest rating by the regulators since a strong capital
position is a significant part of the regulators' rating. For all banking
organizations not rated in the highest category, the minimum leverage ratio is
at least 100 to 200 basis points above the 3% minimum. Thus, the effective
minimum leverage ratio, for all practical purposes, is at least 4% or 5%. In
addition to these uniform risk-based capital guidelines and leverage ratios that
apply across the industry, the regulators have the discretion to set individual
minimum capital requirements for specific institutions at rates significantly
above the minimum guidelines and ratios.
D-8
The following table presents the capital ratios for the Company and the Bank as
of December 31, 2008:
Minimum
The Company's The Bank's Regulatory
Ratio Ratio Capital Level
----- ----- -------------
RISK-BASED CAPITAL RATIO:
Total Capital 11.74% 9.43% 8%
Tier 1 Capital 10.74% 8.43% 4%
TIER 1 LEVERAGE CAPITAL RATIO: 7.85% 6.10% 4%
Prompt Corrective Action and Other Enforcement Mechanisms
Each federal banking agency is required to take prompt corrective action to
resolve the problems of insured depository institutions, including but not
limited to those that fall below one or more of the prescribed minimum capital
ratios. The law requires each federal banking agency to promulgate regulations
defining the following five categories in which an insured depository
institution will be placed, based on the level of its capital ratios:
well-capitalized, adequately capitalized, undercapitalized, significantly
undercapitalized and critically undercapitalized.
An insured depository institution generally is classified in the following
categories based on capital measures indicated below:
"Well-Capitalized":
Total risk-based capital of 10% or more; Tier 1
risk-based ratio capital of 6% or more; and Leverage
ratio of 5% or more.
"Adequately Capitalized":
Total risk-based capital of at least 8%; Tier 1
risk-based capital of at least 4%; and Leverage ratio
of at least 4%.
"Undercapitalized":
Total risk-based capital less than 8% Tier 1
risk-based capital less than 4%; or Leverage ratio
less than 4%.
"Significantly Undercapitalized":
Total risk-based capital less than 6% Tier 1
risk-based capital less than 3%; or Leverage ratio
less than 3%.
"Critically Undercapitalized":
Tangible equity to total assets less than 2%.
D-9
Due to the increased provision for loan and lease losses and the OTTI losses
(see Item 7, Management's Discussion and Analysis of Financial Condition and
Results of Operations and Note Q of the Financial Statements), with the
exception of the total risk-based capital ratio, as of December 31, 2008, the
Bank is classified as "well-capitalized" under the above guidelines. An
institution that, based upon its capital levels, is classified as
well-capitalized, adequately capitalized, or undercapitalized may be treated as
though it were in the next lower capital category if the appropriate federal
banking agency, after notice and opportunity for hearing, determines that an
unsafe or unsound condition or an unsafe or unsound practice warrants such
treatment. At each successive lower capital category, an insured depository
institution is subject to more restrictions. The federal banking agencies,
however, may not treat an institution as "critically undercapitalized" unless
its capital ratio actually warrants such treatment. If an insured depository
institution is undercapitalized, it will be closely monitored by the appropriate
federal banking agency. Undercapitalized institutions must submit an acceptable
capital restoration plan with a guarantee of performance issued by the holding
company. Further restrictions and sanctions are required to be imposed on
insured depository institutions that are critically undercapitalized. The most
important additional measure is that the appropriate federal banking agency is
required to either appoint a receiver for the institution within 90 days or
obtain the concurrence of the FDIC in another form of action. In addition to
measures taken under the prompt corrective action provisions, commercial banking
organizations may be subject to potential enforcement actions by the federal
regulators for unsafe or unsound practices in conducting their businesses or for
violations of any law, rule, regulation or any condition imposed in writing by
the agency or any written agreement with the agency. Enforcement actions may
include the imposition of a conservator or receiver, the issuance of a
cease-and-desist order that can be judicially enforced, the termination of
insurance of deposits (in the case of a depository institution), the imposition
of civil money penalties, the issuance of directives to increase capital, the
issuance of formal and informal agreements, the issuance of removal and
prohibition orders against institution-affiliated parties and the enforcement of
such actions through injunctions or restraining orders based upon a prima facie
showing by the agency that such relief is appropriate. Additionally, a holding
company's inability to serve as a source of strength to its subsidiary banking
organizations could serve as an additional basis for a regulatory action against
the holding company.
Safety and Soundness Standards
The federal banking agencies have established safety and soundness standards for
insured financial institutions covering: (1) internal controls, information
systems and internal audit systems; (2) loan and lease documentation; (3) credit
underwriting; (4) interest rate exposure; (5) asset growth; (6) compensation,
fees and benefits; (7) asset quality and earnings; (8) excessive compensation
for executive officers, directors or principal shareholders which could lead to
material financial loss; and (9) information security standards. If an agency
determines that an institution fails to meet any standard established by the
guidelines, the agency may require the financial institution to submit to the
agency an acceptable plan to achieve compliance with the standard. These
guidelines also set forth standards for evaluating and monitoring earnings and
for ensuring that earnings are sufficient for the maintenance of adequate
capital and reserves. If the agency requires submission of a compliance plan and
the institution fails to timely submit an acceptable plan or to implement an
accepted plan, the agency must require the institution to correct the
deficiency.
Restrictions on Dividends and Other Distributions
The power of the board of directors of an insured depository institution to
declare a cash dividend or other distribution with respect to capital is subject
to statutory and regulatory restrictions which limit the amount available for
such distribution depending upon the earnings, financial condition and cash
needs
D-10
of the institution, as well as general business conditions. Federal Law
prohibits insured depository institutions from paying management fees to any
controlling persons or, with certain limited exceptions, making capital
distributions, including dividends, if, after such transaction, the institution
would be undercapitalized.
The Company's ability to pay dividends depends in large part on the ability of
the Bank to pay dividends to the Company. The ability of the Bank to pay
dividends is subject to restrictions set forth in the National Banking Act and
regulations of the OCC. See "Market Price for Registrant's Common Equity,
Related Stockholder Matters and Issuer Purchases of Equity Securities" herein.
In addition, provided the Preferred Stock issued to the Treasury, described in
Note L to Consolidated Financial Statements, is held by the Treasury, the Common
Stock dividend may not be increased without the consent of the Treasury for
three (3) years from the date of the investment by the Treasury. On February 24,
2009 and March 27, 2009, the Federal Reserve Board issued supervisory guidance
to all bank holding companies regarding the payment of dividends as well as
stock redemptions and repurchases by bank holding companies. Such guidance
expressed the view that the Board of Directors should ensure that dividends are
prudent relative to the financial position of the institution and that a bank
holding company should inform the FRB in advance of declaring a dividend that
exceeds earnings for the period or that could result in a material adverse
change to an organization's capital structure. The supervisory guidance further
stated that dividends should be eliminated, deferred, or limited if net income
from the past four quarters is not sufficient to fund the dividend or if
prospective earnings retention is not consistent with capital needs or the
condition and future prospects of the institution or if the bank holding company
is in danger of not meeting minimum regulatory capital returns.
Additionally, a bank may not make any capital distribution, including the
payment of dividends, if, after making such distribution, the bank would be in
any of the "under-capitalized" categories under the OCC's Prompt Corrective
Action regulations. Regulation Y requires bank holding companies to provide the
FRB with written notice before purchasing or redeeming equity securities if the
gross consideration for the purchase or redemption, when aggregated with the net
consideration paid by the Company for all such purchases or redemptions during
the preceding twelve (12) months, is equal to ten percent (10%) or more of the
Company's consolidated net worth. For purposes of Regulation Y, "net
consideration" is the gross consideration paid by a company for all of its
equity securities purchased or redeemed during the period, minus the gross
consideration received for all of its equity securities sold during the period
other than as part of a new issue. However, a bank holding company generally
need not obtain FRB approval of any equity security redemption when: (i) the
bank holding company's capital ratios exceed the threshold established for
"well-capitalized" state member banks before and immediately after the
redemption; (ii) the bank holding company is well-managed; and (iii) the bank
holding company is not the subject of any unresolved supervisory issues.
However, letters issued by the FRB to the industry dated February 24, 2009 and
March 27, 2009 advise bank holding companies to inform the FRB of proposed stock
repurchases resulting in a net reduction of common or preferred stock below the
amount of such instrument outstanding at the beginning of the quarter in which
the repurchase occurs. In addition, as a recipient of TARP CPP funds, the
Company must communicate with the Treasury as well as the FRB in advance of any
stock redemptions. Generally, during the first three years the Company
participates in the TARP CPP, the approval of the Treasury will be required
before the Company could repurchase any common stock. The Company may redeem the
TARP CPP Preferred Stock at any time in consultation with the Treasury and its
primary supervisory agencies.
The OCC also has the authority to prohibit the Bank from engaging in business
practices which the OCC considers to be unsafe or unsound. It is possible,
depending upon the financial condition of a bank and other factors, that the OCC
could assert that the payment of dividends or other payments in some
circumstances might be such an unsafe or unsound practice and thereby prohibit
such payment.
D-11
FDIC Insurance
The Bank's deposits are insured under the Federal Deposit Insurance Act up to
maximum limits by the Deposit Insurance Fund (DIF) and are subject to deposit
insurance assessments.
Congress has temporarily increased FDIC deposit insurance from $100,000 to
$250,000 per depositor through December 31, 2009. Effective April 1, 2006, the
federal deposit insurance limits on certain retirement accounts increased so
that such retirement accounts are separately insured up to $250,000. In
addition, the Bank participates in the TLGP, whereby non-interest bearing
checking accounts and NOW accounts with interest rates no higher than 0.50 %
will be FDIC insured in full.
FDIC insurance of deposits may be terminated by the FDIC, after notice and a
hearing, upon a finding by the FDIC that the insured institution has engaged in
unsafe or unsound practices, or is in an unsafe or unsound condition to continue
operations, or has violated any applicable law, regulation, rule or order of, or
condition imposed by the FDIC. A bank's failure to meet the minimum capital and
risk-based capital guidelines discussed below would be considered to be unsafe
and unsound banking practices. The Bank, as a nationally-chartered FDIC-insured
bank, is regulated by the OCC. The OCC also conducts its own periodic
examinations of the Bank, and the Bank is required to submit financial and other
reports to the OCC on a quarterly and annual basis, or as otherwise required by
the OCC. FDIC-insured banks, such as the Bank, pay premium assessments to the
FDIC for the insurance of deposits.
A few years ago, the FDIC adopted a risk-based insurance assessment system
designed to tie what banks pay for deposit insurance more closely to the risks
they pose. The FDIC also adopted a schedule of rates that the FDIC could adjust
up or down, depending on the needs of the DIF.
Recently, the FDIC adopted a restoration plan that would increase the reserve
ratio to the 1.15% threshold within seven years. As part of that plan, in
December, 2008, the FDIC voted to increase risk-based assessment rates due to
deteriorating financial conditions in the banking industry. Changes to the
risk-based assessment system include increasing premiums for institutions that
rely on excessive amounts of brokered deposits, including CDARS, increasing
premiums for excessive use of secured liabilities, including Federal Home Loan
Bank advances, lowering premiums for smaller institutions with very high capital
levels, and adding financial ratios and debt issuer ratings to the premium
calculations for banks with over $10 billion in assets, while providing a
reduction for their unsecured debt. It is generally expected that rates will
continue to increase in the near future due to the significant cost of bank
failures beginning in the third quarter of 2008 and the increase in the number
of troubled banks. The FDIC recently announced that, in view of the significant
decrease in the deposit insurance funds reserves, it will impose a special
assessment in the second quarter of 2009. Banks must continue to pay base
premium rates on top of any special assessment. Furthermore, banks may be
subject to an "emergency" special assessment in 2009 in addition to other
special assessments and regular premium rates. The amount of an emergency
special assessment imposed on a bank will be determined by the FDIC if such
amount is necessary to provide sufficient assessment income to repay amounts
borrowed from the U.S. Department of Treasury (Treasury); to provide sufficient
assessment income to repay obligations issued to and other amounts borrowed from
insured depository institutions; or for any other purpose the FDIC may deem
necessary.
Inter-Company Borrowings
Bank holding companies are also restricted as to the extent to which they and
their subsidiaries can borrow or otherwise obtain credit from one another or
engage in certain other transactions. The "covered transactions" that an insured
depository institution and its subsidiaries are permitted to engage in with
their nondepository affiliates are limited to the following amounts: (1) in the
case of any one
D-12
such affiliate, the aggregate amount of covered transactions of the insured
depository institution and its subsidiaries cannot exceed 10% of the capital
stock and the surplus of the insured depository institution; and (2) in the case
of all affiliates, the aggregate amount of covered transactions of the insured
depository institution and its subsidiaries cannot exceed 20% of the capital
stock and surplus of the insured depository institution. In addition, extensions
of credit that constitute covered transactions must be collateralized in
prescribed amounts. "Covered transactions" are defined by statute to include a
loan or extension of credit to the affiliate, a purchase of securities issued by
an affiliate, a purchase of assets from the affiliate (unless otherwise exempted
by the FRB), the acceptance of securities issued by the affiliate as collateral
for a loan and the issuance of a guarantee, acceptance, or letter of credit for
the benefit of an affiliate. Further, a bank holding company and its
subsidiaries are prohibited from engaging in certain tie-in arrangements in
connection with any extension of credit, lease or sale of property or furnishing
of services.
Effects of Government Policy
Legislation adopted in recent years has substantially increased the scope of
regulations applicable to the Bank and the Company and the scope of regulatory
supervisory authority and enforcement power over the Bank and the Company.
Virtually every aspect of the Bank's business is subject to regulation with
respect to such matters as the amount of reserves that must be established
against various deposits, the establishment of branches, reorganizations,
nonbanking activities and other operations. Numerous laws and regulations also
set forth special restrictions and procedural requirements with respect to the
extension of credit, credit practices, the disclosure of credit terms and
discrimination in credit transactions.
The descriptions of the statutory provisions and regulations applicable to banks
and bank holding companies set forth above do not purport to be a complete
description of such statutes and regulations and their effects on the Bank and
the Company. Proposals to change the laws and regulations governing the banking
industry are frequently introduced in Congress, in the state legislatures and
before the various bank regulatory agencies. The likelihood and timing of any
changes and the impact such changes might have on the Bank and the Company are
difficult to determine.
Gramm-Leach-Bliley Financial Services Modernization Act of 1999
The Gramm-Leach-Bliley Financial Services Modernization Act of 1999 provides
bank holding companies, banks, securities firms, insurance companies, and
investment management firms the option of engaging in a broad range of financial
and related activities by opting to become a "financial holding company." These
holding companies are subject to oversight by the FRB, in addition to other
regulatory agencies. Under the financial holding company structure, financial
institutions have the ability to purchase or establish broker/dealer
subsidiaries, as well as the option to purchase insurance companies.
Additionally, securities and insurance firms are permitted to purchase
full-service banks.
As a general rule, the individual entities within a financial holding company
structure are regulated according to the type of services provided which is
referred to as functional regulation. Under this approach, a financial holding
company with banking, securities, and insurance subsidiaries will have to
interact with several regulatory agencies (e.g., appropriate banking agency,
SEC, state insurance commissioner).
While the Act facilitates the ability of financial institutions to offer a wide
range of financial services, large financial institutions appear to be the
primary beneficiaries as a result of this Act because many community banks are
less able to devote the capital and management resources needed to facilitate
D-13
broad expansion of financial services. The Company has no current plans to
operate within a financial holding company structure.
The Sarbanes-Oxley Act of 2002
The purpose of the Sarbanes-Oxley Act is to protect investors by improving the
accuracy and reliability of corporate disclosures made pursuant to the
securities laws, and for other purposes.
The Sarbanes-Oxley Act amends the Exchange Act to prohibit a registered public
accounting firm from performing specified nonaudit services contemporaneously
with a mandatory audit. The Sarbanes-Oxley Act also vests the audit committee of
an issuer with responsibility for the appointment, compensation, and oversight
of any registered public accounting firm employed to perform audit services. It
requires each committee member to be a member of the board of directors of the
issuer, and to be otherwise independent. The Sarbanes-Oxley Act further requires
the chief executive officer and chief financial officer of an issuer to make
certain certifications as to each annual or quarterly report.
In addition, the Sarbanes-Oxley Act requires officers to forfeit certain bonuses
and profits under certain circumstances. Specifically, if an issuer is required
to prepare an accounting restatement due to the material noncompliance of the
issuer as a result of misconduct with any financial reporting requirements under
the securities laws, the chief executive officer and chief financial officer of
the issuer shall be required to reimburse the issuer for (1) any bonus or other
incentive-based or equity based compensation received by that person from the
issuer during the 12-month period following the first public issuance or filing
with the SEC of the financial document embodying such financial reporting
requirement; and (2) any profits realized from the sale of securities of the
issuer during that 12-month period.
Pursuant to the Sarbanes-Oxley Act, the SEC has adopted rules to require:
o disclosure of all material off-balance sheet transactions and
relationship that may have a material effect upon the financial status
of an issuer; and
o the presentation of pro forma financial information in a manner that is
not misleading, and which is reconcilable with the financial condition
of the issuer under generally accepted accounting principles.
The Sarbanes-Oxley Act, among other things, also provides for mandated internal
control report and assessment with the annual report and an attestation and a
report on such report by the Company's auditor. In accordance with the
requirements of Section 404, Management's report on internal controls is
included herein at Item 9A(T). The SEC has delayed until fiscal years ending
after December 15, 2009 the auditor's attestation report on internal controls
over financial reporting. The SEC also requires an issuer to institute a code of
ethics for senior financial officers of the Company.
The USA Patriot Act
On October 26, 2001, President Bush signed into law The Uniting and
Strengthening America by Providing Appropriate Tools Required to Intercept and
Obstruct Terrorism Act of 2001 (the "Patriot Act"). On March 10, 2006, the
President signed legislation making permanent certain provisions of the Patriot
Act. The terrorist attacks in September, 2001 have impacted the financial
services industry and led to federal legislation that addresses certain issues
involving financial institutions. Part of the Patriot Act is the International
Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 ("IMLA").
IMLA authorizes the Secretary of the Treasury, in consultation with the heads of
other government agencies, to adopt special measures applicable to banks, bank
holding companies, and other
D-14
financial institutions. These measures may include enhanced recordkeeping and
reporting requirements for certain financial transactions that are of primary
money laundering concern, due diligence requirements concerning the beneficial
ownership of certain types of accounts, and restrictions or prohibitions on
certain types of accounts with foreign financial institutions.
Among its other provisions, IMLA requires each financial institution to: (i)
establish an anti-money laundering program; (ii) establish due diligence
policies, procedures and controls with respect to its private banking accounts
and correspondent banking accounts involving foreign individuals and certain
foreign banks; and (iii) avoid establishing, maintaining, administering, or
managing correspondent accounts in the United States for, or on behalf of, a
foreign bank that does not have a physical presence in any country. In addition,
IMLA contains a provision encouraging cooperation among financial institutions,
regulatory authorities and law enforcement authorities with respect to
individuals, entities and organizations engaged in, or reasonably suspected of
engaging in, terrorist acts or money laundering activities. IMLA expands the
circumstances under which funds in a bank account may be forfeited and requires
covered financial institutions to respond under certain circumstances to
requests for information from federal banking agencies within 120 hours. IMLA
also amends the BHCA and the Bank Merger Act to require the federal banking
agencies to consider the effectiveness of a financial institution's anti-money
laundering activities when reviewing an application under these acts. The Bank
has implemented policies and procedures to address the requirements of the
Patriot Act and IMLA.
Recent Legislative and Regulatory Initiatives to Address Difficult Market and
Economic Conditions
On October 3, 2008, President Bush signed into law the Emergency Economic
Stabilization Act of 2008 (EESA), which, among other measures, authorizes the
Treasury to purchase from financial institutions and their holding companies up
to $700 billion in mortgage loans, mortgage-related securities and certain other
financial instruments, including debt and equity securities issued by financial
institutions and their holding companies, under the TARP CPP. The purpose of
TARP CPP is to restore confidence and stability to the U.S. banking system and
to encourage financial institutions to increase their lending to customers and
to each other. Under the TARP CPP, the Treasury is purchasing equity securities
from participating institutions. The Series A Preferred Stock and warrant
offered by this prospectus were issued by the Company to the Treasury pursuant
to the TARP CPP. The EESA also increased federal deposit insurance on most
deposit accounts from $100,000 to $250,000. This increase is in place until the
end of 2009 and is not covered by deposit insurance premiums paid by the banking
industry.
The EESA followed, and has been followed by, numerous actions by the FRB, the
U.S. Congress, the Treasury, the FDIC, the SEC and others to address the current
liquidity and credit crisis that has followed the sub-prime meltdown that
commenced in 2007. These measures include homeowner relief that encourage loan
restructuring and modification; the establishment of significant liquidity and
credit facilities for financial institutions and investment banks; the lowering
of the federal funds rate; emergency action against short selling practices; a
temporary guaranty program for money market funds; the establishment of a
commercial paper funding facility to provide back-stop liquidity to commercial
paper issuers; and coordinated international efforts to address illiquidity and
other weaknesses in the banking sector.
On February 17, 2009, the American Recovery and Reinvestment Act of 2009
("ARRA") was signed into law. The ARRA, more commonly known as the economic
stimulus bill or economic recovery package, is intended to stimulate the economy
and provides for broad infrastructure, education and health spending.
D-15
As discussed above, on October 14, 2008, the FDIC announced the establishment of
a temporary liquidity guarantee program to provide full deposit insurance for
all non-interest bearing transaction accounts and guarantees of certain newly
issued senior unsecured debt issued by FDIC-insured institutions and their
holding companies. Insured institutions were automatically covered by this
program from October 14, 2008 until December 5, 2008, unless they opted out
prior to that date. Under the program, the FDIC will guarantee timely payment of
newly issued senior unsecured debt issued on or before June 30, 2009. The debt
includes all newly issued unsecured senior debt including promissory notes,
commercial paper and inter-bank funding. The aggregate coverage for an
institution may not exceed 125% of its debt outstanding on September 30, 2008
that was scheduled to mature before June 30, 2009, or, for certain insured
institutions, 2% of liabilities as of September 30, 2008. The guarantee will
extend to June 30, 2012 even if the maturity of the debt is after that date.
The purpose of these legislative and regulatory actions is to stabilize the U.S.
banking system. The EESA, the ARRA and the other regulatory initiatives
described above may not have their desired effects. If the volatility in the
markets continues and economic conditions fail to improve or worsen, the
Company's business, financial condition, results of operations and cash flows
could be materially and adversely affected.
The Securities Purchase Agreement Between the Company and the Treasury Permits
the Treasury to Impose Certain Additional Restrictions on the Company so long as
the Company Participates in the TARP CPP
The securities purchase agreement the Company entered into with the Treasury in
connection with the Bank's participation in the TARP CPP permits the Treasury to
unilaterally amend the terms of the securities purchase agreement to comply with
any changes in federal statutes after the date of its execution. The ARRA
imposed additional executive compensation and expenditure limits on all current
and future TARP recipients, including the Company, until the Company has repaid
the Treasury. These additional restrictions may impede the Company's ability to
attract and retain qualified executive officers. The ARRA also permits TARP
recipients to repay the Treasury without penalty or requirement that additional
capital be raised, subject to the Treasury's consultation with the Company's
primary federal regulator while the securities purchase agreement required that,
for a period of three years, the Series A Preferred Stock could generally only
be repaid if the Company raised additional capital to repay the securities and
such capital qualified as Tier 1 capital. Additional unilateral changes in the
securities purchase agreement could have a negative impact on the Company's
financial condition and results of operations.
Impact of Monetary Policies
Banking is a business which depends on interest rate differentials. In general,
the difference between the interest paid by a bank on its deposits and other
borrowings and the interest rate earned by a bank on loans and leases,
securities and other interest-earning assets comprises the major source of
banks' earnings. Thus, the earnings and growth of banks are subject to the
influence of economic conditions generally, both domestic and foreign, and also
to the monetary and fiscal policies of the United States and its agencies,
particularly the FRB. The FRB implements national monetary policy, such as
seeking to curb inflation and combat recession, by its open-market dealings in
United States government securities, by adjusting the required level of reserves
for financial institutions subject to reserve requirements and through
adjustments to the discount rate applicable to borrowings by banks which are
members of the FRB. The actions of the FRB in these areas influence the growth
of bank loans and leases, investments and deposits and also affect interest
rates. The nature and timing of any future changes in such policies and their
impact on the Company cannot be predicted. In addition, adverse
D-16
economic conditions could make a higher provision for loan and lease losses a
prudent course and could cause higher loan and lease loss charge-offs, thus
adversely affecting the Bank's net earnings.
Employees
The Company, the Bank and its subsidiaries employ 112 full-time employees and 10
part-time employees. Neither the Company nor the Bank are parties to any
collective bargaining agreements, and employee relations are considered good.
Forward Looking Statements
This Form 10-K and future filings made by the Company with the SEC, as well as
other filings, reports and press releases made or issued by the Company and the
Bank, and oral statements made by executive officers of the Company and Bank,
may include forward-looking statements relating to such matters as (a)
assumptions concerning future economic and business conditions and their effect
on the economy in general and on the markets in which the Company and the Bank
do business, and (b) expectations for increased revenues and earnings for the
Company and Bank through growth resulting from acquisitions, attraction of new
deposit and loan and lease customers and the introduction of new products and
services. Such forward-looking statements are based on assumptions rather than
historical or current facts and, therefore, are inherently uncertain and subject
to risk. For those statements, the Company claims the protection of the safe
harbor for forward-looking statements contained in the Private Securities
Litigation Reform Act of 1995.
The Company notes that a variety of factors could cause the actual results or
experience to differ materially from the anticipated results or other
expectations described or implied by such forward-looking statements. The risks
and uncertainties that may affect the operations, performance, development and
results of the Company's and Bank's business include the following: (a) the risk
of adverse changes in business conditions in the banking industry generally and
in the specific markets in which the Bank operates; (b) changes in the
legislative and regulatory environment that negatively impact the Company and
Bank through increased operating expenses; (c) increased competition from other
financial and non-financial institutions (d) the impact of technological
advances; and (e) other risks detailed from time to time in the Company's
filings with the SEC.
Such developments could have an adverse impact on the Company's financial
position and results of operation.
Availability of Financial Information
The Company files reports with the SEC. Those reports include the annual report
on Form 10-K, quarterly reports on Form 10-Q, current event reports on Form 8-K
and proxy statements, as well as any amendments to those reports. The public may
read and copy any materials that the Company files with the SEC at the SEC's
Public Reference Room at 100 F Street, N.E., Washington, DC 20549. The public
may obtain information on the operation of the Public Reference Room by calling
the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains
quarterly and annual reports, proxy and information statements, and other
information regarding issuers that file electronically with the SEC at
http://www.sec.gov. The Company's website address is: www.fnbl.com.
ITEM 2. PROPERTIES
The Company is not the owner or lessee of any properties. The properties
described below are properties owned or leased by the Bank.
D-17
The Bank's main office is located at 13 North Street, Litchfield, Connecticut.
In addition to the Bank's main office in Litchfield, the Bank has branches in
Marble Dale, Washington Depot, Goshen, Canton, New Milford, Roxbury and
Torrington, Connecticut.
During the year ended December 31, 2008, the net rental expenses paid by the
Bank for all of its office properties was approximately $240,000. All properties
are considered to be in good condition and adequate for the purposes for which
they are used. The following table outlines all owned or leased property of the
Bank.
Owned Lease
Location Address Leased Expiration
-------- ------- ------ ----------
Main Office 13 North Street Owned since 1816
Litchfield, CT
Marble Dale Route 202 Leased 2009
Marble Dale, CT
Washington Depot Bryan Plaza Owned since 1959
Washington Depot, CT
Goshen Routes 4 & 63 Owned since 1989
Goshen, CT
Roxbury Route 67 Leased 2009 with one 5-year
Roxbury, CT extension
New Milford Route 202 Leased 2016 with one 10-year
New Milford, CT extension
Torrington 1057 Torringford Street Leased 2026 with option
Torrington, CT to purchase
Canton 188 Albany Turnpike Owned since 2005
Canton, CT
Trust Department 40 West Street Owned since 1996
Old Borough Firehouse
Litchfield, CT
Torrington, North 397 Main Street Owned since 2007
Torrington, CT
Finance Department 29 West Street Leased 2009 with one 3-year
Litchfield, CT extension
ITEM 3. LEGAL PROCEEDINGS
Neither the Company nor the Bank (or any of their properties) are the subject of
any material pending legal proceedings other than routine litigation that is
incidental to their business.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
D-18
Market Price
The Company's Common Stock is traded on the Over the Counter ("OTC") Bulletin
Board under the symbol FLFL.OB. As of April 14, 2009, there were 2,506,622
shares issued and 2,356,875 shares outstanding, which were held by approximately
403 shareholders.
The following information, provided by Oppenheimer and Co., sets forth
transactions in the Company's Common Stock in each quarter of the two most
recently completed fiscal years:
2007 High/Low
---------------
First Quarter................ $21.85 $ 19.10
Second Quarter............. 20.40 18.60
Third Quarter............... 19.00 13.50
Fourth Quarter.............. 16.95 14.99
2008 High/Low
---------------
First Quarter................ $16.40 $ 13.25
Second Quarter............. 14.25 11.50
Third Quarter............... 13.00 10.60
Fourth Quarter.............. 11.00 5.25
On September 20, 2007, the Company approved a stock repurchase program to
acquire in the next twelve months up to an aggregate of 30,000 shares of the
Company's outstanding Common Stock. Pursuant to the repurchase program, shares
purchased during 2007 and 2008 totaled 8,263 and 16,718, respectively. The
repurchase program expired in September 2008 and was not renewed. The Company is
prohibited from repurchasing any shares of Common Stock pursuant to terms of the
CPP in which the Company participates, during the first three years of
participation.
Dividends
All shares of the Company's Common Stock are entitled to participate equally and
ratably in such dividends as may be declared by the Board of Directors out of
funds legally available therefore. During 2007 and 2008, the Company declared
cash dividends of 60 cents per share. During 2007 the Company declared stock
dividends of 5.00%. There were no stock dividends declared for the year ended
December 31, 2008. At their March 26, 2009 meeting, the Company's Board of
Directors declared a quarterly cash dividend of five cents per share, a
reduction from prior quarters in which the Company paid quarterly cash dividends
of fifteen cents per share.
The Company is prohibited from increasing the quarterly common stock dividend
above $.15 per share without the consent of the U. S. Treasury until the third
anniversary of the date of the investment, or December 12, 2011, unless prior to
such third anniversary the senior preferred stock is redeemed in whole or the U.
S. Treasury has transferred all of the senior preferred stock to third parties.
The Company's ability to pay dividends is limited by the prudent banking
principles applicable to all bank holding companies and by the provisions of
Delaware Corporate law, which provides that a company may, unless otherwise
restricted by its certificate of incorporation, pay dividends in cash, property
or shares of capital stock out of surplus or, if no surplus exists, out of net
profits for the fiscal year in which declared or out of net profits for the
preceding fiscal year (provided that such payment will not reduce the company's
capital below the amount of capital represented by classes of stock having a
preference upon distributions of assets).
D-19
As a practical matter, the Company's ability to pay dividends is generally
limited by the Bank's ability to dividend funds to the Company. As a national
bank, the declaration and payment of dividends by the Bank must be in accordance
with the National Bank Act. More specifically, applicable law provides that the
Board of Directors may declare quarterly, semiannual and annual dividends so
long as the Bank carries at least ten percent (10%) of its net profits for the
preceding half year in its surplus fund, and, in the case of annual dividends,
has carried not less than one-tenth of its net profits of the preceding two
consecutive half year periods in its surplus fund. National banks are required
to obtain the approval of the OCC if the total dividends declared by it in any
calendar year exceed the total of its net profits for that year combined with
any retained net profits of the preceding two years less any required transfers.
In addition to such statutory requirements, the payment of an excessive dividend
which would deplete a bank's capital base to an inadequate level could be
considered to be an unsafe or unsound banking practice and be a basis for
supervisory action by the OCC. Due to the earnings performance in 2008 there was
no undistributed net income of the Bank available for distribution to the
Company as dividends. However, the ability of the Bank to declare and pay such
dividends would be subject to safe and sound banking practices.
Recent Sales of Unregistered Securities
On December 12, 2008 the Company issued Fixed-Rate Cumulative Perpetual
Preferred Stock to the Treasury for $10 million in a private placement exempt
from registration. EESA authorized the U. S. Treasury to appropriate funds to
eligible financial institutions participating in the TARP CPP. The capital
investment included the issuance of preferred shares of the Company and a
warrant to purchase common shares pursuant to a Letter Agreement and a
Securities Purchase Agreement (collectively "the Agreement"). The dividend rate
of 5% increases to 9% after the first five years. Dividend payments are made on
the 15th day of February, May, August and November of each year. The warrant
allows the holder to purchase up to 199,203 shares of the Company's common stock
over a 10-year period at an exercise price per share of $7.53. The preferred
shares and the warrant qualify as Tier 1 regulatory capital. The Agreement
subjects the Company to certain restrictions and conditions including those
related to common dividends, share repurchases, executive compensation, and
corporate governance.
The Company recorded the total $10 million of the preferred shares and the
warrant at their relative fair values of $9,716,000 and $284,000, respectively.
The difference from the par amount of the preferred shares is accreted to
preferred stock over five years using the interest method with a corresponding
adjustment to preferred dividends.
The Company cannot increase the quarterly common stock dividend above $.15 per
share without the consent of the Treasury until the third anniversary of the
date of the investment, or December 12, 2011, unless prior to such third
anniversary the senior preferred stock is redeemed in whole or the Treasury has
transferred all of the senior preferred stock to third parties.
There have been no other sales of unregistered securities in the period covered
by this report.
Securities Authorized for Issuance under Equity Compensation Plans
The following schedule provides information with respect to compensation plans
under which equity securities are authorized for issuance as of December 31,
2008:
D-20
Equity Compensation Plan Information
- ------------------------------------------------------------------------------------------------------------------------
Number of
securities to be
issued upon Number of securities
exercise of remaining available for
outstanding future issuance under equity
options, Weighted average exercise compensation plans
Plan Category warrants and price of outstanding options, (excluding securities
rights warrants and rights reflected in Column (a))
- ------------------------------------------------------------------------------------------------------------------------
(a) (b) (c)
- ------------------------------------------------------------------------------------------------------------------------
Equity compensation plans approved 5,434 $11.93 21,500
by shareholders
- ------------------------------------------------------------------------------------------------------------------------
Equity compensation plans not N/A N/A N/A
approved by shareholders
- ------------------------------------------------------------------------------------------------------------------------
Total 5,434 $11.93 21,500
- ------------------------------------------------------------------------------------------------------------------------
ITEM 6. SELECTED FINANCIAL DATA
The selected consolidated financial data set forth below should be read in
conjunction with "Management's Discussion and Analysis of Financial Condition
and Results of Operations," the audited consolidated financial statements and
the notes thereto and the other information contained in this Form 10-K. The
selected balance sheet data as of December 31, 2008 and 2007, and the selected
income statement data for the years ended December 31, 2008 and 2007 are derived
from, and are qualified by reference to, the audited consolidated financial
statements of the Company appearing elsewhere in this Form 10-K. The balance
sheet data as of December 31, 2006, 2005 and 2004, and income statement data for
the years ended December 31, 2006, 2005, and 2004, are derived from audited
consolidated financial statements of the Company not included herein.
D-21
At or For the Year Ended December 31,
2008 2007 2006 2005 2004
------------- ------------- -------------- ------------- ---------------
Income Statement Data
Interest Income $ 28,188,882 $ 28,098,261 $ 25,805,321 $ 21,665,441 $ 19,809,236
Interest Expense 13,249,297 14,885,202 13,114,088 7,594,052 6,216,042
Net Interest (Loss) Income 14,939,585 13,213,059 12,691,233 14,071,389 13,593,194
Noninterest (Loss) Income (5,362,105) 3,431,476 2,272,986 2,889,313 2,432,094
Noninterest Expense 15,340,149 14,267,491 13,202,841 11,081,440 10,228,091
(Loss) Income Before Income Taxes (7,598,968) 2,173,044 1,341,378 5,547,234 5,437,197
Income Taxes (3,112,459) 225,702 (67,525) 1,511,343 1,520,962
Net (Loss) Income (4,490,384) 1,947,342 1,408,903 4,035,891 3,915,235
Balance Sheet Data
Total Loans, Leases and
Loans Held for Sale 370,460,285 329,012,939 296,338,181 242,152,589 218,220,157
Allowance for Loan and Lease Losses 3,698,820 2,151,622 2,106,100 1,759,611 1,389,947
Total Investment Securities 113,502,751 129,013,733 147,820,791 182,949,393 173,864,701
Total Assets 532,257,607 507,653,629 501,232,357 467,560,946 424,304,747
Total Deposits 343,326,624 335,617,664 333,428,874 277,870,361 300,847,379
Total Borrowings 138,825,684 140,079,676 137,610,667 157,301,172 96,620,588
Total Liabilities 499,790,343 479,291,017 474,976,163 441,591,209 399,759,074
Shareholders' Equity 32,413,389 28,312,612 26,206,194 25,969,737 24,545,673
Selected Ratios and Per Share Data
Return on Average Assets (0.85)% 0.39% 0.29% 0.91% 0.93%
Return on Average Equity (17.10)% 7.25% 5.43% 15.94% 17.33%
Basic Net (Loss) Income Per Share (1) $ (1.92) $ 0.82 $ 0.60 $ 1.72 $ 1.68
Diluted Net (Loss) Income Per Share (1) (1.92) 0.82 0.59 1.70 1.65
Price Per Common Share (1) 6.23 14.50 21.73 27.25 30.00
Book Value Per Common Share (1) 9.51 11.96 11.63 12.16 12.12
Dividends Declared:
Cash $ 0.60 $ 0.60 $ 0.60 $ 0.57 $ 0.50
Stock -- 5.00% 5.00% 5.00% 5.00%
Cash Dividend Yield 9.63% 4.14% 2.76% 2.09% 1.67%
(1) All per-share data has been adjusted to give retroactive effect to all stock
dividends and splits.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following is Management's discussion of financial condition of the Company
on a consolidated basis as of December 31, 2008 and 2007 and results of
operations and analysis of the Company on a consolidated basis for the two years
ended December 31, 2008 and 2007. The consolidated financial statements of the
Company include the accounts of the Company and its wholly-owned subsidiary, The
First National Bank of Litchfield (the "Bank") and the Bank's wholly owned
subsidiaries, Lincoln Corporation and Litchfield Mortgage Service Corporation.
Additionally included in these statements as of December 31, 2008 and 2007, and
for the twelve month periods ended December 31, 2008 and 2007, are the accounts
of First Litchfield Leasing Corporation; a subsidiary in which the Bank owns a
majority interest. This discussion should be read in conjunction with the
consolidated financial statements and the related notes of the Company presented
elsewhere herein.
D-22
Critical Accounting Policies
In the ordinary course of business, the Bank has made a number of estimates and
assumptions relating to the reported results of operations and financial
condition in preparing its financial statements in conformity with accounting
principles generally accepted in the United States of America. Actual results
could differ significantly from those estimates under different assumptions and
conditions.
The Bank utilizes a loan and lease review and rating process which classifies
loans and leases according to the Bank's uniform classification system in order
to identify potential problem loans and leases at an early stage, alleviate
weaknesses in the Bank's lending policies, oversee the individual loan and lease
rating system and ensure compliance with the Bank's underwriting, documentation,
compliance and administrative policies. Loans and leases included in this
process are considered by management as being in need of special attention
because of some deficiency related to the credit or documentation, but which are
still considered collectable and performing. Such attention is intended to act
as a preventative measure and thereby avoid more serious problems in the future.
ALLOWANCE FOR LOAN AND LEASE LOSSES: The allowance for loan and lease losses
consists of specific, general and unallocated components. The specific component
relates to loans and leases that are classified as impaired. For impaired loans
and leases, an allowance is established when the discounted cash flows (or
collateral value or observable market price) of the impaired loan or lease is
lower than the carrying value of that loan or lease. The general component
covers non-impaired loans and leases and is based on historical loss experience
adjusted for qualitative factors. An unallocated component is maintained to
cover uncertainties that could affect management's estimate or probable losses.
The unallocated component of the allowance reflects the margin of imprecision
inherent in the underlying assumptions.
The Bank makes provisions for loan and lease losses on a quarterly basis as
determined by a continuing assessment of the adequacy of the allowance for loan
and lease losses. The Bank performs an ongoing review of loans and leases in
accordance with an individual loan and lease rating system to determine the
required allowance for loan and lease losses at any given date. The review of
loans and leases is performed to estimate potential exposure to losses.
Management's judgment in determining the adequacy of the allowance is inherently
subjective and is based on an evaluation of the known and inherent risk
characteristics and size of the loan and lease portfolios, the assessment of
current economic and real estate market conditions, estimates of the current
value of underlying collateral, past loan and lease loss experience, review of
regulatory authority examination reports and evaluations of impaired loans and
leases, and other relevant factors. Loans and leases, including impaired loans
and leases, are charged against the allowance for loan and lease losses when
management believes that the uncollectibility of principal is confirmed. Any
subsequent recoveries are credited to the allowance for loan and lease losses
when received. In connection with the determination of the allowance for loan
and lease losses and the valuation of foreclosed real estate, management obtains
independent appraisals for significant properties, when considered necessary.
There were no material changes in loan and lease concentrations or loan and
lease quality that had a significant affect on the allowance for loan and lease
losses calculation at December 31, 2008. In addition, there were no material
changes in the estimation methods and assumptions used in the Company's
allowance for loan and lease losses calculation, and there were no material
reallocations of the allowance among different parts of the loan and lease
portfolio. The Company recorded a provision of $1,836,000 for 2008 as compared
to a provision of $204,000 for 2007. The increased provision is reflective of
specific allocations related to certain impaired or substandard loans.
Additionally the increased provision was attributable to the weakness in the
economic environment.
OTHER THAN TEMPORARY IMPAIRMENT ("OTTI"): The Company's investment securities
portfolio is comprised of available-for-sale
D-23
and held-to-maturity investments. The available-for-sale portfolio is carried at
estimated fair value, with any unrealized gains or losses, net of taxes,
reported as accumulated other comprehensive income or loss in shareholders'
equity. The held-to-maturity portfolio is carried at amortized cost. Management
determines the classification of a security at the time of its purchase.
The Company conducts a periodic review of our investment securities portfolio to
determine if the value of any security has declined below its cost or amortized
cost, and whether such decline is other-than-temporary. If such decline is
deemed other-than-temporary, the security is written down to a new cost basis
and the resulting loss is reported within non-interest income in the
consolidated statement of income.
Significant judgment is involved in determining when a decline in fair value is
other-than-temporary. The factors considered by Management include, but are not
limited to:
o The Company's intent and ability to retain the investment for a period of
time sufficient to allow for the anticipated recovery in market value,
which may be until maturity;
o Percentage and length of time by which an issue is below book value;
o Financial condition and near-term prospects of the issuer including their
ability to meet contractual obligations in a timely manner;
o Credit ratings of the security;
o Whether the decline in fair value appears to be issuer specific or,
alternatively, a reflection of general market or industry conditions;
o Whether the decline is due to interest rates and spreads or credit risk;
and
o The value of underlying collateral.
Adverse changes in Management's assessment of the factors used to determine that
a security was not OTTI could lead to additional impairment charges. Conditions
affecting a security that the Company determined to be temporary could become
other than temporary and warrant an impairment charge. Additionally, a security
that had no apparent risk could be affected by a sudden or acute market
condition and necessitate an impairment charge. During 2008, the Company
recorded OTTI losses totaling $9,422,650 related to the Company's investments in
Freddie Mac and Fannie Mae preferred stock/auction rate securities holding such
stock, and two pooled trust preferred securities.
FINANCIAL CONDITION
Total assets as of December 31, 2008 were $532,257,607, an increase of
$24,603,978, or 4.9% from year-end 2007 total assets of $507,653,629.
The net loan and lease ("loan") portfolio as of December 31, 2008 totaled
$366,392,079 and increased by 11.9% or $38,916,708, from the December 31, 2007
balance of $327,475,371. The volume of loan growth during 2008 was realized
primarily in commercial mortgages and commercial loans and leases. Construction
mortgages totaled $38,153,503 as of December 31, 2008 which is an increase of
$3,344,519 or 9.6% over the year-end 2007 balance. The commercial mortgage
portfolio totaled $67,454,925 as of December 31, 2008, increasing over the
year-end 2007 balance of $55,752,240. Consistent with Management's strategy to
migrate to a more profitable composition of earning assets, and through the
acquisition of commercial lending expertise, expanded markets and the addition
of the leasing subsidiary, commercial loan and lease growth was strong during
2008. Commercial loans totaled $46,249,689 as of December 31, 2008 which was an
increase of $12,608,010 or 37.5% from the December 31, 2007 balance of
$33,641,679. Growth in commercial loans has been in both lines of credit and in
term financing and continues to be a result of the sales development and
commercial
D-24
calling initiatives for traditional and contiguous markets. As a complement to
the Bank's commercial lending product line, First Litchfield Leasing Corporation
began offering equipment financing leases to middle market companies during
2007. In its second year of operation the subsidiary funded over $16 million of
loans and leases. Leases were in amounts ranging from $7,000 to $2,600,000.
