UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1997
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 1-10506
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Essex Bancorp, Inc.
(Exact name of registrant as specified in its charter)
Delaware 54-1721085
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(State of organization) (I.R.S. Employer
Identification No.)
The Koger Center
Building 9, Suite 200
Norfolk, Virginia 23502
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(Address of principal (Zip Code)
executive offices)
Registrant's telephone number, including area code (757) 893-1300
Securities registered pursuant to Section 12(b) of the Act:
Common Stock, Par Value $.01 Per Share American Stock Exchange
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(Title of Class) (Exchange on Which Registered)
Securities registered pursuant to Section 12(g) of the Act:
None
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(Title of Class)
Indicate by check mark whether the Registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
Registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No ____
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained to
the Registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [___]
The aggregate market value of the Registrant's common stock on the
American Stock Exchange on March 25, 1998 held by nonaffiliates of the
Registrant was $5,536,582.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Annual Report to Stockholders for the year ended December 31,
1997 are incorporated by reference into Parts I and II hereof.
Portions of the Proxy Statement for the Annual Meeting to be held on May 28,
1998 are incorporated by reference into Part III hereof.
Essex Bancorp, Inc.
Annual Report on Form 10-K for the
Year Ended December 31, 1997
Table of Contents
Page
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Part I
Item 1 Business................................................ 3
Item 2 Properties.............................................. 41
Item 3 Legal Proceedings....................................... 41
Item 4 Submission of Matters to a Vote
of Security Holders................................. 42
Part II
Item 5 Market for Registrant's Common Equity
and Related Stockholder Matters..................... 42
Item 6 Selected Financial Data................................. 43
Item 7 Management's Discussion and
Analysis of Financial Condition
and Results of Operations........................... 43
Item 8 Financial Statements and
Supplementary Data.................................. 43
Item 9 Changes in and Disagreements with
Accountants on Accounting and
Financial Disclosure................................ 43
Part III
Item 10 Directors and Executive Officers
of the Registrant................................... 44
Item 11 Executive Compensation.................................. 45
Item 12 Security Ownership of Certain
Beneficial Owners and Management.................... 45
Item 13 Certain Relationships and
Related Transactions................................ 45
Part IV
Item 14 Exhibits, Financial Statement Schedules
and Reports on Form 8-K............................. 46
2
PART I
Item 1. Business
Organization and Background
General. The following organizational chart depicts Essex Bancorp, Inc.
and its subsidiaries as of December 31, 1997. It is intended to facilitate the
readers' understanding of the companies discussed in this report. Following the
chart is a glossary of terms which are used throughout this report.
Essex Bancorp, Inc. and Subsidiaries
Organizational Chart
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| The Company |
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| The Bank | | EMC | | EAC |
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| 69% | 31%
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| Essex First | | ECC |
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| Essex Home |
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| EHADC |
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Unless otherwise noted, each company is owned 100% by its parent entity.
3
Defined Term Formal Name
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Company Essex Bancorp, Inc., successor to Essex Financial
Partners, L.P. and Essex Bancorp.
Partnership Essex Financial Partners, L.P.
Bancorp Essex Bancorp.
EAC Essex Acquisition Corporation
Bank Essex Savings Bank, F.S.B.
EMC Essex Mortgage Corporation
Essex First Essex First Mortgage Corporation
ECC Essex Capital Corporation
Essex Home Essex Home Mortgage Servicing Corporation
EHADC E H Asset Disposition Corporation
TMS Thrift Management Services, Inc. - General Partner
The Company is a Delaware corporation that is the holding company for
the Bank, a federally-chartered savings bank which operates four branches
located in North Carolina and Virginia. The Company is the successor by merger
to the Partnership, a Delaware limited partnership, which was formed in 1989 in
order to acquire an existing corporation that was the holding company for one of
the Bank's predecessor institutions. The Partnership and Bancorp, the Bank's
former holding company, were merged into the Company in January 1995. The
Company is engaged primarily in the operation of the Bank as a wholly-owned
subsidiary. The Company's other principal operating subsidiaries are Essex
First, a wholly-owned subsidiary of the Bank that is engaged primarily in the
origination and sale of residential mortgage loans, and Essex Home, an indirect
subsidiary of the Company and the Bank that is engaged primarily in the
servicing of mortgage loans owned by the Bank, various governmental agencies and
various third party investors. At December 31, 1997, the Company had total
assets of $195.1 million, total liabilities of $180.3 million, including total
deposits of $153.9 million, and total shareholders' equity of $14.8 million.