Lease receivables were $19,785,870 at December 31, 2008. Management attributes
the second year success of the subsidiary to Bank cross sales and more
importantly to the depth in experience and knowledge of the subsidiary's
management team. As of December 31, 2008, the installment loan portfolio totaled
$5,113,400, a decrease of 21.6% from the year-end 2007 balance of $6,519,812.
The decline in this portfolio is related to the amortization of a small pool of
consumer auto loans purchased by the Company during 2006.
The securities portfolio totaled $113,502,751 as of December 31, 2008, a
decrease of 12.0% from the December 31, 2007 balance of $129,013,733. The
decrease in the portfolio is primarily due to a continued restructuring of the
balance sheet towards a more profitable mix of earning assets which is focused
on loans and leases rather than investments. In addition, during the year ended
December 31, 2008, the Company recorded a loss of $9,422,650 related to the
other-than-temporary impairment of the Company's investments in Freddie Mac and
Fannie Mae preferred stock auction rate securities holding such stock, and two
pooled trust preferred securities.
Cash and cash equivalents totaled $9,238,783, as of December 31, 2008, which was
a decrease of $12,258,411, or 57.0% compared to the balance of $21,497,194 as of
December 31, 2007. Much of the decrease is due to a lower level of funds
temporarily invested in interest bearing correspondent bank balances resulting
from temporary balance sheet liquidity at year-end 2007.
Net premises and equipment totaled $7,370,252 as of December 31, 2008,
decreasing by $388,509 from the year-end 2007 balance of $7,758,761. Decreases
in premises and equipment during 2008 were primarily related to the disposals of
equipment as well as depreciation expense. During 2008, depreciation and
amortization of bank premises and equipment totaled $734,020 and net purchases
totaled $347,699.
Deferred tax assets totaled $5,082,957 as of December 31, 2008, which is an
increase of $3,755,422, or 282.9% from the December 31, 2007 balance of
$1,327,535. Most of the increase was associated with the increase in the
allowance for loan and lease losses, and the aforementioned OTTI write downs of
the Bank's investments in Freddie Mac and Fannie Mae preferred stock/auction
rate securities holding such stock and two pooled trust preferred securities.
Total liabilities were $499,790,343 as of December 31, 2008, an increase of
$20,499,326 from the December 31, 2007 balance of $479,291,017.
Deposits as of December 31, 2008 were $343,326,624, increasing $7,708,960, or
2.3%, from the December 31, 2007 balance of $335,617,664. Non-interest bearing
demand deposits totaled $69,548,261 as of December 31, 2008, which was a 1.4%
decrease from the year-end 2007 balance. Savings deposits totaled $58,582,375,
which was an increase of $2,237,497, or 4.0% from the December 31, 2007 balance.
Growth in savings deposits was due to increases in traditional savings products
including a business savings account. Additionally contributing to the growth in
savings deposits was the popularity of the Bank's health savings accounts (HSA).
Money market deposits totaled $93,085,126, which was an increase of $14,346,420,
or 18.2% from the December 31, 2007 balance of $78,738,706. This increase is
primarily due to continued growth in the competitively priced "Synergy"
relationship money market product introduced during 2006. Higher balances held
for the Bank's trust customers also contributed to this increase. Time
certificates of deposit totaled $122,110,861 as of December 31, 2008, which was
a decrease of 6.1%, or $7,858,953 from year-end 2007. Much of this
D-25
decrease was due to lower levels of brokered certificates of deposit through
financial institution counterparties. There were no brokered deposits at year
end 2008, compare to brokered deposits totaling $3,000,000 at year-end 2007. The
remaining cause of the decrease in time certificates of deposit is due to the
consumer's preference for liquidity in their investments.
As of December 31, 2008, Federal Home Loan Bank (FHLBB) advances totaled
$81,608,000 as compared to $91,500,000 as of December 31, 2007. At December 31,
2008, borrowings under repurchase agreements totaled $44,672,571, an increase of
$8,979,798 from the year-end 2007 balance of $35,692,773. As of December 31,
2008 and 2007, included in repurchase agreements was $18,222,571 and
$14,142,773, respectively, of balances in the overnight investment product
offered to the Bank's commercial and municipal cash management customers. At
December 31, 2008, total borrowings under repurchase agreements with financial
institutions and FHLBB advances totaled $108,058,000 compared to the balance of
$113,050,000 at December 31, 2007. As of December 31, 2008 and 2007, obligations
under subordinated debt totaled $10,104,000. The subordinated debt represents
the Company's liability for junior subordinated notes with regard to First
Litchfield Statutory Trust I and II, which were issued in 2003 and 2006,
respectively. At year-end 2008 and 2007, the ratio of borrowed funds to total
assets remained at similar levels of 26.0% and 27.6%, respectively.
Collateralized borrowings totaled $1,375,550 and $1,699,336 as of December 31,
2008 and 2007, respectively. The borrowings are related to participation
agreements for the sale of loans that include provisions for the Bank to
repurchase the loans at its future discretion, and therefore disqualifying the
classification of these loans as sold.
RESULTS OF OPERATIONS - 2008 COMPARED TO 2007
Net interest income is the single largest source of the Company's income. Net
interest income is determined by several factors and is defined as the
difference between interest and dividend income from earning assets, primarily
loans, leases and investment securities, and interest expense due on deposits
and borrowed money.
For the year ended December 31, 2008 the Company reported a net loss available
to common shareholders of $4,516,773 as compared to earnings of $1,947,342 for
the same period in 2007. Basic and diluted loss per common share for the year
ended December 31, 2008 was $1.92, compared to basic and diluted income per
common share of $.82 for the year ended December 31, 2007. The net loss in 2008
is due to the OTTI write-down on Freddie Mac and Fannie Mae preferred
stock/auction rate securities holding such stock, and two trust preferred debt
securities, recorded during the year. The net after tax effect of these charges
reduced 2008 earnings by $6,218,949. Additionally the 2008 provision for loan
and lease losses totaled $1,836,299 and contributed to the loss.
The Company's return on average shareholders' equity totaled (17)% for 2008
versus 7% for 2007.
Net Interest Income
Net interest income for the year of 2008 totaled $14,939,585, an increase of
13.1% or $1,726,526, from 2007. See "Rate/Volume Analysis" below for a
description of the various factors that impacted net interest income. Average
earning assets, which represent the Company's balance in loans, leases,
investment securities and Federal funds sold, totaled $497 million for 2008,
which was a 7.3% increase over the 2007 average of $463 million. Additionally,
the change in the composition of earning assets was significant. Average loans
and leases increased from $311,594,000 and 67% of average earning assets in 2007
to $346,113,000 and 70% of the average earning assets in 2008. The loan and
lease
D-26
growth was realized in the commercial lending, leasing and mortgage portfolios
and was funded primarily by growth in savings and money market deposits as well
as increases in borrowed money.
The following table presents the Company's average balance sheets (computed on a
daily basis), net interest income, and interest rates for the years ended
December 31, 2008 and 2007. Average loans outstanding include nonaccruing loans.
Interest income is presented on a tax-equivalent basis, which reflects a federal
tax rate of 34% for all periods presented.
2008 2007
------------ ------------
Interest and dividend income $ 28,188,882 $ 28,098,261
Tax-equivalent adjustments 618,353 611,559
Interest expense (13,249,297) (14,885,202)
------------ ------------
Net interest income $ 15,557,938 $ 13,824,618
============ ============
As shown below, the 2008 net interest margin increased 14 basis points from the
2007 level of 2.99% to 3.13%. The net interest spread also increased from the
2007 level of 2.43% to 2.70% primarily due to less expensive funding costs.
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY;
INTEREST RATES AND INTEREST DIFFERENTIAL
2008 2007
------------------------------------------- -----------------------------------------
Interest Interest
Average Earned/ Yield/ Average Earned/ Yield/
Balance Paid Rate Balance Paid Rate
------- ---- ---- ------- ---- ----
Assets
Interest Earning Assets:
Loans and leases $ 346,113,000 $ 21,593,992 6.24% $ 311,594,000 $ 21,057,941 6.76%
Investment securities 141,356,000 6,992,756 4.95% 142,460,000 7,250,336 5.09%
Other interest earning assets 9,187,000 220,487 2.40% 9,032,000 401,543 4.45%
-------------- ------------- -------------- --------------
Total interest earning assets 496,656,000 28,807,235 5.80% 463,086,000 28,709,820 6.20%
-------------- ------------- -------- -------------- -------------- -------
Allowance for loan and
lease losses (2,214,000) (2,130,000)
Cash and due from banks 10,899,000 12,268,000
Premises and equipment 7,533,000 7,679,000
Net unrealized losses on
securities (3,629,000) (2,815,000)
Other assets 17,832,000 17,097,000
-------------- --------------
Total Average Assets $ 527,077,000 $ 495,185,000
============== ==============
D-27
Liabilities and Shareholders' Equity
Interest Bearing Liabilities:
Savings deposits $ 58,788,000 $ 609,306 1.04% $ 55,026,000 $ 752,024 1.37%
Money Market deposits 83,116,000 1,563,305 1.88% 75,832,000 2,241,181 2.96%
Time deposits 132,813,000 4,907,151 3.69% 136,764,000 6,280,686 4.59%
Borrowed funds 152,108,000 6,169,535 4.06% 127,716,000 5,611,311 4.39%
------------- ------------- -------------- --------------
Total interest bearing liabilities 426,825,000 13,249,297 3.10% 395,338,000 14,885,202 3.77%
------------- -------- -------------- ------
Demand deposits 68,864,000 68,278,000
Other liabilities 5,128,000 4,705,000
Shareholders' Equity 26,260,000 26,864,000
------------- --------------
Total liabilities and equity $527,077,000 $ 495,185,000
============= ==============
Net interest income $ 15,557,938 $ 13,824,618
============= ==============
Net interest spread 2.70% 2.43%
======== ======
Net interest margin 3.13% 2.99%
======== ======
Rate/Volume Analysis
The following table, which is presented on a tax-equivalent basis, reflects the
changes for the year ended December 31, 2008 when compared to the year ended
December 31, 2007 in net interest income arising from changes in interest rates
and from changes in asset and liability volume. The change in interest
attributable to both rate and volume has been allocated to the changes in the
rate and the volume on a pro rata basis.
2008 Compared to 2007
Increase (Decrease) Due to
--------------------------
Volume Rate Total
----------- ----------- -----------
Interest earned on:
Loans and leases $ 2,227,018 $(1,690,967) $ 536,051
Investment securities (56,528) (201,052) (257,580)
Other interest earning assets 6,777 (187,833) (181,056)
----------- ----------- -----------
Total interest earning assets 2,177,267 (2,079,852) 97,415
----------- ----------- -----------
Interest paid on:
Deposits 239,956 (2,434,085) (2,194,129)
Borrowed money 1,012,966 (454,742) 558,224
----------- ----------- -----------
Total interest bearing liabilities 1,252,922 (2,888,827) (1,635,905)
----------- ----------- -----------
Increase (decrease) in net interest income $ 924,345 $ 808,975 $ 1,733,320
=========== =========== ===========
Tax equivalent net interest income for 2008 increased $1,733,320 or 12.5% over
2007. The increase in net interest income was due to increased margin resulting
mainly from reduced funding costs in 2008. The 2008 net interest margin (net
interest income divided by average earning assets) increased from the previous
year's level of 2.99% by 14 basis points to 3.13%. Interest income on average
earning assets for 2008 totaled $28,807,235, which was an increase of .3%, or
$97,415 from 2007 interest income on average earning assets of $28,709,820.
Interest expense totaled $13,249,297 for 2008, which was a decrease of
$1,635,905 or 11.0% from 2007.
As shown in the Rate/Volume Analysis above, the improvement in the net interest
margin and increase in net interest income was reflective of the ability to
decrease funding costs at a quicker pace than the corresponding decrease in
yield on earning assets. The 2008 yield on average earning assets was 5.8% which
was a decrease of 40 basis points from the 2007 yield of 6.2%. The related
interest cost from average interest bearing liabilities was 3.1% which was a
decrease of 67 basis points from the 2008 cost of 3.77%. Management's ability to
decrease rates paid on money market and time certificates of deposit
D-28
was the critical reason for the improvement in margin. The decrease in costs is
attributed to the decreases in short term rates in the interest rate
environment.
Additionally, mitigating the overall decrease in yield on earning assets was the
additional yield and income resulting from the changes in the earning asset mix.
As shown in the Rate/Volume Analysis above, the increase in net interest income
due to volume totaled $924,345. This increase is due to interest income on loans
which increased by $2,227,018 reflecting increased volume in the loan portfolio
which, on average, was $34.5 million higher than 2007. The related costs for
funding the higher level of earning assets totaled $1,252,922, resulting in a
$924,345 net increase from volume considerations. Funding through borrowed money
averaged $152,108,000 which was an increase of $24,392,000, or 19.1% from the
2007 average.
Noninterest (Loss) Income
Non-interest loss for 2008 totaled $5,362,105, which is a difference of
$8,793,581, or 256.3% from 2007 non-interest income of $3,431,476. The decrease
in noninterest income is the direct result of the $9,422,650 third and fourth
quarter OTTI write downs of the Bank's investments in Freddie Mac and Fannie Mae
preferred stock/auction rate securities holding such stock and two pooled trust
preferred securities. There were no similar balance sheet transactions during
2007. Also during 2008, available for sale securities were sold for the purpose
of enhancing credit quality, shortening the duration of the portfolio and to
deleverage the balance sheet. These sales resulted in net gains totaling
$537,790. Sales of available for sale securities transacted in 2007 for yield
and price volatility maintenance purposes resulted in gains totaling $19,632.
Other areas of non-interest income contributed to the decrease from 2007
results. Fees from trust services for 2008 totaled $1,300,162, a decrease of
$72,837, or 5.3% from the previous year's fees of $1,372,999. This decrease is
the result of the weakened economic and market conditions in spite of new
business growth experienced in the Bank's wealth management business.
Additionally other non-interest income was slightly below 2007 results due to
lower fees from retail investment income. Offsetting these declines were fees
from banking service charges which were up $180,761 or 13.3% from 2007.
Noninterest Expenses
Noninterest expenses totaled $15,340,149 in 2008, an increase of 7.5%, or
$1,072,658 from 2007 noninterest expenses of $14,267,491. The increase in
noninterest expense is due to higher costs in personnel, occupancy, equipment,
and other noninterest expenses. Increased salary and benefits expenses were due
to additional compliance personnel and an increased emphasis on commercial and
small business development. Occupancy cost increases are due to a larger branch
network and its related maintenance costs. The increase in other noninterest
expenses is a result of higher 2008 costs for exam and audit fees as they relate
to regulatory reporting compliance and internal audit initiatives. Also
contributing to the increase were costs for placement fees for key personnel
during the first quarter of 2008.
Salary and benefits costs totaled $8,401,740, increasing $471,580, or 5.9% from
2007 costs of $7,930,160. This increase reflects the staffing for the
compliance, and commercial and small business lending. The increase in these
costs, however was mitigated by cost containment strategies for staffing and
group insurance.
D-29
Computer services costs totaled $1,028,106 for 2008 which was an increase of
$167,506, or 19.5% from 2007 costs of $860,600. This increase is primarily due
to vendor credits from the Bank's core processor which were used during 2007.
Net occupancy and equipment costs totaled $1,847,298, which was an increase of
$62,649, or 3.5% above 2007 costs. Depreciation, building maintenance, property
taxes and utilities expenses caused increases in these expenses. Advertising
fees totaled $589,733 which was an increase of $120,348 over 2007 costs. This
increase is due primarily to the Bank's image campaign which was launched during
the fourth quarter of 2007 as well as product and publicity promotions.
Commissions, services and fees expenses totaled $396,050, decreasing $109,362,
from 2007. The majority of this expense for 2008 was advice and consulting
relating to corporate initiatives, investment and interest rate risk, lending,
trust, retail and personnel. Other noninterest expenses totaled $2,228,737 and
increased 16.3% over the 2007 expenses. This expense includes costs for
telephone, software, travel, contributions, exam and audit, regulatory
assessments and insurance.
Non-accrual, Past Due, Restructured Loans and Leases and Other Real Estate Owned
The Bank's non-accrual loans and leases ("loans"), other real estate owned
("OREO") and loans and leases past due in excess of ninety days and accruing
interest at December 31, 2004 through 2008 are presented below.
December 31,
2008 2007 2006 2005 2004
---------- ---------- ---------- ---------- ----------
Nonaccrual loans and leases $5,639,735 $2,959,074 $1,504,551 $ 273,330 $1,634,999
Other real estate owned -- -- -- -- --
---------- ---------- ---------- ---------- ----------
Total nonperforming assets $5,639,735 $2,959,074 $1,504,551 $ 273,330 $1,634,999
========== ========== ========== ========== ==========
Loans and leases past due in excess of
90 days and accruing interest $ 19,603 $ 3,111 $ 343 $ 4,884 $ --
========== ========== ========== ========== ==========
The accrual of interest income is generally discontinued when a loan or lease
becomes 90 days past due as to principal or interest, or when, in the judgment
of management, collectibility of the loan, lease or loan interest become
uncertain. When accrual of interest is discontinued, any unpaid interest
previously accrued is reversed from income. Subsequent recognition of income
occurs only to the extent payments are received subject to management's
assessment of the collectibility of the remaining principal and interest. The
accrual of interest on loans and leases past due 90 days or more, including
impaired loans and leases, may be continued when the value of the loan's or
lease's collateral is believed to be sufficient to discharge all principal and
accrued interest income due on the loan or lease, and the loan or lease is in
the process of collection. A non-accrual loan or lease is restored to accrual
status when it is no longer delinquent and collectibility of interest and
principal is no longer in doubt. A loan or lease is classified as a restructured
loan or lease when certain concessions have been made to the original
contractual terms, such as reduction of interest rates or deferral of interest
or principal payments, due to the borrower's financial condition. OREO is
comprised of properties acquired through foreclosure proceedings and acceptance
of a deed in lieu of foreclosure. These properties are carried at the lower of
cost or fair value less estimated costs of disposal. At the time these
properties are obtained, they are recorded at fair value with any difference
between carrying value and fair value reflected as a direct charge against the
allowance for loan and lease losses which establishes a new cost basis. Any
subsequent declines in value are charged to income with a corresponding
adjustment to the allowance for foreclosed real estate. Revenue and expense from
the operation of foreclosed real estate and changes in the valuation allowance
are included in operations. Costs relating to the development and improvement of
the property are capitalized, subject to the limit of fair value. Upon
disposition, gains and losses, to the extent they exceed the corresponding
valuation allowance, are reflected in the statement of operations.
D-30
Restructured loans and leases on non-accrual status are included in the table
above. As of December 31, 2008 and 2007, there were no restructured loans or
leases considered performing.
Had the non-accrual loans and leases performed in accordance with their original
terms, gross interest income for the years ended December 31, 2008 and 2007
would have increased by approximately $163,000 and $88,000, respectively.
The Bank considers all non-accrual loans and leases, other loans and leases past
due 90 days or more based on contractual terms, and restructured loans and
leases to be impaired. A loan or lease is considered impaired when it is
probable that the Bank will be unable to collect amounts due, both principal and
interest, according to the contractual terms of the loan or lease agreement.
When a loan or lease is impaired, impairment is measured using (1) the present
value of expected future cash flows of the impaired loan or lease discounted at
the loan's or lease's original effective interest rate; (2) the observable
market price of the impaired loan or lease; or (3) the fair value of the
collateral of a collateral-dependent loan or lease. When a loan or lease has
been deemed to have impairment, a valuation allowance is established for the
amount of impairment.
The following table summarizes the Bank's OREO, past due and non-accrual loans
and leases, and non-performing assets as of December 31, 2008, 2007, 2006, 2005
and 2004.
December 31,
2008 2007 2006 2005 2004
------------ ------------ ------------ ------------ ------------
Non-accrual loans and leases $ 5,639,735 $ 2,959,074 $ 1,504,551 $ 273,330 $ 1,634,999
Other real estate owned -- -- -- -- --
------------ ------------ ------------ ------------ ------------
Total non-performing assets $ 5,639,735 $ 2,959,074 $ 1,504,551 $ 273,330 $ 1,634,999
============ ============ ============ ============ ============
Loans and leases past due in excess of ninety days
and accruing interest $ 19,603 $ 3,111 $343 $ 4,884 $ --
============ ============ ============ ============ ============
Ratio of non-performing assets to total loans,
leases and OREO 1.52% 0.90% 0.51% 0.11% 0.75%
Ratio of non-performing assets to total loans,
leases past due in excess of ninety days accruing
interest to total loans, leases and OREO 1.53% 0.90% 0.51% 0.11% 0.75%
Ratio of allowance for loan and lease losses to total
loans and leases 1.00% 0.65% 0.71% 0.73% 0.64%
Ratio of allowance for loan and lease losses to
non-performing assets and loans and leases in excess of
ninety days past due and accruing interest 65.36% 72.64% 139.95% 632.47% 85.01%
Ratio of non-performing assets, loans and leases
in excess of ninety days past due and accruing interest
to total shareholders' equity 17.46% 10.46% 5.74% 1.07% 6.66%
Total non-performing assets increased by $2,680,661, or 90.59%, to $5,639,735 at
December 31, 2008, from $2,959,074 at December 31, 2007. The increase in
non-performing assets from year-end 2007 is due mostly to the addition of a
small number of mid-size mortgages and commercial loans and leases during 2008.
Additionally, as of December 31, 2008 there was approximately $170,000 in
purchased sub-prime consumer loans included in nonperforming loans which was a
decrease of $97,000 from December 31, 2007. As of December 31, 2008 and 2007,
loans and leases past due in excess of ninety days and accruing interest totaled
$19,603 and $3,111, respectively.
Total non-performing assets represented 1.52% of total loans, leases and other
real estate owned at year-end December 31, 2008 compared to .90% at year-end
2007. The allowance for loan and lease losses as of December 31, 2008 was 1.00%
of total loans and leases. As compared to the level from 2007 when
D-31
the allowance was approximately .65% of total loans and leases. The allowance
for loan and lease losses was equivalent to 65.36% of non-accrual loans and
leases at December 31, 2008, as compared to 72.64% at December 31, 2007. The
decrease in the coverage ratio is a result of increased level of non-performing
assets at year end 2008.
Potential Problem Loans and Leases
As of December 31, 2008, there were eight loans totaling $3.2 million which are
not disclosed above which cause Management to have concern as to the ability of
the borrowers to comply with the present loan repayment terms. The Bank's
carrying value of these loans totaled $3.2 million at December 31, 2008. These
loans are still accruing interest but are classified as impaired. Although these
loans are currently performing, Management views them as having potential and
well-defined weaknesses that could jeopardize the liquidation of the debt.
Allowance for Loan and Lease Losses
The following table summarizes the activity in the allowance for loan and lease
losses for the years ended December 31, 2004 through 2008. The allowance is
maintained at a level consistent with the identified loss potential and the
perceived risk in the portfolio.
(Dollar Amounts in Thousands)
December 31,
------------------------------------------------
2008 2007 2006 2005 2004
------- ------- ------- ------- -------
Balance, at beginning of period $ 2,152 $ 2,106 $ 1,760 $ 1,390 $ 1,149
Loans and Leases charged-off:
Commercial and financial 90 16 -- 37 80
Real estate -- -- -- -- --
Installment loans to individuals 287 160 96 60 104
------- ------- ------- ------- -------
377 176 96 97 184
------- ------- ------- ------- -------
Recoveries on loans and leases charged-off:
Commercial and financial -- -- 1 81 --
Real estate -- -- -- -- --
Installment loans to individuals 88 18 21 44 65
------- ------- ------- ------- -------
88 18 22 125 65
------- ------- ------- ------- -------
Net loan charge-offs/(recoveries) 289 158 74 (28) 119
------- ------- ------- ------- -------
Provisions charged to operations 1,836 204 420 342 360
------- ------- ------- ------- -------
Balance, at the end of period $ 3,699 $ 2,152 $ 2,106 $ 1,760 $ 1,390
======= ======= ======= ======= =======
Ratio of net charge-offs/(recoveries) during the period
to average loans and leases outstanding during the period 0.08% 0.05% 0.03% -0.01% 0.06%
======= ======= ======= ======= =======
Ratio of allowance for loan and lease losses
to total loans and leases 1.00% 0.65% 0.71% 0.73% 0.64%
======= ======= ======= ======= =======
During 2008, net charge-offs totaled $289,000, which is an increase of $131,000
from 2007 net chargeoffs of $158,000. The increase in net charge-offs was due to
a higher level of net charge-offs in the installment loan portfolio. During 2008
and 2007 the Bank experienced higher levels of charge-offs, which were primarily
related to a pool of subprime consumer auto loans the Bank purchased during
2006. Net charge-offs totaled $199,000 from installment loans in 2008 increasing
$57,000 from 2007. The increased level of net charge-offs is related to losses
on loans whereby the collateral asset value was considerably less than the loan
amount.
D-32
The following table reflects the allowance for loan and lease losses as of
December 31, 2008, 2007, 2006, 2005 and 2004.
Analysis of Allowance for Loan and Lease Losses
(Amounts in thousands)
December 31,
Loans and
Leases by Type 2008 2007 2006 2005
- -------------- ------------------------ ----------------------- -------------------------- ------------------------
Allocation Percentage Allocation Percentage Allocation Percentage Allocation Percentage
of Allowance of Loans of Allowance of Loans of Allowance of Loans of Allowance of Loans
for Loan and in each for Loan and in each for Loan and in each for Loan and Each
Lease Losses Category Lease Losses Category Lease Losses Category Lease Losses Category
to Total to Total to Total to Total
Loans Loans Loans Loans
------------------------ ----------------------- -------------------------- ------------------------
Commercial $ 981 12.52% $ 317 10.23% $ 204 9.13% $ 357 8.73%
Real Estate
Construction 570 10.32% 231 10.58% 480 10.36% 224 11.79%
Residential 1,068 52.13% 863 57.61% 769 59.97% 411 60.26%
Commercial 678 18.26% 465 16.94% 401 18.05% 518 17.40%
Installment 210 1.38% 180 1.98% 181 2.43% 54 1.79%
Other 18 0.03% 16 0.03% 17 0.06% 38 0.03%
Commercial
Leases 174 5.36% 80 2.63% -- -- -- --
Unallocated -- -- -- -- 54 -- 158 --
------------------------------------------------------------------------------------------------------------
Total $ 3,699 100% $ 2,152 100% $ 2,106 100% $ 1,760 100%
============================================================================================================
Loans and
Leases by Type 2004
- -------------- --------------------------
Allocation Percentage
of Allowance of Loans
for Loan and Each
Lease Losses Category
to Total
Loans
--------------------------
Commercial $ 261 8.21%
Real Estate
Construction 82 5.31%
Residential 550 68.13%
Commercial 379 15.42%
Installment 58 2.89%
Other 39 0.04%
Commercial
Leases -- --
Unallocated 21 --
-------------------------
Total $ 1,390 100%
=========================
The unallocated portion of the allowance reflects Management's estimate of
probable but unconfirmed losses inherent in the portfolio. Such estimates are
influenced by uncertainties in economic conditions, delays in obtaining
information, including unfavorable information about a borrower's financial
condition, difficulty in identifying triggering events that correlate perfectly
to subsequent loss rates, and risk factors that have not yet manifested
themselves in loss allocation factors.
LIQUIDITY
Management's objective is to ensure continuous ability to meet cash needs as
they arise. Such needs may occur from time to time as a result of fluctuations
in loan and lease demand and the level of total deposits. Accordingly, the Bank
has a liquidity policy that provides flexibility to meet cash needs. The
liquidity objective is achieved through the maintenance of readily marketable
investment securities as well as a balanced flow of asset maturities and prudent
pricing on loan, lease and deposit products. Management believes that the
liquidity is adequate to meet the Company's future needs.
The Bank is a member of the Federal Home Loan Bank System, ("FHLB") which
provides credit to its member banks. This enhances the liquidity position of the
Bank by providing a source of available overnight as well as short-term
borrowings. Additionally, borrowings through repurchase agreements, federal
funds and the sale of mortgage loans in the secondary market are available to
fund short-term cash needs. The Company is aware of recent news and FHLB member
bank press releases regarding the financial strength of the FHLB system. The
Company is actively monitoring its ability to borrow from the FHLB Bank of
Boston and has determined additional sources of liquidity as part of the
aforementioned liquidity policy.
D-33
SHORT-TERM BORROWINGS
The following information relates to the Bank's short-term borrowings at the
Federal Home Loan Bank for the years ended December 31:
2008 2007
------------- --------------
Balance at December 31, $ 1,608,000 $ --
Maximum Month-End Borrowings 17,300,000 17,307,000
Average Balance 4,156,000 3,090,000
Average Rate at Year-End 0.46% -
Average Rate during the Period 1.73% 3.99%
The following information relates to the Bank's short-term repurchase agreements
with customers for the years ended December 31:
2008 2007
------------- -------------
Balance at December 31, $ 18,222,571 $ 14,142,773
Maximum Month-End Borrowings 23,151,139 15,342,920
Average Balance 13,499,884 10,259,208
Average Rate at Year-End 1.42% 3.34%
Average Rate during the Period 1.93% 3.47%
OFF-BALANCE SHEET ARRANGEMENTS
See Note O on page ? of the consolidated financial statements for the disclosure
of off-balance sheet arrangements.
CAPITAL
At December 31, 2008, total shareholders' equity was $32,413,389 compared to
$28,312,612 at December 31, 2007. From a regulatory perspective, with the
exception of the total risk-based capital ratio, the Bank's capital ratios place
the Bank in the well-capitalized categories under applicable regulations. As of
December 31, 2008, the Bank's total risk-based capital ratio was 9.41%. The
various capital ratios of the Company and the Bank are as follows as of December
31, 2008:
Minimum
Regulatory
Capital Level The Company The Bank
------------- ----------- --------
Tier 1 leverage capital ratio 4% 7.85% 6.10%
Tier 1 risk-based capital ratio 4% 10.74% 8.43%
Total risk-based capital ratio 8% 11.74% 9.43%
Included in the Company's capital used to determine these ratios at December 31,
2008 and December 31, 2007 is $9.8 million related to the Company's investment
in First Litchfield Statutory Trust I and First Litchfield Statutory Trust II,
which is recorded as subordinated debt in the Company's balance sheets at
December 31, 2008 and 2007, respectively. Trust preferred securities are
currently considered regulatory capital for purposes of determining the
Company's Tier I capital ratios. On March 1, 2005, the Board of Governors of the
Federal Reserve System, which is the Company's banking regulator, approved final
rules that allow for the continued inclusion of outstanding and prospective
issuances of trust preferred securities in regulatory capital subject to new,
more strict limitations. The Company has until March 31, 2009 to meet the new
limitations. Management does not believe these final rules will have a
significant impact on the Company. On December 12, 2008 the Company participated
in the CPP (also known as TARP capital), and issued $10,000,000 of cumulative
perpetual preferred stock with a common stock warrant attached to the U. S.
Treasury. The Company's purpose in participating
D-34
in the TARP Capital Purchase program was to insure that the Company and the Bank
maintained its well-capitalized status given the uncertain economic environment.
On December 12, 2008, under the TARP CPP, the Company sold 10,000 shares of
senior preferred stock to the Treasury, having a liquidation amount equal to
$1,000 per share, or $10,000,000. Although the Company is currently
well-capitalized under regulatory guidelines, the Board of Directors believed it
was advisable to take advantage of the TARP CPP to raise additional capital to
ensure that during these uncertain times, the Company is well-positioned to
support the Company's existing operations as well as anticipated future growth.
Additional information concerning the TARP CPP is included elsewhere in this
Form 10-K and in Note L to the Consolidated Financial Statements.
The Company expects that it (and the banking industry as a whole) may be
required by market forces and/or regulation to operate with higher capital
ratios than in the recent past. In addition, on the preferred stock issued in
the CPP capital preferred dividend increases from 5% to 9% in 2013, making it
much more expensive as a source of capital if not redeemed at or prior to that
time. Therefore, in addition to maintaining higher levels of capital, the
Company's capital structure may be subject to greater variation over the next
few years than has been true historically.
INCOME TAXES
The income tax benefit for 2008 totaled $3,112,459 in comparison to income tax
expense of $225,702 in 2007. The change in income tax expense between 2008 and
2007 is due to the pretax loss in 2008, as a result of the OTTI charges during
the year. The effective tax rates for 2008 and 2007 were (41) % and 10%,
respectively. Also, in both years, provisions for income taxes included the tax
benefit related to income associated with Litchfield Mortgage Service
Corporation ("LMSC"), which was formed by the Bank in 2000. The income from LMSC
is considered passive investment income pursuant to Connecticut law, under which
LMSC was formed and is operating, and is not subject to state taxes which
resulted in no state tax expense for all years.
IMPACT OF INFLATION AND CHANGING PRICES
The Consolidated Financial Statements and related notes thereto presented
elsewhere herein have been prepared in accordance with accounting principles
generally accepted in the United States of America, which require the
measurement of financial position and operating results in terms of historical
dollars without considering changes in the relative value of money over time due
to inflation. Unlike many industrial companies, most of the assets and virtually
all of the liabilities of the Company are monetary in nature. As a result,
interest rates have a more significant impact on the Company's performance than
the general level of inflation. Over short periods of time, interest rates may
not necessarily move in the same direction or in the same magnitude as
inflation.
D-35
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Annual Financial Information
- -----------------------------
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets at December 31, 2008 and 2007
Consolidated Statements of Operations for the Years Ended December 31, 2008 and
2007
Consolidated Statements of Changes in Shareholders' Equity for the Years Ended
December 31, 2008 and 2007
Consolidated Statements of Cash Flows for the Years Ended December 31, 2008 and
2007
Notes to Consolidated Financial Statements
D-36
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Board of Directors and Shareholders
First Litchfield Financial Corporation and Subsidiary
We have audited the accompanying consolidated balance sheets of First Litchfield
Financial Corporation and Subsidiary (the "Company") as of December 31, 2008 and
2007, and the related consolidated statements of operations, changes in
shareholders' equity and cash flows for the years then ended. These financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these financial statements based on
our audits.
We conducted our audits in accordance with 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 financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements. An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of First Litchfield
Financial Corporation and Subsidiary as of December 31, 2008 and 2007, and the
results of their operations and their cash flows for the years then ended, in
conformity with U.S. generally accepted accounting principles.
As described in Note A to the consolidated financial statements, during 2008 the
Company adopted EITF No. 06-4, "Accounting for Endorsement Split-Dollar Life
Insurance Arrangements."
We were not engaged to examine management's assertion about the effectiveness of
the Company's internal control over financial reporting as of December 31, 2008
included in the accompanying "Management's Report on Internal Control Over
Financial Reporting" and accordingly, we do not express an opinion thereon.
/s/ McGladrey & Pullen, LLP
New Haven, Connecticut
April 14, 2009
D-37
CONSOLIDATED BALANCE SHEETS
As of December 31, 2008 2007
------------- -------------
ASSETS
Cash and due from banks $ 9,238,320 $ 10,876,445
Interest - bearing accounts due from banks 463 10,620,749
------------- -------------
CASH AND CASH EQUIVALENTS 9,238,783 21,497,194
------------- -------------
Securities:
Available for sale securities, at fair value 113,486,201 128,979,548
Held to maturity securities (fair value $16,553-2008 and $33,712-2007) 16,550 34,185
------------- -------------
TOTAL SECURITIES 113,502,751 129,013,733
------------- -------------
Federal Home Loan Bank stock, at cost 5,427,600 5,067,400
Federal Reserve Bank stock, at cost 225,850 225,850
Other restricted stock, at cost 100,000 95,000
Loans held for sale 1,013,216 --
Loan and lease receivables, net of allowance for loan and lease
losses of $3,698,820 -2008, $2,151,622 -2007
NET LOANS AND LEASES 366,392,079 327,475,371
Premises and equipment, net 7,370,252 7,758,761
Deferred income taxes 5,082,957 1,327,535
Accrued interest receivable 2,262,918 2,609,606
Cash surrender value of insurance 10,416,651 10,020,540
Due from broker for security sales 9,590,823 --
Other assets 1,633,727 2,562,639
------------- -------------
TOTAL ASSETS $ 532,257,607 $ 507,653,629
============= =============
LIABILITIES
Deposits:
Noninterest bearing $ 69,548,261 $ 70,564,267
Interest bearing 273,778,363 265,053,397
------------- -------------
TOTAL DEPOSITS 343,326,624 335,617,664
------------- -------------
Federal Home Loan Bank advances 81,608,000 91,500,000
Repurchase agreements with financial institutions 26,450,000 21,550,000
Repurchase agreements with customers 18,222,571 14,142,773
Junior subordinated debt issued by unconsolidated trust 10,104,000 10,104,000
Collateralized borrowings 1,375,550 1,699,336
Capital lease obligation 1,065,563 1,083,567
Due to broker for security purchases 12,994,945 --
Accrued expenses and other liabilities 4,643,090 3,593,677
------------- -------------
TOTAL LIABILITIES 499,790,343 479,291,017
------------- -------------
Minority interest 53,875 50,000
SHAREHOLDERS' EQUITY
Preferred stock $.00001 par value; 1,000,000
shares authorized 2008 - 10,000 shares
issued and outstanding
2007 - no shares issued and outstanding -- --
Common stock $.01 par value; 5,000,000 shares authorized
2008 - Issued - 2,506,622 shares, outstanding - 2,356,875 shares
2007 - Issued - 2,501,229 shares, outstanding - 2,368,200 shares 25,038 25,012
Additional paid-in capital 37,892,831 27,858,841
(Accumulated deficit) retained earnings (3,325,920) 2,623,110
Less: Treasury stock at cost- 149,747 as of 12/31/08, 133,029 as of 12/31/07 (1,154,062) (926,964)
Accumulated other comprehensive loss, net of taxes (1,024,498) (1,267,387)
------------- -------------
TOTAL SHAREHOLDERS' EQUITY 32,413,389 28,312,612
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 532,257,607 $ 507,653,629
============= =============
See Notes to Consolidated Financial Statements.
D-38
CONSOLIDATED STATEMENTS OF OPERATIONS
Years Ended December 31, 2008 2007
------------ ------------
INTEREST AND DIVIDEND INCOME
Interest and fees on loans and leases $ 21,579,957 $ 21,053,610
------------ ------------
Interest and dividends on securities:
Mortgage-backed securities 3,320,225 2,564,052
US Treasury and other securities 1,580,125 2,129,407
State and municipal securities 1,118,924 1,355,523
Trust Preferred and other securities 369,164 594,126
------------ ------------
Total interest on securities 6,388,438 6,643,108
------------ ------------
Other interest income 220,487 401,543
------------ ------------
TOTAL INTEREST AND DIVIDEND INCOME 28,188,882 28,098,261
------------ ------------
INTEREST EXPENSE
Interest on deposits:
Savings 609,306 752,024
Money market 1,563,305 2,241,181
Time certificates of deposit in denominations
of $100,000 or more 1,918,298 2,618,965
Other time certificates of deposit 2,988,853 3,661,721
------------ ------------
TOTAL INTEREST ON DEPOSITS 7,079,762 9,273,891
Interest on Federal Home Loan Bank advances 3,970,574 3,270,982
Interest on repurchase agreements 1,430,176 1,395,488
Interest on subordinated debt 606,396 791,523
Interest on collateralized borrowings 105,393 95,395
Interest on capital lease obligation 56,996 57,923
------------ ------------
TOTAL INTEREST EXPENSE 13,249,297 14,885,202
------------ ------------
NET INTEREST INCOME 14,939,585 13,213,059
PROVISION FOR LOAN AND LEASE LOSSES 1,836,299 204,000
------------ ------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN AND LEASE LOSSES 13,103,286 13,009,059
------------ ------------
NONINTEREST INCOME
Banking service charges and fees 1,543,519 1,362,758
Trust 1,300,162 1,372,999
(Losses) gains on available for sale securities (8,884,860) 19,632
Increase in cash surrender value of insurance 396,110 384,079
Other 282,964 292,008
------------ ------------
TOTAL NONINTEREST (LOSS) INCOME (5,362,105) 3,431,476
------------ ------------
NONINTEREST EXPENSE
Salaries 6,670,676 6,351,946
Employee benefits 1,731,064 1,578,214
Net occupancy 1,233,420 1,157,703
Equipment 613,878 626,946
Legal fees 307,004 246,815
Directors fees 198,400 208,403
Computer services 1,028,206 860,600
Supplies 193,217 202,381
Commissions, services and fees 396,050 505,412
Postage 149,864 143,070
Advertising 589,733 469,385
Other 2,228,637 1,916,616
------------ ------------
TOTAL NONINTEREST EXPENSE 15,340,149 14,267,491
------------ ------------
(LOSS) INCOME BEFORE INCOME TAXES (7,598,968) 2,173,044
(BENEFIT) PROVISION FOR INCOME TAXES (3,112,459) 225,702
------------ ------------
NET (LOSS) INCOME BEFORE MINORITY INTEREST (4,486,509) 1,947,342
MINORITY INTEREST (3,875) --
------------ ------------
NET (LOSS) INCOME (4,490,384) 1,947,342
------------ ------------
DIVIDENDS ON PREFERRED SHARES 26,389 --
------------ ------------
NET (LOSS) INCOME AVAILABLE TO COMMON SHAREHOLDERS (4,516,773) 1,947,342
============ ============
INCOME (LOSS) PER COMMON SHARE
BASIC NET (LOSS) INCOME PER COMMON SHARE $ (1.92) $ 0.82
============ ============
DILUTED NET (LOSS) INCOME PER COMMON SHARE $ (1.92) $ 0.82
============ ============
DIVIDENDS PER COMMON SHARE $ 0.60 $ 0.60
============ ============
See Notes to Consolidated Financial Statements.
D-39
FIRST LITCHFIELD FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
Retained Accumulated
Additional Earnings Other Total
Preferrred Common Paid-In (Accumulated Treasury Comprehensive Shareholders'
Stock Stock Capital Deficit) Stock Loss Equity
---------- --------- ------------- ------------- ------------ -------------- -------------
Balance, December 31, 2006 - 23,724 25,840,623 3,953,216 (794,756) (2,816,613) 26,206,194
Comprehensive income:
Net income - - - 1,947,342 - 1,947,342
Other comprehensive income,
net of taxes
Net unrealized holding
gain on
available for sale
securities - - - - - 1,286,413 1,286,413
Net actuarial gain for pension
benefits - - - - - 262,813 262,813
-------------
Other comprehensive income 1,549,226
-------------
Total comprehensive income 3,496,568
-------------
Cash dividends declared:
$0.60 per share - - - (1,371,563) - - (1,371,563)
5% stock dividend declared
November 29,2007-
118,873 shares
including 6,334
treasury shares - 1,189 1,900,779 (1,901,968) - - -
Fractional shares paid in cash - - - (3,917) - - (3,917)
Purchase of treasury shares
- 8,263 shares - - - - (132,208) - (132,208)
Stock options exercised
- 9,922 shares - 99 87,388 - - - 87,487
Tax benefit on stock options
exercised - - 30,051 - - - 30,051
---------- --------- ------------- ------------- ------------ --------------
-------------
Balance, December 31, 2007 - 25,012 27,858,841 2,623,110 (926,964) (1,267,387) 28,312,612
-------------
Comprehensive loss:
Net loss - - - (4,490,384) - (4,490,384)
Other comprehensive income,
net of taxes:
Net unrealized holding gain
on available
for sale securities - - - - - 927,584 927,584
Net actuarial loss for
pension benefits - - - - - (684,695) (684,695)
-------------
Other comprehensive income 242,889
-------------
Total comprehensive loss (4,247,495)
-------------
Cash dividends declared:
$0.60 per share - - - (1,416,888) - - (1,416,888)
Preferred stock dividends - - - (26,389) - (26,389)
Purchase of treasury shares
- 16,718 shares - - - - (227,098) - (227,098)
Stock options exercised
- 1,893 shares - 19 20,463 - - - 20,482
Tax benefit on stock
options exercised - - 2,025 - - - 2,025
Restricted stock grants
and expense - 7 8,405 - - - 8,412
Issuance of preferred stock
and warrants - - 10,000,000 - - - 10,000,000
Accretion of preferred stock - - 3,097 (3,097) - - -
Adoption of EITF 06-4 - - - (12,272) - - (12,272)
---------- --------- ------------- ------------- ------------ -------------- -------------
Balance, December 31, 2008 $ - $ 25,038 $ 37,892,831 $ (3,325,920) $(1,154,062) $(1,024,498) $ 32,413,389
========== ========= ============= ============= ============ ============== =============
See Notes to Consolidated Financial Statements.
D-40
FIRST LITCHFIELD FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
Years Ended December 31,
2008 2007
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net (loss) income $ (4,490,384) $ 1,947,342
Adjustments to reconcile net (loss) income to net cash provided
by operating activities:
Minority interest in earnings at subsidiary 3,875 --
Amortization and accretion of premiums and discounts on investment
securities, net 146,828 177,406
Provision for loan and lease losses 1,836,299 204,000
Depreciation and amortization 734,020 751,259
Deferred income taxes (3,868,274) 47,413
Loss on impairment write-down of available for sale securities 9,422,650 --
Gains on sales of available for sale securities (537,790) (19,632)
Loans originated for sale (4,225,152) (4,015,817)
Proceeds from sales of loans held for sale 3,232,832 5,093,056
Gains on sales of loans held for sale (20,896) (35,056)
Losses on sale of repossessed assets 32,024 --
Losses (gains) on disposals of bank premises and equipment 2,188 (17,677)
Stock based compensation 8,412 --
Decrease (increase) in accrued interest receivable 346,688 (10,880)
Decrease in other assets 863,573 182,315
Increase in cash surrender value of insurance (396,111) (384,079)
Increase in deferred loan origination costs (116,571) (70,494)
(Decrease) increase in accrued expenses and other liabilities (292,494) 38,125
------------ ------------
Net cash provided by operating activities 2,681,717 3,887,281
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Available for sale securities:
Proceeds from principal payments 45,521,948 10,224,784
Purchases (77,949,889) (5,928,540)
Proceeds from sales 43,699,152 16,295,820
Held to maturity securities:
Proceeds from maturities and principal payments 17,635 6,331
Purchase of restricted stock (5,000) (15,000)
Purchase of Federal Home Loan Bank stock (360,200) (634,500)
Redemption of Federal Home Loan Bank stock -- 10,500
Net increase in loans and leases (40,604,639) (33,779,870)
Proceeds from sales of repossessed assets 256,873 --
Purchases of premises and equipment (347,699) (1,074,027)
Proceeds from sale of premises and equipment -- 22,000
------------ ------------
Net cash used in investing activities (29,771,819) (14,872,502)
------------ ------------
D-41
FIRST LITCHFIELD FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS, Cont.
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in savings, money market and demand deposits 15,567,912 20,761,499
Net decrease in certificates of deposit (7,858,952) (18,572,709)
Proceeds from Federal Home Loan Bank advances -- 112,000,000
Repayments on Federal Home Loan Bank advances (11,500,000) (86,500,000)
Net increase (decrease) in overnight Federal Home Loan Bank borrowings 1,608,000 (1,000,000)
Net increase (decrease) in repurchase agreements with financial institutions 4,900,000 (25,650,000)
Net increase in repurchase agreements with customers 4,079,798 1,936,750
Net (decrease) increase in collateralized borrowings (323,786) 1,699,336
Proceeds from issuance of preferred stock and warrants 10,000,000 --
Principal repayments on capital lease obligation (18,004) (17,077)
Purchase of treasury shares (227,098) (132,208)
Distribution in cash for fractional shares of common stock -- (3,917)
Proceeds from exercise of stock options 20,482 87,487
Tax benefit of stock options exercised 2,025 30,051
Dividend paid on common stock (1,418,686) (1,354,434)
------------- -------------
Net cash provided by financing activities 14,831,691 3,284,778
------------- -------------
Net decrease in cash and cash equivalents (12,258,411) (7,700,443)
CASH AND CASH EQUIVALENTS, at the beginning of year 21,497,194 29,197,637
------------- -------------
CASH AND CASH EQUIVALENTS, at end of year $ 9,238,783 $ 21,497,194
============= =============
SUPPLEMENTAL INFORMATION
Cash paid during the year for:
Interest on deposits and borrowings $ 13,368,965 $ 15,155,901
============= =============
Income taxes $ 1,000 $ 750
============= =============
Noncash investing and financing activities:
Due to broker for securities purchased $ 12,994,945 $ --
============= =============
Due from broker for securities purchased $ 9,590,823 $ --
============= =============
Transfer of loans to repossessed assets $ 224,481 $ 71,018
============= =============
Accrued dividends declared $ 379,896 $ 355,229
============= =============
Increase in leases and other liabilities for
equipment payable related to financed leases $ 256,278 $ --
============= =============
Increase in liabilities and decrease in retained earnings for
adoption of EITF 06-4 $ 12,272 $ --
============= =============
Change in other assets and other liabilities
related to unfunded pension liability $ (1,037,417) $ 398,201
============= =============
See Notes to Consolidated Financial Statements
D-42
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
December 31, 2008
NOTE A - NATURE OF OPERATIONS AND SIGNIFICANT ACCOUNTING POLICIES
The consolidated financial statements include the accounts of the First
Litchfield Financial Corporation (the "Company") and The First National Bank of
Litchfield (the "Bank"), a nationally-chartered commercial bank, and the Bank's
wholly owned subsidiaries, Litchfield Mortgage Service Corporation, Lincoln
Corporation, and First Litchfield Leasing Corporation, an entity in which the
Bank has an eighty percent ownership. Deposits in the Bank are insured up to
specified limits by the Bank Insurance Fund, which is administered by the
Federal Deposit Insurance Corporation (the "FDIC"). The Bank provides a full
range of banking services to individuals and businesses located primarily in
Northwestern Connecticut. These products and services include demand, savings,
NOW, money market and time deposits, residential and commercial mortgages,
consumer installment and other loans and leases as well as trust services. The
Bank is subject to competition from other financial institutions. The Bank is
also subject to the regulations of certain federal agencies and undergoes
periodic regulatory examinations.
On January 7, 2000, the Company filed a Form 10-SB registration statement with
the Securities and Exchange Commission (the "SEC") to register the Company's
$.01 par value common stock under the Securities and Exchange Act of 1934 (the
"Exchange Act"). The Company files periodic financial reports with the SEC as
required by the Exchange Act. On June 26, 2003, the Company formed First
Litchfield Statutory Trust I ("Trust 1") for the purpose of issuing trust
preferred securities and investing the proceeds in subordinated debentures
issued by the Company. On June 16, 2006, the Company formed First Litchfield
Statutory Trust II ("Trust II") for the purpose of issuing trust preferred
securities and investing the proceeds in subordinated debentures issued by the
Company. (See Note I).
The significant accounting policies followed by the Company and the methods of
applying those policies are summarized in the following paragraphs:
BASIS OF FINANCIAL STATEMENT PRESENTATION: The consolidated financial statements
have been prepared in accordance with accounting principles generally accepted
in the United States of America and general practices within the banking
industry. All significant intercompany balances and transactions have been
eliminated. Trust I and Trust II are not included in the consolidated financial
statements as they do not meet the requirements for consolidation. In preparing
the financial statements, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities, and
disclosures of contingent assets and liabilities, as of the date of the balance
sheet and the reported amounts of revenues and expenses for the reporting
period. Actual results could differ from those estimates. Material estimates
that are particularly susceptible to significant change in the near term relate
to the determination of the allowance for loan and lease losses and the
evaluation of investment securities for other-than-temporary impairment.
SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK: Most of the Company's
activities are with customers located within Litchfield County, Connecticut.
Note C discusses the types of securities that the Company invests in. Note E
discusses the types of lending and lease financing that the Company engages in.
The Company does not have any significant loan and lease concentrations to any
one industry or customer. Note K discusses a concentration related to the cash
surrender value of the life insurance.
D-43
SEGMENT REPORTING: The Company has two business segments, community banking and
commercial leasing. During the periods presented these segments represented all
the revenues and income for the consolidated group and therefore, are the only
reported segments as defined by Statement of Financial Accounting Standards
("SFAS") No. 131, "Disclosures about Segments of an Enterprise and Related
Information" (SFAS 131).
DEBT AND MARKETABLE EQUITY SECURITIES: Management determines the appropriate
classification of securities at the date individual investment securities are
acquired, and the appropriateness of such classification is reassessed at each
balance sheet date.
Debt securities that management has the positive intent and ability to hold to
maturity are classified as "held to maturity" and recorded at amortized cost.
Trading securities, if any, are carried at fair value, with unrealized gains and
losses recognized in earnings. Securities not classified as held to maturity or
trading, including equity securities with readily determinable fair values, are
classified as "available for sale" and recorded at fair value, with unrealized
gains and losses excluded from earnings and reported in other comprehensive
income, net of taxes.
Purchase premiums and discounts are recognized in interest income using the
interest method over the terms of the securities. 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.
In estimating other-than-temporary impairment losses, management considers (1)
the length of time and extent to which the fair value has been less than cost,
(2) the financial condition and near-term prospects of the issuer, and (3) the
intent and ability of the Company to retain its investment in the issuer for a
period of time sufficient to allow for any anticipated recovery in fair value.
Gains and losses on the sale of securities are recorded on the trade date and
are determined using the specific identification method.
The sale of a held maturity security within three months of its maturity date or
after collection of at least 85% of the principal outstanding at the time the
security was acquired is considered a maturity for purposes of classification
and disclosure.
INTEREST AND FEES ON LOANS AND LEASES: Interest on loans and leases is included
in income as earned based on contractual rates applied to principal amounts
outstanding. The accrual of interest income is generally discontinued when a
loan or lease becomes 90 days past due as to principal or interest, or when, in
the judgment of management, collectibility of the loan, lease, loan interest or
lease interest become uncertain. When accrual of interest is discontinued, any
unpaid interest previously accrued is reversed from income. Subsequent
recognition of income occurs only to the extent payment is received subject to
management's assessment of the collectibility of the remaining principal and
interest. The accrual of interest on loans and leases past due 90 days or more,
including impaired loans and leases, may be continued when the value of the
loan's or lease's collateral is believed to be sufficient to discharge all
principal and accrued interest income due on the loan or lease and the loan or
lease is in the process of collection. A non-accrual loan or lease is restored
to accrual status when it is no longer delinquent and collectibility of interest
and principal is no longer in doubt. Loan and lease origination fees and certain
direct loan and lease origination costs are deferred and the net amount is
amortized as an adjustment of the related loan's or lease's yield. The Bank
generally amortizes these amounts over the contractual life of the related loans
and leases, utilizing a method which approximates the interest method.
LOANS HELD FOR SALE: Loans originated and intended for sale in the secondary
market are carried at the lower of aggregate cost or fair value, as determined
by aggregate outstanding commitments from
D-44
investors or current investor yield requirements. Net unrealized losses, if any,
are recognized through a valuation allowance by charges to noninterest income.
Mortgage loans held for sale are generally sold with the mortgage servicing
rights retained by the Company. Gains or losses on sales of mortgage loans are
recognized based on the difference between the selling price and the carrying
value of the related mortgage loans sold on the trade date.
TRANSFER OF FINANCIAL ASSETS: Transfers of financial assets are accounted for as
sales, when control over the assets has been surrendered. Control over
transferred assets is deemed to be surrendered when (1) the assets have been
isolated from the Company, (2) the transferee obtains the right to pledge or
exchange the transferred assets and no condition both constrains the transferee
from taking advantage of that right and provides more than a trivial benefit for
the transferor, and (3) the transferor does not maintain effective control over
the transferred assets through either (a) an agreement that both entitles and
obligates the transferor to repurchase or redeem the assets before maturity or
(b) the ability to unilaterally cause the holder to return specific assets,
other than through a cleanup call. Transfers that are not accounted for as sales
are accounted for as secured borrowings.
LOANS AND LEASES RECEIVABLE: Loans and leases receivable, other than those held
for sale, are reported at their principal amount outstanding, net of unearned
discounts and unamortized nonrefundable fees and direct costs associated with
their origination or acquisition. Management has the ability and intent to hold
its loans and leases for the foreseeable future or until maturity or payoff.
Leases are for equipment to customers under leases that qualify as direct
financing leases for financial reporting. Under the direct financing method of
accounting, the minimum lease payments to be received under the lease contract,
together with the estimated residual value, are recorded as lease receivables
when the lease contract is signed and the leased property is delivered to the
customer. The excess of the minimum lease payments and residual values over the
cost of the equipment is recorded as unearned income. Unearned income is
recognized at an effective level yield method over the life of the lease
contract. Lease payments are recorded when due under the lease contract.
A loan or lease is classified as a restructured loan or lease when certain
concessions have been made to the original contractual terms, such as reductions
of interest rates or deferral of interest or principal payments, due to the
borrowers' financial condition.
A loan or lease is considered impaired when it is probable that the creditor
will be unable to collect amounts due, both principal and interest, according to
the contractual terms of the loan or lease agreement. When a loan or lease is
impaired, impairment is measured using (1) the present value of expected future
cash flows of the impaired loan or lease discounted at the loan's or lease's
original effective interest rate, (2) the observable market price of the
impaired loan or lease or (3) the fair value of the collateral if the loan or
lease is collateral-dependent. When a loan or lease has been deemed to have an
impairment, a valuation allowance is established for the amount of impairment.
The Bank considers all non-accrual loans and leases; other loans or leases past
due 90 days or more, based on contractual terms, and restructured loans or
leases to be impaired.
ALLOWANCE FOR LOAN AND LEASE LOSSES: The allowance for loan and lease losses is
established as losses are estimated to have occurred through a provision for
loan and lease losses charged to earnings. Loan and lease losses are charged
against the allowance when management believes the uncollectibility of a loan or
lease balance is confirmed. Subsequent recoveries, if any, are credited to the
allowance.
D-45
The allowance for loan and lease losses is evaluated on a regular basis by
management and is based upon management's periodic review of the collectibility
of the loans or leases in light of historical experience, the nature and volume
of the loan or lease portfolio, adverse situations that may affect the
borrower's ability to repay, 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.
The allowance consists of specific, general and unallocated components. The
specific component relates to loans and leases that are classified as impaired.
For such loans and leases that are classified as impaired, an allowance is
established when the discounted cash flows (or observable market price or
collateral value if the loan or lease is collateral dependent) of the impaired
loan or lease is lower than the carrying value of that loan or lease. The
general component covers non-impaired loans and leases and is based on
historical loss experience adjusted for qualitative factors. An unallocated
component is maintained to cover uncertainties that could affect management's
estimate of probable losses. The unallocated component of the allowance reflects
the margin of imprecision inherent in the underlying assumptions.
The Bank's mortgage loans and leases are collateralized by real estate located
principally in Litchfield County, Connecticut. Accordingly, the ultimate
collectibility of a substantial portion of the Bank's loan and lease portfolio
is susceptible to changes in local market conditions. In addition, medical
equipment secures a substantial portion of the Leasing Company's lease
portfolio. Accordingly, the ultimate collectibility of a substantial portion of
the lease portfolio is susceptible to changes in the medical equipment market.
Management believes that the allowance for loan and lease losses is adequate.
While management uses available information to recognize losses on loans and
leases, future additions to the allowance or write-downs may be necessary based
on changes in economic conditions, particularly in Connecticut. In addition, the
Office of the Comptroller of the Currency (the "OCC"), as an integral part of
its examination process, periodically reviews the Bank's allowance for loan and
lease losses. The OCC may require the Bank to recognize additions to the
allowance or write-downs based on their judgment about information available to
them at the time of their examination.
RATE LOCK COMMITMENTS: The Company enters into commitments to originate loans
and leases whereby the interest rate on the loan or lease is determined prior to
funding (rate lock commitments). Rate lock commitments on mortgage loans that
are intended to be sold are considered to be derivatives. Accordingly, such
commitments, along with any related fees received from potential borrowers, are
recorded at fair value in other assets or liabilities, with changes in fair
value recorded in the net gain or loss on sale of mortgage loans. Fair value is
based on fees currently charged to enter into similar agreements, and for
fixed-rate commitments also considers the difference between current levels of
interest rates and the committed rates.
DERIVATIVE FINANCIAL INSTRUMENTS: The Company records derivative financial
instruments in accordance with SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." This Statement requires that all
derivatives be recognized as assets or liabilities in the balance sheet and
measured at fair value.
PREMISES AND EQUIPMENT: Bank premises and equipment are stated at cost for
purchased assets, and for assets under capital lease, at the lower of fair value
or net present value of the minimum lease
D-46
payments required over the term of the lease, net of accumulated depreciation
and amortization. Depreciation is charged to operations using the straight-line
method over the estimated useful lives of the related assets, which range from
three to forty years. Leasehold improvements are capitalized and amortized over
the shorter of the terms of the related leases or the estimated economic lives
of the improvements.
Gains and losses on dispositions are recognized upon realization. Maintenance
and repairs are expensed as incurred and improvements are capitalized.
IMPAIRMENT OF LONG-LIVED ASSETS: Long-lived assets, including premises and
equipment and certain identifiable intangible assets which are held and used by
the Company, are reviewed for impairment whenever events or changes in
circumstances indicate that the carrying amount of an asset may not be
recoverable. If impairment is indicated by that review, the asset is written
down to its estimated fair value through a charge to noninterest expense.
FORECLOSED REAL ESTATE: Foreclosed real estate, if any, is comprised of
properties acquired through foreclosure proceedings or acceptance of a deed in
lieu of foreclosure. These properties are carried at the lower of cost or fair
value less estimated costs of disposal. At the time these properties are
obtained, they are recorded at fair value with any difference between the
carrying value and fair value reflected as a direct charge against the allowance
for loan and lease losses, which establishes a new cost basis. Any subsequent
declines in value are charged to income with a corresponding adjustment to the
allowance for foreclosed real estate. Revenue and expense from the operation of
foreclosed real estate and changes in the valuation allowance are included in
operations. Costs relating to the development and improvement of the property
are capitalized, subject to the limit of fair value. Upon disposition, gains and
losses, to the extent they exceed the corresponding valuation allowance, are
reflected in the statement of operations.
COLLATERALIZED BORROWINGS: Collateralized borrowings represent the portion of
loans transferred to other institutions under loan participation agreements
which were not recognized as sales due to recourse provisions and/or
restrictions on the participant's right to transfer their portion of the loan.
REPURCHASE AGREEMENTS WITH CUSTOMERS: Repurchase agreements with customers are
classified as secured borrowings, and generally mature within one to three days
of the transaction date. Repurchase agreements are reflected at the amount of
cash received in connection with the transaction. The Bank may be required to
provide additional collateral based on the fair value of the underlying
securities.
TRUST ASSETS: Assets of the Trust Department, other than trust cash on deposit
at the Bank, are not included in these consolidated financial statements because
they are not assets of the Company. Trust fees are recognized on the accrual
basis of accounting.
INCOME TAXES: The Company recognizes income taxes under the asset and liability
method. Under this method, deferred tax assets and liabilities are recognized
for the future tax consequences attributable to differences between the
financial statement carrying amounts of existing assets and liabilities and
their respective tax bases. Deferred tax assets and liabilities are measured
using enacted tax rates expected to apply to taxable income in the years in
which those temporary differences are expected to be recovered or settled. The
effect on deferred tax assets and liabilities of a change in tax rates is
recognized in income in the period that includes the enactment date. Deferred
tax assets may be reduced by a valuation allowance
D-47
when, in the opinion of management, it is more likely than not that some portion
or all of the deferred tax assets will not be realized.
When tax returns are filed, it is highly certain that some positions taken will
be sustained upon examination by the taxing authorities, while others are
subject to uncertainty about the merits of the position taken or the amount of
the position that would be ultimately sustained. The benefit of a tax position
is recognized in the financial statements in the period during which, based on
all available evidence, management believes it is more likely than not that the
position will be sustained upon examination, including the resolution of appeals
or litigation processes, if any. The evaluation of a tax position taken is
considered by itself and not offset or aggregated with other positions. Tax
positions that meet the more-likely-than-not recognition threshold are measured
as the largest amount of tax benefit more than fifty percent likely of being
realized upon settlement with the applicable taxing authority.
Interest and penalties associated with unrecognized tax benefits, if any, would
be classified as additional provision for income taxes in the statement of
operations.
PENSION PLAN: The Bank has a noncontributory defined benefit pension plan that
covers substantially all employees. Pension costs are accrued based on the
projected unit credit method and the Bank's policy is to fund annual
contributions in amounts necessary to meet the minimum funding standards
established by the Employee Retirement Income Security Act (ERISA) of 1974.
In September 2006, the Financial Accounting Standards Board (the "FASB") issued
FASB Statement No. 158 ("SFAS No. 158"), "Employers' Accounting for Defined
Benefit Pension and Other Postretirement Plans, an amendment of FASB Statements
No. 87, 88, 106, and 132(R)," which requires companies to recognize a net
liability or asset to report the funded status of their defined benefit pension
and other postretirement benefit plans on their balance sheets. The Company
adopted SFAS No. 158 effective December 31, 2006 and as a result of the
adoption, a liability was recognized for the under funded status of the
Company's qualified pension plan and the net impact was recognized as an
after-tax charge to accumulated other comprehensive income. Subsequent to
December 31, 2006, changes in the under funded status of the plan are recognized
as a component of other comprehensive income.
SFAS 158 also requires an employer to measure the funded status of a plan as of
the employer's year-end reporting date. The Company adopted the measurement date
provisions of SFAS No. 158 in 2008 and there was no impact to the financial
statements upon adoption.
STOCK OPTION PLANS: In December 2004, the FASB issued Statement No. 123 (revised
2004), Share-Based Payment ("SFAS No. 123(R)"). SFAS No. 123(R) requires that
the compensation cost relating to share-based payment transactions be recognized
in financial statements. That cost is measured based on the fair value of the
equity or liability instruments issued. SFAS No. 123(R) covers a wide range of
share-based compensation arrangements including stock options, restricted share
plans, performance-based awards, share appreciation rights, and employee share
purchase plans. SFAS No. 123(R) is a replacement of SFAS No. 123, "Accounting
for Stock-Based Compensation," and supersedes APB Opinion No. 25, "Accounting
for Stock Issued to Employees," and its related interpretive guidance. This
statement requires entities to measure the cost of employee services received in
exchange for stock options based on the grant-date fair value of the award, and
to recognize the cost over the period the employee is required to provide
services for the award. SFAS No. 123(R) permits entities to use any
option-pricing model that meets the fair value objective in the Statement.
D-48
The Company elected to adopt SFAS No. 123(R) on January 1, 2006 under the
modified prospective method. Compensation is measured using the fair value of an
award on the grant dates and is recognized over the service period, which is
usually the vesting period. Compensation cost related to the unvested portion of
awards outstanding as of that date was based on the grant- date fair value of
those awards as calculated under the original provisions of SFAS No 123; that
is, the Company was not required to re-measure the grant-date fair value
estimate of the unvested portion of awards granted prior to the effective date
of SFAS No 123(R).
EARNINGS PER SHARE: Basic earnings per share represents income available to
common shareholders and is computed by dividing net income available to common
shareholders by the weighted-average number of common shares outstanding.
Diluted earnings per share reflects additional common shares that would have
been outstanding if dilutive potential common shares had been issued, as well as
any adjustment to income that would result from the assumed issuance. Potential
common shares that may be issued by the Company relate to outstanding stock
options and are determined using the treasury stock method.
RELATED PARTY TRANSACTIONS: Directors and officers of the Company and Bank and
their affiliates have been customers of and have had transactions with the Bank,
and it is expected that such persons will continue to have such transactions in
the future. Management believes that all deposit accounts, loans and leases,
services and commitments comprising such transactions were made in the ordinary
course of business, on substantially the same terms, including interest rates
and collateral, as those prevailing at the time for comparable transactions with
other customers who are not directors or officers. In the opinion of the
management, the transactions with related parties did not involve more than
normal risks of collectibility or favored treatment or terms, or present other
unfavorable features. Notes D, H, and P contain details regarding related party
transactions.
COMPREHENSIVE INCOME: Accounting principles generally require that recognized
revenue, expenses, gains and losses are included in net income. Although certain
changes in assets and liabilities, such as unrealized gains and losses on
available for sale securities and defined benefit pension liabilities, are
reported as a separate component of the shareholders' equity section of the
balance sheet, such items, along with net income, are components of
comprehensive income.
STATEMENTS OF CASH FLOWS: Cash and due from banks, Federal funds sold and
interest-earning deposits in banks are recognized as cash equivalents in the
statements of cash flows. For purposes of reporting cash flows, the Company
considers all highly liquid debt instruments purchased with a maturity of three
months or less to be cash equivalents. Generally, Federal funds sold have a
one-day maturity. Cash flows from loans, leases and deposits are reported net.
The Company maintains amounts due from banks and Federal funds sold which, at
times, may exceed federally insured limits. The Company has not experienced any
losses from such concentrations.
FAIR VALUE
In September 2006, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards No. 157, Fair Value Measurements
("SFAS No. 157"). SFAS No. 157 defines fair value, establishes a framework for
measuring fair value, and expands disclosures about fair value measurement. SFAS
No. 157 also emphasizes that fair value is a market-based measurement, not an
entity-specific measurement, and sets out a fair value hierarchy with the
highest priority being quoted prices in active markets. Under SFAS No. 157, the
three categories within the hierarchy are as follows:
D-49
- --------------------------------------------------------------------------------
Level 1 Quoted prices in active markets for identical assets
and liabilities.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Level 2 Observable inputs other than Level 1 prices such as
quoted prices for similar assets or liabilities in
active markets, quoted prices in markets that are not
active; and model-based valuation techniques for which
all significant inputs are observable or can be
corroborated by observable market data for
substantially the full term of the assets or
liabilities.
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Level 3 Unobservable inputs that are supported by little or
no market activity and that are significant to the
fair value of the assets or liabilities. Level 3
assets and liabilities include financial instruments
whose value is determined using pricing models,
discounted cash flow methodologies, or similar
techniques, as well as instruments for which the
determination of fair value requires significant
management judgment or estimation.
- --------------------------------------------------------------------------------
In February 2008, the FASB issued FASB Staff Position No. 157-2, Effective Date
of FASB Statement No. 157, which permits a one-year deferral for the
implementation of SFAS No. 157 with regard to nonfinancial assets and
liabilities that are not recognized or disclosed at fair value in the financial
statements on a recurring basis.
In October 2008, the FASB issued Staff Positions No. FAS 157-3, Determining the
Fair Value of a Financial Asset When the Market for That Asset is Not Active
("FSP No. 157-3"). FSP No. 157-3 amends SFAS No. 157 and clarifies its
application in an inactive market. In reaction to the recent financial crisis,
this FSP provides clarification as to whether to use direct market information
or internally generated estimates of the fair value of financial assets when a
market is not active. Application issues addressed by FSP No. 157-3 include: i)
how management's internal assumptions should be considered when measuring fair
value when relevant observable data do not exist, ii) how observable market
information in a market that is not active should be considered when measuring
fair value, and iii) how the use of market quotes should be considered when
assessing the relevance of observable and unobservable data available to measure
fair value. FSP No. 157-3 was effective upon its October 10, 2008 issuance. This
FSP did not have an impact on the Company's financial statements.
The Company adopted SFAS No. 157 for the fiscal year beginning January 1, 2008,
except for nonfinancial assets and nonfinancial liabilities that are recognized
or disclosed at fair value in the financial statements on a nonrecurring basis
for which delayed application is permitted as described above. The adoption of
SFAS No. 157 did not have an impact on the Company's financial statements, and
the adoption of the remaining provisions of SFAS No. 157 is not expected to have
a material impact on the Company's financial statements.
See Note R for additional information regarding fair value.
RECENT ACCOUNTING PRONOUNCEMENTS: In September 2006, the FASB ratified Emerging
Issues Task Force ("EITF") Issue No. 06-4, "Accounting for Deferred Compensation
and Postretirement
D-50
Benefits Associated with Endorsement Split-Dollar Life Insurance Arrangements"
("EITF 06-4"), and in March 2007, the FASB ratified EITF Issue No. 06-10,
"Accounting for Collateral Assignment Split-Dollar Life Insurance Arrangements"
("EITF 06-10"). EITF 06-4 requires deferred compensation or postretirement
benefit aspects of an endorsement-type split-dollar life insurance arrangement
to be recognized as a liability by the employer and states the obligation is not
effectively settled by the purchase of a life insurance policy. The liability
for future benefits should be recognized based on the substantive agreement with
the employee, which may be either to provide a future death benefit or to pay
for the future cost of the life insurance. EITF 06-10 provides recognition
guidance for postretirement benefit liabilities related to collateral assignment
split-dollar life insurance arrangements, as well as recognition and measurement
of the associated asset on the basis of the terms of the collateral assignment
split-dollar life insurance arrangement. EITF 06-4 and EITF 06-10 are effective
for fiscal years beginning after December 15, 2007. The adoption of EITF 06-4
resulted in a decrease to retained earnings of $12,272.
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 (Statement 159) which permits an entity to choose to measure
certain financial instruments and certain other items at fair value, on an
instrument-by-instrument basis. Once an entity has elected to record eligible
items at fair value, the decision is irrevocable and the entity should report
unrealized gains and losses on items for which the fair value option has been
elected in earnings. Statement 159 is effective for fiscal years beginning after
November 15, 2007. At the effective date, an entity may elect the fair value
option for eligible items that exist at that date with the effect of the first
measurement to fair value reported as a cumulative-effect adjustment to the
opening balance of retained earnings. There was no impact on the consolidated
financial statements of the Company as a result of the adoption of Statement 159
during the first quarter of 2008 since the Company has not elected the fair
value option for any eligible items, as defined in Statement 159.
In December 2007, the FASB issued SFAS No. 141(R), "Business Combinations,"
("SFAS 141(R)") which replaces SFAS 141. SFAS 141(R) establishes principles and
requirements for how an acquirer in a business combination recognizes and
measures in its financial statements the identifiable assets acquired, the
liabilities assumed, and any controlling interest; recognizes and measures
goodwill acquired in the business combination or a gain from a bargain purchase;
and determines what information to disclose to enable users of the financial
statements to evaluate the nature and financial effects of the business
combination. FAS 141(R) is effective for acquisitions by the Company taking
place on or after January 1, 2009. Early adoption is prohibited. Accordingly, a
calendar year-end company is required to record and disclose business
combinations following existing accounting guidance until January 1, 2009. The
Company will assess the impact of SFAS 141(R) if and when a future acquisition
occurs.
In December 2007, the FASB issued SFAS No. 160, "Noncontrolling Interests in
Consolidated Financial Statements - an amendment of ARB No. 51" ("SFAS 160").
SFAS 160 establishes new accounting and reporting standards for the
noncontrolling interest in a subsidiary and for the deconsolidation of a
subsidiary. Before this statement, limited guidance existed for reporting
noncontrolling interests (minority interest). As a result, diversity in practice
exists. In some cases minority interest is reported as a liability and in others
it is reported in the mezzanine section between liabilities and equity.
Specifically, SFAS 160 requires the recognition of a noncontrolling interest
(minority interest) as equity in the consolidated financials statements and
separate from the parent's equity. The amount of net income attributable to the
noncontrolling interest will be included in consolidated net income on the face
of the income statement. SFAS 160 clarifies that changes in a parent's ownership
interest in a subsidiary
D-51
that do not result in deconsolidation are equity transactions if the parent
retains its controlling financial interest. In addition, this statement requires
that a parent recognize gain or loss in net income when a subsidiary is
deconsolidated. Such gain or loss will be measured using the fair value of the
noncontrolling equity investment on the deconsolidation date. SFAS 160 also
includes expanded disclosure requirements regarding the interests of the parent
and its noncontrolling interests. SFAS 160 is effective for the Company on
January 1, 2009. Earlier adoption is prohibited. The Company is currently
evaluating the impact, if any, the adoption of SFAS 160 will have on its
financial position, results of operations and cash flows.
In June 2008, the FASB issued FASB Staff Position (FSP) EITF 03-6-1, Determining
Whether Instruments Granted in Share-Based Payment Transactions Are
Participating Securities. This FSP addresses whether instruments granted in
share-based payment transactions are participating securities prior to vesting
and, therefore, need to be included in the earnings allocation in computing
earnings per share (EPS) under the two-class method described in paragraphs 60
and 61 of FASB Statement No. 128, Earnings per Share. This FSP shall be
effective for financial statements issued for fiscal years beginning after
December 15, 2008, and interim periods within those years. All prior-period EPS
data presented shall be adjusted retrospectively (including interim financial
statements, summaries of earnings, and selected financial data) to conform with
the provisions of this FSP. Early application is not permitted. The Company does
not expect this FSP to have a significant effect on the Company's financial
statements.
In December 2008, the FASB issued Staff Position No. FAS 132(R)-1, "Employers'
Disclosures about Postretirement Benefit Plan Assets" ("FSP FAS 132(R)-1"). FSP
FAS 132(R)-1 requires more detailed disclosures about employers' plan assets in
a defined benefit pension or other postretirement plan, including employers'
investment strategies, major categories of plan assets, concentrations of risk
within plan assets, and inputs and valuation techniques used to measure the fair
value of plan assets. FSP FAS 132(R)-1 also requires, for fair value
measurements using significant unobservable inputs (Level 3), disclosure of the
effect of the measurements on changes in plan assets for the period. The
disclosures about plan assets required by FSP FAS 132(R)-1 must be provided for
fiscal years ending after December 15, 2009. As this pronouncement is only
disclosure-related, it will not have an impact on the Company's financial
statements.
NOTE B - RESTRICTIONS ON CASH AND DUE FROM BANKS
The Bank is required to maintain reserves against its transaction accounts and
nonpersonal time deposits. At December 31, 2008 and 2007 the Bank was required
to have cash and liquid assets of approximately $235,000 and $148,000,
respectively, to meet these requirements. In addition, the Bank is required to
maintain $200,000 in the Federal Reserve Bank for clearing purposes at both
December 31, 2008 and 2007.
NOTE C - SECURITIES
The amortized cost, gross unrealized gains, gross unrealized losses and
approximate fair values of securities which are classified as available for sale
and held to maturity at December 31, 2008 and 2007 are as follows:
D-52
AVAILABLE FOR SALE December 31, 2008
------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ------------ ------------ ----------
Debt Securities:
U.S. Treasury securities $ 3,110,574 $ 107,876 $ -- $ 3,218,450
U.S. Government Agency securities 26,500,000 65,763 (3,386) 26,562,377
State and Municipal Obligations 19,931,000 77,501 (376,069) 19,632,432
Trust Preferred Securities 493,615 -- -- 493,615
------------ ------------ ------------ ------------
50,035,189 251,140 (379,455) 49,906,874
------------ ------------ ------------ ------------
Mortgage-Backed Securities:
GNMA 9,495,917 12 (8,094) 9,487,835
FNMA 35,675,421 467,875 (263,567) 35,879,729
FHLMC 14,994,269 210,723 (9,228) 15,195,764
------------ ------------ ------------ ------------
60,165,607 678,610 (280,889) 60,563,328
------------ ------------ ------------ ------------
Marketable Equity Securities 3,045,878 -- (29,879) 3,015,999
------------ ------------ ------------ ------------
Total available for sale securities $113,246,674 $ 929,750 $ (690,223) $113,486,201
============ ============ ============ ============
December 31, 2007
-------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ------------ ------------ ------------
Debt Securities:
U.S. Treasury securities $ 4,007,040 $ 62,179 $ -- $ 4,069,219
U.S. Government Agency securities 30,992,780 8,895 (106,435) 30,895,240
State and Municipal Obligations 31,190,175 364,035 (49,871) 31,504,339
Trust Preferred Securities 4,898,731 -- (445,731) 4,453,000
------------ ------------ ------------ ------------
71,088,726 435,109 (602,037) 70,921,798
------------ ------------ ------------ ------------
Mortgage-Backed Securities:
GNMA 674,447 -- (16,521) 657,926
FNMA 40,041,144 221,704 (996,597) 39,266,251
FHLMC 12,311,134 61,541 (295,091) 12,077,584
------------ ------------ ------------ ------------
53,026,725 283,245 (1,308,209) 52,001,761
------------ ------------ ------------ ------------
Marketable Equity Securities 6,030,000 54,000 (28,011) 6,055,989
------------ ------------ ------------ ------------
Total available for sale securities $130,145,451 $ 772,354 $ (1,938,257) $128,979,548
============ ============ ============ ============
HELD TO MATURITY December 31, 2008
--------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ------------ ------------ ------------
Mortgage-Backed Securities:
GNMA $ 16,550 $ 3 $ -- $ 16,553
============ ============ ============ ============
December 31, 2007
--------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
------------ ------------ ------------ ------------
Mortgage-Backed Securities:
GNMA $ 34,185 $ -- $ (473) $ 33,712
============ ============ ============ ============
The following table presents the Bank's securities' gross unrealized losses and
fair value, aggregated by the length of time the individual securities have been
in a continuous unrealized loss position at December 31, 2008:
D-53
Less than 12 Months 12 Months or More Total
------------------------ ------------------------ -----------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
------------------------ ------------------------ -----------------------
Investment Securities
U.S. Government Agency securities $ 7,996,614 $ 3,386 $ -- $ -- $ 7,996,614 $ 3,386
State & Municipal obligations 8,804,717 303,267 2,574,433 72,802 11,379,150 376,069
----------- ----------- ----------- ----------- ----------- -----------
16,801,331 306,653 2,574,433 72,802 19,375,764 379,455
----------- ----------- ----------- ----------- ----------- -----------
Mortgage-Backed Securities
GNMA -- -- 465,643 8,094 465,643 8,094
FNMA 10,067,156 112,219 4,209,833 151,348 14,276,989 263,567
FHLMC -- -- 1,351,769 9,228 1,351,769 9,228
----------- ----------- ----------- ----------- ----------- -----------
10,067,156 112,219 6,027,245 168,670 16,094,401 280,889
----------- ----------- ----------- ----------- ----------- -----------
Marketable Equity Securities -- -- 1,970,122 29,879 1,970,122 29,879
----------- ----------- ----------- ----------- ----------- -----------
Total $26,868,487 $ 418,872 $10,571,800 $ 271,351 $37,440,287 $ 690,223
=========== =========== =========== =========== =========== ===========
The following table presents the Bank's securities' gross unrealized losses and
fair value, aggregated by the length of time the individual securities have been
in a continuous unrealized loss position at December 31, 2007:
Less than 12 Months 12 Months or More Total
------------------------ ------------------------ ------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
------------------------ ------------------------ ------------------------
Investment Securities
U.S. Government Agency securities $ -- $ -- $21,893,564 $ 106,435 $21,893,564 $ 106,435
State & Municipal obligations 8,077,673 49,871 -- -- 8,077,673 49,871
Corporate & Other bonds 4,453,000 445,731 -- -- 4,453,000 445,731
----------- ----------- ----------- ----------- ----------- -----------
12,530,673 495,602 21,893,564 106,435 34,424,237 602,037
----------- ----------- ----------- ----------- ----------- -----------
Mortgage-Backed Securities
GNMA 348,421 6,769 327,981 9,752 676,402 16,521
FNMA 110,712 817 27,637,383 995,780 27,748,095 996,597
FHLMC -- -- 9,546,400 295,091 9,546,400 295,091
----------- ----------- ----------- ----------- ----------- -----------
459,133 7,586 37,511,764 1,300,623 37,970,897 1,308,209
----------- ----------- ----------- ----------- ----------- -----------
Marketable Equity Securities -- -- 1,971,989 28,011 1,971,989 28,011
----------- ----------- ----------- ----------- ----------- -----------
Total $12,989,806 $ 503,188 $61,377,317 $ 1,435,069 $74,367,123 $ 1,938,257
=========== =========== =========== =========== =========== ===========
At December 31, 2008, thirty-seven securities have unrealized losses. The
following summarizes, by investment security type, the basis for the conclusion
that the applicable investment securities within the Company's available for
sale portfolio were not other-than-temporarily impaired at December 31, 2008:
Trust Preferred Securities--As of December 31, 2008 there were no unrealized
losses on the Company's investment in corporate bonds and notes. This compares
to the unrealized losses of $445,731 at December 31, 2007. As of December 31,
2008, this portfolio consisted of two pooled trust preferred securities. During
the third quarter of 2008, the Company recorded an other-than-temporary
impairment charge of $1,916,100 on one of these securities due to a credit
rating downgrade at that time. Subsequent to December 31, 2008, both securities
were downgraded to a rating of Ca, indicating a more severe deterioration in the
creditworthiness of the underlying issuers of these securities. As a result, the
Company recorded additional other-than-temporary impairment charges of
$2,476,552 as of December 31, 2008 related to these securities
D-54
Equity securities--The unrealized losses on the Company's investment in four
marketable equity securities totaled $29,879 which was similar to the unrealized
loss of $28,011 as of December 31, 2007. The unrealized loss as of December 31,
2008 is after the other-than-temporary impairment charges of $5.0 million for
the year ended December 31, 2008. This portfolio consists of two marketable
investment funds with a total fair value of $2,970,171, a money market fund with
a fair value of $45,828, and perpetual preferred stock of government sponsored
enterprises which have been written down to a fair value of $2 at December 31,
2008. Given the small unrealized loss remaining in this segment of the
portfolio, and the Company's ability and intent to hold the investments for a
reasonable period of time sufficient for a forecasted recovery of amortized
cost, the Company does not consider these investments to be
other-than-temporarily impaired at December 31, 2008.
Mortgage-backed securities--The unrealized losses on the Company's investment in
mortgage-backed securities decreased from $1,308,209 at December 31, 2007 to
$280,889 at December 31, 2008. There were no other-than-temporary impairment
charges for mortgage-backed securities for the year ended December 31, 2008.
These securities are U.S. Government Agency or sponsored agency securities and
the contractual cash flows for these investments are performing as expected.
Management believes the decline in fair value is attributable to investors'
perception of credit and the lack of liquidity in the marketplace. The Company
expects to collect all principal and interest on these securities and has the
ability and intent to hold these investments until a recovery of amortized cost,
which may be at maturity. The Company does not consider these investments to be
other-than-temporarily impaired at December 31, 2008.
State and Municipal Obligations--The unrealized losses on the Company's
investment in state and municipal obligations increased from $49,871 at December
31, 2007 to $376,069 at December 31, 2008. There were no other-than-temporary
impairment charges for these securities during 2008. The increase in the
unrealized loss at December 31, 2008 is attributable to concerns about the
economy, credit, lack of bank participation in this market and downgrades of the
monoline insurers as well as some perceived lack of credibility of the credit
rating agencies. At this point, all securities are performing, the Company is
receiving all interest and principal payments as contractually agreed, and all
these securities are rated as investment grade. The Company does not consider
these investments to be other-than-temporarily impaired at December 31, 2008.
U.S. Government Agency Securities--The unrealized losses on the Company's
investment in these securities decreased from $106,435 at December 31, 2007 to
$3,386 at December 31, 2008. Given the small unrealized loss remaining in this
segment of the portfolio, and the Company's ability and intent to hold the
investments for a reasonable period of time sufficient for a recovery of
amortized cost, the Company does not consider these investments to be
other-than-temporarily impaired at December 31, 2008.
The amortized cost and fair value of debt securities at December 31, 2008, by
contractual maturity, are shown below. Actual maturities of mortgage-backed
securities may differ from contractual maturities because the mortgages
underlying the securities may be called or prepaid with or without call or
prepayment penalties. Because mortgage-backed securities are not due at a single
maturity date, they are not included in the maturity categories in the following
maturity summary.
D-55
December 31,2008
-----------------------------------------------------------
Available-for-Sale Securities Held-to-Maturity Securities
-------------------------- --------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
------------ ------------ ------------ ------------
Due in one year or less $ -- $ -- $ -- $ --
Due after one year through five years 25,110,576 25,272,025 -- --
Due after five years through ten years 6,403,590 6,443,810 -- --
Due after ten years 18,521,023 18,191,039 -- --
------------ ------------ ------------ ------------
50,035,189 49,906,874 -- --
Mortgage-backed securities 60,165,607 60,563,328 16,550 16,553
------------ ------------ ------------ ------------
TOTAL DEBT SECURITIES $110,200,796 $110,470,202 $ 16,550 $ 16,553
============ ============ ============ ============
For the years ended December 31, 2008 and 2007, proceeds from the sales of
available for sale securities were $43,699,152 and $16,295,820, respectively.
Gross gains of $825,103 and gross losses of $287,313 were realized on sales in
2008 and gross gains of $19,632 were realized on sales in 2007. In addition,
during the year ended December 31, 2008, the Company recorded a loss of
$9,422,650 related to the other-than-temporary impairment of the Company's
investments in Freddie Mac and Fannie Mae preferred stock auction rate
securities holding such stock, and two pooled trust preferred securities.
Investment securities with a carrying value of $76,450,000 and $62,582,000 were
pledged as collateral to secure treasury tax and loan, trust assets, securities
sold under agreements to repurchase and public funds at December 31, 2008 and
2007, respectively.
During 2008 and 2007, there were no transfers of securities from the available
for sale category into the held to maturity or trading categories, and there
were no securities classified as held to maturity that were transferred to
available for sale or trading categories.
The OTTI charge in the fourth quarter was related to the impairment write-down
on two trust preferred investment securities. The write-down was the result of
the significant downgrading of these investments by Moody's credit rating
agency. The downgrades were the result of continued weak economic conditions,
the number of interest payment deferrals and the exposure of these securities
issued by small to medium sized U. S. Community bank and insurance companies to
the crisis in the financial industry.
NOTE D - LOANS TO RELATED PARTIES
In the normal course of business the Bank has granted loans to officers and
directors of the Bank and to their associates. As of December 31, 2008 and 2007,
all loans to officers, directors and their associates were performing in
accordance with the contractual terms of the loans. Changes in these loans to
persons considered to be related parties are as follows:
2008 2007
-------------- -------------
Balance at the beginning of year $ 2,219,055 $ 2,471,904
Advances 383,945 596,691
Repayments (406,636) (792,962)
Other changes (118,491) (56,578)
-------------- -------------
Balance at the end of year $ 2,077,873 $ 2,219,055
============== =============
D-56
Other changes in loans to related parties resulted from loans to individuals who
ceased being related parties during the year, as well as existing loans
outstanding at the beginning of the year to individuals who became related
parties during the year.