In January 1995, following approval by the holders of the Partnership's
limited partnership units ("LPUs"), both the Partnership and Bancorp were merged
with and into the Company (collectively, the "Merger"), which resulted in a
single holding company structure for the Bank and the other subsidiaries of the
Company. As a result of the consummation of the Merger, each holder of LPUs
received one share of Company common stock ("Common Stock") for every two LPUs
beneficially owned, and the former corporate general partner of the Partnership
received 10,496 shares of Common Stock (which represented 1.0% of the issued and
outstanding Common Stock) in exchange for its general partner's interest. The
Merger was undertaken, among other reasons, in order (i) to eliminate a
cumbersome business structure that no longer provided the originally intended
benefits to the Partnership's unitholders, (ii) to expand the base of potential
investors in the Company by eliminating a complicated and nontraditional holding
company structure, and (iii) to provide the Company with greater access to
public and private equity capital markets. The Company had 1,049,687 shares of
Common Stock outstanding immediately following the Merger. As a consequence of
the Merger, the Company succeeded to all of the assets and liabilities of the
Partnership and Bancorp. In this report, unless the context otherwise requires,
the term "Company" refers to the Partnership prior to the Merger and/or the
Company subsequent to the Merger, in each case including all subsidiaries
thereof.
4
Operations of the Partnership Prior to the Merger. The Partnership was
the predecessor to the Company and was formed in 1989 as a publicly-traded
master limited partnership with the issuance of 2,078,382 LPUs priced at $20 per
LPU. The Partnership raised $41.6 million in partnership equity in order to fund
the acquisition of smaller, predominantly undercapitalized thrift institutions
located in the southeastern United States. The Partnership's goal was to
operationally link these thrift institutions through common control by Bancorp,
a multi-state thrift holding company. The bank branch network was little more
than a platform from which to raise deposits, largely "mini-jumbo" certificates
of deposit in denominations of $25,000 to $80,000, offering yields typically
priced at the top of the deposit market. The funds provided by these deposits
would be used to operate an active secondary marketing function which would
acquire mortgage loans, principally second mortgage loans in geographically
dispersed markets purchased at premiums, in the secondary market. Pools of loans
were then to be aggregated and sold to or participated among Bancorp's bank
subsidiaries. The Partnership, however, made only three acquisitions.
In January 1991 EMC, the Partnership's non-bank mortgage subsidiary,
issued $23.4 million in mortgage servicing backed notes (the "Essex 11's")
through a private placement. Proceeds of these notes were used over a 17-month
period to acquire mortgage servicing rights for sale on the secondary market.
Issuance of the Essex 11's coincided with the decline in interest rates to their
lowest level in 20 years and, not unexpectedly, the Partnership and its
subsidiaries suffered the adverse financial impact of impairment to the carrying
value of the Partnership's purchased and originated servicing rights portfolios
and loan premiums. Concurrently, the Partnership also suffered dramatic
deterioration in the quality of its loan portfolio, necessitating substantial
additional loan loss reserves and provisions for losses on foreclosed
properties.
By mid-1992, the Partnership was (i) operating under a broadly
restrictive supervisory agreement imposed by its regulators after the 1990
examination of the Partnership and its subsidiaries, (ii) failing its regulatory
capital requirements, an event which required the submission of a capital
restoration plan, (iii) in default on certain terms of the indenture under which
the Essex 11's were issued and (iv) indefinitely delaying payment of dividends
as a result of a lack of liquidity at the Partnership. In response to the
serious deterioration in the financial condition of the Partnership, in May 1992
the Investment Committee of the Partnership, a body effectively controlled by
members employed by the Partnership's investment banker, PaineWebber Inc.
("PWI"), acting pursuant to certain provisions of the Agreement of Limited
Partnership, removed the Partnership's corporate general partner.