NOTE E - LOAN AND LEASE RECEIVABLES
A summary of loans and leases receivable at December 31, 2008 and 2007 is as
follows:
2008 2007
------------- -------------
Real estate- residential mortgage $ 192,561,108 $ 189,556,668
Real estate- commercial mortgage 67,454,925 55,752,240
Real estate- construction 38,153,503 34,808,984
Commercial loans 46,249,689 33,641,679
Commercial leases (net of unearned discount of $2,657,871) 19,785,870 8,634,199
Installment 5,113,400 6,519,812
Other 128,574 99,357
------------- -------------
TOTAL LOANS AND LEASES 369,447,069 329,012,939
Net deferred loan origination costs 562,242 445,671
Premiums on purchased loans 81,588 168,383
Allowance for loan and lease losses (3,698,820) (2,151,622)
------------- -------------
NET LOANS AND LEASES $ 366,392,079 $ 327,475,371
============= =============
Changes in the allowance for loan and lease losses for the years ended December
31, 2008 and 2007 were as follows:
2008 2007
----------- -----------
Balance at the beginning of year $ 2,151,622 $ 2,106,100
Provision for loan and lease losses 1,836,299 204,000
Loans and leases charged off (377,071) (176,777)
Recoveries of loans and leases previously charged off 87,970 18,299
----------- -----------
BALANCE AT END OF YEAR $ 3,698,820 $ 2,151,622
=========== ===========
A summary of nonperforming loans and leases follows:
2008 2007
---------- ----------
Non-accrual loans and leases $5,639,735 $2,959,074
Accruing loans and leases contractually past due 90 days or more 19,603 3,111
---------- ----------
TOTAL $5,659,338 $2,962,185
========== ==========
If interest income on non-accrual loans and leases throughout the year had been
recognized in accordance with their contractual terms, approximately $163,000
and $88,000 of additional interest would have been recorded for the years ended
December 31, 2008 and 2007, respectively.
The following information relates to impaired loans and leases, which include
all nonaccrual loans and leases and other loans and leases past due 90 days or
more, and all restructured loans and leases, as of and for the years ended
December 31, 2008 and 2007:
D-57
2008 2007
---------- ----------
Loans and leases receivable for which there is a related allowance for loan
and lease losses $6,225,481 $ 327,027
========== ==========
Loans and leases receivable for which there is no related allowance for loan
and lease losses $2,657,655 $2,632,047
========== ==========
Allowance for loan and lease losses related to impaired loans and leases $ 939,066 $ 181,119
========== ==========
Additional information related to impaired loans and leases is as follows:
2008 2007
---------- ----------
Average recorded investment in impaired loans and leases $4,646,000 $1,865,000
========== ==========
Interest income recognized $ 600,000 $ 228,000
========== ==========
Cash interest received $ 540,000 $ 186,000
========== ==========
The Bank's lending activities are conducted principally in the Litchfield County
section of Connecticut. The Bank grants single-family and multi-family
residential loans, commercial real estate loans, commercial business loans and a
variety of consumer loans. In addition, the Bank grants loans for the
construction of residential homes, residential developments and for land
development projects. Although lending activities are diversified, a substantial
portion of many of the Bank's customers' net worth is dependent on real estate
values in the Bank's market area. The Bank's leasing activities are conducted
primarily in the New England states as well as in New Jersey. The leasing
company's activities are primarily equipment financing.
The Bank has established credit policies applicable to each type of lending
activity in which it engages, evaluates the creditworthiness of each customer
and, in most cases, extends credit of up to 80% of the market value of the
collateral at the date of the credit extension depending on the Bank's
evaluation of the borrowers' creditworthiness and type of collateral. The market
value of collateral is monitored on an ongoing basis and additional collateral
is obtained when warranted. Real estate is the primary form of collateral. Other
important forms of collateral are marketable securities, time deposits,
automobiles, boats, motorcycles and recreational vehicles. While collateral
provides assurance as a secondary source of repayment, the Bank ordinarily
requires the primary source of repayment to be based on the borrower's ability
to generate continuing cash flows. The Bank's policy for real estate collateral
requires that, generally, the amount of the loan may not exceed 80% of the
original appraised value of the property. Private mortgage insurance is required
for the portion of the loan in excess of 80% of the original appraised value of
the property. For installment loans, the Bank may loan up to 100% of the value
of the collateral. For leases, the leasing company will lend 100% of the asset
value financed.
NOTE F - PREMISES AND EQUIPMENT
The major categories of premises and equipment as of December 31, 2008 and 2007
are as follows:
D-58
2008 2007
---- ----
Land $ 1,245,465 $ 1,245,465
Buildings and improvements 7,740,270 7,584,199
Furniture and fixtures 3,617,064 3,597,603
Leasehold improvements 220,761 212,106
----------- -----------
12,823,560 12,639,373
Less accumulated depreciation and amortization 5,453,308 4,880,612
----------- -----------
$ 7,370,252 $ 7,758,761
=========== ===========
Depreciation and amortization expense on premises and equipment for the years
ended December 31, 2008 and 2007 was $734,020 and $751,259, respectively.
Included in buildings and improvements, premises under capital lease totaled
$1,100,644, and related accumulated amortization as of December 31, 2008 and
2007 totaled $110,202 and $55,101, respectively.
NOTE G - LEASES
The Company leases a branch office of the Bank under a twenty-year capital lease
that expires in 2026. In addition, at December 31, 2008, the Company was
obligated under various non-cancellable operating leases for office space.
Certain leases contain renewal options and provide for increased rentals based
principally on increases in the average consumer price index. The Company also
pays certain executory costs under these leases. Net rent expense under
operating leases was approximately $240,000 and $242,000 for 2008 and 2007,
respectively. The future minimum payments under the capital lease and operating
leases are as follows:
Capital Lease Operating Leases
---------------- ------------------
2009 $ 75,000 $ 151,053
2010 75,000 108,742
2011 75,917 112,018
2012 86,000 115,365
2013 86,000 118,819
2014 and thereafter 1,320,833 301,630
---------------- ------------------
1,718,750 $ 907,627
==================
Less amount representing interest (653,187)
----------------
Present value of future minimum lease
payments-capital lease obligation $ 1,065,563
================
NOTE H - DEPOSITS
A summary of deposits at December 31, 2008 and 2007 is as follows:
D-59
2008 2007
---- ----
Noninterest bearing:
Demand $ 69,548,261 $ 70,564,267
------------ ------------
Interest bearing:
Savings 58,582,376 56,344,878
Money market 93,085,126 78,738,706
Time certificates of deposit in
denominations of $100,000 or more 41,003,855 52,345,036
Other time certificates of deposit 81,107,006 77,624,777
------------ ------------
Total interest bearing 273,778,363 265,053,397
------------ ------------
$343,326,624 $335,617,664
============ ============
Included in deposits as of December 31, 2008 are approximately $15,902,000 of
brokered deposits which have varying maturities through December 2009.
The following is a summary of time certificates of deposits by contractual
maturity as of December 31, 2008:
2009 95,891,432
2010 24,494,209
2011 528,997
2012 556,922
2013 639,301
------------
Total 122,110,861
Deposit accounts of officers, directors and their associates aggregated
$4,965,692 and $9,015,747 at December 31, 2008 and 2007, respectively.
NOTE I - BORROWINGS AND FEDERAL HOME LOAN BANK STOCK
Federal Home Loan Bank Borrowings and Stock
The Bank, which is a member of the Federal Home Loan Bank of Boston (the
"FHLBB"), is required to maintain as collateral, an investment in capital stock
of the FHLBB in an amount equal to a certain percentage of its outstanding
residential first mortgage loans. Purchases of Federal Home Loan Bank stock
totaled $360,200 during 2008 and $634,500 during 2007. There were no redemptions
during 2008. Redemptions during 2007 amounted to $10,500. The 2008 and 2007
increases in FHLBB stock are due to capital structure changes implemented during
the second quarter of 2004 by the Federal Home Loan Bank of Boston (FHLBB).
These changes require each institution's stock investment in the FHLBB to be
reflective of that institution's use of FHLBB products. The Company views its
investment in the FHLBB stock as a long-term investment. Accordingly, when
evaluating for impairment, the value is determined based on the ultimate
recovery of the par value rather than recognizing temporary declines in value.
The determination of whether a decline affects the ultimate recovery is
influenced by criteria such as: 1) the significance of the decline in net assets
of the FHLBB as compared to the capital stock amount and length of time a
decline has persisted; 2) impact of legislative and regulatory changes on the
FHLBB and 3) the liquidity position of the FHLBB. The FHLBB announced in
February 2009 that it will suspend its dividend for the first quarter of 2009,
will likely not pay any dividends for the remainder of 2009, and will continue
its moratorium on excess stock repurchases announced in December 2008. The FHLBB
noted their primary concern related to the impact of other-than-temporary
impairment charges recorded on private label mortgage-backed securities (MBS) as
of December 31, 2008. In addition, in March 2009, the FHLBB announced that it
D-60
was filing its Form 10-K with the SEC late because of the need to further
evaluate potential additional losses on its MBS.
While the FHLBB announced that it remained adequately capitalized as of December
31, 2008 in its February announcement, the Company is unable to determine if the
potential additional charges to earnings will change this regulatory capital
classification. The Company does not believe that its investment in the FHLBB is
impaired as of this date. However, this estimate could change in the near term
as a result of any of the following events: 1) additional significant impairment
losses are incurred on the MBS causing a significant decline in the FHLBB's
regulatory capital status; 2) the economic losses resulting from credit
deterioration on the MBS increases significantly and 3) capital preservation
strategies being utilized by the FHLBB become ineffective.
As a member of the FHLBB, the Bank has access to a preapproved line of credit of
up to 2% of its total assets and the capacity to obtain additional advances up
to 30% of its total assets. In accordance with an agreement with the FHLBB, the
Bank is required to maintain qualified collateral, as defined in the FHLBB
Statement of Products Policy, free and clear of liens, pledges and encumbrances
for the advances. FHLBB stock and certain loans which aggregate approximately
100% of the outstanding advances are used as collateral. At December 31, 2008,
advances under the Federal Home Loan Bank line of credit totaled $1,608,000. At
December 31, 2007, there were no advances under the Federal Home Loan Bank line
of credit. At December 31, 2008 and 2007, other outstanding advances from the
FHLBB aggregated $80,000,000 and $91,500,000, respectively, at interest rates
ranging from 3.95% to 4.59%, and 3.27% to 4.70%, respectively.
Repurchase Agreements with Financial Institutions
- -------------------------------------------------
At December 31, 2008 and 2007, securities sold under agreements to repurchase
totaled $26,450,000 and $21,550,000, respectively, at interest rates ranging
from 3.19% to 3.635%, and 3.20% to 4.19%, respectively.
Repurchase Agreements with Customers
- ------------------------------------
At December 31, 2008 and 2007, the balance of securities sold under repurchase
agreements with customers was $18,222,571 and $14,142,773, respectively.
Securities sold under agreements to repurchase, which are classified as secured
borrowings, generally mature within one to four days from the transaction date.
Securities sold under agreements to repurchase are reflected at the amount of
cash received in connection with the transactions.
Collateralized Borrowings
- -------------------------
Collateralized borrowings amounted to $1,375,550 and $1,699,336 as of December
31, 2008 and 2007, respectively. Pursuant to FASB Statement No. 140, certain
loan participation agreements did not qualify for sale accounting due to buyback
provisions included within the agreement, thus the Company has not surrendered
control over the transferred loans and has accounted for the transfers as
collateralized borrowings.
Junior Subordinated Debt Issued by Unconsolidated Trusts
- --------------------------------------------------------
The Company has established two Delaware statutory trusts, First Litchfield
Statutory Trust I and First Litchfield Statutory Trust II, for the sole purpose
of issuing trust preferred securities and related trust
D-61
common securities. The proceeds from such issuances were used by the trusts to
purchase junior subordinated notes of the Company, which are the sole assets of
each trust.
Concurrently with the issuance of the trust preferred securities, the Company
issued guarantees for the benefit of the holders of the trust preferred
securities. The trust preferred securities are issues that qualify, and are
treated by the Company, as Tier 1 regulatory capital. The Company wholly owns
all of the common securities of each trust. The trust preferred securities
issued by each trust rank equally with the common securities in right of
payment, except that if an event of default under the indenture governing the
notes has occurred and is continuing, the preferred securities will rank senior
to the common securities in right of payment.
The table below summarizes the outstanding junior subordinated notes and the
related trust preferred securities issued by each trust as of December 31, 2008:
First Litchfield First Litchfield
Statutory Trust I Statutory Trust II
----------------------- ---------------------
Junior Subordinated Notes:
Principal balance $ 7,011,000 $ 3,093,000
Annual interest rate 3 mo libor + 3.10% 3 mo libor + 1.65%
Stated maturity date June 26,2033 June 30,2036
Call date June 26,2008 June 30,2011
Trust Preferred Securities:
Face value 6,800,000 3,000,000
Annual distribution rate 3 mo libor + 3.10% 3 mo libor + 1.65%
Issuance date June 1,2033 June 1,2006
Distribution dates (1) Quarterly Quarterly
(1) All cash distributions are cumulative
Trust preferred securities are currently considered regulatory capital for
purposes of determining the Company's Tier I capital ratios. On March 1, 2005,
the Board of Governors of the Federal Reserve System, which is the Company's
banking regulator, approved final rules that allow for the continued inclusion
of outstanding and prospective issuances of trust preferred securities in
regulatory capital subject to new, more strict limitations. The Company has
until March 31, 2009 to meet the new limitations. Management does not believe
these final rules will have a significant impact on the Company.
The trust preferred securities are subject to mandatory redemption, in whole or
in part, upon repayment of the junior subordinated notes at the stated maturity
date or upon redemption on a date no earlier than June 26, 2008 for First
Litchfield Statutory Trust I and June 30, 2011 for First Litchfield Statutory
Trust II. Prior to these respective redemption dates, the junior subordinated
notes may be redeemed by the Company (in which case the trust preferred
securities would also be redeemed) after the occurrence of certain events that
would have a negative tax effect on the Company or the trusts, would cause the
trust preferred securities to no longer qualify as Tier 1 capital, or would
result in a trust being treated as an investment company. Each trust's ability
to pay amounts due on the trust preferred securities is solely dependent upon
the Company making payment on the related junior subordinated notes. The
Company's obligation under the junior subordinated notes and other relevant
trust agreements, in aggregate, constitute a full and unconditional guarantee by
the Company of each trust's obligations under the trust
D-62
preferred securities issued by each trust. The Company has the right to defer
payment of interest on the notes and, therefore, distributions on the trust
preferred securities, for up to five years, but not beyond the stated maturity
date in the table above. During any such deferral period the Company may not pay
cash dividends on its common stock and generally may not repurchase its common
stock.
The contractual maturities of the Company's long-term borrowings at December 31,
2008, by year, are as follows:
Fixed Floating
Rate Rate Total
------------------ ----------------- ------------------
2009 $ 15,034,000 $ - $ 15,034,000
2010 15,090,000 - 15,090,000
2011 97,000 - 97,000
2012 5,104,000 - 5,104,000
2013 22,612,000 - 22,612,000
Thereafter 49,889,000 10,104,000 59,993,000
------------------ ----------------- ------------------
TOTAL LONG-TERM DEBT $ 107,826,000 $ 10,104,000 $ 117,930,000
================== ================= ==================
NOTE J - INCOME TAXES
The components of the income tax (benefit) provision are as follows:
2008 2007
----------- -----------
Current Provision:
Federal $ 755,815 $ 178,289
Deferred (Benefit) Provision
Federal (3,868,274) 47,413
----------- -----------
$(3,112,459) $ 225,702
=========== ===========
A reconciliation of the anticipated income tax expense (computed by applying the
Federal statutory income tax rate of 34% to the income before taxes) to the
(benefit) provision for income taxes as reported in the statements of operations
is as follows:
2008 2007
------------------- ---------------------
(Benefit) provision for income taxes at statutory Federal rate $ (2,583,649) (34)% $ 738,835 34%
Increase (decrease) resulting from:
Tax exempt interest income (451,306) (6)% (464,076) (21)%
Nondeductable interest expense 47,273 1% 62,718 3%
Tax exempt income from insurance policies (134,677) (2)% (130,587) (6)%
Other 9,900 - 18,812 -
------------------- ---------------------
(Benefit) Provision for income taxes $ (3,112,459) (41)% $ 225,702 10%
=================== =====================
The tax effects of temporary differences that give rise to significant
components of the deferred tax assets and deferred tax liabilities at December
31, 2008 and 2007 are presented below:
D-63
2008 2007
----------- -----------
Deferred tax assets:
Allowance for loan and lease losses $ 1,257,598 $ 731,552
Depreciation 207,789 140,883
Accrued expenses 387,740 282,836
Alternative minimum taxes 452,992 261,503
Unfunded pension liability 609,211 256,490
Unrealized loss on available for sale securities -- 396,407
Securities write-downs 3,203,701 --
----------- -----------
Total gross deferred tax assets 6,119,031 2,069,671
----------- -----------
Deferred tax liabilities:
Tax bad debt reserve (153,536) (153,536)
Prepaid pension costs (268,902) (246,976)
Net deferred loan and lease costs (191,162) (151,528)
Leases (338,328) (151,856)
Unrealized gain on available for sale securities (81,439) --
Prepaid expenses and other (2,707) (38,240)
----------- -----------
Total gross deferred tax liabilities (1,036,074) (742,136)
----------- -----------
Net deferred tax asset $ 5,082,957 $ 1,327,535
=========== ===========
Based on the Company's income taxes paid in prior years and expected future
earnings, management believes that it is more likely than not that the deferred
tax asset will be realized.
Effective for taxable years commencing after December 31, 1998, financial
services institutions doing business in Connecticut are permitted to establish a
"passive investment company" ("PIC") to hold and manage loans secured by real
property. PICs are exempt from Connecticut corporation business tax, and
dividends received by the financial services institution's parent from PICs are
not taxable. In August 2000, the Bank established a PIC, as a wholly-owned
subsidiary, and beginning in October 2000, transferred a portion of its
residential and commercial mortgage loan portfolios from the Bank to the PIC. A
substantial portion of the Company's interest income is now derived from the
PIC, an entity that has been organized as a state tax exempt entity, and
accordingly there is no provision for state income taxes in 2008 and 2007.
NOTE K - EMPLOYEE BENEFITS
PENSION PLAN: The Bank has a noncontributory defined benefit pension plan (the
"Plan") that covers substantially all employees who have completed one year of
service and have attained age 21. The benefits are based on years of service and
the employee's compensation during the last five years of employment. During the
first quarter of 2005, the Bank's pension plan was curtailed. Prior to the
Plan's curtailment, the Bank's funding policy was to contribute amounts to the
Plan sufficient to meet the minimum funding requirements set forth in ERISA,
plus such additional amounts as the Bank determined to be appropriate from time
to time. The actuarial information has been calculated using the projected unit
credit method.
The following table sets forth the Plan's funded status and amounts recognized
in the consolidated balance sheets at December 31, 2008 and 2007 using a
measurement date of December 31:
D-64
2008 2007
----------- -----------
Change in benefit obligation
Benefit obligation, beginning $ 3,270,153 $ 3,408,732
Service Cost -- --
Interest Cost 187,272 184,166
Actuarial loss (19,938) (31,536)
Benefits paid (441,864) (291,209)
----------- -----------
Benefit obligation, ending 2,995,623 3,270,153
----------- -----------
Change in plan assets:
Fair value of plan assets, beginning 3,242,172 2,939,118
Actual return on plan assets (905,594) 494,263
Employer contribution 100,000 100,000
Benefits paid (441,864) (291,209)
----------- -----------
Fair value of plan assets, ending 1,994,714 3,242,172
----------- -----------
Funded status at end of year included
in accrued expenses and other liabilities $(1,000,909) $ (27,981)
=========== ===========
The accumulated benefit obligation was $2,995,623 and $3,270,153 at December 31,
2008 and 2007, respectively. At December 31, 2008 and 2007, $1,791,798 and
$754,381, respectively of net actuarial losses are included in accumulated other
comprehensive loss. The estimated net loss that will be amortized from
accumulated other comprehensive loss into net periodic benefit cost in 2009 is
$95,741.
2008 2007
----------- -----------
Components of net periodic benefit cost and other
amounts recognized in other comprehensive income:
Service cost $ -- $ --
Interest cost 187,272 184,166
Expected return on plan assets (206,533) (200,249)
Amortization of unrealized loss 54,772 72,651
----------- -----------
Net periodic benefit cost 35,511 56,568
----------- -----------
Other changes in plan assets and benefit obligations
recognized in other comprehensive income:
Net loss (gain) 1,037,417 (398,201)
----------- -----------
Total recognized in net periodic
benefit cost and other comprehensive loss (income) $ 1,072,928 $ (341,633)
=========== ===========
Weighted-average assumptions used to determine benefit obligations at December
31:
2008 2007
----------- -----------
Discount rate 6.00% 6.00%
Rate of compensation increase N/A N/A
D-65
Weighted-average assumptions used to determine net periodic benefit cost for
years ended December 31:
2008 2007
---------- ----------
Discount rate 6.00% 6.00%
Expected return on plan assets 7.50% 7.50%
Rate of compensation increase N/A N/A
The pension expense for the Plan was $35,511 and $56,568 for the years ended
December 31, 2008 and 2007, respectively, and is calculated based upon a number
of actuarial assumptions, including an expected long-term rate of return on Plan
assets of 7.50% each year. In developing the expected long-term rate of return
assumption, management evaluated input from its investment advisor and
actuaries, including their review of asset class return expectations as well as
long-term inflation assumptions. Management anticipates that investments will
continue to generate long-term returns averaging at least 7.50%. Management
regularly reviews the asset allocations and periodically rebalances investments
when considered appropriate. Management continues to believe that 7.50% is a
conservatively reasonable long-term rate of return on Plan assets. Management
will continue to evaluate the actuarial assumptions, including the expected rate
of return, at least annually, and will adjust as necessary.
The Bank's pension plan weighted average asset allocations at December 31, 2008
and 2007 by asset category are as follows:
Percentage of
Plan Assets as of
December 31,
Asset Category 2008 2007
- -------------- ---- ----
Cash and receivables 10% 7%
Corporate debt and equity securities 63% 66%
Pooled funds/ Mutual funds 8% 13%
Government securities 19% 14%
----------
Total 100% 100%
==========
The purpose of the pension investment program is to provide the means to pay
retirement benefits to participants and their beneficiaries in the amounts and
at the times called for by the Plan. Plan benefits were frozen effective May 1,
2005. The Bank made a $100,000 contribution to the Plan during both 2008 and
2007, Contributions of $54,167 are anticipated to be made in 2009.
Plan assets are diversified and invested in accordance with guidelines
established by the Bank's Compensation and Trust Committees. The portfolio is
managed according to a standard Growth and Income Investment Objective model.
The target asset allocation is 60% equity and 40% fixed income exposure.
Rebalancing takes place when the investment mix varies more than 5% of its
Investment Objective model. Equity plan assets are further diversified in
investment styles ranging from large cap, mid cap, small cap and international.
Individual corporate, government agency and municipal bonds/notes, fixed income
mutual funds and exchange traded funds, as well as certificates of deposits,
provide fixed income for the plan and are diversified by type, credit quality
and duration. The fixed income investments are laddered by maturity in order to
mitigate interest rate sensitivity and income fluctuations over time.
D-66
The following benefit payments, which reflect expected future service, as
appropriate, are expected to be paid:
2009 $ 191,000
2010 203,000
2011 241,000
2012 239,000
2013 234,000
2014-2018 1,178,000
EMPLOYEE SAVINGS PLAN: The Bank offers an employee savings plan under section
401(k) of the Internal Revenue Code. Under the terms of the Plan, employees may
contribute up to 10% of their pre-tax compensation. For the years ended December
31, 2008 and 2007, the Bank made matching contributions equal to 50% of
participant contributions up to the first 6% of pre-tax compensation of a
contributing participant. The Bank also made a contribution of 3% of pre-tax
compensation for all eligible participants regardless of whether the participant
made voluntary contributions to the 401(k) plan. Participants vest immediately
in both their own contributions and the Bank's contributions. Employee savings
plan expense was $273,483 and $237,461 for 2008 and 2007, respectively.
OTHER BENEFIT PLANS: Beginning in 1996, the Company offered directors the option
to defer their directors' fees. If deferred, the fees are held in a trust
account with the Bank. The Bank has no control over the trust. The fair value of
the related trust assets and corresponding liability of $93,234 and $180,951 at
December 31, 2008, and 2007, respectively are included in the Company's balance
sheet. During 2005, the plan was amended to cease the deferral of any future
fees.
In 2000, the Bank adopted a long-term incentive compensation plan for its
executive officers and directors. Under this plan, officers and directors are
awarded deferred incentive compensation annually based on the earnings
performance of the Bank. Twenty percent of each award vests immediately and the
remainder vests ratably over the next four years, however, awards are
immediately vested upon change of control of the Bank, or when the participants
reach their normal retirement date or early retirement age, as defined. In
addition, interest is earned annually on the vested portion of the awards. Upon
retirement, the participants' total deferred compensation, including earnings
thereon, may be paid out in one lump sum, or paid in equal annual installments
over fifteen years for executive officers and ten years for directors. For the
years ended December 31, 2008 and 2007, $53,001 and $72,702, respectively, were
charged to operations under this plan. The related liability, of $465,237 and
$419,187 at December 31, 2008 and 2007, respectively, is included in accrued
expenses and other liabilities. At December 31, 2007, unvested benefits earned
under this plan were approximately $19,000.
In 2005, the Bank established an Employee Stock Ownership Plan ("ESOP"), for the
benefit of its eligible employees. The ESOP invests in the stock of the Company
providing participants with the opportunity to participate in any increases in
the value of Company stock. Under the ESOP, eligible employees, which represent
substantially all full-time employees, are awarded shares of the Company's stock
which are allocated among participants in the ESOP in proportion to their
compensation. The Board determines the total amount of compensation to be
awarded under the plan. That amount of compensation divided by the fair value of
the Company's shares at the date the shares are transferred to the plan
determines the number of shares contributed to the plan. Dividends are allocated
to participant accounts in proportion to their respective shares. For the years
ended December 31, 2008 and 2007, there were no expenses incurred under the
ESOP. During 2006, the Company contributed 2,414 shares to the ESOP, and no
shares were contributed to the ESOP during 2008 or 2007. Under the terms of the
D-67
ESOP, the Company is required to repurchase shares from participants upon death
or termination. The fair value of shares subject to repurchase at December 31,
2008 is less than $25,000.
Effective January 1, 2006, the Bank entered into supplemental retirement
agreements with three of the Bank's Senior Officers. At December 31, 2008 and
2007, accrued supplemental retirement benefits of $377,000 and $214,000,
respectively, are recognized in the Company's balance sheet related to these
plans. Upon retirement, the plans provide for payments to these individuals
ranging from 10% to 25% of the three year average of the executive's
compensation prior to retirement for the life expectancy of the executive at the
retirement date
The Bank has an investment in, and is the beneficiary of, life insurance
policies on the lives of certain current and former directors and officers. The
purpose of these life insurance investments is to provide income through the
appreciation in cash surrender values of the policies, which is used to offset
the costs of the long-term incentive compensation plan as well as other employee
benefit plans. These policies have aggregate cash surrender values of
approximately $10,417,000 and $10,021,000 at December 31, 2008 and 2007,
respectively. In addition, these assets are unsecured and are maintained with
four insurance carriers.
The Company has agreements with certain members of senior management which
provide for cash severance payments equal to two times annual compensation for
the previous year, upon involuntary termination or reassignment of duties
inconsistent with the duties of a senior executive officer, within 24 months
following a "change in control" (as such terms are defined in the agreements).
In addition, the agreements provide for the continuation of health and other
insurance benefits for a period of 24 months following a change in control. The
Company has similar agreements with other members of management which provide
for cash severance of six months annual compensation if termination or
reassignment of duties occurs within six months following a change of control,
and provide for the continuation of health and other insurance benefits for a
period of six months following a change in control.
The Company has agreements under split-dollar life insurance arrangements with
certain members of management which provide for the payment of fixed amounts to
such individual's beneficiaries. In conjunction with the adoption of EITF 06-4
on January 1, 2008, the Company recorded an increase to accrued expenses of
$12,272 related to these agreements. At December 31, 2008, $41,431 is included
in accrued expenses related to these agreements.
NOTE L - SHAREHOLDERS' EQUITY AND EARNINGS PER SHARE
In November 2007, the Board of Directors declared 5% stock dividends payable on
December 31, 2007. Payment of these dividends resulted in the issuance of
118,873 additional common shares in December 2007. There were no stock dividends
declared in 2008. The market value of the shares issued was charged to retained
earnings, the par value of the shares issued was credited to common stock and
the remainder was credited to additional paid-in capital. Fractional shares were
payable in cash on an equivalent share basis of $16.00 for the 2007 stock
dividend. Weighted-average shares and per share data have been restated to give
effect to all stock dividends and splits.
On December 12, 2008 the Company issued Fixed-Rate Cumulative Perpetual
Preferred Stock to the U. S. Department of the Treasury for $10 million in a
private placement exempt from registration. The EESA authorized the U. S.
Treasury to appropriate funds to eligible financial institutions participating
in the TARP Capital Purchase Program. The capital investment included the
issuance of preferred shares
D-68
of the Company and a warrant to purchase common shares pursuant to a Letter
Agreement and a Securities Purchase Agreement (collectively the "Agreement").
The dividend rate of 5% increases to 9% after the first five years. Dividend
payments are made on the 15th day of February, May, August and November of each
year. The warrant allows the holder to purchase up to 199,203 shares of the
Company's common stock over a 10-year period at an exercise price per share of
$7.53. The preferred shares and the warrant qualify as Tier 1 regulatory
capital. The Agreement subjects the Company to certain restrictions and
conditions including those related to common dividends, share repurchases,
executive compensation, and corporate governance.
The following is information about the computation of net (loss) income per
share for the years ended December 31, 2008 and 2007. Shares outstanding include
all shares contributed to the ESOP as all such shares have been allocated to the
participants.
For the Year Ended December 31, 2008
------------------------------------------------
Net Weighted Average Per Share
Loss Shares Amount
--------------- ------------- -------------
Basic Net Loss Per Share
Loss available to common stockholders $ (4,516,773) 2,362,897 $ (1.92)
=============
Effect of Dilutive Securitites
Options/unvested restricted shares outstanding - - -
--------------- -------------
Diluted Net Loss Per Share
Loss available to common stockholders plus assumed conversions $ (4,516,773) 2,362,897 $ (1.92)
=============== ============= =============
For the Year Ended December 31, 2007
------------------------------------------------
Net Weighted Average Per Share
Income Shares Amount
--------------- ------------- -------------
Basic Net Income Per Share
Income available to common stockholders $ 1,947,342 2,369,210 $ 0.82
=============
Effect of Dilutive Securities
Options outstanding - 3,513
--------------- -------------
Diluted Net Income Per Share
Income available to common stockholders plus assumed conversions $ 1,947,342 2,372,723 $ 0.82
=============== ============= =============
For the year ended December 31, 2008, the effect of stock options and unvested
restricted shares was not considered because the effect would have been
anti-dilutive.
NOTE M - STOCK OPTION PLANS
At December 31, 2008, the Company had one fixed option plan, which is described
below. Effective January 1, 2006, the Company adopted SFAS No. 123(R) utilizing
the modified prospective approach. Prior to the adoption of SFAS No. 123(R), the
Company accounted for the stock options grants in accordance with APB Opinion
No. 25, "Accounting for Stock Issued to Employees" (the intrinsic value method),
and accordingly, recognized no compensation expense for stock option grants.
Because there were no unvested share-based awards at January 1, 2006, the
adoption of this statement had no initial effect on the Company's financial
statements.
STOCK COMPENSATION PLAN: During 2007 the Company approved a restricted stock
plan (the "2007 Plan") for senior management. These awards vest at the end of a
five-year period, or earlier if the senior manager ceases to be a senior manager
for any reason other than cause, for example, retirement. The holders of these
awards participate fully in the rewards of stock ownership of the Company,
including voting and dividend rights. The senior managers are not required to
pay any consideration to
D-69
the Company for the restricted stock awards. The Company measures the fair value
of the awards based on the average of the high price and low price at which the
Company's common stock traded on the date of the grant. For the year ended
December 31, 2008, $8,412 was recognized as compensation expense under the 2007
Plan. At December 31, 2008, unrecognized compensation cost of $37,473 related to
these awards is expected to vest over a weighted average period of 4 years.
A summary of unvested shares as of and for the year ended December 31, 2008 is
as follows:
Weighted Average
Grant Date
Shares Fair Value
----------- -------------------
Unvested shares, beginning of year - $ -
Shares granted during the year 3,500 13.11
Shares vested during the year - -
----------- -------------------
Unvested shares, end of year 3,500 $ 13.11
=========== ===================
OPTION PLAN FOR OFFICERS AND OUTSIDE DIRECTORS
A stock option plan for officers and outside directors was approved by the
shareholders during 1994. The price and number of options in the plan have been
adjusted for all stock dividends and splits.
The stock option plan for directors automatically granted each director an
initial option of 3,721 shares of the Company's common stock. Automatic annual
grants of an additional 631 shares for each director were given for each of the
four following years.
The stock option plan for officers, grants options based upon individual officer
performance.
Under both the director and officer plans, the price per share of the option is
the fair market value of the Company's stock at the date of the grant. No option
may be exercised until 12 months after it is granted at which time options fully
vest. Options are exercisable for a period of ten years from the grant thereof.
Activity in the option plan for officers and outside directors for 2008 and 2007
is summarized as follows: (The number of shares and price per share have been
adjusted to give retroactive effect to all stock dividends and splits.)
2008 2007
-------------------------- --------------------------
Weighted Weighted
Average Average
Number of Exercise Price Number of Exercise Price
Shares Per Share Shares Per Share
-------------------------- --------------------------
Options outstanding at the beginning of the year 7,327 $11.64 17,744 $9.74
Granted - - - -
Exercised 1,893 10.82 10,417 8.40
Cancelled - - - -
------------ ------------
Options outstanding and exercisable at end of year 5,434 $11.93 7,327 $11.64
============ ============
At December 31, 2008, the remaining contractual life was 1 month.
D-70
Shares reserved for issuance of common stock under all the option plans is equal
to the amount of options outstanding at the end of 2008 or 5,434.
The intrinsic value of options outstanding and exercisable at December 31, 2008
and 2007 is $0 and $20,932, respectively. The intrinsic value of options
exercised during the years ended December 31, 2008 and 2007 was $0 and $63,571,
respectively.
NOTE N - RESTRICTIONS ON SUBSIDIARY DIVIDENDS, LOANS OR ADVANCES
Dividends are paid by the Company from its assets which are mainly provided by
dividends from the Bank. However, certain restrictions exist regarding the
ability of the Bank to transfer funds to the Company in the form of cash
dividends, loans or advances. The approval of the Comptroller of the Currency is
required to pay dividends in excess of the Bank's earnings retained in the
current year plus retained net profits for the preceding two years. As of
December 31, 2008, the Bank had retained earnings of approximately $26,102,000,
of which there was no undistributed net income available for distribution to the
Company as dividends.
Under Federal Reserve regulation, the Bank is also limited in the amount it may
loan to the Company, unless such loans are collateralized by specified
obligations. At December 31, 2008, the amount available for transfer from the
Bank to the Company in the form of loans is limited to 10% of the Bank's capital
stock and surplus.
NOTE O - COMMITMENTS AND CONTINGENCIES
FINANCIAL INSTRUMENTS WITH OFF-BALANCE-SHEET RISK
In the normal course of business, the Bank is party to financial instruments
with off-balance sheet risk to meet the financing needs of its customers. These
instruments include commitments to extend credit and unused lines of credit, and
expose the Bank to credit risk in excess of the amounts recognized in the
balance sheets.
The contractual amounts of commitments to extend credit represent the amounts of
potential accounting loss should: the contract be fully drawn upon; the customer
default; and the value of any existing collateral become worthless. The Bank
uses the same credit policies in making off-balance-sheet commitments and
conditional obligations as it does for on-balance-sheet instruments. Management
believes that the Bank controls the credit risk of these financial instruments
through credit approvals, credit limits, monitoring procedures and the receipt
of collateral as deemed necessary. Total credit exposures at December 31, 2008
and 2007 related to these items are summarized below:
D-71
2008 2007
Contract Amount Contract Amount
------------ ------------
Loan and lease commitments:
Approved loan and lease commitments $ 18,336,000 $ 16,791,000
Unadvanced portion of:
Construction loans 13,979,000 15,061,000
Commercial lines of credit 76,817,000 49,189,000
Home equity lines of credit 34,932,000 31,922,000
Overdraft protection and other consumer lines 961,000 994,000
Credit cards 3,618,000 3,362,000
Standby letters of credit 2,173,000 2,773,000
------------ ------------
$150,816,000 $120,092,000
============ ============
Loan and lease commitments are agreements to lend to a customer as long as there
is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since some of the commitments are expected to expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. The Bank evaluates each customer's credit
worthiness on a case-by-case basis. The amount of collateral obtained, if deemed
necessary by the Bank upon extension of credit, is based on management's credit
evaluation of the counterparty. Collateral for loans is primarily residential
property. Collateral for leases is primarily equipment. Interest rates on the
above are primarily variable. Standby letters of credit are written commitments
issued by the Bank to guarantee the performance of 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 and lease facilities to customers. As of January
1, 2003, newly issued or modified guarantees that are not derivative contracts
have been recorded on the Company's consolidated balance sheet at their fair
value at inception. No liability related to guarantees was required to be
recorded at December 31, 2008 and 2007.
LEGAL PROCEEDINGS
The Company is involved in various legal proceedings which arose during the
course of business and are pending against the Company. Management believes the
ultimate resolution of these actions and the liability, if any, resulting from
such actions will not materially affect the financial condition or results of
operations of the Company.
NOTE P - RELATED PARTY TRANSACTIONS
For the years ended December 31, 2008 and 2007, the Bank paid approximately
$8,500 and $25,000, respectively, for rent and legal fees, to companies, the
principals of which are Directors of the Company. During the year ended December
31, 2007, the Company paid approximately $421,000 to a company, the principal
which is a Director of the Company, for rent and the purchase of branch
property.
NOTE Q - REGULATORY CAPITAL
The Company (on a consolidated basis) and the Bank are subject to various
regulatory capital requirements administered by the federal banking agencies.
Failure to meet minimum capital requirements can initiate certain mandatory and
possibly additional discretionary actions by regulators that, if undertaken,
could have a direct material effect on the Company's and the Bank's financial
statements. Under capital adequacy guidelines and the regulatory framework for
prompt corrective
D-72
action, the Company and the Bank must meet specific capital guidelines that
involve quantitative measures of the assets, liabilities and certain
off-balance-sheet items as calculated under regulatory accounting practices. The
Bank's capital amounts and classification are also subject to qualitative
judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Bank to maintain minimum amounts and ratios (set
forth in the table below) of total and Tier 1 Capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier 1 Capital (as
defined) to average assets (as defined). Management believes, as of December 31,
2008 that the Company and the Bank meet all capital adequacy requirements to
which it is subject.
Tier 1 capital consists of common shareholders' equity, noncumulative and
cumulative perpetual preferred stock, and minority interests less goodwill.
Total capital includes the allowance for loan and lease losses (up to a certain
amount), perpetual preferred stock (not included in Tier 1), hybrid capital
instruments, term subordinated debt and intermediate-term preferred stock. Trust
preferred securities are currently considered regulatory capital for purposes of
determining the Company's Tier I capital ratios. Risk adjusted assets are assets
adjusted for categories of on and off-balance sheet credit risk.
As of December 31, 2008 the most recent notification from the OCC 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. Due to the increased provision for loan and lease losses as
well as the OTTI losses, as of December 31, 2008 the Bank was not considered
well capitalized. During the first quarter of 2009 the Company contributed
$4,000,000 in capital to the Bank. As a result of this action, as of March 31,
2009, the Bank met all conditions to be considered well capitalized. There were
no conditions or events since that notification that management believes have
changed the Bank's category.
The Company's and Bank's actual capital amounts and ratios compared to required
regulatory amounts and ratios are presented below:
Minimum Required To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Purposes
----------------------- ----------------------- -----------------------
As of December 31, 2008: Amount Ratio Amount Ratio Amount Ratio
----------------------- ----------------------- -----------------------
The Company
Total Capital to Risk Weighted Assets $ 43,361,000 11.74% $ 29,548,000 8% N/A N/A
Tier I Capital to Risk Weighted Assets 39,662,000 10.74% 14,772,000 4% N/A N/A
Tier I Capital to Average Assets 39,662,000 7.85% 20,210,000 4% N/A N/A
The Bank
Total Capital to Risk Weighted Assets $ 34,778,000 9.43% $ 29,504,000 8% $ 36,880,000 10%
Tier I Capital to Risk Weighted Assets 31,079,000 8.43% 14,747,000 4% 22,120,000 6%
Tier I Capital to Average Assets 31,079,000 6.10% 20,380,000 4% 25,475,000 5%
D-73
Minimum Required To Be Well Capitalized
For Capital Under Prompt Corrective
Actual Adequacy Purposes Action Purposes
------------------------ ------------------------- ------------------------
As of December 31, 2007: Amount Ratio Amount Ratio Amount Ratio
------------------------ ------------------------- ------------------------
The Company
Total Capital to Risk Weighted Assets $ 41,561,000 12.61% $ 25,367,000 8% $ N/A N/A
Tier I Capital to Risk Weighted Assets 39,409,000 11.96% 13,180,000 4% N/A N/A
Tier I Capital to Average Assets 39,409,000 8.04% 19,606,000 4% N/A N/A
The Bank
Total Capital to Risk Weighted Assets $ 38,312,000 11.65% $ 26,309,000 8% $ 32,886,000 10%
Tier I Capital to Risk Weighted Assets 36,160,000 11.00% 13,149,000 4% 19,724,000 6%
Tier I Capital to Average Assets 36,160,000 7.36% 19,652,000 4% 24,565,000 5%
NOTE R - FAIR VALUE OF FINANCIAL INSTRUMENTS AND INTEREST RATE RISK
Effective January 1, 2008, the Company adopted SFAS No. 157, which, defines fair
value, establishes a framework for measuring fair value under generally accepted
accounting principles, and expands disclosures about fair value measurements. As
defined in SFAS No. 157, fair value is the price that would be received to sell
an asset or paid to transfer a liability in an orderly transaction between
market participants at the measurement date. In determining fair value, the
Company uses various methods including market, income and cost approaches. Based
on these approaches, the Company often utilizes certain assumptions that market
participants would use in pricing the asset or liability, including assumptions
about risk or the risks inherent in the inputs to the valuation technique. These
inputs can be readily observable, market corroborated, or generally unobservable
inputs. The Company utilizes valuation techniques that maximize the use of
observable inputs and minimize the use of unobservable inputs. Based on the
observability of the inputs used in the valuation techniques the Company is
required to provide the following information according to the fair value
hierarchy described in Note A. The fair value hierarchy ranks the quality and
reliability of the information used to determine fair values.
A description of the valuation methodologies used for assets and liabilities
recorded at fair value, and for estimating fair value for financial instruments
not recorded at fair value in accordance with SFAS No. 107, "Disclosures About
Fair Values of Financial Instruments" ("SFAS No. 107"), is set forth below.
Cash and Due From Banks, Federal Funds Sold, Accrued Interest Receivable,
Accrued Interest Payable, Collateralized Borrowings, and Short-term Borrowings:
These assets and liabilities are short-term, and therefore, book value is a
reasonable estimate of fair value. These financial instruments are not carried
at fair value on a recurring basis.
Federal Home Loan Bank Stock, Federal Reserve Bank Stock and Other Restricted
Stock: Such stock is estimated to equal the carrying value, due to the
historical experience that these stocks are redeemed at par. These financial
instruments are not carried at fair value on a recurring basis.
Available for Sale and Held to Maturity Securities: Where quoted prices are
available in an active market, securities are classified within Level 1 of the
valuation hierarchy. Level 1 securities include U.S. Treasury securities and
certain equity securities that are traded in an active exchange market. If
quoted prices are not available, then fair values are estimated by using pricing
models (i.e., matrix pricing) or quoted prices of securities with similar
characteristics and are classified within Level 2 of the valuation hierarchy.
Examples of such instruments include U.S. Government agency and sponsored agency
bonds, mortgage-backed and debt securities, state and municipal obligations,
corporate and other bonds and equity securities in markets that are not active,
and certain collateral dependent loans.
D-74
Available for sale securities are recorded at fair value on a recurring basis,
and held to maturity securities are only disclosed at fair value.
Loans Held for Sale: The fair value of loans and leases held for sale is based
on quoted market prices.
Loans: For variable rate loans which reprice frequently and have no significant
change in credit risk, carrying values are a reasonable estimate of fair values,
adjusted for credit losses inherent in the portfolios. The fair value of fixed
rate loans is estimated by discounting the future cash flows using the year end
rates, estimated using local market data, at which similar loans would be made
to borrowers with similar credit ratings and for the same remaining maturities,
adjusted for credit losses inherent in the portfolios. Loans are generally not
recorded at fair value on a recurring basis. However, from time to time,
nonrecurring fair value adjustments to collateral-dependent impaired loans are
recorded to reflect partial write-downs based on the observable market price or
current appraised value of collateral.
Deposits: The fair value of demand deposits, savings and money market deposits
is the amount payable on demand at the reporting date. The fair value of
certificates of deposit is estimated using a discounted cash flow calculation
that applies interest rates currently being offered for deposits of similar
remaining maturities to a schedule of aggregated expected maturities on such
deposits. Deposits are not recorded at fair value on a recurring basis.
Long-term debt: The fair value of long-term debt is estimated using a discounted
cash flow calculation that applies current interest rates for borrowings of
similar maturity to a schedule of maturities of such advances. Long-term debt is
not recorded at fair value on a recurring basis.
Off-balance-sheet instruments: Fair values for off-balance-sheet lending
commitments are based on fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and the
counterparties' credit standings. Off-balance sheet instruments are not recorded
at fair value on a recurring basis.
The following table details the financial instruments that are carried at fair
value and measured at fair value on a recurring basis as of December 31, 2008,
and indicates the fair value hierarchy of the valuation techniques utilized by
the Company to determine the fair value.
The Company uses models when quotations are not available for certain securities
or in markets where trading activity has slowed or ceased. When quotations are
not available, and are not provided by third party pricing services,
management's judgment is necessary to determine fair value. In situations
involving management judgment, fair value is determined using discounted cash
flow analysis or other valuation models which incorporate available market
information, including appropriate benchmarking to similar instruments, analysis
of default and recovery rates, estimation of prepayment characteristics and
implied volatilities.
Fair Value Measurements at December 31, 2008, Using
Quoted Prices in Significant
December Active Markets for Significant Other Unobservable
31, 2008 Identical Assets Observable Inputs Inputs
Total (Level 1) (Level 2) (Level 3)
------------- ----------------- ----------------- -------------
Assets:
Available for sale securities $ 113,486,201 $ 5,188,571 $ 108,297,630 $ -
============= ================= ================= =============
D-75
U.S. Treasury securities and one equity security, with a carrying value of
$5,188,571 at December 31, 2008, are the only assets whose fair values are
measured on a recurring basis using Level 1 inputs (active market quotes).
The fair values of other U. S. Government and agency mortgaged backed securities
and debt securities, State and Municipal obligations, other corporate bonds, and
certain equity securities are measured on a recurring basis, using Level 2
inputs of observable market data on similar securities. The carrying value of
these securities totaled $108,297,630 as of December 31, 2008.
The following table details the financial instruments carried at fair value and
measured at fair value on a nonrecurring basis as of December 31, 2008 and
indicates the fair value hierarchy of the valuation techniques utilized by the
Company to determine the fair value:
December 31, 2008
------------------------------------------------------------------------------
Quoted Prices in Significant Significant
Balance Active Markets for Observable Unobservable
as of Identical Assets Inputs Inputs
December 31, 2008 (Level 1) (Level 2) (Level 3)
----------------- ------------------ ----------- ------------
Financial assets held at fair value
Impaired Loans (1) $ 3,271,452 $ - $ 694,650 $ 2,576,802
============ ========= =========== ============
(1) Represents carrying value and related write-downs for which adjustments are
based on the appraised value
The Company will apply the fair value measurement and disclosure provisions of
SFAS No. 157 effective January 1, 2009 to nonfinancial assets and liabilities
measured on a nonrecurring basis. The Company may measure the fair value of the
following on a nonrecurring basis: (1) long-lived assets; and (2) other real
estate owned.
SFAS No. 107 requires disclosure of fair value information about financial
instruments, whether or not recognized in the statement of financial condition,
for which it is practicable to estimate that value. SFAS No. 107 excludes
certain financial instruments from its disclosure requirements. Accordingly, the
aggregate fair value amounts presented do not represent the underlying value of
the Company.
The estimated fair value amounts for 2008 and 2007 have been measured as of
their respective year-ends and have not been reevaluated or updated for purposes
of these financial statements subsequent to those respective dates. As such, the
estimated fair values of these financial instruments subsequent to the
respective reporting dates may be different than amounts reported at each
year-end.
The information presented should not be interpreted as an estimate of the fair
value of the entire Company since a fair value calculation is only required for
a limited portion of the Company's assets and liabilities. Due to the wide range
of valuation techniques and the degree of subjectivity used in making the
estimates, comparisons between the Company's disclosures and those of other
companies may not be meaningful.
The recorded book balances and estimated fair values of the Company's financial
instruments at December 31, 2008 and 2007 are as follows:
D-76
2008 2007
---------------------------------- ----------------------------------
Book Estimated Book Estimated
Value Fair Value Value Fair Value
---------------------------------- ----------------------------------
Financial Assets:
Cash and due from banks $ 9,238,783 9,238,783 $ 21,497,194 21,497,194
Available for sale securities 113,486,201 113,486,201 128,979,548 128,979,548
Held to maturity securities 16,550 16,553 34,185 33,712
Federal Home Loan Bank Stock 5,427,600 5,427,600 5,067,400 5,067,400
Federal Reserve Bank Stock 225,850 225,850 225,850 225,850
Other restricted stock 100,000 100,000 95,000 95,000
Loans held for sale 1,013,216 1,013,216 - -
Loans and leases, net 366,392,079 365,191,872 327,475,371 335,526,483
Accrued interest receivable 2,262,918 2,262,918 2,609,606 2,609,606
Financial Liabilities:
Savings deposits 58,582,376 58,582,376 56,344,878 56,344,878
Money market and demand deposits 162,633,387 162,633,387 149,302,973 149,302,973
Time certificates of deposit 122,110,861 122,607,975 129,969,813 130,267,235
Federal Home Loan Bank advances 81,608,000 86,044,755 91,500,000 96,219,124
Repurchase agreements with
financial institutions 26,450,000 26,316,528 21,550,000 21,421,552
Repurchase agreements with customers 18,222,571 18,222,571 14,142,773 14,142,773
Subordinated debt 10,104,000 10,104,000 10,104,000 10,104,000
Accrued interest payable 611,829 611,829 731,496 731,496
Collateralized borrowings 1,375,550 1,375,550 1,699,336 1,699,336
Loan and lease commitments, rate lock derivative commitments and other
commitments, on which the committed interest rate is less than the current
market rate are insignificant at December 31, 2008 and 2007.
The Bank assumes interest rate risk (the risk that general interest rate levels
will change) as a result of its normal operations. As a result, the fair values
of the Bank's financial instruments will change when interest rate levels change
and that change may be either favorable or unfavorable to the Bank. Management
attempts to match maturities of assets and liabilities to the extent believed
necessary to minimize interest rate risk. However, borrowers with fixed rate
obligations are less likely to prepay in a rising rate environment and more
likely to prepay in a falling rate environment. Conversely, depositors who are
receiving fixed rates are more likely to withdraw funds before maturity in a
rising rate environment and less likely to do so in a falling rate environment.
Management monitors rates and maturities of assets and liabilities and attempts
to minimize interest rate risk by adjusting terms of new loans, leases and
deposits and by investing in securities with terms that mitigate the Bank's
overall interest rate risk.
NOTE S - OTHER COMPREHENSIVE INCOME (LOSS)
Accumulated other comprehensive loss is comprised of the following at December
31, 2008 and 2007:
D-77
2008 2007
----------- -----------
Unrealized (gains) losses on available for sale
securities, net of taxes $ (158,088) $ 769,496
Unfunded pension liability, net of taxes 1,182,586 497,891
----------- -----------
$ 1,024,498 $ 1,267,387
=========== ===========
Other comprehensive income for the years ended December 31, 2008 and 2007 is as
follows:
2008
--------------------------------------------------
Before- Tax Net-of-Tax
Amount Taxes Amount
--------------- -------------- --------------
Unrealized holding losses arising during the period $ (7,479,430) $ 2,543,006 $ (4,936,424)
Less: reclassification adjustment for losses recognized in net loss 8,884,860 (3,020,852) 5,864,008
--------------- -------------- --------------
Unrealized holding gain on available for sale securities,
net of taxes 1,405,430 (477,846) 927,584
Net pension loss (1,037,417) 352,722 (684,695)
--------------- -------------- --------------
Total other comprehensive income, net of taxes $ 368,013 $ (125,124) $ 242,889
=============== ============== ==============
2007
--------------------------------------------------
Before- Tax Net-of-Tax
Amount Taxes Amount
--------------- -------------- --------------
Unrealized holding gains arising during the period $ 1,968,743 $ (669,373) $ 1,299,370
Less: reclassification adjustment for gains recognized in net income (19,632) 6,675 (12,957)
--------------- -------------- --------------
Unrealized holding gain on available for sale securities, net of taxes 1,949,111 (662,698) 1,286,413
Net pension gain 398,201 (135,388) 262,813
--------------- -------------- --------------
Total other comprehensive income, net of taxes $ 2,347,312 $ (798,086) $ 1,549,226
=============== ============== ==============
NOTE T - FIRST LITCHFIELD FINANCIAL CORPORATION PARENT COMPANY ONLY FINANCIAL
INFORMATION
D-78
FIRST LITCHFIELD FINANCIAL CORPORATION
Condensed Balance Sheets December 31,
------------------------
2008 2007
----------- -----------
Assets
Cash and due from banks $ 8,564,235 $ 3,114,290
Investment in The First National Bank of Litchfield 33,629,067 34,863,604
Investment in the First Litchfield Statutory Trusts I, II 304,000 304,000
Other assets 408,973 501,838
----------- -----------
Total Assets $42,906,275 $38,783,732
=========== ===========
Liabilities and Shareholder's Equity
Liabilities:
Subordinated Debt $10,104,000 $10,104,000
Other liabilities 388,886 367,120
----------- -----------
Total Liabilites 10,492,886 10,471,120
----------- -----------
Shareholders' equity 32,413,389 28,312,612
----------- -----------
Total Liabilities and Shareholders' Equity $42,906,275 $38,783,732
=========== ===========
Condensed Statements of Operations Years Ended December 31,
-------------------------
2008 2007
----------- -----------
Dividends from subsidiary $ 1,425,000 $ 1,900,000
Other expenses, net 682,166 877,608
----------- -----------
Income before taxes and equity in earnings
of subsidiary 742,834 1,022,392
Income tax benefit 231,936 298,386
----------- -----------
Income before equity in undistributed (losses)
earnings of subsidiary 974,770 1,320,778
Equity in undistributed (losses) earnings
of subsidiary (5,465,154) 626,564
----------- -----------
Net (loss) income $(4,490,384) $ 1,947,342
=========== ===========
Condensed Statements of Cash Flows Years Ended December 31,
---------------------------
2008 2007
------------ ------------
Cash flows from operating activities:
Net (loss) income $ (4,490,384) $ 1,947,342
Adjustments to reconcile net (loss) income
to cash provided by operating activities:
Equity in undistributed losses (earnings)
of subsidiary 5,465,154 (626,564)
Other, net 98,679 135,247
------------ ------------
Cash provided by operating activities 1,073,449 1,456,025
------------ ------------
Cash flows from investing activities:
Investment in the First National Bank
of Litchfield (4,000,000) --
------------ ------------
Cash used in investing activities (4,000,000) --
------------ ------------
Cash flows from financing activities:
Stock options exercised 20,482 87,487
Distribution in cash for financial shares
of common stock -- (3,917)
Proceeds from issuance of preferred shares 10,000,000 --
Purchase of treasury shares (227,098) (132,208)
Dividends paid on common stock (1,416,888) (1,354,434)
------------ ------------
Cash provided by (used in) financing activities 8,376,496 (1,403,072)
------------ ------------
Net increase in cash and due from banks 5,449,945 52,953
Cash and due from banks at the beginning of the year 3,114,290 3,167,243
------------ ------------
Cash and due from banks at the end of the year $ 8,564,235 $ 3,114,290
============ ============
D-79
NOTE U - SEGMENT REPORTING
Beginning in 2007, with First Litchfield Leasing Corporation fully operational,
the Company has two operating segments for purposes of reporting business line
results. These segments are Community Banking and Leasing. The Community Banking
segment is defined as all the operating results of The First National Bank of
Litchfield. The Leasing segment is defined as the results of First Litchfield
Leasing Corporation. Because First Litchfield Leasing Corporation is a new
subsidiary, methodologies and organizational hierarchies are newly developed and
will be subject to periodic review and revision. The following presents the
operating results and total assets for the segments of First Litchfield
Financial Corporation for the years ended December 31, 2008 and 2007. The
Company uses an internal reporting system to generate information by operating
segment. Estimates and allocations are used for noninterest expenses and income
taxes. The Company uses a matched maturity funding concept to allocate interest
expense to First Litchfield Leasing Corporation. The matched maturity funding
concept utilizes the origination date and the maturity date of the lease to
assign an interest expense to each lease.
For the Year Ended
December 31, 2008
----------------------------------------------------------------------
Community Elimination Consolidated
Banking Leasing Entries Total
---------------- ---------------- --------------- ---------------
Net interest income $ 14,274,471 $ 665,114 $ - $ 14,939,585
Provision for loan and lease losses 1,742,186 94,113 - 1,836,299
---------------- ---------------- --------------- ---------------
Net interest income after provision for
loan and lease losses 12,532,285 571,001 - 13,103,286
Noninterest (loss) income (5,366,133) 4,028 - (5,362,105)
Noninterest expense 14,970,593 369,556 - 15,340,149
---------------- ---------------- --------------- ---------------
Income (loss) before income taxes (7,804,441) 205,473 - (7,598,968)
Income tax provision (benefit) (3,175,720) 63,261 - (3,112,459)
Minority Interest 3,875 - - 3,875
---------------- ---------------- --------------- ---------------
Net income (loss) $ (4,632,596) $ 142,212 $ - $ (4,490,384)
================ ================ =============== ===============
Total assets as of December 31, 2008 $ 509,370,298 $ 23,089,258 $ (201,949) $ 532,257,607
================ ================ =============== ===============
For the Year Ended
December 31, 2007
----------------------------------------------------------------------
Community Elimination Consolidated
Banking Leasing Entries Total
---------------- ---------------- --------------- ---------------
Net interest income $ 12,951,760 $ 261,299 $ - $ 13,213,059
Provision for loan and lease losses 123,726 80,274 - 204,000
---------------- ---------------- --------------- ---------------
Net interest income after provision for
loan and lease losses 12,828,034 181,025 - 13,009,059
Noninterest income 3,431,476 - - 3,431,476
Noninterest expense 13,948,648 318,843 - 14,267,491
---------------- ---------------- --------------- ---------------
Income (loss) before income taxes 2,310,862 (137,818) - 2,173,044
Income tax provision (benefit) 274,159 (48,457) - 225,702
---------------- ---------------- --------------- ---------------
Net income (loss) $ 2,036,703 $ (89,361) $ - $ 1,947,342
================ ================ =============== ===============
Total assets as of December 31, 2007 $ 535,136,271 $ 10,972,121 $ (38,454,763) $ 507,653,629
================ ================ =============== ===============
D-80
NOTE V - FOURTH QUARTER ADJUSTMENTS
The Company reported a net loss of $4,490,384 or $1.92 diluted loss per common
share for the year ended December 31, 2008 and a net loss of $205,853 or $.09
diluted loss per common share for the fourth quarter of 2008. During the fourth
quarter the Company recorded a $1,469,299 provision for loan and lease losses
and an impairment charge on available for sale securities of $2,476,552.
Additionally during the fourth quarter the Company recognized the $1,710,200
deferred tax benefit on third quarter impairment losses related to Fannie Mae
and Freddie Mac preferred stock and auction rate securities holding such stock.
The increased fourth quarter provision for loan and lease losses was primarily
attributable to the increase in impaired loans during the fourth quarter as a
result of the deteriorating market conditions. Impaired loans increased from
$4,719,588 at September 30, 2008 to $8,883,136 at December 31, 2008, most of
which was concentrated in Connecticut. In addition, the Company increased its
general allowance for loan and lease losses component to reflect the current
market conditions and increases in delinquent loans.
During the three months and quarter ended September 30, 2008, the Company
incurred a $5,030,000 loss from the other-than-temporary impairment of Fannie
Mae and Freddie Mac preferred stock and auction rate preferred securities
holding such stock. As of September 30, 2008, these losses were considered
capital losses for Federal income tax purposes, which are only deductible if
such losses are offset against capital gains. Because the Company did not have
any such capital gains in the tax carryback period, and because there were no
tax strategies available to generate future capital gains to utilize such
losses, a deferred tax valuation allowance of $1,710,200 was recorded at
September 30, 2008, which represented the amount of deferred tax benefit related
to the impairment losses. Subsequent to September 30, 2008, the passage of the
Federal Emergency Economic Stabilization Act changed the Federal tax laws to
allow the deductions of losses to be treated as ordinary losses for Federal
Income tax purposes. Therefore, the Company in the fourth quarter of 2008,
recognized the deferred tax benefit of $1,710,200 in the fourth quarter of 2008.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
There were no changes in or disagreements with the accountants of the Company
during the 24 month period prior to December 31, 2008, or subsequently.
ITEM 9A(T). CONTROLS AND PROCEDURES
(a) Evaluation of disclosure controls and procedures
The Company maintains disclosure controls and procedures that are designed to
ensure that information required to be disclosed in the Company's Exchange Act
report is recorded, processed, summarized and reported within the time periods
specified in the SEC's rules and forms, and that such information is accumulated
and communicated to the Company's management, including its Chief Executive
Officer and Chief Financial Officer, as appropriate to allow timely decisions
regarding required disclosure. In designing and evaluating the disclosure
controls and procedures, management recognizes that any controls and procedures,
no matter how well designed and operated, can provide only reasonable
D-81
assurance of achieving the desired control objectives, and management
necessarily is required to apply its judgment in evaluating the cost-benefit of
possible controls and procedures.
The Company's Management, under the supervision and with the participation of
the Company's Chief Executive Officer and the Company's Chief Financial Officer
evaluated the effectiveness of the Company's disclosure controls and procedures
as of December 31, 2008. Based on the foregoing, the Company's Chief Executive
Officer and Chief Financial Officer concluded that the Company's disclosure
controls and procedures were effective.
(b) Management's Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining, for the Company,
adequate internal control over financial reporting, as such term is defined in
Exchange act Rule 13a-15(f) under the Securities Exchange Act of 1934. Under the
supervision and with the participation of the Chief Executive Officer and the
Chief Financial Officer, we conducted an evaluation of the effectiveness of our
control over financial reporting based on the framework in Internal
Control-Integrated Framework issued by the Committee of Sponsoring Organizations
of the Treadway Commission ("COSO"). Based on our evaluation under the
framework, management has concluded that our internal control over financial
reporting was effective as of December 31, 2008. There were no material
weaknesses in the Company's internal control over financial reporting identified
by management.
The annual report does not include an attestation report 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) Changes in Internal Control over Financial Reporting
There was no change in the Company's internal control over financial reporting
that occurred during the Company's fourth quarter of 2008 that has materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
D-82
Annex E
FIRST LITCHFIELD FINANCIAL CORPORATION
EXCERPTS FROM FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2009
AS FILED WITH THE SECURITIES AND EXCHANGE COMMISSION
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
E-1
FIRST LITCHFIELD FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS (Unaudited) September 30, December 31,
2009 2008
------------- -------------
ASSETS
Cash and due from banks $ 43,182,377 $ 9,238,320
Interest - bearing accounts due from banks 61,209 463
------------- -------------
CASH AND CASH EQUIVALENTS 43,243,586 9,238,783
------------- -------------
Securities:
Available for sale securities, at fair value 98,308,680 113,486,201
Held to maturity securities (fair value $15,420 -2009 and $16,553-2008) 15,064 16,550
------------- -------------
TOTAL SECURITIES 98,323,744 113,502,751
------------- -------------
Federal Home Loan Bank stock, at cost 5,427,600 5,427,600
Federal Reserve Bank stock, at cost 225,850 225,850
Other restricted stock, at cost 105,000 100,000
Loans held for sale 95,000 1,013,216
Loan and lease receivables, net of allowance for loan and lease
losses of $6,084,194 -2009, $3,698,820-2008
NET LOANS AND LEASES 376,566,884 366,392,079
Premises and equipment, net 7,098,133 7,370,252
Foreclosed real estate 547,040 --
Deferred income taxes 5,327,407 5,082,957
Accrued interest receivable 1,939,745 2,262,918
Cash surrender value of life insurance 10,710,080 10,416,651
Due from broker for security sales -- 9,590,823
Other assets 1,593,294 1,633,727
------------- -------------
TOTAL ASSETS $ 551,203,363 $ 532,257,607
============= =============
LIABILITIES
Deposits:
Noninterest bearing $ 70,023,494 $ 69,548,261
Interest bearing 312,500,950 273,778,363
------------- -------------
TOTAL DEPOSITS 382,524,444 343,326,624
Federal Home Loan Bank advances 80,000,000 81,608,000
Repurchase agreements with financial institutions 22,500,000 26,450,000
Repurchase agreements with customers 19,409,085 18,222,571
Junior subordinated debt issued by unconsolidated trust 10,104,000 10,104,000
Collateralized borrowings -- 1,375,550
Capital lease obligation 1,051,421 1,065,563
Due to broker for security purchases -- 12,994,945
Accrued expenses and other liabilities 4,225,497 4,643,090
------------- -------------
TOTAL LIABILITIES 519,814,447 499,790,343
------------- -------------
EQUITY
SHAREHOLDERS' EQUITY
Preferred stock $.00001 par value; 1,000,000 shares authorized, 10,000 shares -- --
outstanding as of 9/30/09 and 12/31/08
Common stock $.01 par value
Authorized - 5,000,000 shares
2009 - Issued - 2,506,622 shares, outstanding - 2,356,875 shares
2008 - Issued - 2,506,622 shares, outstanding - 2,356,875 shares 25,044 25,038
Additional paid-in capital 37,937,617 37,892,831
Accumulated deficit (3,781,940) (3,325,920)
Less: Treasury stock at cost- 149,747 as of 9/30/09 and 12/31/08 (1,154,062) (1,154,062)
Accumulated other comprehensive loss, net of taxes (1,786,077) (1,024,498)
------------- -------------
TOTAL FIRST LITCHFIELD FINANCIAL CORPORATION
SHAREHOLDERS' EQUITY 31,240,582 32,413,389
------------- -------------
NONCONTROLLING INTERESTS 148,334 53,875
------------- -------------
TOTAL EQUITY 31,388,916 32,467,264
------------- -------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 551,203,363 $ 532,257,607
============= =============
See Notes to Consolidated Financial Statements.
E-2
FIRST LITCHFIELD FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
Three Months Ended Nine Months Ended
September 30, September 30,
2009 2008 2009 2008
-------------- -------------- -------------- --------------
INTEREST AND DIVIDEND INCOME
Interest and fees on loans and leases $ 5,328,296 $ 5,363,809 $ 16,217,789 $ 16,200,748
-------------- -------------- -------------- --------------
Interest and dividends on securities:
Mortgage-backed securities 450,007 991,860 1,837,716 2,647,249
US Treasury and other securities 87,288 397,073 361,834 1,325,699
State and municipal securities 200,673 279,144 626,860 905,529
Trust Preferred and other securities 17,976 65,299 120,521 285,075
-------------- -------------- -------------- --------------
Total interest on securities 755,944 1,733,376 2,946,931 5,163,552
-------------- -------------- -------------- --------------
Other interest income 27,219 43,482 47,684 210,868
-------------- -------------- -------------- --------------
TOTAL INTEREST AND DIVIDEND INCOME 6,111,459 7,140,667 19,212,404 21,575,168
-------------- -------------- -------------- --------------
INTEREST EXPENSE
Interest on deposits:
Savings 65,163 173,193 255,021 479,079
Money market 131,823 363,373 603,929 1,185,540
Time certificates of deposit 937,871 1,130,642 2,774,018 3,976,610
-------------- -------------- -------------- --------------
TOTAL INTEREST ON DEPOSITS 1,134,857 1,667,208 3,632,968 5,641,229
Interest on Federal Home Loan Bank advances 850,917 1,013,339 2,616,091 3,035,762
Interest on repurchase agreements 230,128 398,077 785,004 1,147,314
Interest on subordinated debt 139,273 137,523 377,276 453,284
Interest on collateralized borrowings 15,686 25,418 58,837 80,221
Interest on capital lease obligation 13,973 14,220 42,108 42,837
-------------- -------------- -------------- --------------
TOTAL INTEREST EXPENSE 2,384,834 3,255,785 7,512,284 10,400,647
-------------- -------------- -------------- --------------
NET INTEREST INCOME 3,726,625 3,884,882 11,700,120 11,174,521
PROVISION FOR LOAN AND LEASE LOSSES 2,682,691 155,000 3,470,280 367,000
-------------- -------------- -------------- --------------
NET INTEREST INCOME AFTER PROVISION
FOR LOAN AND LEASE LOSSES 1,043,934 3,729,882 8,229,840 10,807,521
-------------- -------------- -------------- --------------
NONINTEREST INCOME (LOSS)
Banking service charges and fees 412,883 417,803 1,165,371 1,143,723
Trust 345,357 319,049 892,896 992,142
(Losses) gains on available for sale securities (6,490) (6,720,523) 314,584 (6,687,682)
Increase in cash surrender value of life insurance 99,224 101,702 293,429 299,279
Gains on the sale of loans 349,294 17,085 509,552 34,904
Other 14,767 57,356 83,721 200,041
-------------- -------------- -------------- --------------
TOTAL NONINTEREST INCOME (LOSS) 1,215,035 (5,807,528) 3,259,553 (4,017,593)
-------------- -------------- -------------- --------------
NONINTEREST EXPENSE
Salaries 1,689,178 1,650,937 4,878,218 4,968,276
Employee benefits 440,930 406,287 1,350,877 1,298,126
Net occupancy 290,254 293,833 919,779 898,056
Equipment 137,492 151,144 434,010 465,528
Legal fees 128,647 85,703 370,440 203,323
Directors fees 43,925 51,175 137,900 151,475
Computer services 291,898 259,291 870,125 746,378
Supplies 50,863 58,020 124,537 148,449
Consulting, services and fees 189,554 70,393 442,106 314,431
Postage 37,757 40,056 112,767 113,676
Advertising 36,050 170,839 349,091 465,209
FDIC assessments 210,829 91,395 930,055 183,744
Loss due to dishonored items 768,583 -- 768,583 --
Other 786,524 423,957 1,877,044 1,419,121
-------------- -------------- -------------- --------------
TOTAL NONINTEREST EXPENSE 5,102,484 3,753,030 13,565,532 11,375,792
-------------- -------------- -------------- --------------
LOSS BEFORE INCOME TAXES (2,843,515) (5,830,676) (2,076,139) (4,585,864)
BENEFIT FOR INCOME TAXES (770,444) (404,786) (705,887) (274,945)
-------------- -------------- -------------- --------------
NET LOSS BEFORE NONCONTROLLING INTERESTS (2,073,071) (5,425,890) (1,370,252) (4,310,919)
NET INCOME ATTIBUTABLE TO
NONCONTROLLING INTERESTS 41,832 -- 94,459 --
-------------- -------------- -------------- --------------
NET LOSS $ (2,114,903) $ (5,425,890) $ (1,464,711) $ (4,310,919)
DIVIDENDS AND ACCRETION ON PREFERRED SHARES 137,874 -- 412,910 --
-------------- -------------- -------------- --------------
NET LOSS AVAILABLE TO COMMON SHAREHOLDERS $ (2,252,777) $ (5,425,890) $ (1,877,621) $ (4,310,919)
============== ============== ============== ==============
LOSS PER SHARE
BASIC NET LOSS PER COMMON SHARE $ (0.96) $ (2.30) $ (0.80) $ (1.82)
============== ============== ============== ==============
DILUTED NET LOSS PER COMMON SHARE $ (0.96) $ (2.30) $ (0.80) $ (1.82)
============== ============== ============== ==============
DIVIDENDS PER SHARE $ -- $ 0.15 $ 0.10 $ 0.45
============== ============== ============== ==============
See Notes to Consolidated Financial Statements.
E-3
FIRST LITCHFIELD FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(Unaudited)
Retained Accumulated
Additional Earnings Other Total
Noncontrolling Preferred Common Paid-In (Accumulated Treasury Comprehensive Shareholders'
Interests Stock Stock Capital Deficit) Stock Loss Equity
-------------- --------- ------ ------- ----------- -------- ------------ ------------
Nine months
ended
September 30, 2008
Balance,
December 31, 2007 $ 50,000 $ - $ 25,012 $27,858,841 $ 2,623,110 $ (926,964) $(1,267,387) $28,362,612
Adoption of
EITF issue,
Acccounting
for Deferred
Compensation and
Postretirement
Benefits Associated
with Endorsement
Split Dollar
Arrangements as of
January 1, 2008 - - - - (12,272) - - (12,272)
Comprehensive income
(loss):
Net income - - - - (4,310,919) - - ( 4,310,919)
Other comprehensive
loss, net of taxes:
Net unrealized
holding loss on
available for
sale securities - - - - - - (2,129,230) (2,129,230)
Net actuarial loss
and prior service
cost for pension
benefits - - - - - - (537,088) (537,088)
-----------
Other comprehensive loss (2,666,318)
-----------
Total comprehensive loss (6,977,237)
Cash dividends declared:
$0.30 per share - - - - (1,063,457) - - (1,063,457)
Purchase of
treasury shares - - - - - (227,098) - (227,098)
Stock options
exercised -
1,893 shares - - 19 20,464 - - - 20,483
Tax benefit on stock
options exercised - - - 2,025 - - - 2,025
Restricted stock grants
and expense - - 5 6,113 - - - 6,118
----------- -------- -------- ----------- ----------- ----------- ----------- -----------
Balance, September 30, 2008 $ 50,000 $ - $ 25,036 $27,887,443 $(2,763,538) $(1,154,062) $(3,933,705) $20,111,174
=========== ======== ======== =========== =========== =========== =========== ===========
Nine months ended
September 30, 2009
Balance, December 31, 2008 $ 53,875 $ - $ 25,038 $37,892,831 $(3,325,920) $(1,154,062) $(1,024,498) $32,467,264
Comprehensive income (loss):
Net income (loss) 94,459 - - - (1,464,711) - - (1,370,252)
Other comprehensive income
(loss), net of taxes:
Net unrealized holding
gain on available
for sale securities - - - - - - 775,905 775,905
Net unrealized holding
loss on cash
flow hedges - - - - - - (27,462) (27,462)
Net actuarial gain
and prior service
cost for pension
benefits - - - - - - 147,291 147,291
-----------
Other comprehensive income 895,734
-----------
Total comprehensive loss (474,518)
Cumulative effect of
adopting FASB
staff position,
Recognition and
Presentation
of Other-than-Temporary
Impairments (net of
$853,767 tax effect) - - - - 1,657,313 - (1,657,313) -
Cash dividends declared:
$0.10 per share - - - - (235,712) - - (235,712)
Restricted stock grants
and expense - - 6 6,876 - - - 6,882
Preferred stock dividends - - - - (375,000) - - (375,000)
Accretion of discount
on preferred stock - - - 37,910 (37,910) - - -
---------- -------- -------- ----------- ----------- ----------- ----------- -----------
Balance, September 30, 2009 $ 148,334 $ - $ 25,044 37,937,617 $(3,781,940) $(1,154,062) $(1,786,077) $31,388,916
========== ======== ======== =========== ============ =========== =========== ===========
See Notes to Consolidated Financial Statements.
E-4
FIRST LITCHFIELD FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) September 30,
2009 2008
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES
Net loss $ (1,464,711) $ (4,310,919)
Adjustments to reconcile net loss to net cash provided by operating activities:
Net income attributable to non-controlling interest 94,459 --
Amortization (accretion) of discounts and premiums
on investment securities, net 277,333 (124,184)
Provision for loan and lease losses 3,470,280 367,000
Depreciation and amortization 520,171 550,204
Loss on impairment write-down of available for sale securities -- 6,946,098
Gains on sale of available for sale securities (314,584) (258,416)
Loss on sale of foreclosed real estate 55,640 --
Losses on sales of repossessed assets 185,865 26,275
Loans originated for sale (13,283,029) (2,124,000)
Proceeds from sales of loans held for sale 27,447,044 2,143,887
Gains on sales of loans held for sale (509,552) (34,904)
(Gain) losses on disposals of bank premises and equipment (3,457) 2,188
Deferred income taxes (705,887) --
Stock based compensation 6,883 6,118
Decrease in accrued interest receivable 323,173 309,132
Increase in other assets (39,065) (235,487)
Increase in cash surrender value of life insurance (293,429) (299,279)
Increase in deferred loan origination costs (74,537) (90,048)
Decrease in accrued expenses and other liabilities (911,673) (1,024,395)
------------ ------------
Net cash provided by operating activities 14,780,924 1,849,270
------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES
Available for sale securities:
Proceeds from maturities and principal payments 52,361,754 29,370,830
Purchases (76,402,584) (58,903,339)
Proceeds from sales 37,027,093 43,804,423
Held to maturity mortgage-backed securities:
Proceeds from maturities and principal payments 1,486 2,952
Increase in due from broker for security sale -- (11,643,821)
Purchase of restricted stock (5,000) (5,000)
Purchase of Federal Home Loan Bank stock -- (360,200)
Net increase in loans and leases (26,811,335) (22,637,407)
Purchase of bank premises and equipment (248,052) (129,143)
Proceeds from sale of bank premises and equipment 3,457 --
Proceeds from sale of foreclosed real estate 419,360 --
Proceeds from sales of repossessed assets 56,676 214,532
------------ ------------
Net cash used in investing activities (13,597,145) (20,286,173)
------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES
Net increase in savings, money market and demand deposits 3,733,149 11,907,339
Net increase (decrease) in certificates of deposit 35,464,671 (6,797,900)
Repayments on Federal Home Loan Bank advances -- (4,500,000)
Net (decrease) increase in Federal Home Loan Bank overnight borrowings (1,608,000) 941,000
Net (decrease) increase in repurchase agreements with financial institutions (3,950,000) 4,900,000
Net increase (decrease) in repurchase agreements with customers 1,186,514 (873,356)
Net decrease in collateralized borrowings (1,375,550) (310,166)
Principal repayments on capital lease obligation (14,142) (13,413)
Purchase of treasury shares -- (227,098)
Proceeds from the exercise of stock options -- 20,483
Tax benefit of stock options exercised -- 2,025
Dividends paid on common stock (615,618) (1,065,082)
------------ ------------
Net cash provided by financing activities 32,821,024 3,983,832
------------ ------------
Net increase (decrease) in cash and cash equivalents 34,004,803 (14,453,071)
CASH AND CASH EQUIVALENTS, at beginning of period 9,238,783 21,497,194
------------ ------------
CASH AND CASH EQUIVALENTS, at end of period $ 43,243,586 $ 7,044,123
============ ============
SUPPLEMENTAL INFORMATION
Cash paid during the period for:
Interest on deposits and borrowings $ 7,612,852 $ 10,523,661
============ ============
Income taxes $ 1,000 $ 1,000
============ ============
Noncash investing and financing activities:
Accrued dividends declared $ 375,000 $ 353,603
============ ============
Transfer of loans to repossessed assets $ 90,423 $ 181,400
============ ============
Transfer of loans to OREO $ 1,022,040 $ --
============ ============
Increase in leases and other liabilities for
equipment payable related to financed leases $ 680,533 $ 2,082,719
============ ============
Increase in mortgage servicing assets $ 269,037 $ 15,017
============ ============
Increase in liabilities and decrease in retained
earnings for the adopting FASB staff position, "Accounting
for Deferred Compensation and Postretirement Benefit Aspects
of Endorsement Split-Dollar Life Insurance Arrangements" $ -- $ 12,272
============ ============
Change in other liabilities related to the unfunded pension liability $ 223,167 $ 813,770
============ ============
Change in gross unrealized holding losses on available for sale securities $ 1,715,613 $ 3,226,105
============ ============
Transfer of loans to loans held for sale $ 13,005,284 $ --
============ ============
See Notes to Consolidated Financial Statements.
E-5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. The consolidated balance sheet at December 31, 2008 of First Litchfield
Financial Corporation (the "Company") has been derived from the audited
financial statements at that date, but does not include all of the
information and footnotes required by accounting principles generally
accepted in the United States of America for complete financial statements.
Certain 2008 amounts have been reclassified to conform with the 2009
presentation. Such reclassifications had no effect on net income.
2. The accompanying unaudited consolidated financial statements and related
notes have been prepared pursuant to the rules and regulations of the
Securities and Exchange Commission. Accordingly, certain information and
footnote disclosures normally included in financial statements prepared in
accordance with accounting principles generally accepted in the United
States of America have been omitted pursuant to such rules and regulations.
The accompanying financial statements and related notes should be read in
conjunction with the audited financial statements of the Company and notes
thereto for the fiscal year ended December 31, 2008.
These financial statements reflect, in the opinion of Management, all
adjustments, consisting of only normal recurring adjustments, necessary for
a fair presentation of the Company's financial position and the results of
its operations and its cash flows for the periods presented. The results of
operations for the three and nine months ended September 30, 2009 are not
necessarily indicative of the results of operations that may be expected for
all of 2009.
The Financial Accounting Standards Board's (FASB) Accounting Standards
Codification (ASC) became effective on July 1, 2009. At that date, the ASC
became FASB's officially recognized source of authoritative U.S. generally
accepted accounting principles (GAAP) applicable to all public and
non-public non-governmental entities, superseding existing FASB, American
Institute of Certified Public Accountants (AICPA), Emerging Issues Task
Force (EITF) and related literature. Rules and interpretive releases of the
SEC under the authority of federal securities laws are also sources of
authoritative GAAP for SEC registrants. All other accounting literature is
considered non-authoritative. The switch to the ASC affects the way
companies refer to U.S. GAAP in financial statements and accounting
policies. Citing particular content in the ASC involves specifying the
unique numeric path to the content through the Topic, Subtopic, Section and
Paragraph structure.
During the first quarter of 2009, the Company entered into two interest rate
swap agreements to hedge certain interest rate exposures. The Company does
not use derivatives for speculative purposes. The Company applies
"Accounting for Derivative Instruments and Hedging Activities," as amended,
which establishes accounting and reporting standards for derivative
instruments and hedging activities. This accounting guidance requires the
Company to recognize all derivatives as either assets or liabilities in its
Consolidated Balance Sheets and to measure those instruments at fair value.
The estimated fair value is based primarily on projected future swap rates.
E-6
The Company applies cash flow hedge accounting to interest rate swaps
designated as hedges of the variability of future cash flows from floating
rate liabilities due to the benchmark interest rate. The Company uses
regression analysis to perform an ongoing prospective and retrospective
assessment of these hedging relationships. Changes in the fair value of
these interest rate swaps are recorded to "net holding gain on cash flow
hedges" as a component of accumulated other comprehensive income (loss)
("OCI") in Shareholders' equity, to the extent they are effective. Amounts
recorded to accumulated other comprehensive income (loss) are then
reclassified to interest expense as interest on the hedged borrowing is
recognized. Any ineffective portion of the change in fair value of these
instruments is recorded to interest expense.
3. The Company is required to present basic income per share and diluted income
per share in its consolidated statements of income. Basic income per share
amounts are computed by dividing net income by the weighted average number
of common shares outstanding. Diluted income per share assumes exercise of
all potential common stock equivalents in weighted average shares
outstanding, unless the effect is anti-dilutive. The Company is also
required to provide a reconciliation of the numerator and denominator used
in the computation of both basic and diluted income per share. Income
attributable to common shareholders has been reduced and losses have been
increased by preferred share dividends and discount accretion related to the
Company`s participation in TARP Capital Purchase program. For the three and
nine month periods ended September 30, 2009 this amount totaled $137,874 and
$412,910, respectively.
The following is information about the computation of net loss per share for
the three and nine month periods ended September 30, 2009 and 2008. The
Company had no dilutive securities outstanding at September 30, 2009.
Three Months Ended
September 30, 2009
------------------------------------
Net Per Share
Loss Shares Amount
-------------- --------- ---------
Basic Net Loss Per Share
Loss attributable to common shareholders $(2,252,777) 2,356,875 $ (0.96)
========
Effect of Dilutive Securities
Options Outstanding -- --
Diluted Net Loss Per Share
Loss attributable to common shareholders
----------- --------
plus assumed conversions $(2,252,777) 2,356,875 $ (0.96)
=========== ========= ========
E-7
Three Months Ended
September 30, 2008
--------------------------------------------
Net Per Share
Loss Shares Amount
------------- ------------- ----------
Basic Net Loss Per Share
Loss attributable to common shareholders $ (5,425,890) 2,358,267 $ (2.30)
==========
Effect of Dilutive Securities
Options Outstanding - -
Diluted Net Loss Per Share
Loss attributable to common shareholders
------------- -------------
plus assumed conversions $ (5,425,890) 2,358,267 $ (2.30)
============= ============= ==========
Nine Months Ended
September 30, 2009
---------------------------------------------
Net Per Share
Loss Shares Amount
------------- ------------- ------------
Basic Net Loss Per Share
Loss attributable to common shareholders $ (1,877,621) 2,356,875 $ (0.80)
============
Effect of Dilutive Securities
Options Outstanding - -
Diluted Net Loss Per Share
Loss attributable to common shareholders
------------- -------------
plus assumed conversions $ (1,877,621) 2,356,875 $ (0.80)
============= ============= ============
Nine Months Ended
September 30, 2008
---------------------------------------------
Net Per Share
Loss Shares Amount
------------- ------------- ------------
Basic Net Loss Per Share
Loss attributable to common shareholders $ (4,310,919) 2,364,904 $ (1.82)
============
Effect of Dilutive Securities
Options Outstanding - 536
Diluted Net Loss Per Share
Loss attributable to common shareholders
------------- -------------
plus assumed conversions $ (4,310,919) 2,365,440 $ (1.82)
============= ============= ============
4. Other comprehensive income (loss), which is comprised of the change in
unrealized gains and losses on available for sale securities, net cash flow
hedges, as well as net pension gain, is as follows:
E-8
Three Months Ended
September 30, 2009
--------------------------------------------------------
Before-Tax Tax Net-of-Tax
Amount Effect Amount
-------------- --------------- -----------------
Unrealized holding gain arising during the period $ 1,204,164 $ (409,416) $ 794,748
Less: reclassification adjustment for loss recognized in net income 6,490 (2,207) 4,283
-------------- --------------- -----------------
Unrealized holding gain on available for sale securities, net of taxes 1,210,654 (411,623) 799,031
Net cash flow hedges, net of taxes (204,165) 69,416 (134,749)
Net pension gain, net of taxes 168,944 (57,440) 111,504
-------------- --------------- -----------------
Total other comprehensive income, net of taxes $ 1,175,433 $ (399,647) $ 775,786
============== =============== =================
Three Months Ended
September 30, 2008
--------------------------------------------------------
Before-Tax Tax Net-of-Tax
Amount Effect Amount
-------------- --------------- -----------------
Unrealized holding losses arising during the period $ (5,602,610) $ 194,688 $ (5,407,922)
Add: reclassification adjustment for loss recognized in net income 6,720,523 (574,778) 6,145,745
-------------- --------------- -----------------
Unrealized holding gains on available for sale securities, net of taxes 1,117,913 (380,090) 737,823
Net pension loss, net of taxes (334,418) 113,702 (220,716)
-------------- --------------- -----------------
Total other comprehensive income, net of taxes $ 783,495 $ (266,388) $ 517,107
============== =============== =================
Nine Months Ended
September 30, 2009
--------------------------------------------------------
Before-Tax Tax Net-of-Tax
Amount Effect Amount
-------------- --------------- -----------------
Unrealized holding gain arising during the period $ 1,490,197 $ (506,667) $ 983,530
Less: reclassification adjustment for gain recognized in net income (314,584) 106,959 (207,625)
-------------- --------------- -----------------
Unrealized holding gains on available for sale securities, net of taxes 1,175,613 (399,708) 775,905
Net cash flow hedges, net of taxes (41,609) 14,147 (27,462)
Net pension gain, net of taxes 223,167 (75,876) 147,291
-------------- --------------- -----------------
Total other comprehensive income, net of taxes $ 1,357,171 $ (461,437) $ 895,734
============== =============== =================
Nine Months Ended
September 30, 2008
--------------------------------------------------------
Before-Tax Tax Net-of-Tax
Amount Effect Amount
-------------- --------------- -----------------
Unrealized holding losses arising during the period $ (9,913,788) $ 1,660,488 $ (8,253,300)
Add: reclassification adjustment for loss recognized in net income 6,687,682 (563,612) 6,124,070
-------------- --------------- -----------------
Unrealized holding losses on available for sale securities, net of taxes (3,226,106) 1,096,876 (2,129,230)
Net pension loss, net of taxes (813,770) 276,682 (537,088)
-------------- --------------- -----------------
Total other comprehensive loss, net of taxes $ (4,039,876) $ 1,373,558 $ (2,666,318)
============== =============== =================
E-9
5. The Company's subsidiary, The First National Bank of Litchfield (the
"Bank") has a noncontributory defined benefit pension plan (the "Plan")
that covers substantially all employees who have completed one year of
service and have attained age 21. The benefits are based on years of
service and the employee's compensation during the last five years of
employment. During the first quarter of 2005, the Bank's pension plan was
curtailed. Prior to the Plan's curtailment, the Bank's funding policy was
to contribute amounts to the plan sufficient to meet the minimum funding
requirements set forth in ERISA, plus such additional amounts as the Bank
determined to be appropriate from time to time. The actuarial information
has been calculated using the projected unit credit method.