The change of control of the Partnership was initiated on May 1, 1992
and was concluded on May 6, 1992 with the installation of an interim corporate
general partner of the Partnership. Following regulatory approval in 1993, TMS
was installed as the permanent corporate general partner of the Partnership. TMS
was controlled by Gene D. Ross, the present president and chief executive
officer of the Company, who had also been the president and chief executive
officer of the interim general partner since the 1992 change in control.
The Partnership's new management undertook four principal courses of
action. First, the Company replaced certain members of its former senior
management with individuals with significant experience in banking and problem
asset rehabilitation. Second, the Company reorganized its risk management and
collections department in order to focus on the early identification of
potential problem assets and the administration, rehabilitation or liquidation
of the Company's nonperforming assets. Third, the Partnership's three separate
savings bank subsidiaries were consolidated into Essex Savings Bank, F.S.B. (the
"Bank") in May 1993, which created operating efficiencies and a simplified
organizational structure. At the time of the consolidation, the Bank did not
comply with its minimum regulatory capital requirements. As a result, the
Partnership obtained a $3.0 million loan from PaineWebber Capital Inc. ("PWC"),
the proceeds of which were contributed to the Bank in order to bring the
institution into regulatory capital compliance. This $3.0 million loan was
5
evidenced by a seven-year note (the "Seven-Year Note") from the Partnership to
PWC. Fourth, PWC successfully tendered for and repurchased at par all of the
outstanding Essex 11's. In exchange for the cancellation of substantially all of
the Essex 11's, the Partnership delivered a ten-year note (the "Ten-Year Note")
in the original principal amount of $14.2 million to PWC in May 1993, and PWC
received the proceeds of the sale of the balance of EMC's mortgage servicing
rights, which was consummated in mid-1993. On October 24, 1994, the total
outstanding principal and interest owed with respect to the Seven- and Ten-Year
Notes and the remaining Essex 11's held by PWC were forgiven in connection with
the settlement of the litigation discussed below.
By the end of 1993, although the Bank had made significant progress in
resolving many of its financial and operational problems, it again fell out of
compliance with its minimum regulatory capital requirements. Management of the
Bank had already concluded that in order to reposition the Bank's activities
along the lines of a more traditional financial institution and in order to
focus the Bank's lending and deposit gathering activities within the Bank's
primary market of North Carolina and Virginia, it would be necessary to sell the
Bank's Florida branches. The sale of the Florida branches to a third party,
which was consummated on June 30, 1994, brought the Bank into compliance with
its minimum regulatory capital requirements.
In December 1993, the Partnership also became a defendant, together
with PaineWebber and others, in certain class action litigation (the
"Litigation") relating to the original offering by the Partnership and the
management of the Partnership and its subsidiaries prior to the 1992 change in
control. In September 1994, the United States District Court for the Eastern
District of Texas entered an order approving a proposed class action settlement
(the "Settlement") of the Litigation. The Settlement substantially improved the
financial condition of the Partnership and its subsidiaries by providing for the
forgiveness by PaineWebber, effective October 24, 1994, of all of the debt
outstanding under the Seven- and Ten-Year Notes and the remaining Essex 11's.
The aggregate amount of such debt totaled approximately $20.7 million at October
24, 1994.
The benefit of the debt forgiveness was offset to some extent by (i)
litigation expenses of approximately $90,000, (ii) the Partnership's
contribution of $1.3 million to a settlement fund established by the defendants
to pay the plaintiffs' attorneys' fees and certain costs associated with the
Settlement and to make certain payments to the named plaintiffs, and (iii) the
issuance by the Company to former holders of LPUs of a total of $1.0 million in
preferred stock (the "Series A Preferred Stock"). As a result of the Settlement,
the Company also recognized approximately $330,000 of alternative minimum taxes
("AMT") and the Company's net operating loss ("NOL") carryforwards were reduced
by approximately $20.0 million, resulting in a NOL carryforward of $20.5 million
and a $330,000 AMT carryover at December 31, 1994.