Components of net periodic benefit cost for the three months ended
September 30:
2009 2008
-------------- -------------
Service cost $ - $ -
Interest cost 42,700 46,306
Expected return on plan assets (43,104) (50,363)
Amortization of unrealized loss 19,523 14,812
-------------- -------------
Net periodic benefit cost $ 19,119 $ 10,755
============== =============
Components of net periodic benefit cost for the nine months ended
September 30:
2009 2008
-------------- -------------
Service cost $ - $ -
Interest cost 128,100 138,919
Expected return on plan assets (129,311) (151,090)
Amortization of unrealized loss 58,569 44,437
-------------- -------------
Net periodic benefit cost $ 57,358 $ 32,266
============== =============
6. The Bank is a member of the Federal Home Loan Bank of Boston (the "FHLBB").
As a member of the FHLBB, the Bank has access to a preapproved line of
credit of up to 2% of its total assets and the capacity to borrow up to 30%
of its total assets. In accordance with an agreement with the FHLBB, the
Bank is required to maintain qualified collateral, as defined in the FHLBB
Statement of Products Policy, free and clear of liens, pledges and
encumbrances for the advances. FHLBB stock and certain loans which aggregate
approximately 100% of the outstanding advance are used as collateral. The
Company views its investment in the FHLBB stock as a long-term investment.
Accordingly, when evaluating for impairment, the value is determined based
on the ultimate recovery of the par value rather than recognizing temporary
declines in value. The determination of whether a decline affects the
ultimate recovery is influenced by criteria such as: 1) the significance of
the decline in net assets of the FHLBB as compared to the capital stock
amount and length of time a decline has persisted; 2) impact of legislative
and regulatory changes on the FHLBB; and 3) the liquidity position of the
FHLBB. The FHLBB announced in February 2009 that it would suspend its
dividend for the first quarter of 2009, and will likely not pay any
dividends for the remainder of 2009, and will continue its moratorium on
excess stock repurchases announced in
E-10
December 2008. The FHLBB noted their primary concern related to the impact
of other-than-temporary impairment ("OTTI") charges recorded on private
label mortgage-backed securities (MBS) as of December 31, 2008.
While the FHLBB announced that it remained adequately capitalized as of
December 31, 2008 in its February announcement, the Company is unable to
determine if the potential additional charges to earnings will change this
regulatory capital classification. On October 29, 2009, the FHLBB
communicated to its members that the FHLBB recorded a net loss of $105.4
million for the third quarter of 2009. The primary challenge for the FHLBB
continues to be losses due to the other-than-temporary impairment of its
investments in private-label mortgage-backed securities resulting in a
credit loss of $174.2 million during the quarter. The associated non-credit
loss on these securities this quarter was $1.6 million and resulted in an
accumulated other comprehensive loss of $1.0 billion at September 30, 2009.
Retained earnings were $136.3 million at September 30, 2009, down from
$241.7 million at June 30, 2009. In spite of these losses, the FHLBB
remained in compliance with all regulatory capital ratios as of September
30, 2009.
The FHLBB explained that the ongoing impact of the economy as well as the
housing and capital markets is likely to continue to provide challenges for
the Bank. The underlying credit quality especially as it relates to the
FHLBB's investments in private-label mortgage-backed securities, remains
vulnerable. Trends in determining future OTTI are still challenging and
include: rising unemployment rates, some further decline in housing prices,
higher default rates, lower voluntary prepayment rates, and deepened loss
severities.
FHLBB's management is focused on the long-term agenda: returning the FHLBB
to profitability, preserving the FHLBB's capital base, and building retained
earnings. They have begun to implement elements of a plan that will, over
time, work to restore the FHLBB to a position where they can once again
repurchase stock, pay members a dividend, and fund the Affordable Housing
Program. The Company does not believe that its investment in the FHLBB is
impaired as of this date. However, this estimate could change in the near
term as a result of any of the following events: 1) additional significant
impairment losses are incurred on the MBS causing a significant decline in
the FHLBB's regulatory capital status; 2) the economic losses resulting from
credit deterioration on the MBS increases significantly; and 3) capital
preservation strategies being utilized by the FHLBB become ineffective.
Federal Home Loan Bank advances as of September 30, 2009 are as follows:
E-11
due 10/02/2009 $ 6,000,000 @ 4.50%
due 11/30/2009 5,000,000 @ 3.95%
due 6/24/2010 5,000,000 @ 4.15%
due 11/02/2010 10,000,000 @ 4.45%
due 5/29/2012 5,000,000 @ 4.32%
due 5/02/2014 7,000,000 @ 4.59% , callable 5/3/2010
due 8/20/2014 7,000,000 @ 4.25% , callable 8/20/2010
due 5/05/2016 10,000,000 @ 4.53% , callable 11/5/2009
due 3/23/2017 10,000,000 @ 4.29% , callable 12/23/2009
due 7/20/2017 10,000,000 @ 4.29% , callable 10/20/2009
due 11/20/2017 5,000,000 @ 4.29% , callable 11/19/2012
------------------
Total $ 80,000,000
==================
As of September 30, 2009, the Bank had borrowings under repurchase
agreements with financial institutions totaling $22,500,000. This amount
includes borrowings:
due 3/12/2013 $ 12,500,000 @ 3.19% , callable 3/12/2011
due 5/23/2013 10,000,000 @ 3.64% , callable 5/23/2011
------------------
Total $ 22,500,000
==================
7. A reconciliation of the anticipated income tax expense (computed by
applying the Federal statutory income tax rate of 34% to the income before
taxes) to the (benefit) provision for income taxes as reported in the
statements of operations is as follows:
For the three months ended September 30,
-------------------------------------------------------------
2009 2008
---------------------------- --------------------------
Provision for income taxes at statutory Federal rate $ (966,795) (34)% $ (1,982,430) (34)%
Increase (decrease) resulting from:
Tax exempt income (104,392) (2) (148,249) (3)
Nondeductible interest expense 5,234 - 10,423 -
Increase in valuation allowance - - 1,710,200 30
Unrecognized tax benefits 292,014 10 - -
Other 3,495 (1) 5,270 -
--------------- --------- -------------- --------
Benefit for income taxes $ (770,444) (27)% $ (404,786) (7)%
=============== ========= ============== ========
For the nine months ended September 30,
-------------------------------------------------------------
2009 2008
---------------------------- --------------------------
Provision for income taxes at statutory Federal rate $ (705,887) (34)% $ (1,559,194) (34)%
Increase (decrease) resulting from:
Tax exempt income (320,252) (16) (477,969) (11)
Nondeductible interest expense 17,742 1 36,207 1
Increase in valuation allowance - - 1,710,200 37
Unrecognized tax benefits 292,014 14 - -
Other 10,496 1 15,811 1
--------------- --------- --------------- -------
Benefit for income taxes $ (705,887) (34)% $ (274,945) (6)%
=============== ========= =============== =======
E-12
As of September 30, 2009 and December 31, 2008, the Company had recorded net
deferred income tax assets of approximately $5.3 million and $5.1 million,
respectively. The determination of the amount of deferred income tax assets
which are more likely than not to be realized is primarily dependent on
projections of future earnings, which are subject to uncertainty and
estimates that may change given economic conditions and other factors. A
valuation allowance related to deferred tax assets is required when it is
considered more likely than not that all or part of the benefit related to
such assets will not be realized. Management has reviewed the deferred tax
position of the Company at September 30, 2009. The deferred tax position has
been affected by several significant transactions in the past three years.
These transactions included other-than-temporary impairment write-offs of
certain investments and significant permanent differences between accounting
and tax income such as non-taxable municipal security income, which
securities have been sold and replaced with assets which will generate
taxable income in the future, and certain specific expenditures not expected
to reoccur. As a result, the Company is in a cumulative net loss position
(pretax income (loss) for a three year period adjusted for permanent items)
as of September 30, 2009. However, under the applicable accounting guidance,
the Company has concluded that it is "more likely than not" that the Company
will be able to realize its deferred tax assets based on the non-recurring
nature of these items and the Company's expectation of future taxable
income. In the future, management's conclusion regarding the need for a
deferred tax asset valuation allowance could change, resulting in the
establishment of a valuation allowance for a portion or all of the deferred
tax asset. The Company will continue to analyze the recoverability of its
deferred tax assets quarterly.
Federal tax returns for all years subsequent to 2006 remain open to
examination. For the Company's principal state tax jurisdiction of
Connecticut, tax returns for years subsequent to 2001 remain open to
examination. There were no interest or penalties paid during the nine-month
period ended September 30, 2009 or the twelve-month period ended December
31, 2008. No accrued interest or penalties were recorded as of September 30,
2009 or December 31, 2008. The Company believes that it has appropriate
support for the income tax positions taken and to be taken on its tax
returns, and that its accruals for tax liabilities are adequate for all open
years based on an assessment of many factors including past experience and
interpretations of tax law applied to the facts of each matter.
8. The amortized cost, gross unrealized gains, gross unrealized losses and
approximate fair values of securities which are classified as available for
sale and held to maturity at September 30, 2009 and December 31, 2008 are as
follows:
E-13
AVAILABLE FOR SALE September 30, 2009
----------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------------- -------------- --------------- -----------------
Debt Securities:
U.S. Treasury securities $ 3,080,963 $ 70,287 $ - $ 3,151,250
U.S. Government Agency securities 12,227,759 90,220 (41,179) 12,276,800
State and Municipal Obligations 12,441,684 127,478 (155,868) 12,413,294
Trust Preferred Securities (1) 2,994,101 - (2,114,570) 879,531
----------------- -------------- --------------- -----------------
30,744,507 287,985 (2,311,617) 28,720,875
----------------- -------------- --------------- -----------------
Mortgage-Backed Securities:
GNMA 461,783 7,785 (52) 469,516
FNMA 29,490,613 618,691 (12,885) 30,096,419
FHLMC 21,638,206 320,132 (20,918) 21,937,420
----------------- -------------- --------------- -----------------
51,590,602 946,608 (33,855) 52,503,355
----------------- -------------- --------------- -----------------
Marketable Equity Securities 17,069,511 14,939 - 17,084,450
----------------- -------------- --------------- -----------------
Total available for sale securities $ 99,404,620 $ 1,249,532 $ (2,345,472) $ 98,308,680
================= ============== =============== =================
(1) Net of other-than-temporary impairment writedowns recognized in earnings,
other than such noncredit-related amounts reclassified on April 1, 2009.
December 31, 2008
----------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------------- -------------- --------------- -----------------
Debt Securities:
U.S. Treasury securities $ 3,110,574 $ 107,876 $ - $ 3,218,450
U.S. Government Agency securities 26,500,000 65,763 (3,386) 26,562,377
State and Municipal Obligations 19,931,000 77,501 (376,069) 19,632,432
Trust Preferred Securities (2) 493,615 - - 493,615
----------------- -------------- --------------- -----------------
50,035,189 251,140 (379,455) 49,906,874
----------------- -------------- --------------- -----------------
Mortgage-Backed Securities:
GNMA 9,495,917 12 (8,094) 9,487,835
FNMA 35,675,421 467,875 (263,567) 35,879,729
FHLMC 14,994,269 210,723 (9,228) 15,195,764
----------------- -------------- --------------- -----------------
60,165,607 678,610 (280,889) 60,563,328
----------------- -------------- --------------- -----------------
Marketable Equity Securities 3,045,878 - (29,879) 3,015,999
----------------- -------------- --------------- -----------------
Total available for sale securities $ 113,246,674 $ 929,750 $ (690,223) $ 113,486,201
================= ============== =============== =================
(2) Net of other-than-temporary impairment writedowns recognized in earnings.
HELD TO MATURITY September 30, 2009
---------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------------- -------------- --------------- -----------------
Mortgage-Backed Securities:
GNMA $ 15,064 $ 356 $ - $ 15,420
================= ============== =============== =================
December 31, 2008
---------------------------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
----------------- -------------- --------------- -----------------
Mortgage-Backed Securities:
GNMA $ 16,550 $ 3 $ - $ 16,553
================= ============== =============== =================
E-14
The Company adopted the FASB staff position, "Recognition and Presentation
of Other-Than-Temporary Impairments," for the interim period ended June 30,
2009, which was applied to existing and new debt securities held by the
Company as of April 1, 2009. For those debt securities for which the fair
value of the security is less than its amortized cost and the Company does
not intend to sell such security and it is more likely than not that it will
not be required to sell such security prior to the recovery of its amortized
cost basis less any credit losses, the accounting principle requires that
the credit component of the other-than-temporary impairment losses be
recognized as a loss in earnings while the noncredit component is recognized
in other comprehensive loss, net of related taxes. As a result of the
adoption of the accounting principle, the Company reclassified the noncredit
component of the other-than-temporary impairment loss previously recognized
in earnings during 2008. The reclassification was reflected as a cumulative
effect adjustment of $1,657,313 ($2,511,080 before taxes) that increased
retained earnings and increased accumulated other comprehensive loss. The
amortized cost basis of these debt securities for which other-than-temporary
impairment losses were recognized during 2008 were adjusted by the amount of
the cumulative effect adjustment before taxes.
The following table presents the Bank's securities' gross unrealized losses
and fair value, aggregated by the length of time the individual securities
have been in a continuous unrealized loss position at September 30, 2009:
Less than 12 Months 12 Months or More Total
------------------------ ------------------------ ------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
------------------------ ------------------------ ------------------------
Investment Securities
U.S. Government Agency Securities $ 4,993,650 $ 41,179 $ -- $ -- $ 4,993,650 $ 41,179
State & Municipal obligations -- -- 4,258,191 155,868 4,258,191 155,868
Trust Preferred Securities (1) 879,531 2,114,570 -- -- 879,531 2,114,570
----------- ----------- ----------- ----------- ----------- -----------
5,873,181 2,155,749 4,258,191 155,868 10,131,372 2,311,617
----------- ----------- ----------- ----------- ----------- -----------
Mortgage-Backed Securities
GNMA -- -- 46,057 52 46,057 52
FNMA 1,407,460 268 1,777,533 12,617 3,184,993 12,885
FHLMC 3,764,485 17,796 75,781 3,122 3,840,266 20,918
----------- ----------- ----------- ----------- ----------- -----------
5,171,945 18,064 1,899,371 15,791 7,071,316 33,855
----------- ----------- ----------- ----------- ----------- -----------
----------- ----------- ----------- ----------- ----------- -----------
Total $11,045,126 $ 2,173,813 $ 6,157,562 $ 171,659 $17,202,688 $ 2,345,472
=========== =========== =========== =========== =========== ===========
(1) Net of other-than-temporary impairment writedowns recognized in earnings,
other than such noncredit-related amounts reclassified on April 1, 2009 in
accordance with the adoption of "Recognition and Presentation of
Other-Than-Temporary Impairments."
The following table presents the Bank's securities' gross unrealized losses and
fair value, aggregated by the length of time the individual securities have been
in a continuous unrealized loss position at December 31, 2008:
E-15
Less than 12 Months 12 Months or More Total
------------------------------ -------------------------------- ------------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
------------------------------ -------------------------------- ------------------------------
Investment Securities
U.S. Government Agency securities $ 7,996,614 $ 3,386 $ - $ - $ 7,996,614 $ 3,386
State & Municipal obligations 8,804,717 303,267 2,574,433 72,802 11,379,150 376,069
--------------- ------------- ---------------- -------------- ---------------- -------------
16,801,331 306,653 2,574,433 72,802 19,375,764 379,455
--------------- ------------- ---------------- -------------- ---------------- -------------
Mortgage-Backed Securities
GNMA - - 465,643 8,094 465,643 8,094
FNMA 10,067,156 112,219 4,209,833 151,348 14,276,989 263,567
FHLMC - - 1,351,769 9,228 1,351,769 9,228
--------------- ------------- ---------------- -------------- ---------------- -------------
10,067,156 112,219 6,027,245 168,670 16,094,401 280,889
--------------- ------------- ---------------- -------------- ---------------- -------------
Marketable Equity Securities - - 1,970,122 29,879 1,970,122 29,879
--------------- ------------- ---------------- -------------- ---------------- -------------
Total $ 26,868,487 $ 418,872 $ 10,571,800 $ 271,351 $ 37,440,287 $ 690,223
=============== ============= ================ ============== ================ =============
At September 30, 2009, seventeen securities had unrealized losses. At
September 30, 2009, gross unrealized holding losses on available for sale
and held to maturity securities totaled $2,345,472. Of the securities with
unrealized losses, there were nine securities that have been in a
continuous unrealized loss position for a period of twelve months or more.
The unrealized losses on these securities totaled $171,659 at September 30,
2009. The following summarizes by investment security type, the basis for
the conclusion that the applicable investment securities within the
Company's available for sale portfolio were not other-than-temporarily
impaired at September 30, 2009.
Management conducts a formal review of investment securities on a quarterly
basis for the presence of other-than-temporary impairment ("OTTI"). For the
second quarter of 2009, the Company adopted the provisions of FASB staff
position, "Recognition and Presentation of Other-Than-Temporary
Impairments." Management assesses whether OTTI is present when the fair
value of a debt security is less than its amortized cost basis at the
balance sheet date. Under these circumstances as required by the new staff
position, OTTI is considered to have occurred (1) if the Company intends to
sell the security; (2) if it is "more likely than not" that the Company
will be required to sell the security before recovery of its amortized cost
basis; or (3) the present value of expected cash flows is not sufficient to
recover the entire amortized cost basis. The "more likely than not"
criteria is a lower threshold than the "probable" criteria used under
previous guidance.
The staff position requires that credit-related OTTI is recognized in
earnings while non-credit related OTTI on securities not expected to be
sold is recognized in OCI. Non-credit related OTTI is caused by other
factors, including illiquidity. For securities classified as
held-to-maturity ("HTM"), the amount of OTTI recognized in OCI is accreted
to the credit-adjusted expected cash flow amounts of the securities over
future periods. Non-credit related OTTI recognized in earnings previous to
April 1, 2009 is reclassified from retained earnings to accumulated OCI as
a cumulative effect adjustment. The Company adopted this staff position
effective April 1, 2009. The adoption of this staff position resulted in
the reclassification of $2,511,080, ($1,657,313, net of tax) of non-credit
related OTTI to accumulated OCI which had previously been recognized as a
loss in earnings.
E-16
Management's OTTI evaluation process also follows the guidance of the
standard entitled "Accounting for Certain Investments in Debt and Equity
Securities," "Recognition of Interest Income and Impairment on Purchased
and Retained Beneficial Interests in Securitized Financial Assets," and
"Amendments to the Impairment and Interest Income Measurement Guidance."
This guidance requires the Company to take into consideration current
market conditions, fair value in relationship to cost, extent and nature of
change in fair value, issuer rating changes and trends, volatility of
earnings, current analysts' evaluations, and all available information
relevant to the collectability of debt securities. The Company is also
required to consider its ability and intent to hold investments until a
recovery of fair value, which may be maturity, and other factors when
evaluating the existence of OTTI in its securities portfolio. The
accounting principle was issued on January 12, 2009 and is effective for
reporting periods ending after December 15, 2008. This accounting principle
amends the previous accounting principle by eliminating the requirement
that a holder's best estimate of cash flows be based upon those that a
market participant would use. Instead, the provision requires that OTTI be
recognized as a realized loss through earnings when there has been an
adverse change in the holder's expected cash flows such that it is
"probable" that the full amount will not be received.
In addition, the disclosure and related discussion of unrealized losses is
presented pursuant to the EITF topic entitled, "The Meaning of
Other-Than-Temporary Impairment and Its Application to Certain
Investments." The staff position replaces certain impairment evaluation
guidance of the EITF topic; however, the disclosure requirements of EITF
topic remain in effect. This staff position addresses the determination of
when an investment is considered impaired, whether the impairment is
considered to be other-than-temporary, and the measurement of an impairment
loss. The staff position also supersedes EITF Topic entitled "Recognition
of Other-Than-Temporary Impairment upon the Planned Sale of a Security
Whose Cost Exceeds Fair Value," and clarifies that an impairment loss
should be recognized no later than when the impairment is deemed
other-than-temporary, even if a decision to sell an impaired security has
not been made.
For the three and nine months ended September 30, 2009, the Company did not
recognize any OTTI charges.
For all security types discussed below where no OTTI is considered to exist
at September 30, 2009, management applied the criteria of the staff
position to each investment individually. That is, for each security
evaluated, management concluded that it does not intend to sell the
security and it is not more likely than not that management will be
required to sell the security before recovery of its amortized cost basis
and as such OTTI was not recognized as a loss in earnings.
The following summarizes, by investment security type, the basis for the
conclusion that the applicable investment securities within the Company's
available for sale portfolio were not other-than-temporarily impaired at
September 30, 2009:
U.S. Government Agency Securities - The unrealized losses in the Company's
investment in these securities as of September 30, 2009 totaled $41,179.
This compares to unrealized losses of $3,386 at December 31, 2008. As the
unrealized losses in this sector of the
E-17
portfolio relate mostly to interest rates, the Company does not consider
these investments to be other-than-temporarily impaired at September 30,
2009.
State and Municipal Obligations - The unrealized losses on the Company's
investment in state and municipal obligations decreased from $376,069 at
December 31, 2008 to $155,868 at September 30, 2009. There were no OTTI
charges for these securities during the third quarter of 2009. These
securities are primarily insured AA and A rated general obligation bonds
with stable ratings. The decrease in the unrealized loss at September 30,
2009 is attributable to sales in this sector of the portfolio during the
third quarter. As of September 30, 2009, all securities are performing, the
Company is receiving all interest and principal payments as contractually
agreed, and all these securities are rated as investment grade. The Company
does not consider these investments to be other-than-temporarily impaired
at September 30, 2009.
Trust Preferred Securities - As of September 30, 2009, the unrealized
losses on the Company's investment in trust preferred securities totaled
$2,114,570. As of September 30, 2009, this portfolio consisted of two
pooled trust preferred securities with a carrying value of $2,994,101 and a
market value of $879,531. These securities are in the form of mezzanine
classes which are comprised of bank and insurance collateral. During the
first quarter of 2009, both securities were downgraded to a rating of Ca
indicating a more severe deterioration in the creditworthiness of the
underlying issuers of these securities. As a result, the Company recorded
OTTI losses effective as of December 31, 2008. Management evaluated current
credit ratings, credit support and stress testing for future defaults.
Management also reviewed analytics provided by the trustee, reports from
third-party sources and internal documents. As previously indicated, the
Company adopted the provisions of the staff position, and in connection
therewith determined that other-than-temporary impairments at April 1, 2009
consisted of $1,881,573 related to credit losses and $2,511,080 related to
other factors. There were no other-than-temporary impairments for the three
months ended September 30, 2009.
The unrealized losses on the Company's trust preferred securities were
caused by a lack of liquidity and uncertainties facing the banking and
insurance industries. During 2009, the Company was notified that these
securities will not be remitting interest payments and that going forward,
the Company would be receiving payments "in kind." As a result of this, the
Company has discontinued interest accruals on the securities and an
impairment loss has been recorded on one security as discussed above. Based
on the aforementioned valuation analysis to determine expected credit
losses prepared on both of these securities, management expects to fully
recover amortized cost of each security. However, additional interest
deferrals and/or defaults could result in future other-than-temporary
impairment charges. Because the Company does not intend to sell the
investments and it is not more likely than not that the Company will be
required to sell the investments before recovery of their amortized cost
bases, which may be maturity, the Company does not consider the non-credit
impairment of these investments to be recognized in earnings as
other-than-temporary impairments at September 30, 2009.
E-18
Mortgage-backed securities - The unrealized losses on the Company's
investment in mortgage-backed securities decreased from $280,889 at
December 31, 2008 to $33,855 at September 30, 2009. There were no OTTI
charges for the nine months ended September 30, 2009. These securities are
U.S. Government Agency or sponsored agency securities secured by
residential properties. The contractual cash flows for these investments
are performing as expected. Management believes the increase in fair value
is attributable to investor's perception of improvement in credit and
liquidity in the marketplace. The Company expects to collect all principal
and interest on these securities. Because the Company does not intend to
sell these investments and it is not more likely than not that the Company
will be required to sell these investments until a recovery of amortized
cost, which may be at maturity, the Company does not consider these
investments to be other-than-temporarily impaired at September 30, 2009.
Equity securities - There were no unrealized losses on the Company's
investment which was a decrease from the unrealized losses of $29,879 as of
December 31, 2008. As of September 30, 2009, this portfolio consists of a
marketable investment fund with a fair value of $2,014,939, a money market
fund with a fair value of $15,069,509, and perpetual preferred stock of
government sponsored enterprises which have been written down to a fair
value of $2. Given that there is no unrealized loss remaining in this
segment of the portfolio, no other-than-temporary evaluation was warranted
at September 30, 2009.
The following table presents a roll-forward of the balance of
credit-related impairment losses on debt securities held at September 30,
2009 for which a portion of the other-than-temporary impairment was
recognized in other comprehensive loss:
For the Three Months ended September 30, 2009:
Balance at July 1, 2009 $ 1,881,573
Credit component of other-than-temporary impairment not reclassified to other
comprehensive loss in conjunction with the cumulative effect adjustment -
Additions for credit component for which other-than-temporary impairment was
not previously recognized -
----------------
Balance at September 30, 2009 $ 1,881,573
================
For the Nine Months ended September 30, 2009:
Balance at January 1, 2009 $ -
Credit component of other-than-temporary impairment not reclassified to other
comprehensive loss in conjunction with the cumulative effect adjustment 1,881,573
Additions for credit component for which other-than-temporary impairment was
not previously recognized -
----------------
Balance at September 30, 2009 $ 1,881,573
================
As of September 30, 2009, debt securities with other-than-temporary
impairment losses related to credit and were recognized in earnings
consisted of pooled trust preferred securities. In accordance with the staff
position regarding other-than-temporary impairment issued in April 2009, the
Company estimated the portion of loss attributable to credit using a
discounted
E-19
cash flow model. Significant inputs for the Trust Preferred Securities
included estimated cash flows and prospective deferrals, defaults and
recoveries based on the underlying seniority status and subordination
structure of the pooled trust preferred debt tranche at the time of
measurement. The valuations of trust preferred securities were based upon
fair value guidance issued in April 2009 using cash flow analysis.
Contractual cash flows and a market rate of return were used to derive fair
value for each of these securities. Factors that affected the market rate of
return included (1) any uncertainty about the amount and timing of the cash
flows, (2) the credit risk, (3) liquidity of the instrument, and (4)
observable yields from trading data and bid/ask indications. Credit risk
spreads and liquidity premiums were analyzed to derive the appropriate
discount rate. Prospective deferral, default and recovery estimates
affecting projected cash flows were based on an analysis of the underlying
financial condition of the individual issuers, with consideration of the
issuer's capital adequacy, credit quality, lending concentrations and other
factors. Assumptions for deferral and constant default rates were 100% for
nonperforming in 2011, from 2% to 4.85% for nonperforming during 2010, 3.5%
for 2011 and 1% for performing after 2011. The assumptions for collateral
conditional default rates ranged from 0% to 4% and severity of defaults
assumptions ranged from 68% to 95%. Assumptions for internal rates of return
were from 12% to 17% and prepayment assumptions were from 0% to 2%.
All cash flow estimates were based on the securities' tranche structure and
contractual rate and maturity terms. The Company utilized the services of a
third-party vendor to obtain information about the structure in order to
determine how the underlying collateral cash flows will be distributed to
each security issued from the structure. The present value of the expected
cash flows was compared to the Company's holdings to determine the
credit-related impairment loss.
The amortized cost and fair value of debt securities at September 30, 2009
and December 31, 2008, by contractual maturity, are shown below. Actual
maturities of mortgage-backed securities may differ from contractual
maturities because the mortgages underlying the securities may be called or
prepaid with or without call or prepayment penalties. Because
mortgage-backed securities are not due at a single maturity date, they are
not included in the maturity categories in the following maturity summary.
September 30, 2009
-------------------------------------------------------------------------
Available-for-Sale Securities Held-to-Maturity Securities
----------------------------------- -----------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
---------------- ---------------- ---------------- ----------------
Due in one year or less $ 999,178 $ 1,010,938 $ - $ -
Due after one year through five years 5,226,049 5,294,963 - -
Due after five years through ten years 10,584,778 10,642,659 - -
Due after ten years 13,934,502 11,772,315 - -
---------------- ---------------- ---------------- ----------------
30,744,507 28,720,875 - -
Mortgage-backed securities 51,590,602 52,503,355 15,064 15,420
---------------- ---------------- ---------------- ----------------
TOTAL DEBT SECURITIES $ 82,335,109 $ 81,224,230 $ 15,064 $ 15,420
================ ================ ================ ================
E-20
December 31,2008
------------------------------------------------------------------------
Available-for-Sale Securities Held-to-Maturity Securities
----------------------------------- -----------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
---------------- ----------------- ----------------- ----------------
Due in one year or less $ - $ - $ - $ -
Due after one year through five years 25,110,576 25,272,025 - -
Due after five years through ten years 6,403,590 6,443,810 - -
Due after ten years 18,521,023 18,191,039 - -
---------------- ----------------- ----------------- ----------------
50,035,189 49,906,874 - -
Mortgage-backed securities 60,165,607 60,563,328 16,550 16,553
---------------- ----------------- ----------------- ----------------
TOTAL DEBT SECURITIES $ 110,200,796 $ 110,470,202 $ 16,550 $ 16,553
================ ================= ================= ================
9. A summary of the Bank's loan and lease portfolio at September 30, 2009 and
December 31, 2008 is as follows:
2009 2008
------------- -------------
Real estate--residential mortgage $ 172,572,153 $ 192,561,108
Real estate--commercial mortgage 100,564,068 67,454,925
Real estate--construction 27,262,941 38,153,503
Commercial Loans 41,015,054 46,249,689
Commercial Leases (net of unearned
discount of $3,999,055-2009, $2,501,895-2008) 35,324,433 19,785,870
Installment 4,882,886 5,113,400
Other 372,074 128,574
------------- -------------
TOTAL LOANS AND LEASES 381,993,609 369,447,069
Net deferred loan origination costs 636,779 562,242
Premiums on purchased loans 20,690 81,588
Allowance for loan and lease losses (6,084,194) (3,698,820)
------------- -------------
NET LOANS AND LEASES $ 376,566,884 $ 366,392,079
============= =============
Changes in the allowance for loan and lease losses for the three months
ended September 30, 2009 and 2008 are as shown below:
2009 2008
---------------- ----------------
Balance at June 30, $ 4,029,790 $ 2,233,578
Provision for loan and lease losses 2,682,691 155,000
Loans and leases charged off (767,429) (123,192)
Recoveries of loans and leases charged off 139,142 1,716
---------------- ----------------
Balance at the end of the period $ 6,084,194 $ 2,267,102
================ ================
Changes in the allowance for loan and lease losses for the nine months
ended September 30, 2009 and 2008 are as shown below:
E-21
2009 2008
---------------- ----------------
Balance at beginning of the year $ 3,698,820 $ 2,151,622
Provision for loan and lease losses 3,470,280 367,000
Loans and leases charged off (1,416,376) (275,457)
Recoveries of loans and leases charged off 331,470 23,937
---------------- ----------------
Balance at the end of the period $ 6,084,194 $ 2,267,102
================ ================
The following information relates to impaired loans and leases, which
include all nonaccrual loans and leases and other loans and leases past due
90 days or more, and all restructured loans and leases, as of and for the
nine months ended September 30, 2009 and December 31, 2008.
2009 2008
-------------- --------------
Loans and leases receivable for which there is a related allowance for loan
and lease losses $ 4,140,031 $ 6,225,481
============== ==============
Loans and leases receivable for which there is no related allowance for loan
and lease losses $ 7,578,146 $ 2,657,655
============== ==============
Allowance for loan and lease losses related to impaired loans and leases $ 1,375,040 $ 939,066
============== ==============
10. Other real estate owned ("OREO") represents the estimated net realizable
value of real estate received in satisfaction of a non-performing loan
through foreclosure proceedings during 2009. The Bank had no OREO during
2008. A summary of the other real estate owned operations for the nine
months ended September 30, 2009 and 2008 included in other expenses is as
follows:
2009 2008
-------------- ------------
Expense of holding other real estate owned $ 98,875 $ -
Write-down of other real estate owned property - -
-------------- ------------
Expense of holding other real estate owned operations, net $ 98,875 $ -
============== ============
11. A summary of the Bank's deposits at September 30, 2009 and December 31,
2008 is as follows:
E-22
2009 2008
-------------- --------------
Noninterest bearing:
Demand $ 70,023,494 $ 69,548,261
-------------- --------------
Interest bearing:
Savings 72,532,547 58,582,376
Money market 82,392,871 93,085,126
Time certificates of deposit in
denominations of $100,000 or more 76,917,868 41,003,855
Other time certificates of deposit 80,657,664 81,107,006
-------------- --------------
Total Interest bearing deposits 312,500,950 273,778,363
-------------- --------------
TOTAL DEPOSITS $ 382,524,444 $ 343,326,624
============== ==============
Included in deposits as of September 30, 2009 and December 31, 2008 are
approximately $29,510,000 and $15,902,000, respectively, of brokered
deposits which have varying maturities through December 2009 and December
2010, respectively.
12. During 2007, the Company approved a restricted stock plan (the "2007
Plan") for senior management. On February 15, 2008, the Company granted
3,500 restricted stock awards to senior management from the 2007 Plan.
These awards vest over a five-year period, or earlier if the senior
manager ceases to be a senior manager for reasons such as retirement or
change in control. The holders of these awards participate fully in the
rewards of stock ownership of the Company, including voting and dividend
rights. The senior managers are not required to pay any consideration to
the Company for the restricted stock awards. The Company measures the fair
value of the awards based on the average of the high price and low price
at which the Company's common stock traded on the date of the grant. For
the three and nine months ended September 30, 2009, $2,294 and $6,882
respectively was recognized as compensation expense under the 2007 Plan.
At September 30, 2009, unrecognized compensation cost of $30,591 related
to these awards is expected to vest over a weighted average period of 4
years.
A summary of unvested shares as of and for the nine months ended September
30, 2009, is as follows:
Weighted Average
Shares Grant Date
(in thousands) Fair Value
------------------ ---------------------
Unvested at January 1, 2009 3,500 $ 13.11
Granted - -
Vested - -
Forfeited - -
------------------ ---------------------
Unvested at September 30, 2009 3,500 $ 13.11
================== =====================
E-23
13. The Company has two operating segments for purposes of reporting business
line results: Community Banking and Leasing. The Community Banking segment
is defined as all the operating results of the Company and the Bank. The
Leasing segment is defined as the results of First Litchfield Leasing
Corporation. Because First Litchfield Leasing Corporation is a relatively
new subsidiary, methodologies and organizational hierarchies are newly
developed and will be subject to periodic review and revision. The
following presents the operating results and total assets for the segments
of the Company as of and for the three and nine months ended September 30,
2009 and 2008, respectively. The Company uses an internal reporting system
to generate information by operating segment. Estimates and allocations are
used for noninterest expenses and income taxes. The Company uses a matched
maturity funding concept to allocate interest expense to First Litchfield
Leasing Corporation. The matched maturity funding concept utilizes the
origination date and the maturity date of the lease to assign an interest
expense to each lease.
E-24
Three Months Ended
September 30, 2009
-------------------------------------------------------------------------
Community Elimination Consolidated
Banking Leasing Entries Total
--------------- --------------- --------------- -----------------
Net interest income $ 3,308,163 $ 418,462 $ - $ 3,726,625
Provision for credit losses 2,660,513 22,178 - 2,682,691
--------------- --------------- --------------- -----------------
Net interest income after provision for
credit losses 647,650 396,284 - 1,043,934
Noninterest income 1,215,035 - - 1,215,035
Noninterest expense 5,019,960 82,524 - 5,102,484
--------------- --------------- --------------- -----------------
(Loss) income before income taxes (3,157,275) 313,760 - (2,843,515)
Income tax benefit (provision) 875,044 (104,600) - 770,444
--------------- --------------- --------------- -----------------
Net (loss) income $ (2,282,231) $ 209,160 $ - $ (3,613,959)
=============== =============== =============== =================
Total assets as of September 30, 2009 $ 513,221,094 $ 38,184,219 $ 201,950 $ 551,203,363
=============== =============== =============== =================
Three Months Ended
September 30, 2008
-------------------------------------------------------------------------
Community Elimination Consolidated
Banking Leasing Entries Total
--------------- --------------- --------------- -----------------
Net interest income $ 3,713,276 $ 171,606 $ - $ 3,884,882
Provision for credit losses 119,909 35,091 - 155,000
--------------- --------------- --------------- -----------------
Net interest income after provision
for credit losses 3,593,367 136,515 - 3,729,882
Noninterest (loss) income (5,811,556) 4,028 - (5,807,528)
Noninterest expense 3,672,156 80,874 - 3,753,030
--------------- --------------- --------------- -----------------
(Loss) Income before income taxes (5,890,345) 59,669 - (5,830,676)
Income tax benefit (provision) 423,034 (18,248) - 404,786
--------------- --------------- --------------- -----------------
Net (loss) income $ (5,467,311) $ 41,421 $ - $ (5,425,890)
=============== =============== =============== =================
Total assets as of September 30, 2008 $ 484,358,599 $ 22,381,788 $ 201,950 $ 506,538,437
=============== =============== =============== =================
E-25
Nine Months Ended
September 30, 2009
-------------------------------------------------------------------------
Community Elimination Consolidated
Banking Leasing Entries Total
--------------- --------------- --------------- -----------------
Net interest income $ 10,626,062 $ 1,074,058 $ - $ 11,700,120
Provision for credit losses 3,357,959 112,321 - 3,470,280
--------------- --------------- --------------- -----------------
Net interest income after provision for
credit losses 7,268,103 961,737 - 8,229,840
Noninterest income 3,256,647 2,906 - 3,259,553
Noninterest expense 13,307,487 258,045 - 13,565,532
--------------- --------------- --------------- -----------------
(Loss) Income before income taxes (2,782,737) 706,598 - (2,076,139)
Income tax benefit (provision) 940,188 (234,301) - 705,887
--------------- --------------- --------------- -----------------
Net (loss) income $ (1,842,549) $ 472,297 $ - $ (1,370,252)
=============== =============== =============== =================
Total assets as of September 30, 2009 $ 513,221,094 $ 38,184,219 $ 201,950 $ 551,203,363
=============== =============== =============== =================
Nine Months Ended
September 30, 2008
-------------------------------------------------------------------------
Community Elimination Consolidated
Banking Leasing Entries Total
--------------- --------------- --------------- -----------------
Net interest income $ 10,708,773 $ 465,748 $ - $ 11,174,521
Provision for credit losses 280,226 86,774 - 367,000
--------------- --------------- --------------- -----------------
Net interest income after provision for
credit losses 10,428,547 378,974 - 10,807,521
Noninterest (loss) income (4,021,621) 4,028 - (4,017,593)
Noninterest expense 11,119,124 256,668 - 11,375,792
--------------- --------------- --------------- -----------------
(Loss) income before income taxes (4,712,198) 126,334 - (4,585,864)
Income tax benefit (provision) 313,270 (38,325) - 274,945
--------------- --------------- --------------- -----------------
Net (loss) income $ (4,398,928) $ 88,009 $ - $ (4,310,919)
=============== =============== =============== =================
Total assets as of September 30, 2008 $ 484,358,599 $ 22,381,788 $ 201,950 $ 506,538,437
=============== =============== =============== =================
14. The fair value of an asset or liability is the price that would be received
to sell that asset or paid to transfer that liability in an orderly
transaction occurring in the principal market (or most advantageous market
in the absence of a principal market) for such asset or liability. In
estimating fair value, the Company utilizes valuation techniques that are
consistent with the market approach, the income approach and/or the cost
approach. Such valuation techniques are consistently applied. Inputs to
valuation techniques include the assumptions that market participants would
use in pricing an asset or liability. The standard issued by the FASB
entitled, "Fair Value Measurements" establishes a fair value hierarchy for
valuation inputs that gives the highest priority to quoted prices in active
markets for identical assets or
E-26
liabilities and the lowest priority to unobservable inputs. The fair value
hierarchy is as follows:
Level 1 Quoted prices in active markets for identical assets or
liabilities. Level 1 assets include debt and equity securities that
are traded in an active exchange market, as well as U.S. Treasury
securities, that are highly liquid and are actively traded in
over-the-counter markets.
Level 2 Observable inputs other than Level 1 prices such as quoted prices
for similar assets or liabilities; quoted prices in markets that are
not active; or other inputs that are observable or can be
corroborated by observable market data for substantially the full
term of the assets or liabilities. Level 2 assets and liabilities
include debt securities with quoted prices that are traded less
frequently than exchange-traded instruments whose value is determined
using a pricing model with inputs that are observable in the market
or can be derived principally from or corroborated by observable
market data. This category generally includes other U.S. Government
and agency mortgage-backed and debt securities, state and municipal
obligations, and equity securities quoted in markets that are not
active. Also included are interest rate swaps, certain
collateral-dependent impaired loans, loans held for sale and
foreclosed property.
Level 3 Unobservable inputs that are supported by little or no market
activity and that are significant to the fair value of the assets or
liabilities. Level 3 assets and liabilities include financial
instruments whose value is determined using pricing models,
discounted cash flow methodologies, or similar techniques, as well as
instruments for which the determination of fair value requires
significant management judgment or estimation. For example, this
category could include certain private equity investments, trust
preferred securities and certain collateral-dependent impaired loans.
The following table details the financial instruments that are carried at
fair value and measured at fair value on a recurring basis as of September
30, 2009 and December 31, 2008 and indicates the fair value hierarchy of
the valuation techniques utilized by the Company to determine fair value:
Fair Value Measurements at September 30, 2009, Using
Quoted Prices in Significant
September Active Markets for Significant Other Unobservable
30, 2008 Identical Assets Observable Inputs Inputs
Total (Level 1) (Level 2) (Level 3)
---------------- ----------------- ------------------ ---------------
Assets:
Available for sale securities $ 98,308,680 $ 20,235,700 $ 77,193,449 $ 879,531
================= ================= ================== ================
Liabilities:
Interest rate swaps $ 41,609 $ - $ 41,609 $ -
================= ================= ================== ================
E-27
Fair Value Measurements at December 31, 2008, Using
Quoted Prices in Significant
December Active Markets for Significant Other Unobservable
31, 2008 Identical Assets Observable Inputs Inputs
Total (Level 1) (Level 2) (Level 3)
------------- ----------------- ----------------- -------------
Assets:
Available for sale securities $ 113,486,201 $ 5,188,571 $ 108,297,630 $ -
============= ================= ================= =============
As of September 30, 2009, U.S. Treasury securities and two equity
securities, with carrying values of $20,235,700 are the only assets whose
fair values are measured on a recurring basis, using Level 1 inputs
(active market quotes). At December 31, 2008, U.S. Treasury securities and
one equity security with carrying values of $5,188,571, are the only
assets whose fair values are measured on a recurring basis using Level 1
inputs.
The fair values of U. S. Government and agency mortgaged backed securities
and debt securities, State and Municipal obligations, and certain equity
securities are measured on a recurring basis, using Level 2 inputs of
observable market data on similar securities. As of September 30, 2009 and
December 31, 2008, the carrying values of these securities totaled
$77,193,449 and $108,297,630, respectively.
The fair value of the Bank's interest rate swap derivative instruments are
determined based on inputs that are readily available in public markets or
can be derived from information available in publicly quoted markets.
Therefore, the Bank has categorized these derivative instruments as Level
2 within the fair value hierarchy.
Securities measured at fair value in Level 3 include certain
collateralized debt obligations that are backed by trust preferred
securities issued by banks, thrifts and insurance companies. Management
determined that an orderly and active market for these securities and
similar securities did not exist based on a significant reduction in
trading volume and widening spreads relative to historical levels.
The following table shows a reconciliation of the beginning and ending
balances for Level 3 assets:
Nine Months Ended
September 30, 2009
------------------
Balance at beginning of period $ -
Increase in fair value of securities included in other comprehensive loss 385,916
Transfers to (from) level 3 - Trust Preferred securities 493,615
------------
Balance at end of period $ 879,531
============
The following tables detail the assets and liabilities carried at fair
value and measured at fair value on a nonrecurring basis as of September
30, 2009 and December 31, 2008
E-28
and indicate the fair value hierarchy of the valuation techniques utilized
by the Company to determine the fair value:
September 30, 2009
-----------------------------------------------------------------------------------
Quoted Prices in Significant Significant
Balance Active Markets for Observable Unobservable
as of Identical Assets Inputs Inputs
September 30, 2009 (Level 1) (Level 2) (Level 3)
------------------- -------------------- ------------------- -------------------
Financial assets held at fair value
Foreclosed Property (1) $ 547,040 $ - $ 547,040 $ -
=================== ==================== =================== ===================
Impaired Loans (1) $ 8,885,054 $ - $ - $ 8,885,054
=================== ==================== =================== ===================
Loans held for sale $ 95,000 $ - $ 95,000 $ -
=================== ==================== =================== ===================
December 31, 2008
-----------------------------------------------------------------------------------
Quoted Prices in Significant Significant
Balance Active Markets for Observable Unobservable
as of Identical Assets Inputs Inputs
December 31, 2008 (Level 1) (Level 2) (Level 3)
------------------- -------------------- ------------------- -------------------
Financial assets held at fair value
Impaired Loans (1) $ 3,271,452 $ - $ 694,650 $ 2,576,802
=================== ==================== =================== ===================
Loans held for sale $ 1,013,216 $ - $ 1,013,216 $ -
=================== ==================== =================== ===================
(1) Represents carrying value and related write-downs for which adjustments are
based on the appraised value.
The Company has no other assets or liabilities carried at fair value or
measured at fair value on a non recurring basis.
The Fair Value Measurements standard requires disclosure of fair value
information about financial instruments, whether or not recognized in the
statement of financial condition, for which it is practicable to estimate
that value. The Fair Value Measurements standard excludes certain
financial instruments from its disclosure requirements. Accordingly, the
aggregate fair value amounts presented do not represent the underlying
value of the Company.
In April 2009, the FASB issued a staff position "Interim Disclosures about
Fair Value of Financial Instruments." This staff position amends
"Disclosures about Fair Value of Financial Instruments," to require
disclosures about fair value instruments for interim reporting periods of
publicly traded companies as well as in financial statements. This staff
position also amends "Interim Financial Reporting," to require those
disclosures in summarized financial information at interim reporting
periods. Effective April 1, 2009, the Company adopted this staff position.
E-29
Cash and Due From Banks, Federal Funds Sold, Interest Income Receivable,
Accrued Interest Payable, Collateralized Borrowings, and Short-term
Borrowings: These assets and liabilities are short-term, and therefore,
book value is a reasonable estimate of fair value. These financial
instruments are not carried at fair value on a recurring basis.
Federal Home Loan Bank Stock, Federal Reserve Bank Stock and Other
Restricted Stock: Such stock is estimated to equal the carrying value, due
to the historical experience that these stocks are redeemed at par. These
financial instruments are not carried at fair value on a recurring basis.
Available for Sale and Held to Maturity Securities: Where quoted prices
are available in an active market, securities are classified within Level
1 of the valuation hierarchy. Level 1 securities include U.S. Treasury
securities that are traded in an active exchange market. If quoted prices
are not available, then fair values are estimated by using pricing models
(i.e., matrix pricing) or quoted prices of securities with similar
characteristics and are classified within Level 2 of the valuation
hierarchy. Examples of such instruments include U.S. Government agency and
sponsored agency bonds, mortgage-backed and debt securities, state and
municipal obligations, and equity securities in markets that are not
active, and certain collateral dependent loans. Securities measured at
fair value in Level 3 include certain collateralized debt obligations that
are backed by trust preferred securities issued by banks, thrifts and
insurance companies. Management determined that an orderly and active
market for these securities and similar securities did not exist based on
a significant reduction in trading volume and widening spreads relative to
historical levels. Available for sale securities are recorded at fair
value on a recurring basis, and held to maturity securities are only
disclosed at fair value.
Loans: For variable rate loans which reprice frequently and have no
significant change in credit risk, carrying values are a reasonable
estimate of fair values, adjusted for credit losses inherent in the
portfolios. The fair value of fixed rate loans is estimated by discounting
the future cash flows using the current market rates as of the reporting
date, estimated using local market data, at which similar loans would be
made to borrowers with similar credit ratings and for the same remaining
maturities, adjusted for credit losses inherent in the portfolios. Loans
are generally not recorded at fair value on a recurring basis. However,
from time to time, nonrecurring fair value adjustments to
collateral-dependent impaired loans are recorded to reflect partial
write-downs based on the observable market price or current appraised
value of collateral.
Loans held for sale: Loans held for sale are required to be carried at the
lower of cost or fair value. Market value is to represent fair value. As
of September 30, 2009, the Company had $95,000 of loans held for sale,
which represented first mortgages committed and subject to settlement
shortly after the end of the period. Due to the short term nature of loans
committed for sale, the carrying value approximates the market price.
Interest rate swap derivatives: The fair value of the Bank's interest rate
swap derivative instruments are determined based on inputs that are
readily available in public markets or can be derived from information
available in publicly quoted markets. Therefore, the Bank has categorized
these derivative instruments as Level 2 within the fair value hierarchy.
E-30
Deposits: The fair value of demand deposits, savings and money market
deposits is the amount payable on demand at the reporting date. The fair
value of certificates of deposit is estimated using a discounted cash flow
calculation that applies current market interest rates being offered for
deposits of similar remaining maturities to a schedule of aggregated
expected maturities on such deposits. Deposits are not recorded at fair
value on a recurring basis.
Long-term debt: The fair value of long-term debt is estimated using a
discounted cash flow calculation that applies current interest rates for
borrowings of similar maturity to a schedule of maturities of such
advances. Long-term debt is not recorded at fair value on a recurring
basis.
Off-balance-sheet instruments: Fair values for off-balance-sheet lending
commitments are based on fees currently charged to enter into similar
agreements, taking into account the remaining terms of the agreements and
the counterparties' credit standings. Off-balance sheet instruments are
not recorded at fair value on a recurring basis.
The recorded book balances and estimated fair values of the Company's
financial instruments at September 30, 2009 and December 31, 2008 are
presented in the following table. The estimated fair value amounts for
September 30, 2009 and December 31, 2008 have been measured as of the end
of the respective periods and have not been revaluated or updated for
purposes of these financial statements subsequent to those respective
dates. As such, the estimated fair values of these financial instruments
subsequent to those respective reporting dates may be different than
amounts reported at period-end.
E-31
September 30, 2009 December 31, 2008
---------------------------------- ----------------------------------
Book Estimated Book Estimated
Value Fair Value Value Fair Value
---------------------------------- ----------------------------------
Financial Assets:
Cash and equivalents $ 43,243,586 43,243,586 $ 9,238,783 9,238,783
Available for sale securities 98,308,680 98,308,680 113,486,201 113,486,201
Held to maturity securities 15,064 15,420 16,550 16,553
Federal Home Loan Bank Stock 5,427,600 5,427,600 5,427,600 5,427,600
Federal Reserve Bank Stock 225,850 225,850 225,850 225,850
Other restricted stock 105,000 105,000 100,000 100,000
Loans held for sale 95,000 95,000 1,013,216 1,013,216
Loans and leases, net 376,566,884 393,828,296 366,392,079 365,191,872
Accrued interest receivable 1,939,745 1,939,745 2,262,918 2,262,918
Interest rate swaps 41,609 41,609 - -
Financial Liabilities:
Savings deposits 72,532,547 72,532,547 58,582,376 58,582,376
Money market and demand deposits 152,416,365 152,416,365 162,633,387 162,633,387
Time certificates of deposit 157,575,532 158,575,338 122,110,861 122,607,975
Federal Home Loan Bank advances 80,000,000 82,950,958 81,608,000 86,044,755
Repurchase agreements with
financial institutions 22,500,000 23,308,788 26,450,000 26,316,528
Repurchase agreements with customers 19,409,085 19,409,085 18,222,571 18,222,571
Subordinated debt 10,104,000 10,104,000 10,104,000 10,104,000
Accrued interest payable 511,261 511,261 611,829 611,829
Collateralized borrowings - - 1,375,550 1,375,550
Loan and lease commitments, rate lock derivative commitments and other
commitments, on which the committed interest rate is less than the current
market rate are insignificant at September 30, 2009 and December 31, 2008.
15. Interest Rate Swaps and Derivative Instruments
The Company manages its interest rate risk by using derivative instruments
in the form of interest rate swaps designed to reduce interest rate risk by
effectively converting a portion of floating rate debt into fixed rate
debt. This action reduces the Company's risk of incurring higher interest
costs in periods of rising interest rates. On February 2, 2009, the Company
entered into two interest rate swap agreements through March of 2014 and
2019, respectively; however, the settlements under the swaps commenced
March 30, 2009. Payments under the swap agreements will continue on the
30th of each quarter end. The Company is accounting for the interest rate
swap agreements as effective cash flow hedges. The notional principal
amounts of these swaps were $6,800,000 and $3,000,000 and the variable
interest rate amounts on related debt were swapped for effective fixed
rates of 5.79% and 4.86%, respectively. These swaps are designated as cash
flow hedges and qualify for hedge accounting treatment under a standard
entitled, "Accounting for Derivative Instruments and Hedging Activities."
E-32
In accordance with this standard, the Company's derivative instruments are
recorded as assets or liabilities at fair value. Changes in fair value
derivatives that have been designated as cash flow hedges are included in
"Unrealized gains (losses) on cash flow hedges" as a component of other
comprehensive income to the extent of the effectiveness of such hedging
instruments. Any ineffective portion of the change in fair value of the
designated hedging instruments would be included in the Consolidated
Statements of Income in interest (income) expense. No such adjustment to
income to reflect hedge ineffectiveness on cash flow hedges was recognized
during the nine months ended September 30, 2009, and Management does not
anticipate the recognition of any such adjustment to income throughout the
terms of the swaps. Gains and losses are reclassified from accumulated
other comprehensive income to the Consolidated Statements of Income in the
period the hedged transaction affects earnings.
Amounts reported in accumulated other comprehensive income related to
derivatives will be reclassified to interest expense as interest payments
are made on the Company's variable-rate debt. Amounts in other
comprehensive income will be reclassified into interest expense over the
term of the swap agreements to achieve the fixed rate on the debt.
Over the next twelve months, the Company estimates that an additional
$221,175 will be reclassified as an increase to interest expense.
The gross carrying values of the interest rate contracts as of September
30, 2009 were $41,609 and were recorded in other liabilities on the
Consolidated Balance Sheets (see Notes 4 and 13). For the nine months ended
September 30, 2009, the amount of income recognized on the effective
portion of these interest rate contracts in accumulated other comprehensive
income on the condensed Consolidated Balance Sheets was ($27,462). For the
quarter ended September 30, 2009, there were no losses on the effective
portion of these interest rate contracts reclassified from accumulated
other comprehensive loss into interest expense of the Consolidated
Statement of Financial Condition. These interest rate swap agreements
contain no credit-risk-related contingency features. Associated with these
swaps, as of September 30, 2009, the Company was required to post
collateral with a fair value totaling $300,000 to cover the estimated peak
exposure of these swaps. No additional collateral is or will be required to
be posted.
16. Recent Accounting Pronouncements
As discussed in Note 1 - Significant Accounting Policies, on July 1, 2009,
the Accounting Standards Codification became FASB's officially recognized
source of authoritative U.S. generally accepted accounting principles
applicable to all public and non-public non-governmental entities,
superseding existing FASB, AICPA, EITF and related literature. Rules and
interpretive releases of the SEC under the authority of federal securities
laws are also sources of authoritative GAAP for SEC registrants. All other
accounting literature is considered non-authoritative. The switch to the
ASC affects the way companies refer to U.S. GAAP in financial statements
and accounting policies. Citing particular content in the ASC involves
specifying the unique numeric path to the content through the Topic,
Subtopic, Section and Paragraph structure.
E-33
Noncontrolling Interests in Consolidated Financial Statements - In
December 2007, the FASB issued an amendment to previous guidance on
noncontrolling interest. This amendment establishes new accounting and
reporting standards for the noncontrolling interest in a subsidiary and
for the deconsolidation of a subsidiary. Before this statement, limited
guidance existed for reporting noncontrolling interests (minority
interest). As a result, diversity in practice existed. In some cases
minority interest was reported as a liability and in others it was
reported in the mezzanine section between liabilities and equity.
Specifically, this amendment requires the recognition of a noncontrolling
interest (minority interest) as equity in the consolidated financials
statement and separate from the parent's equity. The amount of net income
attributable to the noncontrolling interest is included in consolidated
net income on the face of the income statement. This amendment clarifies
that changes in a parent's ownership interest in a subsidiary that do not
result in deconsolidation are equity transactions if the parent retains
its controlling financial interest. In addition, this statement requires
that a parent recognize gain or loss in net income when a subsidiary is
deconsolidated. Such gain or loss is to be measured using the fair value
of the noncontrolling equity investment on the deconsolidation date. The
amendment also includes expanded disclosure requirements regarding the
interests of the parent and its noncontrolling interests. Earlier adoption
was prohibited. The Company adopted this amendment beginning on January 1,
2009 and with the adoption, presented $74,015 as equity in the Company's
consolidated financial statements and modified the presentation of the
Company's financial statements as of March 31, 2009 and December 31, 2008
and going forward.
Share-Based Payment Transaction - In June 2008, the FASB issued new
guidance on "Determining Whether Instruments Granted in Share-Based
Payment Transactions Are Participating Securities." This new guidance
addresses whether instruments granted in share-based payment transactions
are participating securities prior to vesting and, therefore, need to be
included in the earnings allocation in computing earnings per share (EPS)
under the two-class method. This guidance is effective for financial
statements issued for fiscal years beginning after December 15, 2008, and
interim periods within those years. All prior-period EPS data presented
shall be adjusted retrospectively (including interim financial statements,
summaries of earnings, and selected financial data) to conform with the
provisions of this staff position. Early application was not permitted.
The Company adopted the staff position for the quarter ended March 31,
2009. The adoption of this staff position did not have a significant
effect on the Company's financial statements.
Derivatives and Hedging - In March 2008, the FASB issued a new standard
entitled, "Disclosures about Derivative Instruments and Hedging Activities
- an amendment of FASB Statement 133." The standard requires expanded
disclosure to provide greater transparency about (i) how and why an entity
uses derivative instruments, (ii) how derivative instruments and related
hedge items are accounted for under this standard, and (iii) how
derivative instruments and related hedged items affect an entity's
financial position, results of operations and cash flows. To meet those
objectives, the standard requires qualitative disclosures about objectives
and strategies for using derivatives, quantitative disclosures about fair
value amounts of gains and losses on derivative instruments and
disclosures about credit risk-related contingent features in derivative
E-34
agreements. The standard became effective for the Company January 1, 2009
and enhanced disclosures are included in the Company's financial
statements for September 30, 2009.
Impairment Guidance - In January 2009, the FASB issued a FASB Staff
Position entitled "Amendments to the Impairment Guidance of EITF Issue No.
99-20," which amends the impairment guidance in the EITF Issue,
"Recognition of Interest Income and Impairment on Purchased Beneficial
Interests and Beneficial Interests that Continue to be Held by a
Transferor in Securitized Financial Assets." The FSP revises the EITF
issue's impairment guidance for beneficial interests to make it consistent
with the requirements of the standard entitled, "Accounting for Certain
Investments in Debt and Equity Securities," for determining whether an
impairment of other debt and equity securities has occurred. The
impairment model in the standard enables greater judgment to be exercised
in determining whether an OTTI loss needs to be recorded. The impairment
model previously provided for in the EITF issue limited management's use
of judgment in applying the impairment model. The staff position was
effective as of January 1, 2009. The adoption of the staff position did
not have a material impact on the Company's consolidated financial
statements.
Determining Fair Value When the Volume and Level of Activity for the Asset
or Liability Have Significantly Decreased and Identifying Transactions
That Are Not Orderly - In April 2009 FASB issued this guidance which
addresses concerns that Fair Value Measurements emphasized the use of an
observable market transaction even when that transaction may not have been
orderly or the market for that transaction may not have been active. This
provides additional guidance on: (a) determining when the volume and level
of activity for the asset or liability has significantly decreased; (b)
identifying circumstances in which a transaction is not orderly; and (c)
understanding the fair value measurement implications of both (a) and (b).
The effective date of disclosures for this new standard is for interim and
annual reporting periods ending after June 15, 2009. The Company adopted
this guidance on April 1, 2009. The adoption did not have a material
impact on the Company's consolidated financial statements. See Notes 8 and
13 for disclosure.
Other-Than-Temporary Impairments - In April 2009, the FASB issued a staff
position entitled, "Recognition and Presentation of Other-Than-Temporary
Impairments." The staff position (i) changes existing guidance for
determining whether an impairment is other-than-temporary to debt
securities and (ii) replaces the existing requirement that the entity's
management assert it has both the intent and ability to hold an impaired
security until recovery with a requirement that management assert: (a) it
does not have the intent to sell the security; and (b) it is more likely
than not it will not have to sell the security before recovery of its cost
basis. Under the staff position, 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 to the extent the impairment is related to credit losses.
The amount of the impairment related to other factors is recognized in
other comprehensive income. The staff position became effective for the
Company in the quarter ended June 30, 2009, and resulted in the
reclassification of $2,511,080 ($1,657,313, net of tax) of non-credit
related OTTI to OCI which had previously been recognized in earnings and
is disclosed in Note 8 - Investment Securities.
E-35
Fair Value Measurements and Disclosures - In April 2009, the FASB issued a
staff position entitled, "Determining Fair Value when the Volume and Level
of Activity for the Asset or Liability has Significantly Decreased and
Identifying Transactions that are not Orderly." The staff position affirms
that the objective of fair value when the market for an asset is not
active is the price that would be received to sell the asset in an orderly
transaction, and clarifies and includes additional factors for determining
whether there has been a significant decrease in market activity for an
asset when the market for that asset is not active. The staff position
requires an entity to base its conclusion about whether a transaction was
not orderly on the weight of the evidence and expands certain disclosure
requirements. The staff position became effective for the Company in the
quarter ended June 30, 2009. See Note 13 for disclosure.
Interim Disclosure - Fair Value Measurements - In April 2009, the FASB
issued a new staff position entitled, "Interim Disclosures about Fair
Value of Financial Instruments." The staff position requires a publicly
traded company to include disclosures about the fair value of its
financial instruments whenever it issues summarized financial information
for interim reporting periods. In addition, entities must disclose, in the
body or in the accompanying notes of its summarized financial information
for interim reporting periods and in its financial statements for annual
reporting periods, the fair value of all financial instruments for which
it is practicable to estimate that value, whether recognized or not
recognized in the statement of financial position. The staff position
became effective for the Company in the quarter ended June 30, 2009, and
its adoption did not have a significant effect on the Company's financial
position, results of operations, or cash flows. The Company has included
the disclosures required by the staff position in Note 13.
Subsequent Events - In May 2009, the FASB issued a new standard entitled,
"Subsequent Events." This standard establishes general standards of
accounting for and disclosure of events that occur after the balance sheet
date but before financial statements are issued or available to be issued.
This standard defines (i) the period after the balance sheet date during
which a reporting entity's management should evaluate events or
transactions that may occur for potential recognition or disclosure in the
financial statements, (ii) the circumstances under which an entity should
recognize events or transactions occurring after the balance sheet date in
its financial statements, and (iii) the disclosures an entity should make
about events or transactions that occurred after the balance sheet date.
The new standard became effective for the Company's financial statements
for periods ending after June 15, 2009 and did not have a significant
impact on the Company's financial statements.
Transfers and Servicing - In June 2009, the FASB issued a statement
entitled, "Accounting for Transfers of Financial Assets - an amendment of
FASB Statement No. 140." This standard amends prior accounting guidance to
enhance reporting about transfers of financial assets, including
securitizations, and where companies have continuing exposure to the risks
related to transferred financial assets. The new standard eliminates the
concept of a "qualifying special-purpose entity" and changes the
requirements for derecognizing financial assets. The standard also
requires additional disclosures about all continuing involvements with
transferred financial assets including information about gains and losses
resulting from transfers during the period. The standard will be effective
E-36
January 1, 2010 and is not expected to have a significant impact on the
Company's financial statements.
17. Reclassification
Certain 2008 amounts have been reclassified to conform with the 2009
presentation. Such reclassifications had no effect on net income.
18. Subsequent Events
The Company has evaluated events or transactions that occurred after
September 30, 2009 and through the time the financial statements were
originally filed on November 13, 2009 and through December 24, 2009, the
date that the interim financial statements have been reissued, for
potential recognition or disclosure in the interim financial statements.
On October 25, 2009, the Company entered into an Agreement and Plan of
Merger (the "Merger Agreement") by and among the Company, the Bank and
Union Savings Bank ("Union") that provides for the merger of the Company
and the Bank with and into Union (the "Merger"). Under the terms of the
Merger Agreement, shareholders of the Company will receive $15.00 cash for
each share of Company common stock they own on the date of the Merger. The
transaction is valued at approximately $35 million. No fractional shares
will be issued. Consummation of the Merger is subject to approval by the
shareholders of the Company, as well as customary regulatory approvals
including the Office of the Comptroller of the Currency, the State of
Connecticut Department of Banking and the Federal Deposit Insurance
Corporation. The Merger is expected to close in the first quarter of 2010,
although there can be no assurance that this will occur.
On November 9, 2009, the Bank entered into a Formal Agreement (the
"Agreement") with The Office of the Comptroller of the Currency (the
"OCC"). The Agreement is a remedial supervisory action with provisions
intended to improve the Bank's condition and operations. While not
punitive, the Agreement provides a framework for addressing identified
problems, documenting remedial efforts and preventing the reoccurrence of
similar problems so that the Bank's condition will improve and no longer be
considered to be troubled. Management and the Board are of the opinion that
compliance with the Agreement is in the best interest of the Bank but will
require sustained effort and management resources.
To coordinate its compliance efforts pursuant to the Agreement, the Board
of the Bank will appoint a Compliance Committee consisting primarily of
independent Directors. The Compliance Committee will meet at least monthly
to monitor and report the Bank's progress to the Board. The Board will
review the Bank's liquidity plans, capital plans, strategic plans and
management and staffing plans and provide copies of such plans to the OCC
along with copies of the reports of the Compliance Committee and other
relevant information. The Board will assess the adequacy of the Bank's
management and staffing needs to assure that the Bank is well managed and
well staffed. The Bank will also notify the OCC regarding any proposed
changes in the Board, executive management or staff or changes in their
duties or responsibilities.
Pursuant to the Agreement, the Bank will not utilize brokered deposits
without appropriate FDIC and OCC authorization. In this regard, the only
deposits currently utilized by the Bank
E-37
which could be characterized as "brokered deposits" are deposits obtained
through the CDARS program. The Agreement with the OCC does not preclude the
Bank from participating in the CDARS program and the Bank has requested
authorization from the FDIC to continue to participate in such program. The
Bank has approximately $11 million in CDARS deposits, most of which will
mature in January 2010.
The Agreement further requires the Bank to enhance its credit risk
management program within the Bank's loan and lease functions and to
develop and adhere to policies designed to enhance risk rating and risk
monitoring. In addition, the Bank has agreed to take appropriate action to
improve and maintain asset quality. The Bank will prepare written
evaluations of and programs for collecting any loans greater than $750,000
that are subject to criticism, regularly review such loans, and only extend
additional credit on such loans if the Bank determines and documents that
it is consistent with the Bank's plan to collect the loan or strengthen the
assets underlying the loan and the action is necessary to protect the
Bank's interests. In addition, the Bank will enhance and document the
programs it uses to evaluate, maintain and document the adequacy of the
Allowance for Loan and Lease Losses, which enhanced programs were utilized
in the evaluation of the Allowance for Loan and Lease Losses for the third
quarter of 2009, and provide a copy of such program and documentation to
the OCC.
The Agreement precludes the Bank from growing at a rate greater than 5% on
an annual basis. In addition to updating its capital plan with appropriate
contingencies, the Agreement would preclude the payment of any dividends
inconsistent with the capital plan or applicable law and without written
non-objection by the OCC. The Merger Agreement with Union precludes the
payment of dividends to the shareholders of the Company's common stock
pending consummation of the merger.
The Bank understands that the Agreement with the OCC will remain in place
so long as the Bank remains subject to OCC supervision or until such time
as the Agreement is terminated by the OCC, which will generally not occur
until the issues which were the basis of the Agreement have been corrected
and verified through an examination and until there is no basis for
supervisory concern. Failure to comply with the Agreement could result in
more serious supervisory action by the OCC with respect to the Bank, its
officers or directors.
In addition to the Agreement, the Bank has been notified that the OCC will
require the Bank to achieve and maintain the following capital ratios by no
later than March 31, 2010:
o Total risk-based capital at least equal to twelve percent (12%) of
risk-weighted assets (as compared with 10.80% maintained by the Bank at
September 30, 2009 and 10% generally required of well-capitalized banks);
o Tier 1 capital at least equal to ten percent (10%) of risk weighted
assets (as compared with 9.54% maintained by the Bank at September 30,
2009, and 6% generally required of well-capitalized banks); and
E-38
o Tier 1 capital at least equal to eight percent (8%) of adjusted total
assets (as compared with 6.59% maintained by the Bank at September 30, 2009
and 5% generally required of well-capitalized banks).
The Bank expects to consummate its Merger with and into Union prior to the
date by which it would be required to achieve and maintain such capital
ratios. However, there can be no assurance that the Merger will be
consummated within such timeframe. Accordingly, the Bank will develop
contingency plans to address compliance with such capital requirements in
the event that the Merger is not consummated by March 31, 2010.
There are no other subsequent events requiring recognition or disclosure in
the financial statements.
E-39
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
GENERAL
First Litchfield Financial Corporation (the "Company"), a Delaware corporation
formed in 1988, is the one-bank holding company for The First National Bank of
Litchfield (the "Bank"), a national bank supervised and examined by the Office
of the Comptroller of the Currency (the "OCC"). The Bank is the Company's
primary subsidiary and only source of income. The Bank has three subsidiaries,
The Lincoln Corporation and Litchfield Mortgage Service Corporation, which are
Connecticut corporations, and First Litchfield Leasing Corporation ("First
Litchfield Leasing"), which is a Delaware corporation. The purpose of The
Lincoln Corporation is to hold property such as real estate, personal property,
securities, or other assets, acquired by the Bank through foreclosure or
otherwise to compromise a doubtful claim or collect a debt previously
contracted. The purpose of Litchfield Mortgage Service Corporation is to operate
as a passive investment company in accordance with Connecticut law. The purpose
of First Litchfield Leasing is to provide equipment financing and leasing
products to complement the Bank's array of commercial products.
Both the Company and the Bank are headquartered in Litchfield, Connecticut. The
Bank is a full-service commercial bank serving both individuals and businesses
generally within Litchfield County Connecticut. Deposits are insured up to
specific limits of the Federal Deposit Insurance Act by the Deposit Insurance
Fund, which is administered by the Federal Deposit Insurance Corporation. The
Bank's lending activities include loans secured by residential and commercial
mortgages. Other loan products include consumer and business installment
lending, as well as other secured and unsecured lending. The Bank has nine
banking locations located in the towns of Canton, Torrington, Litchfield,
Washington, Marble Dale, Goshen, Roxbury and New Milford, Connecticut. In 1975,
the Bank was granted Trust powers by the OCC. The Bank's Trust Department
provides trust and fiduciary services to individuals, nonprofit organizations
and commercial customers. Additionally, the Bank offers nondeposit retail
investment products such as mutual funds, annuities and insurance through its
relationship with Infinex Investments, Inc.
On June 26, 2003, the Company formed First Litchfield Statutory Trust I for the
purpose of issuing trust preferred securities and investing the proceeds in
subordinated debentures issued by the Company, and on June 26, 2003, the first
series of trust preferred securities were issued. During the second quarter of
2006, the Company formed a second statutory trust, First Litchfield Statutory
Trust II ("Trust II"). The Company owns 100% of Trust II's common stock. Trust
II exists for the sole purpose of issuing trust securities and investing the
proceeds in subordinated debentures issued by the Company. In June 2006, Trust
II issued its first series of trust preferred securities.
On October 25, 2009, the Company entered into an Agreement and Plan of Merger
(the "Merger Agreement") by and among the Company, the Bank and Union Savings
Bank ("Union") that provides for the merger of the Company and the Bank with and
into Union (the "Merger"). Under the terms of the Merger Agreement, shareholders
of the Company will receive $15.00 cash for each share of Company common stock
they own on the date of the
E-40
Merger. The transaction is valued at approximately $35 million. No fractional
shares will be issued. Consummation of the Merger is subject to approval by the
shareholders of the Company, as well as customary regulatory approvals including
the OCC, the State of Connecticut Department of Banking and the Federal Deposit
Insurance Corporation. The Merger is expected to close in the first quarter of
2010, although there can be no assurance that this will occur.
The following discussion and analysis of the Company's consolidated financial
condition and results of operations should be read in conjunction with the
consolidated financial statements and notes to the consolidated financial
statements.
FINANCIAL CONDITION
Total assets as of September 30, 2009 were $551,203,363, an increase of
$18,945,756, or 3.56% from year-end 2008 total assets of $532,257,607.
Net loans and leases increased $10,174,805 or 2.78% over the year-end 2008
amount. Net loans and leases as of September 30, 2009 were $376,566,884, as
compared to the year-end 2008 level of $366,392,079. Consistent with
management's strategy to migrate to a more profitable loan composition,
commercial loan and lease growth was strong during the third quarter of 2009.
Leases, net of unearned income, were $35,324,433 at September 30, 2009, which
was an increase of $15,538,563 or 78.53% from the year-end 2008 balance of
$19,785,870. The growth in the leasing portfolio is in relatively short-term
equipment financing. Commercial mortgages totaled $100,564,068 at September 30,
2009, which was an increase of $33,109,143 or 49.08% from year-end 2008. Growth
in commercial mortgages has been in fixed and variable rate products to
commercial customers located in our traditional and contiguous markets.
Construction mortgages totaled $27,262,941 as compared to the year-end balance
of $38,153,503. The decline in this portfolio was due to the soft commercial
construction market. The residential mortgage loan portfolio totaled
$172,572,153, which was a decrease of $19,988,955 from year-end 2008. The
majority of this decrease was attributable to the sale of residential mortgage
loans in the secondary market which settled in the third quarter. This sale was
transacted for the purpose of strengthening the Company's balance sheet in terms
of interest rate risk and liquidity.
As of September 30, 2009, the securities portfolio totaled $98,323,744, as
compared to the year-end 2008 balance of $113,502,751. The decrease in the
investment portfolio is due to calls in agency bonds as well as sales of
mortgage-backed securities. During the first nine months of 2009, approximately
$26 million in U.S. Government agency bonds were called. These bonds were
replaced with mortgage-backed securities with characteristics of shorter
duration and improved liquidity. In the second quarter, the Company sold
approximately $20 million in twenty and thirty year fixed rate mortgage-backed
securities. Similar to the aforementioned sale of residential mortgages, the
sale was also for the purpose of strengthening the balance sheet in terms of
interest rate risk and liquidity.
E-41
At year-end 2008, the due from broker for security sales totaled $9,590,823, as
a result of a security traded before December 31, 2008 with proceeds not
received until January 2009. There were no similar transactions at September 30,
2009.
Cash and cash equivalents totaled $43,243,586, as compared to the balance of
$9,238,783 at year-end 2008. Cash and cash equivalents is comprised of vault
cash, Federal funds sold, balances at correspondent banks and the Federal
Reserve Bank. The increase in cash and cash equivalents is due to the funds from
the investment sales and calls temporarily invested at correspondent banks.
Total liabilities were $519,814,447 as of September 30, 2009, which was an
increase of $20,024,104 from total liabilities of $499,790,343 as of year-end
2008. Total deposits increased by $39,197,820, or 11.42% from their year-end
levels. Time certificates of deposit totaled $157,575,532 as of September 30,
2009, which was an increase of 29.04%, or $35,464,671 from year-end 2008. The
increase in time deposits is reflective of the customers' desire for yield and
the shifting of money market deposits into short term certificates of deposit.
Additionally, there has been growth in the Bank's CDARs deposits, which provide
customers with FDIC deposit insurance beyond the $250,000 limit. Savings
deposits totaled $72,532,547 at September 30, 2009 which was an increase of
23.81% from the year-end 2008 balance. Growth in savings deposits has been in
traditional savings, health savings and municipal NOW accounts. Money market
deposits decreased by $10,692,255, or 11.49%, as a result of customers seeking
higher rates and locking in those rates via certificates of deposit.
As of September 30, 2009, repurchase agreements with customers totaled
$19,409,085, which was an increase of 6.51% from the year-end 2008 balance.
Because these accounts represent overnight investments by commercial and
municipal cash management customers, fluctuations in the balances of these
accounts are reflective of the temporary nature of these funds. As of September
30, 2009, advances under Federal Home Loan Bank borrowings and repurchase
agreements with financial institutions decreased $1,608,000 and $3,950,000,
respectively. Increases in the loan portfolio were funded by deposit growth and
by the liquidity from investment sales, which enabled management to reduce the
overall level of wholesale borrowings.
E-42
RESULTS OF OPERATIONS - THREE MONTHS ENDED SEPTEMBER 30, 2009 COMPARED TO THREE
MONTHS ENDED SEPTEMBER 30, 2008
Summary
Net loss available to common shareholders for the third quarter of 2009 totaled
$2,252,777 versus net loss of $5,425,890 for the third quarter of 2008. Basic
and diluted net loss per common share for the third quarter of 2009 were both
$.96 compared to basic and diluted loss per share of $2.30 for the third quarter
of 2008. The decrease in net loss available to common shareholders is due
primarily to the loss on available for sale securities in the third quarter of
2008 which did not occur in 2009, partially offset by increases in the provision
for loans and lease losses, loss due to dishonored items, and increases in other
noninterest expenses. Also in the 2009 quarter, dividends payable and accretion
on preferred shares was incurred, which preferred shares were not outstanding in
the 2008 period.
Net Interest Income
Net interest income is the largest component of the Company's operations. Net
interest income is defined as the difference between interest and dividend
income from earning assets, primarily loans and investment securities, and
interest expense on deposits and borrowed money. Interest income is the product
of the average balances outstanding on loans, securities, and interest-bearing
deposit accounts multiplied by their effective yields. Interest expense is
similarly calculated as the result of the average balances of interest-bearing
deposits and borrowed funds multiplied by the average rates paid on those funds.
The net interest spread represents the difference between the average rate on
interest-earning assets and the average cost of interest-bearing liabilities.
The net interest margin represents net interest income before the provision for
loan and lease losses divided by average interest earning assets. Other
components of operating income are the provision for loan losses, noninterest
income such as service charges and trust fees, noninterest expenses and income
taxes.
Net interest income on a fully tax-equivalent basis is comprised of the
following for the three months ended September 30,
2009 2008
---------------- ------------------
Interest and dividend income $ 6,111,459 $ 7,140,667
Tax-equivalent adjustments (1) 99,125 156,436
Interest expense (2,384,834) (3,255,785)
---------------- ------------------
Net interest income $ 3,825,750 $ 4,041,318
================ ==================
(1) Interest income is presented on a tax-equivalent basis which reflects a
federal tax rate of 34% for all periods presented.
E-43
The following table presents on a tax-equivalent basis, the Company's average
balance sheet amounts (computed on a daily basis), net interest income, interest
rates, interest spread, and net interest margin for the three months ended
September 30, 2009 and 2008. Average loans outstanding include nonaccruing
loans.
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY;
INTEREST RATES AND INTEREST DIFFERENTIAL
Three months ended September 30, 2009 Three months ended September 30, 2008
---------------------------------------------- ----------------------------------------------
Interest Interest
Average Earned/ Yield/ Average Earned/ Yield/
Balance Paid Rate Balance Paid Rate
------- ---- ---- ------- ---- ----
Assets
Interest Earning Assets:
Loans and leases $ 386,163,000 $ 5,331,700 5.52% $ 348,266,000 $ 5,367,408 6.16%
Investment securities 101,142,000 851,665 3.37% 155,762,000 1,886,213 4.84%
Other interest earning assets 26,859,000 27,219 0.41% 9,603,000 43,482 1.81%
---------------- ------------- ----------------- --------------
Total interest earning assets 514,164,000 6,210,584 4.83% 513,631,000 7,297,103 5.68%
------------- --------- -------------- ---------
Allowance for loan and
lease losses (4,029,000) (2,222,000)
Cash and due from banks 29,693,000 11,310,000
Premises and equipment 7,161,000 7,440,000
Net unrealized gains (losses)
on securities 599,000 (6,955,000)
Foreclosed real estate 104,000 -
Other assets 17,078,000 18,117,000
---------------- -----------------
Total Average Assets $ 564,770,000 $ 541,321,000
================ =================
Liabilities and Shareholders' Equity
Interest Bearing Liabilities:
Savings deposits $ 73,797,000 65,163 0.35% $ 64,474,000 173,193 1.07%
Money Market deposits 85,544,000 131,823 0.62% 80,602,000 363,373 1.80%
Time deposits 156,343,000 937,871 2.40% 131,370,000 1,130,642 3.44%
Borrowed funds 135,405,000 1,249,977 3.69% 163,604,000 1,588,577 3.88%
---------------- ------------- ----------------- --------------
Total interest bearing liabilities 451,089,000 2,384,834 2.11% 440,050,000 3,255,785 2.96%
------------- --------- -------------- ---------
Demand deposits 73,260,000 72,097,000
Other liabilities 6,873,000 4,446,000
Shareholders' Equity 33,548,000 24,728,000
---------------- -----------------
Total liabilities and equity $ 564,770,000 $ 541,321,000
================ =================
Net interest income $ 3,825,750 $ 4,041,318
============= ==============
Net interest spread 2.72% 2.72%
========= =========
Net interest margin 2.98% 2.99%
========= =========
E-44
Rate/Volume Ananysis
The following table, which is presented on a tax-equivalent basis, reflects the
changes for the three months ended September 30, 2009 when compared to the three
months ended September 30, 2008 in net interest income arising from changes in
interest rates and asset and liability volume mix. The change in interest
attributable to both rate and volume has been allocated to the changes in the
rate and the volume on a pro rata basis.
09/30/09 Compared to 09/30/08
Increase (Decrease) Due to
--------------------------
Volume Rate Total
-------------- -------------- --------------
Interest earned on:
Loans and leases $ 552,982 $ (588,690) $ (35,708)
Investment securities (553,601) (480,947) (1,034,548)
Other interest earning assets 35,782 (52,045) (16,263)
-------------- -------------- --------------
Total interest earning assets 35,163 (1,121,682) (1,086,519)
-------------- -------------- --------------
Interest paid on:
Deposits 211,785 (744,136) (532,351)
Borrowed money (263,316) (75,284) (338,600)
-------------- -------------- --------------
Total interest-bearing liabilities (51,531) (819,420) (870,951)
-------------- -------------- --------------
Increase, (decrease) in net interest income $ 86,694 $ (302,262) $ (215,568)
============== ============== ==============
Tax-equivalent net interest income for the third quarter of 2009 totaled
$3,825,750, a decrease of $215,568, or 5.33% from the third quarter of 2008. The
decreased interest margin caused the decline in net interest income, while the
slight increase in earning asset volume offset the decrease. The effect of
increased volume of earning assets over interest-bearing liabilities increased
net interest income by $86,694. However, for the quarter, the interest earned on
earning assets decreased more than funding costs and resulted in a $302,262
decline in net interest income.
Average earning assets for the third quarter of 2009 totaled $514,164,000, which
was $533,000 or .10% higher than average earning assets for the third quarter of
2008 which totaled $513,631,000. This increase in earning assets, contributed to
an additional $35,163 in interest income. Average loans and leases increased by
$37,897,000, or 10.88%, while average investments and other interest earning
assets decreased by $37,364,000 or 22.59%. The increase in loans and leases came
from organic growth in commercial leasing and mortgage lending. The decrease in
the securities portfolio is the result of the strategy to change the mix of
earning assets from investments to loans. The mix of earning assets for the
third quarter of 2009 was 75% loans to 25% investments and other earning assets
versus the third quarter 2008 mix of 68% loans to 32% investments and other
earning assets.
The tax equivalent net interest margin decreased 1 basis point from 2.99% in the
third quarter of 2008 to 2.98% for the third quarter of 2009. Both funding costs
and the tax equivalent yield on earning assets decreased by 85 basis points when
compared to the third quarter of 2008; however, for the third quarter of 2009,
the ratio of earning assets to total assets was 91%
E-45
compared to 95% for the third quarter of 2008. This lower level of earning
assets to total assets contributed to the slight decline in net interest margin.
The continued low interest rate environment has allowed management to decrease
its deposit rates over the last year. Although yields on earning assets have
been subject to similar declines, the aforementioned strategy to shift to a more
profitable mix of earning assets has offset some of this decline. However,
continued downward repricing of interest-earning assets, which are priced off of
longer market indices, as well as declines in yield due to non-performing assets
have resulted in the drop in net interest income. Retail deposits are the
primary source of the Company's funding; therefore, competition for these
deposits remains the biggest threat to the net interest margin.
Provision for Loan and Lease Losses
The provision for loan and lease losses for the third quarter of 2009 totaled
$2,682,691, which is an increase of $2,527,691 from the third quarter of 2008.
The provision for loan and lease losses is determined quarterly based on the
calculation of the allowance for loan and lease losses. (See discussion of the
Allowance for Loan and Lease Losses.)
During the third quarter of 2009, the Company recorded net charge-offs of
$628,287 compared to third quarter 2008 net charge-offs of $121,476. The change
in the level of charge-offs from 2008 to 2009 is due to commercial mortgage and
commercial loan charge-offs and higher levels of charge-off activity from the
consumer automobile loan portfolio. The change in the level of charge-offs from
2008 to 2009 is considered by management to be reflective of the challenging
economic environment.
Noninterest Income (Loss)
Noninterest income for the third quarter of 2009 totaled $1,215,035, versus
third quarter 2008 noninterest loss of $5,807,528. The change in noninterest
income is primarily attributable to the OTTI losses totaling $6,946,100 recorded
in the third quarter of 2008.
Trust income totaled $345,357, compared to third quarter 2008 trust income of
$319,049. The increase from third quarter 2008 levels is due to increased assets
under management.
During the third quarter of 2009 the Company originated and sold residential
mortgages in the secondary market which resulted in gains on sales of loans of
$349,294 compared to similar sales transacted during the third quarter of 2008
which resulted in gains of $17,085. These sales were transacted with the purpose
of reducing interest rate risk and improving the Company's liquidity position.
Other noninterest income totaled $14,767, which was a decrease of $42,589, or
74.26% from the third quarter of 2008. The decrease was due to expenses incurred
in holding other real estate owned during the third quarter of 2009, there was
no other real estate owned during the third quarter of 2008.
E-46
Noninterest Expense
Third quarter 2009 noninterest expense totaled $5,102,484, increasing 35.96%, or
$1,349,454 from the third quarter 2008 expense of $3,753,030. The majority of
the increase is the result of other noninterest expense and FDIC insurance
assessments. During the third quarter of 2009 the Company recorded an accrual of
$768,583 related to the dishonor of fraudulent items; there were no comparable
items in 2008. Increases in noninterest expenses are also reflected in legal,
computer services, and consulting fees and expenses for the management of
foreclosed properties, loan review, and employment agency fees.
Other noninterest expenses totaled $786,524 which is an increase of $362,567, or
85.52% from the third quarter of 2008. Higher 2009 costs for exam and audit
fees, software, and telephone expenses contributed to the increase in other
noninterest expense.
Income Taxes
The third quarter 2009 income tax benefit totaled $770,444, which is an increase
of $365,658 or 107.76% from the third quarter of 2008 benefit of $404,786. The
effective tax rate for the third quarter of 2009 was 27% as compared to 7% for
the third quarter of 2008. In the third quarter of 2009, the quarterly tax
benefit was limited to the Company's pretax year-to-date loss at the statutory
rate. The third quarter 2008 tax benefit did not relate proportionately to the
pretax loss due to the Company's inability to consider its loss on the Fannie
Mae and Freddie Mac OTTI write-down as ordinary income as of September 30, 2008.
With the October 2008 passage of the Emergency Economic Stabilization Act, banks
with Fannie Mae or Freddie Mac preferred shares and auction rate securities
holding such shares were able treat their losses as ordinary losses for tax
purposes. Pursuant to this change, the Company recognized the tax benefit of
approximately $1,710,000 in the fourth quarter of 2008.
As of September 30, 2009 and December 31, 2008, the Company had recorded net
deferred income tax assets of approximately $5.3 million and $5.1 million,
respectively. The determination of the amount of deferred income tax assets
which are more likely than not to be realized is primarily dependent on
projections of future earnings, which are subject to uncertainty and estimates
that may change given economic conditions and other factors. A valuation
allowance related to deferred tax assets is required when it is considered more
likely than not that all or part of the benefit related to such assets will not
be realized. Management has reviewed the deferred tax position of the Company at
September 30, 2009. The deferred tax position has been affected by several
significant transactions in the past three years. These transactions included
other-than-temporary impairment write-offs of certain investments and
significant permanent differences between accounting and tax income such as
non-taxable municipal security income, which securities have been sold and
replace with assets which will generate taxable income in the future, and
certain specific expenditures not expected to reoccur. As a result, the Company
is in a cumulative net loss position (pretax income (loss) for a three year
period adjusted for permanent items) as of September 30, 2009. However, under
the applicable accounting guidance, the Company has concluded that it is "more
likely than not" that the Company will be able to realize its deferred tax
assets based on the non-recurring nature of these items and the Company's
expectation of future taxable income. If, in the future, management's conclusion
regarding the need for a deferred tax asset valuation allowance could change,
resulting in the
E-47
establishment of a valuation allowance for a portion or all of
the deferred tax asset. The Company will continue to analyze the recoverability
of its deferred tax assets quarterly.
E-48
RESULTS OF OPERATIONS - NINE MONTHS ENDED SEPTEMBER 30, 2009 COMPARED TO NINE
MONTHS ENDED SEPTEMBER 30, 2008
Summary
Net loss available to common shareholders for the nine months ended September
30, 2009 totaled $1,877,621 versus the net loss of $4,310,919 for the nine
months ended September 30, 2008. Basic and diluted net loss per common share for
the nine months ended September 30, 2009 were both $0.80, compared to basic and
diluted loss per share of $1.82, for the nine months ended September 30, 2008.
The decrease in net loss available to common shareholders is due primarily to
the loss on available for sale securities in the nine months of 2008 which was
significantly less in the 2009 period, partially offset by increases in the
provision for loan and lease losses and loss due to dishonored items. Also in
the 2009 period, dividends payable and accretion on preferred shares was
accrued, which preferred shares were not outstanding in 2008.
Net Interest Income
Net interest income is the largest component of the Company's operations. Net
interest income is defined as the difference between interest and dividend
income from earning assets, primarily loans and investment securities, and
interest expense on deposits and borrowed money. Interest income is the product
of the average balances outstanding on loans, securities and interest-bearing
deposit accounts multiplied by their effective yields. Interest expense is
similarly calculated as the result of the average balances of interest-bearing
deposits and borrowed funds multiplied by the average rates paid on those funds.