Business Strategy of the Company and the Bank
General. Since the change in management which occurred in May 1992, the
Company's new management achieved substantial progress in addressing its various
financial, regulatory and operating problems. Such achievements included the
consolidation of the Partnership's three savings bank subsidiaries into the
Bank, the restructuring of the Essex 11's, the sale of the Bank's Florida
branches, and the Settlement of the Litigation (which resulted in the
forgiveness of approximately $20.7 million of debt). Nevertheless, due to the
Bank's financial condition and continued losses from operations, the Bank again
failed certain of its minimum regulatory capital requirements at December 31,
1994. Management had already determined that the raising of additional capital
was critical to the Bank's long-term viability and the accomplishment of the
Bank's business objectives, as well as the Bank's compliance with applicable
regulatory capital requirements.
6
Capital Raising Efforts. On June 29, 1995, the Office of Thrift
Supervision ("OTS"), the Bank's primary regulator, formally notified the Bank
that unless it raised additional capital by June 30, 1995, the Bank would be
subject to the appointment of a conservator or a receiver, as well as other
enforcement actions. The OTS further advised that if the Bank was unable to
provide written evidence by June 30, 1995 that it had entered into a binding
agreement to recapitalize the Bank, the OTS would transfer the Bank to the
Resolution Trust Company ("RTC"), an instrumentality of the U.S. Government
which had the authority to sell and liquidate depository institutions.
Therefore, it was imperative that the Bank raise capital in order to prevent its
imminent seizure by the RTC. In the final analysis, only one party was able to
step forward within the required time-frame. On June 30, 1995, the Company and
the Bank signed an Agreement and Plan of Reorganization (the "Agreement") with
Home Bancorp, Inc. ("Home Bancorp") and its wholly-owned subsidiary Home Savings
Bank, F.S.B. ("Home Savings"), a Norfolk, Virginia based savings institution. On
September 15, 1995, the Company and the Bank merged with Home Bancorp and Home
Savings (the "Home Acquisition"). After this transaction, the Bank exceeded all
of the minimum regulatory capital requirements imposed by federal law.
The Home Acquisition was accounted for using the purchase method of
accounting and the purchase price was allocated among the assets and liabilities
of Home Bancorp and Home Savings at their fair value, which was $60.1 million
and $52.6 million, respectively, as of September 15, 1995. The excess of cost
over net assets acquired ("goodwill") recognized in connection with the Home
Acquisition was approximately $8.6 million.
In exchange for all of the outstanding stock of Home Bancorp, the
stockholders of Home Bancorp received 2,250,000 shares of nonvoting perpetual
preferred stock of the Company with an aggregate redemption and liquidation
value of $15.0 million and warrants to purchase 7,949,000 shares of the
Company's common stock at a price of $0.9375 per share, which was the price of
the Company's Common Stock as of June 30, 1995. The warrants are exercisable
beginning in September 1998 and expire in September 2005. The fair market value
of the preferred stock and the warrants was estimated in a third party valuation
to approximate $15.5 million at the time of the Home Acquisition. Following the
completion of the transaction, two representatives designated by Home Bancorp
joined the Boards of Directors of the Company and the Bank, filling existing
vacancies on those Boards.
Development of Full-Service Branches. The consolidation of the
Partnership's three savings bank subsidiaries in 1993, the sale of the Florida
branches in 1994, and the Home Acquisition in 1995, were important initial steps
in management's efforts to reposition the Bank's activities along the lines of a
more traditional savings institution while allowing the Bank to focus its
lending and deposit gathering activities within its primary markets of Virginia
and North Carolina.
Not long after the Home Acquisition was assimilated, the Board of
Directors of the Company formed a Strategic Evaluation Committee (the
"Committee") to explore the possibility of further expansion or contraction by
branch sales. It was concluded, with assistance from an independent consultant,
that selling non-strategic bank branches and effectively shrinking the size of
the asset base by approximately 50% was a strategy that ultimately would be in
the best interests of the common and preferred shareholders of the Company.
Accordingly, the Bank sold its branches in Charlotte, Raleigh, Greensboro and
Wilmington, North Carolina and in Norfolk, Portsmouth, Hampton, Newport News and
Grafton, Virginia (collectively, the "Branches") in three separate transactions
over a nine-month period in 1996. The outcome of this strategy is that the
Company has retained the most strategic branches with the greatest potential for
significant market share growth, has approximately 7.9% tangible capital as of
December 31, 1997 and has largely removed goodwill from its balance sheet. See
Note 5 on pages 37 and 38 of the Notes to Consolidated Financial Statements of
the 1997 Annual Report to Stockholders, which is attached hereto as Exhibit 13
and incorporated herein by reference.
7
During this downsizing period in 1996, the Bank continued its efforts
to position the remaining strategic branches to more nearly conform to the
activities of a traditional savings institution. To that end, the Bank and its
mortgage banking subsidiary introduced a wider range of consumer and mortgage
loan products to attract new business and maximize the potential of its existing
customer base. In addition, in September 1996 the Bank executed a purchase
agreement on a parcel in Suffolk, Virginia with the intent to relocate its
Suffolk branch from a leased facility location to a location with potential for
significant growth. This parcel was acquired in 1997 and construction has begun
on the new retail bank branch, which will be completed in April 1998.
Expansion of Residential Construction and Consumer Lending. Since 1992,
the Company has increased its emphasis on the origination and purchase of
residential construction and consumer loans because of the shorter-term nature
of such loans and the higher yields available thereon when compared to permanent
residential mortgage lending. However, construction and consumer lending is
generally considered to involve a higher level of risk as compared to
single-family residential lending. Notwithstanding the higher risk aspect, the
portfolio of residential construction loans has grown steadily since 1992
without a loss. For additional information, see "- Lending Activities -
Construction Loans" and "- Consumer Loans."
Reduction in Operating Expenses. Historically, the Company's operating
expenses have been high relative to those of other savings institutions of
similar asset size. This has been primarily due to the presence of duplicative
operating procedures and personnel, a high level of professional fees resulting
from the various financial and operating problems of the Partnership, an
increase in expenses relating to the allocation of resources to the collection
and work-out of nonperforming assets, high levels of provisions for losses on
foreclosed properties and high levels of impairment adjustments relating to
purchased and originated mortgage servicing rights and loan premiums.
Significant reductions have been made in operating expenses since the change in
management which occurred in May 1992. Nevertheless, management continues to
evaluate the Bank's personnel needs and operating requirements in order to
identify areas where additional measures may be taken to reduce costs. During
1997, the Company implemented additional cost reductions so that the on-going
expense structure is compatible with institutions the Company's size and nature
of business. Although the Bank is committed to achieving a lower level of
operating expenses relative to the Bank's operations, management recognizes that
operating expenses will remain higher than much of the Bank's peer group due to
the relatively low level of assets of Essex Home.
Reduction of Nonperforming Assets. As previously discussed, the
Company's new management reorganized the Bank's risk management and collections
department and revised its loan underwriting, collection and monitoring
procedures in an effort to reduce the level of nonperforming assets. As a
result, nonperforming assets have declined from $24.8 million or 5.92% of total
assets at December 31, 1992 to $3.3 million or 1.69% of total assets at December
31, 1997. Such results for 1997 are over a significantly smaller asset base than
the results for 1992. In addition, loans delinquent 30 to 89 days have declined
from $7.0 million or 2.66% of total loans held for investment at December 31,
1992 to $940,000 or 0.6% of total loans held for investment at December 31,
1997. Reduced provisions for loan losses contributed to improved operating
results during the year ended December 31, 1997.
Expansion of Subservicing Activities. In its efforts to generate fee
income, the Bank continues to pursue profitable residential mortgage loan
servicing and subservicing. Essex Home is a service corporation subsidiary
licensed by the Federal National Mortgage Association ("Fannie Mae"), the
Federal Home Loan Mortgage Corporation ("Freddie Mac") and the Government
National Mortgage Association ("Ginnie Mae"). Essex Home also services and
subservices loans for approximately 50 other private investors.
8
Through various networking and referral opportunities and advertising
efforts, Essex Home has attracted other financial institutions and mortgage
banking firms interested in subcontracting their loan servicing function. By
subservicing loans for others, the Bank will be able to utilize more fully its
available resources in a cost efficient and profitable manner. However, on
February 28, 1997, the Company was notified by its largest subservicing client
of its intention not to renew its contract beyond June 1, 1997. Because no
assurances could be made that this significant servicing volume could be
replaced in its entirety in the near term, Essex Home implemented a plan for
operating expense reductions. Notwithstanding the impact of the cancellation of
this subservicing contract, Essex Home offset some of the reduction in its
servicing portfolio in 1997 by acquiring servicing rights and by entering into
18 new subservicing contracts consisting of approximately 2,100 loans with an
aggregate principal balance of $201.4 million as of December 31, 1997.