The net interest spread represents the difference between the average rate on
interest earning assets and the average cost of interest-bearing liabilities.
The net interest margin represents net interest income before the provision for
loan and lease losses divided by average interest earning assets. Other
components of operating income are the provision for loan losses, noninterest
income such as service charges and trust fees, noninterest expenses, and income
taxes.
Net interest income on a fully tax-equivalent basis is comprised of the
following for the nine months ended September 30,
2009 2008
----------------- -----------------
Interest and dividend income $ 19,212,404 $ 21,575,168
Tax-equivalent adjustments (1) 307,188 515,164
Interest expense (7,512,284) (10,400,647)
----------------- -----------------
Net interest income $ 12,007,308 $ 11,689,685
================= =================
(1) Interest income is presented on a tax-equivalent basis which reflects a
federal tax rate of 34% for all periods presented.
E-49
The following table presents on a tax-equivalent basis, the Company's average
balance sheet amounts (computed on a daily basis), net interest income, interest
rates, interest spread, and net interest margin for the nine months ended
September 30, 2009 and 2008. Average loans outstanding include nonaccruing
loans.
DISTRIBUTION OF ASSETS, LIABILITIES AND SHAREHOLDERS' EQUITY;
INTEREST RATES AND INTEREST DIFFERENTIAL
Nine months ended September 30, 2009 Nine months ended September 30, 2008
-------------------------------------------- -----------------------------------------
Interest Interest
Average Earned/ Yield/ Average Earned/ Yield/
Balance Paid Rate Balance Paid Rate
------- ---- ---- ------- ---- ----
Assets
Interest Earning Assets:
Loans and leases $ 388,081,000 $ 16,227,927 5.58% $ 341,230,000 $ 16,209,373 6.33%
Investment securities 112,176,000 3,243,981 3.86% 150,686,000 5,670,091 5.02%
Other interest earning assets 12,995,000 47,684 0.49% 10,967,000 210,868 2.56%
-------------- ------------- -------------- --------------
Total interest earning assets 513,252,000 19,519,592 5.07% 502,883,000 22,090,332 5.86%
------------- --------- -------------- -------
Allowance for loan and
lease losses (3,785,000) (2,184,000)
Cash and due from banks 17,327,000 11,388,000
Premises and equipment 7,239,000 7,586,000
Net unrealized loss on
securities (635,000) (3,473,000)
Foreclosed real estate 188,000 -
Other assets 18,852,000 16,943,000
-------------- --------------
Total Average Assets $ 552,438,000 $ 533,143,000
============== ==============
Liabilities and Shareholders' Equity
Interest Bearing Liabilities:
Savings deposits $ 66,521,000 255,021 0.51% $ 59,062,000 479,079 1.08%
Money Market deposits 86,704,000 603,929 0.93% 81,332,000 1,185,540 1.94%
Time deposits 145,579,000 2,774,018 2.54% 135,138,000 3,976,610 3.92%
Borrowed funds 141,945,000 3,879,316 3.64% 157,692,000 4,759,418 4.02%
-------------- ------------- -------------- --------------
Total interest bearing liabilities 440,749,000 7,512,284 2.27% 433,224,000 10,400,647 3.20%
------------- --------- -------------- -------
Demand deposits 71,146,000 68,055,000
Other liabilities 7,413,000 4,864,000
Shareholders' Equity 33,130,000 27,000,000
-------------- --------------
Total liabilities and equity $ 552,438,000 $ 533,143,000
============== ==============
Net interest income $ 12,007,308 $ 11,689,685
============= ==============
Net interest spread 2.80% 2.66%
========= =======
Net interest margin 3.12% 2.92%
========= =======
E-50
Rate/Volume Analysis
The following table, which is presented on a tax-equivalent basis, reflects the
changes for the nine months ended September 30, 2009 when compared to the nine
months ended September 30, 2008 in net interest income arising from changes in
interest rates and from asset and liability volume mix. The change in interest
attributable to both rate and volume has been allocated to the changes in the
rate and the volume on a pro rata basis.
09/30/09 Compared to 09/30/08
Increase (Decrease) Due to
--------------------------
Volume Rate Total
------------- ------------- -------------
Interest earned on:
Loans and leases $ 2,083,220 $ (2,064,666) $ 18,554
Investment securities (1,273,069) (1,153,041) (2,426,110)
Other interest earning assets 33,124 (196,308) (163,184)
------------- ------------- -------------
Total interest earning assets 843,275 (3,414,015) (2,570,740)
------------- ------------- -------------
Interest paid on:
Deposits 443,154 (2,451,415) (2,008,261)
Borrowed money (452,197) (427,905) (880,102)
------------- ------------- -------------
Total interest bearing liabilities (9,043) (2,879,320) (2,888,363)
------------- ------------- -------------
Increase in net interest income $ 852,318 $ (534,695) $ 317,623
============= ============= =============
Tax-equivalent net interest income for the nine months ended September 30, 2009
totaled $12,007,308, an increase of $317,623, or 2.72% from the nine months
ended September 30, 2008. The impact of the increase in the volume of earning
assets primarily contributed to the increase in net interest income. The effect
of increased volume of earning assets over the effect of the increase in
interest-bearing liabilities increased net interest income by $852,318.
Additionally, the Company was not able to decrease its cost of deposit interest
to a greater degree than the decrease in interest earned on earning assets,
which resulted in a $534,695 decrease in net interest income.
Average earning assets for the nine months ended September 30, 2009 totaled
$513,252,000, which was $10,369,000 or 2.06% higher than average earning assets
for the nine months ended September 30, 2008 which totaled $502,883,000. The net
increase in earning assets, net of the increased volume of interest bearing
liabilities, contributed to an additional $852,318 in net interest income.
Average loans and leases increased by $46,851,000, or 13.73%, while average
investments decreased by $38,510,000 or 25.56%. The increase in loans and leases
came from organic growth in commercial leasing and mortgage lending. The
decrease in the securities portfolio is the result of the strategy to change the
mix of earning assets from investments to loans. The mix of earning assets for
the nine months ended September 30, 2009 was 76% loans to 24% investments versus
the nine months ended September 30, 2008 mix of 68% loans to 32% investments.
E-51
The tax equivalent net interest margin improved 20 basis points from 2.92% for
the nine months ended September 30, 2008 to 3.12% for the nine months ended
September 30, 2009. The improvement in the next interest margin is because
funding costs decreased by 93 basis points while the tax equivalent yield on
earning assets decreased by only 79 basis points. The continued low interest
rate environment has allowed management to continue to decrease its deposit
rates over the last year. Although yields on earning assets have been subject to
similar declines, the aforementioned strategy to shift to a more profitable mix
of earning assets has offset some of this decline. Additionally, many
interest-earning assets are priced off of longer market indices, which are not
as dramatically impacted by decreases in short term rates. Retail deposits are
the primary source of the Company's funding; therefore, competition for these
deposits remains the biggest threat to the net interest margin.
Provision for Loan and Lease Losses
The provision for loan and lease losses for the nine months ended September 30,
2009 totaled $3,470,280, which is an increase of $3,103,280 from the nine months
ended September 30, 2008. The provision for loan and lease losses is determined
quarterly based on the calculation of the allowance for loan and lease losses.
The increased provision is reflective of a higher level of net charge-offs and
management's assessment of inherent losses in the portfolio due to the economic
environment. (See discussion of the Allowance for Loan and Lease Losses.)
During the nine months ended September 30, 2009, the Company recorded net
charge-offs of $1,084,906 compared to nine month 2008 net charge-offs of
$251,520. The change in the level of charge-offs from 2008 to 2009 is due to
residential and commercial mortgage charge-offs and higher levels of charge-off
activity from the consumer automobile loan, and commercial loan portfolios. The
change in the level of charge-offs from 2008 to 2009 is considered by management
to be reflective of a weak economic environment.
Noninterest Income (Loss)
Noninterest income for the nine months ended September 30, 2009 totaled
$3,259,553, versus the loss of $4,017,593 for the nine months ended September
30, 2008. The 2008 noninterest income reflected OTTI charges related to the
$6,946,100 third quarter OTTI write down of the Bank's investments in Freddie
Mac and Fannie Mae preferred stock/auction rate securities holding such stock
and one pooled trust preferred security.
Trust income totaled $892,896, compared to the nine months ended September 30,
2008 trust income of $992,142. The decline from nine months ended September 30,
2008 levels is due to market declines of assets under management.
During the first nine months of 2009, the Company sold residential mortgages in
the secondary market which resulted in gains on sales of loans totaling $509,552
compared to sales transacted during the first nine months of 2008 which resulted
in gains totaling $34,904. Included in those sales was a sale of 94 mortgages
totaling $13 million executed during the third quarter of 2009. These sales were
transacted with the purpose of reducing interest rate risk and improving the
Company's liquidity position.
E-52
Other noninterest income totaled $83,721, as compared to $200,041 from the nine
months ended September 30, 2008. The decrease is primarily related to the loss
on other real estate owned.
During the first nine months of 2009, the Company sold $37 million of available
for sale securities. The purpose of these sales was to decrease interest rate
risk, improve balance sheet liquidity, and reduce price volatility. The net
gains from these sales totaled $314,584. Similar sales were transacted during
the first nine months of 2008 and resulted in gains totaling $215,416.
Noninterest Expense
For the nine months ended September 30, 2009 noninterest expense totaled
$13,565,532, increasing $2,189,740, or 19.25% from the nine months ended
September 30, 2008 expense of $11,375,792. Increases in noninterest expenses are
reflected in regulatory assessments, legal, computer services and consulting
expenses. The largest of these increases was regulatory assessments which
totaled $930,055 for the first nine months of 2009. This expense has increased
$746,311 over the 2008 costs due to increase premiums and the second quarter
2009 special assessment. Also, during 2009 the Company created an accrual of
$768,583 related to the dishonor of fraudulent items; there were no comparable
items in 2008. The increase in consulting and related expenses was primarily
related to loan review, workout and the management of foreclosed properties,
investment banking, and temporary employment. The impact of these increases was
mitigated by cost containment efforts for salaries, equipment and supplies,
director fees, and advertising expense.
Other noninterest expenses totaled $1,877,044 which is an increase of $457,923,
or 32.27% from the nine months ended September 30, 2008. This increase was due
primarily to 2009 costs for exam and audit fees which totaled $361,372 above the
nine month September 30, 2008 costs. Other increases in this category were OREO,
software, and telephone expense. Offsetting these increases were reduced
expenses for insurance, contributions, directors fees, seminars, and travel.
Income Taxes
The income tax benefit for the nine months ending September 30, 2009 totaled
$705,887, which is an increase of $430,942 or 156.74% from the nine month 2008
benefit of $274,945. The effective tax rates were 34% and 6%, respectively for
the nine months ended September 30, 2009 and 2008. The tax benefit for the nine
months ended September 30, 2009, was limited to the Company's year-to-date
pretax loss at the statutory rate of 34%. The tax benefit for the nine months
ended September 30, 2008 did not relate proportionately to the pretax loss
because of the loss related to a $5 million OTTI write down on Fannie Mae and
Freddie Mac preferred shares. This loss was not considered ordinary income, and
therefore no tax benefit related to the loss could be recognized through
September 30, 2008. With the passage of the Economic Stabilization Act, the
Company recognized the tax benefit of the OTTI loss during the fourth quarter of
2008.
E-53
As of September 30, 2009 and December 31, 2008, the Company had recorded net
deferred income tax assets of approximately $5.3 million and $5.1 million,
respectively. The determination of the amount of deferred income tax assets
which are more likely than not to be realized is primarily dependent on
projections of future earnings, which are subject to uncertainty and estimates
that may change given economic conditions and other factors. A valuation
allowance related to deferred tax assets is required when it is considered more
likely than not that all or part of the benefit related to such assets will not
be realized. Management has reviewed the deferred tax position of the Company at
September 30, 2009. The deferred tax position has been affected by several
significant transactions in the past three years. These transactions included
other-than-temporary impairment write-offs of certain investments and
significant permanent differences between accounting and tax income such as
non-taxable municipal security income, which securities have been sold and
replace with assets which will generate taxable income in the future, and
certain specific expenditures not expected to reoccur. As a result, the Company
is in a cumulative net loss position (pretax income (loss) for a three year
period adjusted for permanent items) as of September 30, 2009. However, under
the applicable accounting guidance, the Company has concluded that it is "more
likely than not" that the Company will be able to realize its deferred tax
assets based on the non-recurring nature of these items and the Company's
expectation of future taxable income. If, in the future, management's conclusion
regarding the need for a deferred tax asset valuation allowance could change,
resulting in the establishment of a valuation allowance for a portion or all of
the deferred tax asset. The Company will continue to analyze the recoverability
of its deferred tax assets quarterly.
LIQUIDITY
Management's objective is to ensure continuous ability to meet cash needs as
they arise. Such needs may occur from time to time as a result of fluctuations
in loan demand and the level of total deposits. Accordingly, the Bank has a
liquidity policy that provides flexibility to meet cash needs. The liquidity
objective is achieved through the maintenance of readily marketable investment
securities as well as a balanced flow of asset maturities and prudent pricing on
loan and deposit products.
The Bank is a member of the Federal Home Loan Bank system, which provides credit
to its member banks. This enhances the liquidity position of the Bank by
providing a source of available overnight as well as short-term borrowings.
Additionally, federal funds, borrowings through the use of repurchase
agreements, and the sale of mortgage loans in the secondary market are available
to fund short-term cash needs. (See Note 6 to the Consolidated Financial
Statements for information on Federal Home Loan Bank borrowings and repurchase
agreements.)
As of September 30, 2009, the Company had $116,246,290 in loan commitments and
credit lines outstanding. Because some commitments are expected to expire
without being drawn upon, the total commitment amount does not necessarily
represent all future cash requirements. The funding of these commitments is
anticipated to be met through deposits, loan and security amortizations, and
maturities. Management believes liquidity is adequate to meet its present and
foreseeable needs.
E-54
CAPITAL
Shareholders' equity totaled $31,388,916 as of September 30, 2009 as compared
with $32,467,264 as of December 31, 2008. The decrease in shareholders' equity
is primarily related to the 2009 net loss, the Company's other comprehensive
income charges related to the recognition of the unfunded pension liability,
cash flow hedges, unrealized holding losses on available for sale securities and
common and preferred dividends. From a regulatory perspective, the capital
ratios of the Company and the Bank place each entity in the "well-capitalized"
categories under applicable regulations. During the third and fourth quarters of
2008, the Company increased its investment in the Bank's equity by a total of
$4,000,000. During the first and second quarters of 2009, the Company increased
its investment in the Bank's equity by an additional $5,500,000. These actions
were executed to insure the Bank maintained capital at levels considered to be
well-capitalized by the federal banking agency capital adequacy guidelines.
The various capital ratios of the Company and the Bank are as follows as of
September 30, 2009:
Well-Capitalized
Capital Levels The Company The Bank
-------------- ----------- --------
TIER 1TIER 1:
Leverage capital ratio 5.00% 6.96% 6.59%
Risk-based capital ratio 6.00% 10.09% 9.54%
Total risk-based capital ratio 10.00% 11.34% 10.80%
Included in the Company's capital used to determine these ratios at September
30, 2009 is $9.8 million related to the Company's investment in First Litchfield
Statutory Trust I and First Litchfield Statutory Trust II, which is recorded as
subordinated debt in the Company's balance sheets at September 30, 2009 and
December 31, 2008, respectively. Trust preferred securities are currently
considered regulatory capital for purposes of determining the Company's Tier I
capital ratios. On March 1, 2005, the Board of Governors of the Federal Reserve
System, which is the Company's banking regulator, approved final rules that
allow for the continued inclusion of outstanding and prospective issuances of
trust preferred securities in regulatory capital subject to new, stricter
limitations. The Company has until March 31, 2011, (previously March 31, 2009),
to meet the new limitations. Management does not believe these final rules will
have a significant impact on the Company. On December 12, 2008, the Company
participated in the United States Department of the Treasury's Troubled Assets
Relief Program ("TARP") Capital Purchase Program ("CPP" also known as TARP
capital), and issued $10,000,000 of cumulative perpetual preferred stock with a
common stock warrant attached to the U. S. Treasury. The Company's purpose in
participating in the TARP CPP was to insure that the Company and the Bank
maintained their well-capitalized status given the uncertain economic
environment.
On December 12, 2008, under the TARP CPP, the Company sold 10,000 shares of
senior preferred stock to the U.S. Treasury, having a liquidation amount equal
to $1,000 per share, or $10,000,000. Although the Company is currently
well-capitalized under regulatory guidelines, the Board of Directors believed it
was advisable to take advantage of the TARP CPP to raise additional capital to
ensure that during these uncertain times, the Company is well-positioned to
E-55
support its existing operations as well as anticipated future growth. Additional
information concerning the TARP CPP is included in the Company's 2008 Form
10-K/A Amendment Number One, as filed with the Securities Exchange Commission on
April 23, 2009.
The Company expects that it (and the banking industry as a whole) may be
required by market forces and/or regulation to operate with higher capital
ratios than in the recent past. In addition, as the cumulative dividend rate on
the senior preferred stock issued in the TARP CPP increases from 5% to 9% in
2013, the Company will incur increased capital costs if the senior preferred
stock is not redeemed at, or prior to, that time. Therefore, in addition to
maintaining higher levels of capital, the Company's capital structure may be
subject to greater variation over the next few years than has been true
historically.
CERTAIN SUPERVISORY MATTERS
On November 9, 2009, the Bank entered into a Formal Agreement (the "Agreement")
with the OCC. The Agreement is a remedial supervisory action with provisions
intended to improve the Bank's condition and operations. While not punitive, the
Agreement provides a framework for addressing identified problems, documenting
remedial efforts and preventing the reoccurrence of similar problems so that the
Bank's condition will improve and no longer to be considered to be troubled.
Management and the Board are of the opinion that compliance with the Agreement
is in the best interest of the Bank but will require sustained effort and
management resources.
To coordinate its compliance efforts pursuant to the Agreement, the Board of the
Bank will appoint a Compliance Committee consisting primarily of independent
Directors. The Compliance Committee will meet at least monthly to monitor and
report the Bank's progress to the Board. The Board will review the Bank's
liquidity plans, capital plans, strategic plans and management and staffing
plans and provide copies of such plans to the OCC along with copies of the
reports of the Compliance Committee and other relevant information. The Board
will assess the adequacy of the Bank's management and staffing needs to assure
that the Bank is well managed and well staffed. The Bank will also notify the
OCC regarding any proposed changes in the Board, executive management or staff
or changes in their duties or responsibilities.
Pursuant to the Agreement, the Bank will not utilize brokered deposits without
appropriate FDIC and OCC authorization. In this regard, the only deposits
currently utilized by the Bank which could be characterized as "brokered
deposits" are deposits obtained through the CDARS program. The Agreement with
the OCC does not preclude the Bank from participating in the CDARS program and
the Bank has requested authorization from the FDIC to continue to participate in
such program. The Bank has approximately $11 million in CDARS deposits, most of
which will mature in January 2010.
The Agreement further requires the Bank to enhance its credit risk management
program within the Bank's loan and lease functions and to develop and adhere to
policies designed to enhance risk rating and risk monitoring. In addition, the
Bank has agreed to take appropriate action to improve and maintain asset
quality. The Bank will prepare written evaluations of and programs for
collecting any loans greater than $750,000 that are subject to criticism,
regularly review such loans, and only extend additional credit on such loans if
the Bank determines and documents that
E-56
it is consistent with the Bank's plan to collect the loan or strengthen the
assets underlying the loan and the action is necessary to protect the Bank's
interests. In addition, the Bank will enhance and document the programs it uses
to evaluate, maintain and document the adequacy of the Allowance for Loan and
Lease Losses, which enhanced programs were utilized in the evaluation of the
Allowance for Loan and Lease Losses for the third quarter of 2009, and provide a
copy of such program and documentation to the OCC.
The Agreement precludes the Bank from growing at a rate greater than 5% on an
annual basis. In addition to updating its capital plan with appropriate
contingencies, the Agreement would preclude the payment of any dividends
inconsistent with the capital plan or applicable law and without written
non-objection by the OCC. The Merger Agreement with Union precludes the payment
of dividends to the shareholders of the Company's common stock pending
consummation of the merger.
The Bank understands that the Agreement with the OCC will remain in place so
long as the Bank remains subject to OCC supervision or until such time as the
Agreement is terminated by the OCC, which will generally not occur until the
issues which were the basis of the Agreement have been corrected and verified
through an examination and until there is no basis for supervisory concern.
Failure to comply with the Agreement could result in more serious supervisory
action by the OCC with respect to the Bank, its officers or directors.
In addition to the Agreement, the Bank has been notified that the OCC will
require the Bank to achieve and maintain the following capital ratios by no
later than March 31, 2010:
o Total risk-based capital at least equal to twelve percent (12%) of
risk-weighted assets (as compared with 10.80% maintained by the Bank at
September 30, 2009 and 10% generally required of well-capitalized
banks);
o Tier 1 capital at least equal to ten percent (10%) of risk weighted
assets (as compared with 9.54% maintained by the Bank at September 30,
2009, and 6% generally required of well-capitalized banks); and
o Tier 1 capital at least equal to eight percent (8%) of adjusted total
assets (as compared with 6.59% maintained by the Bank at September 30,
2009 and 5% generally required of well-capitalized banks).
The Bank expects to consummate its Merger with and into Union prior to the date
by which it would be required to achieve and maintain such capital ratios.
However, there can be no assurance that the Merger will be consummated within
such timeframe. Accordingly, the Bank will develop contingency plans to address
compliance with such capital requirements in the event that the Merger is not
consummated by March 31, 2010.
E-57
CRITICAL ACCOUNTING POLICIES
In the ordinary course of business, the Bank has made a number of estimates and
assumptions relating to the reported results of operations and financial
condition in preparing its financial statements in conformity with accounting
principles generally accepted in the United States of America. Actual results
could differ significantly from those estimates under different assumptions and
conditions.
The Bank utilizes a loan and lease review and rating process which classifies
loans and leases according to the Bank's uniform classification system in order
to identify potential problem loans and leases at an early stage, alleviate
weaknesses in the Bank's lending policies, oversee the individual loan and lease
rating system, and ensure compliance with the Bank's underwriting,
documentation, compliance, and administrative policies. Loans and leases
included in this process are considered by management as being in need of
special attention because of some deficiency related to the credit or
documentation, but are still considered collectible and performing. Such
attention is intended to act as a preventative measure and thereby avoid more
serious problems in the future.
Investment securities which are held for indefinite periods of time, which
management intends to use as part of its asset/liability strategy, or which may
be sold in response to changes in interest rates, changes in prepayment risk,
increases in capital requirements, or other similar factors, are classified as
available for sale and are carried at fair value. Net unrealized gains and
losses for such securities, net of tax, are required to be recognized as a
separate component of shareholders' equity and excluded from determination of
net income. Gains or losses on disposition are based on the net proceeds and
cost of the securities sold, adjusted for amortization of premiums and accretion
of discounts, using the specific identification method.
The Company uses the asset and liability method of accounting for income taxes.
Determination of the deferred and current provision requires analysis by
management of certain transactions and the related tax laws and regulations.
Management exercises significant judgment in evaluating the amount and timing of
recognition of the resulting tax liabilities and assets. Those judgments and
estimates are re-evaluated on a continual basis as regulatory and business
factors change. The Company periodically reviews the carrying amount of its
deferred tax assets to determine if the establishment of a valuation allowance
is necessary. If, based on the available evidence in future periods, it is more
likely than not that all or a portion of the Company's deferred tax assets will
not be realized, a deferred tax valuation allowance is established.
Consideration is given to all positive and negative evidence related to the
realization of the deferred tax assets. In evaluating the available evidence,
management considers historical financial performance, expectation of future
earnings, the ability to carryback losses to recoup taxes previously paid,
length of statutory carryforward periods, experience with operating loss and tax
credit carryforwards not expiring unused, tax planning strategies and timing of
reversals of temporary differences. Significant judgment is required in
assessing future earnings trends and the timing of reversals of temporary
differences. The Company's evaluation is based on current tax laws as well as
management's expectations of future performance based on its strategic
initiatives. Changes in existing tax laws and future results that differ from
expectations may result in significant changes in the deferred tax asset
valuation allowance.
E-58
ALLOWANCE FOR LOAN AND LEASE LOSSES:
The allowance for loan and lease losses consists of specific, general, and
unallocated components. The specific component relates to loans and leases that
are classified as impaired. For impaired loans and leases an allowance is
established when the discounted cash flows (or collateral value or observable
market price) of the impaired loan or lease is lower than the carrying value of
that loan or lease. The general component covers non-impaired loans and leases
and is based on historical loss experience adjusted for qualitative factors. An
unallocated component is maintained to cover uncertainties that could affect
management's estimate or probable losses. The unallocated component of the
allowance reflects the margin of imprecision inherent in the underlying
assumptions.
The Bank makes provisions for loan and lease losses on a quarterly basis as
determined by a continuing assessment of the adequacy of the allowance for loan
and lease losses. The Bank performs an ongoing review of loans and leases in
accordance with an individual loan and lease rating system to determine the
required allowance for loan and lease losses at any given date. The review of
loans and leases is performed to estimate potential exposure to losses.
Management's judgment in determining the adequacy of the allowance is inherently
subjective and is based on an evaluation of the known and inherent risk
characteristics and size of the loan and lease portfolios, the assessment of
current economic and real estate market conditions, estimates of the current
value of underlying collateral, past loan and lease loss experience, review of
regulatory authority examination reports and evaluations of impaired loans and
leases, and other relevant factors. Loans and leases, including impaired loans
and leases, are charged against the allowance for loan and lease losses when
management believes that the uncollectibility of principal is confirmed. Any
subsequent recoveries are credited to the allowance for loan and lease losses
when received. In connection with the determination of the allowance for loan
and lease losses and the valuation of foreclosed real estate, management obtains
independent appraisals for significant properties, when considered necessary.
Management reassessed the allowance calculation during the third quarter of
2009. As a result of this assessment, loan categories were further segmented.
Historical factors were modified to reflect the Company's loss experience for
loan categories for which the Company has had losses in recent years. Peer data
was used for loan categories for which the Company has not experienced any
losses in the past several years. Qualitative factors were reevaluated and
additional factors were used to more accurately reflect trends in the portfolio.
There were no material changes in loan or lease concentrations that had a
significant effect on the allowance for loan and lease losses calculation at
September 30, 2009. In addition, there were no material reallocations of the
allowance among different parts of the loan or lease portfolio.
As a result of this assessment, as of September 30, 2009, non-performing assets,
loans and leases were $12,225,363 and represented 3.20% of total loans, leases
and OREO. As of December 31, 2008, non-performing assets and loans and leases
totaled $5,639,735 and represented 1.53% of total loans, leases and OREO. The
ratio of the allowance for such loan and lease losses to total loans and leases
at September 30, 2009 and December 31, 2008 was 1.59% and 1.00% respectively. At
September 30, 2009, the allowance for loan and lease losses was equivalent to
50% of total non-performing assets as compared with 66% of total non-performing
assets at
E-59
December 31, 2008. The ratio of the allowance for loan and lease losses to
non-performing assets decreased over the first nine months of 2009 due to the
increase in non-performing assets and loans and leases despite the increase to
the allowance resulting from commercial loan growth and the increase to the
general allocations. Although the Company did experience an increase in
non-performing assets during the first nine months of the year, the increase in
those non-performing assets was comprised of collateral-based loans which did
not require a specific allocation of the allowance for loan and lease losses
and, therefore, did not result in additional specific allocations with the
allowance. Changes in the allowance for loan and lease losses for the three and
nine month periods ended September 30, 2009 and 2008 are as shown below:
For the three months ended September 30, 2009 2008
------------------ ------------------
Balance as of June 30, $ 4,029,790 $ 2,233,578
Provision for loan and lease losses 2,682,691 155,000
Loans and leases charged off (767,429) (123,192)
Recoveries of loans and leases charged off 139,142 1,716
------------------ ------------------
Balance as of September 30, $ 6,084,194 $ 2,267,102
================== ==================
For the nine months ended September 30, 2009 2008
------------------ ------------------
Balance at beginning of the year $ 3,698,820 $ 2,151,622
Provision for loan and lease losses 3,470,280 367,000
Loans and leases charged off (1,416,376) (275,457)
Recoveries of loans and leases charged off 331,470 23,937
------------------ ------------------
Balance as of September 30, $ 6,084,194 $ 2,267,102
================== ==================
The following table summarizes the Bank's Other Real Estate Owned ("OREO"), past
due in excess of 90 days and still accruing interest and non-accrual loans and
leases, and total nonperforming assets as of September 30, 2009 and December 31,
2008.
September 30, 2009 December 31, 2008
--------------------- ---------------------
Nonaccrual loans and leases $ 11,678,323 $ 5,639,735
Other real estate owned 547,040 -
--------------------- ---------------------
Total nonperforming assets $ 12,225,363 $ 5,639,735
===================== =====================
Loans and leases past due in excess of 90 days and
accruing interest $ 39,854 $ 19,603
===================== =====================
E-60
POTENTIAL PROBLEM LOANS
As of September 30, 2009, there were no potential problem loans or leases not
disclosed above which cause management to have serious doubts as to the ability
of such borrowers to comply with their present loan or lease repayment terms.
OTHER-THAN-TEMPORARY IMPAIRMENT: The Company's investment securities portfolio
is comprised of available-for-sale and held-to-maturity investments. The
available-for-sale portfolio is carried at estimated fair value, with any
unrealized gains or losses, net of taxes, reported as accumulated other
comprehensive income or loss in shareholders' equity. The held-to-maturity
portfolio is carried at amortized cost. Management determines the classification
of a security at the time of its purchase.
The Company conducts a periodic review of our investment securities portfolio to
determine if the value of any security has declined below its cost or amortized
cost, and whether such decline is other-than-temporary. If such decline is
deemed other-than-temporary, the security is written down to a new cost basis
and the resulting loss is reported within non-interest income in the
consolidated statement of income.
Significant judgment is involved in determining when a decline in fair value is
other-than-temporary. The factors considered by management include, but are not
limited to:
o Whether the Company intends to sell the security and whether it is more
likely than not that the Company will be required to sell the security
before the recovery of its amortized cost basis, which may be maturity;
o The length of time and the extent to which the fair value has been less
than the amortized cost basis;
o Adverse conditions specifically related to the security, an industry or
a geographic area;
o The historical and implied volatility of the fair value of the
security;
o The payment structure of the debt security and the likelihood of the
issuer being able to make payment that increase in the future;
o Failure of the issuer of the security to make scheduled interest or
principal payments;
o Any changes to the rating of the security by a rating agency;
o Recoveries or additional declines in fair value subsequent to the
balance sheet date.
Adverse changes in the factors used by management to determine if a security is
OTTI could lead to additional impairment charges. Conditions affecting a
security that the Company determined to be temporary could become
other-than-temporary and warrant an impairment charge. Additionally, a security
that had no apparent risk could be affected by a sudden or acute market
condition and necessitate an impairment charge. During the third and fourth
quarters of 2008, the Company recorded OTTI losses totaling $9,422,650 related
to the Company's investments in Freddie Mac and Fannie Mae preferred
stock/auction rate securities holding such stock, and two pooled trust preferred
securities. There have been no OTTI losses during 2009. The Company adopted the
provisions of the FASB staff position issued in April 2009 relating
E-61
to OTTI during the second quarter of 2009. Adoption of this staff position
resulted in the reclassification of $2,511,080 ($1,657,313, net of tax) of
non-credit related accumulated OTTI to OCI which had previously been recognized
as a loss in earnings and is disclosed in Note 8 - Investment Securities.
OFF-BALANCE SHEET ARRANGEMENTS
The Company is a party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers such
as letters of credit. In the opinion of management, these off-balance sheet
arrangements are not likely to have a material effect on the Company's financial
condition, results of operation, or liquidity.
At September 30, 2009, there have been no significant changes in the Company's
off-balance sheet arrangements from those at December 31, 2008.
FORWARD-LOOKING STATEMENTS
This Quarterly Report and future filings made by the Company with the Securities
and Exchange Commission, as well as other filings, reports and press releases
made or issued by the Company and the Bank, and oral statements made by
executive officers of the Company and Bank, may include forward-looking
statements relating to such matters as (a) assumptions concerning future
economic and business conditions and their effect on the economy in general and
on the markets in which the Company and the Bank do business, and (b)
expectations for increased revenues and earnings for the Company and Bank
through growth resulting from acquisitions, attractions of new deposit and loan
customers and the introduction of new products and services. Such
forward-looking statements are based on assumptions rather than historical or
current facts and, therefore, are inherently uncertain and subject to risk.
For those statements, the Company claims the protection of the safe harbor for
forward-looking statements contained in the Private Securities Litigation Reform
Act of 1995.
The Company notes that a variety of factors could cause the actual results or
experience to differ materially from the anticipated results or other
expectations described or implied by such forward-looking statements. The risks
and uncertainties that may affect the operations, performance, development and
results of the Company's and Bank's business include the following: (a) the risk
of adverse changes in business conditions in the banking industry generally and
in the specific markets in which the Bank operates; (b) changes in the
legislative and regulatory environment that negatively impact the Company and
Bank through increased operating expenses; (c) increased competition from other
financial and nonfinancial institutions; (d) the impact of technological
advances; and (e) other risks detailed from time to time in the Company's
filings with the Securities and Exchange Commission. Such developments could
have an adverse impact on the Company and the Bank's financial position and
results of operations.
E-62
ITEM 4. CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures designed to ensure that
information required to be disclosed in the Company's Exchange Act report is
recorded, processed, summarized and reported within the time periods specified
in the SEC's rules and forms, and that such information is accumulated and
communicated to the Company's management, including its Chief Executive Officer
and Chief Financial Officer, as appropriate, to allow timely decisions regarding
required disclosure. In designing and evaluating the disclosure controls and
procedures, management recognized that any controls and procedures, no matter
how well designed and operated, can provide only reasonable assurance of
achieving the desired control objectives, and management necessarily was
required to apply its judgment in evaluating the cost-benefit of possible
controls and procedures.
As of the end of the period covered by this report, the Company's management,
under the supervision and with the participation of the Company's Chief
Executive Officer and the Company's Chief Financial Officer, carried out an
evaluation of the effectiveness of the design and operation of the Company's
disclosure controls and procedures. Based on the foregoing, the Company's Chief
Executive Officer and Chief Financial Officer concluded the Company's disclosure
controls and procedures were effective.
There were no changes in the Company's internal control over financial reporting
that occurred during the Company's third quarter of 2009 that have materially
affected, or is reasonably likely to materially affect, the Company's internal
control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Neither the Company nor the Bank (or any of their properties) is the subject of
any material pending legal proceedings other than routine litigation that is
incidental to its business.
E-63
[X] PLEASE MARK VOTES
AS IN THIS EXAMPLE
PROXY
FIRST LITCHFIELD FINANCIAL CORPORATION
SPECIAL MEETING OF STOCKHOLDERS
FEBRUARY 19, 2010 -- 3:00 P.M.
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS
The undersigned holder(s) of the Common Stock of First Litchfield
Financial Corporation (the "Company") do hereby nominate, constitute and appoint
Herbert L. Curtiss, Jr. and Arthur B. Webster of Litchfield County, Connecticut,
jointly and severally, as our proxies with full power of substitution, for us
and in our name, place and stead to vote all the Common Stock of said Company,
standing in our name on its books on December 30, 2009 at the Special Meeting of
its stockholders to be held at the Litchfield Inn, 432 Bantam Road, (Route 202),
Litchfield, Connecticut, on February 19, 2010 at 3:00 p.m. or at any adjournment
or postponement thereof with all the powers the undersigned would possess if
personally present, as follows:
(1) APPROVAL OF MERGER AGREEMENT:
To approve the Agreement and Plan of Merger by and among Union Savings
Bank, First Litchfield Financial Corporation and The First National Bank
of Litchfield, dated as of October 25, 2009, and the transactions
contemplated therein, pursuant to which a subsidiary of Union will merge
with and into First Litchfield, with First Litchfield being the surviving
corporation, and First Litchfield will be dissolved and The First National
Bank of Litchfield will merge with and into Union Savings Bank, resulting
in Union Savings Bank being to sole surviving entity.
For Against Abstain
[_] [_] [_]
(2) APPROVAL OF ADJOURNMENTS:
To approve one or more adjournments of the special meeting, if necessary,
to permit further solicitation of proxies if there are not sufficient
votes at the time of the special meeting, or at any adjournment or
postponement of that meeting, to approve the merger agreement.
For Against Abstain
[_] [_] [_]
(3) OTHER BUSINESS:
To consider and act upon such other matters as may properly come before
the special meeting or any adjournment or postponement of that meeting.
The Board of Directors does not expect any other business to be brought before
the special meeting. However, if any other matters are properly brought before
the special meeting, the persons named in this Proxy or their substitutes will
vote in such manner as shall be determined by a majority of the Board of
Directors.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" PROPOSALS (1) & (2)
THIS PROXY WILL BE VOTED IN ACCORDANCE WITH THE SPECIFICATION INDICATED. IF NO
SPECIFICATION IS INDICATED, THIS PROXY WILL BE VOTED "FOR" PROPOSAL 1 AND "FOR"
PROPOSAL 2 AND IN ACCORDANCE WITH THE DETERMINATION OF A MAJORITY OF THE BOARD
OF DIRECTORS AS TO ANY OTHER MATTERS THAT MAY PROPERLY COME BEFORE THE SPECIAL
MEETING.
THIS PROXY MAY BE REVOKED AT ANY TIME PRIOR TO THE SPECIAL MEETING BY WRITTEN
NOTICE TO THE COMPANY OR MAY BE WITHDRAWN AND YOU MAY VOTE IN PERSON SHOULD YOU
ATTEND THE SPECIAL MEETING.
PLEASE COMPLETE, SIGN AND DATE THIS PROXY CARD
-------------------------
Please be sure to date and sign |Date |
this proxy card in the box below. | |
- --------------------------------------------------------------------------------
| |
| |
| |
- -------Sign above---------------------------------------------------------------
- --------------------------------------------------------------------------------
^ Detach above card, complete, sign, date and mail in postage paid ^
envelope provided.
FIRST LITCHFIELD FINANCIAL CORPORATION
- --------------------------------------------------------------------------------
Please sign exactly as name appears. When shares are held in more than one name,
including joint tenants, each party should sign. When signing as attorney,
executor, administrator, trustee or guardian, give full title as such.
- --------------------------------------------------------------------------------
IF YOUR ADDRESS HAS CHANGED, PLEASE CORRECT THE ADDRESS IN THE SPACE PROVIDED
BELOW AND RETURN THIS PORTION WITH THE PROXY IN THE ENVELOPE PROVIDED.
- -------------------------------- ---------------------------------
| ----------------------- |
- -------------------------------- | | PROXY MATERIALS ARE | |
| |AVAILABLE ON-LINE AT:| |
- -------------------------------- | ----------------------- |
| http://www.cfpproxy.com/4824sm |
----------------------------------
4824
PROXY
FIRST LITCHFIELD FINANCIAL CORPORATION
SPECIAL MEETING OF STOCKHOLDERS
FEBRUARY 19, 2010
3:00 P.M.
THIS PROXY IS SOLICITED ON BEHALF OF THE BOARD OF DIRECTORS
The undersigned holder(s) of the Common Stock of First Litchfield
Financial Corporation (the "Company") do hereby nominate, constitute and appoint
Herbert L. Curtiss, Jr. and Arthur B. Webster of Litchfield County, Connecticut,
jointly and severally, as our proxies with full power of substitution, for us
and in our name, place and stead to vote all the Common Stock of said Company,
standing in our name on its books on December 30, 2009 at the Special Meeting of
its stockholders to be held at the Litchfield Inn, 432 Bantam Road, (Route 202),
Litchfield, Connecticut, on February 19, 2010 at 3:00 p.m. or at any adjournment
or postponement thereof with all the powers the undersigned would possess if
personally present, as follows:
THIS PROXY WILL BE VOTED IN ACCORDANCE WITH THE SPECIFICATION INDICATED.
IF NO SPECIFICATION IS INDICATED, THIS PROXY WILL BE VOTED "FOR" PROPOSAL 1 AND
"FOR" PROPOSAL 2 AND IN ACCORDANCE WITH THE DETERMINATION OF A MAJORITY OF THE
BOARD OF DIRECTORS AS TO ANY OTHER MATTERS THAT MAY PROPERLY COME BEFORE THE
SPECIAL MEETING.
THIS PROXY MAY BE REVOKED AT ANY TIME PRIOR TO THE SPECIAL MEETING BY
WRITTEN NOTICE TO THE COMPANY OR MAY BE WITHDRAWN AND YOU MAY VOTE IN PERSON
SHOULD YOU ATTEND THE SPECIAL MEETING.
PLEASE COMPLETE, DATE, SIGN, AND MAIL THIS PROXY CARD PROMPTLY IN THE ENCLOSED
POSTAGE-PAID ENVELOPE OR PROVIDE YOUR INSTRUCTIONS TO VOTE VIA
THE INTERNET OR BY TELEPHONE.
(Continued, and to be marked, dated and signed, on the other side)
v FOLD AND DETACH HERE v
- --------------------------------------------------------------------------------
FIRST LITCHFIELD FINANCIAL CORPORATION -- SPECIAL MEETING, FEBRUARY 19, 2010
YOUR VOTE IS IMPORTANT!
Special Meeting Materials are available on-line at:
http://www.cfpproxy.com/4824
You can vote in one of three ways:
1. Call toll free 1-866-205-9073 on a Touch-Tone Phone. There is NO CHARGE to
you for this call.
or
--
2. Via the Internet at https://www.proxyvotenow.com/flfl.ob and follow the
instructions.
or
--
3. Mark, sign and date your proxy card and return it promptly in the enclosed
envelope.
PLEASE SEE REVERSE SIDE FOR VOTING INSTRUCTIONS
4824
[X] PLEASE MARK VOTES
AS IN THIS EXAMPLE
PROXY
FIRST LITCHFIELD FINANCIAL CORPORATION
Special Meeting of Shareholders
FEBRUARY 19, 2010
(1) APPROVAL OF MERGER AGREEMENT:
To approve the Agreement and Plan of Merger by and among Union Savings
Bank, First Litchfield Financial Corporation and The First National Bank
of Litchfield, dated as of October 25, 2009, and the transactions
contemplated therein, pursuant to which a subsidiary of Union will merge
with and into First Litchfield, with First Litchfield being the surviving
corporation, and First Litchfield will be dissolved and the First National
Bank of Litchfield will merge with and into Union Savings Bank, resulting
in Union Savings Bank being the sole surviving entity.
For Against Abstain
[_] [_] [_]
(2) APPROVAL OF ADJOURNMENTS:
To approve one or more adjournments of the special meeting, if necessary,
to permit further solicitation of proxies if there are not sufficient
votes at the time of the special meeting, or at any adjournment or
postponement of that meeting, to approve the merger agreement.
For Against Abstain
[_] [_] [_]
(3) OTHER BUSINESS:
To consider and act upon such other matters as may properly come before
the special meeting or any adjournment or postponement of that meeting.
The Board of Directors does not expect any other business to be brought before
the special meeting. However, if any other matters are properly brought before
the special meeting, the persons named in this Proxy or their substitutes will
vote in such manner as shall be determined by a majority of the Board of
Directors.
THE BOARD OF DIRECTORS RECOMMENDS A VOTE "FOR" PROPOSALS (1) & (2)
Mark here if you plan to attend the meeting [_]
Mark here for address change and note change [_]
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
- --------------------------------------------------------------------------------
Please sign exactly as name appears. When shares are held in more than one name,
including joint tenants, each party should sign. When signing as attorney,
executor, administrator, trustee or guardian, give full title as such.
-------------------------
Please be sure to date and sign |Date |
this proxy card in the box below. | |
- --------------------------------------------------------------------------------
| |
| |
- -------Sign above---------------------------------------------------------------
- --------------------------------------------------------------------------------
IF YOU WISH TO PROVIDE YOUR INSTRUCTIONS TO VOTE BY TELEPHONE OR INTERNET,
PLEASE READ THE INSTRUCTIONS BELOW
- --------------------------------------------------------------------------------
^ FOLD AND DETACH HERE IF YOU ARE VOTING BY MAIL ^
PROXY VOTING INSTRUCTIONS
Shareholders of record have three ways to vote:
1. By Mail; or
2. By Telephone (using a Touch-Tone Phone); or
3. By Internet.
A telephone or Internet vote authorizes the named proxies to vote your shares in
the same manner as if you marked, signed, dated and returned this proxy. Please
note telephone and Internet votes must be cast prior to 3 a.m., February 19,
2010. It is not necessary to return this proxy if you vote by telephone or
Internet.
- ---------------------------------------- --------------------------------------
| | | |
| Vote by Telephone | | Vote by Internet |
| Call Toll-Free on a Touch-Tone Phone | | anytime prior to |
| anytime prior to | | 3 a.m., February 19, 2010 |
| 3 a.m., February 19, 2010: | | go to |
| 1-866-205-9073 | | https://www.proxyvotenow.com/flfl.ob|
| | | |
- ---------------------------------------- ---------------------------------------
Please note that the last vote received, whether by telephone, Internet or
by mail, will be the vote counted.
-----------------------------------
|ON-LINE SPECIAL MEETING MATERIALS:| http://www.cfpproxy.com/4824sm
-----------------------------------
Your vote is important! ================
| |
================