Strengthening of Loan Policies. Since May 1992, the loan underwriting
policies of the Bank have been substantially revised and strengthened with the
objective of reducing the risk profile of the Bank's loan portfolio. In
addition, the Company's loan portfolio has been restructured in order to improve
its asset quality, reduce the risk-weighting of the Bank's assets and minimize
the Company's exposure to interest rate risk. Specifically, the Company has
significantly reduced its portfolio of second mortgage loans while emphasizing
the origination of both construction and permanent loans secured by
single-family residential real estate. Efforts were made to effect these changes
while continuing to be responsive to the borrowing needs in the Bank's markets.
In addition to strengthening the Bank's underwriting policies and procedures,
other measures were taken to improve the Bank's asset quality, including the
formation of a loan committee, further strengthening of the Bank's internal
audit and quality control functions and enhanced loan origination standards and
practices. During 1997, underwriting policies were further expanded to include
an assessment of the Year 2000 readiness of potential commercial borrowers.
Interest Rate Risk Management. Deposit accounts typically adjust more
quickly to changes in market interest rates than mortgage loans because of the
shorter maturities of deposits. As a result, significant increases in interest
rates may adversely affect the Bank's earnings. To reduce the potential
volatility of the Bank's earnings, management has sought to improve the match
between asset and liability maturities and rates, while maintaining an
acceptable interest rate spread. Pursuant to this strategy, the Bank has (i)
emphasized investment in adjustable-rate single-family residential loans or
shorter-term (seven years or less), fixed-rate single-family residential loans;
(ii) sold longer-term (over seven years), fixed-rate single-family residential
loans in the secondary market; (iii) purchased adjustable-rate mortgage-backed
securities; (iv) maintained higher liquidity by holding short-term investments
and cash equivalents; and (v) increased the average maturity of the Bank's
interest-bearing liabilities by utilizing long-term advances and attempting to
attract longer-term retail deposits.
The interest rate sensitivity gap is defined as the difference between
interest-earning assets and interest-bearing liabilities maturing or repricing
with a given time period. The Bank's one-year interest rate sensitivity gap
amounted to a negative 14.9% at December 31, 1997, which reflects the impact of
shortening deposit maturities as the Bank's deposit customers are reluctant to
enter into extended maturities in the current low interest rate environment. The
negative gap also reflects near-term maturities of higher-rate Federal Home Loan
Bank advances. The Company will benefit from the lower cost of funds as these
borrowings mature and may consider extended maturities in order to mitigate the
impact of an increase in interest rates in the future. While the Company
continues to emphasize investment in adjustable-rate loan portfolios, customer
9
demand for such loans is lessening as borrowers demand for lower fixed-rate
loans is increasing. Within the spectrum of loan products offered by the Bank,
the percentage of balloon payment and adjustable-rate loans with longer initial
adjustment terms has increased. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations - Market Risk Management" on pages
16 through 19 of the 1997 Annual Report to Stockholders, which is attached
hereto as Exhibit 13 and incorporated herein by reference.
General
The Company, as a registered savings and loan holding company, is
subject to examination and regulation by the OTS and is subject to various
reporting and other requirements of the Securities and Exchange Commission (the
"Commission"). The Bank, as a federally chartered savings bank, is subject to
comprehensive regulation and examination by the OTS, as its chartering authority
and primary regulator, and by the Federal Deposit Insurance Corporation
("FDIC"), which administers the Savings Association Insurance Fund ("SAIF"),
which insures the Bank's deposits to the maximum extent permitted by law. The
Bank is a member of the Federal Home Loan Bank of Atlanta ("FHLB"), which is one
of 12 regional banks comprising the Federal Home Loan Bank System. The Bank is
further subject to regulations of the Board of Governors of the Federal Reserve
System ("Federal Reserve Board") governing reserves required to be maintained
against deposits and certain other matters.
The Company's principal focus is currently on the origination (through
Essex First) of both construction and permanent single-family residential loans
(of which substantially all fixed-rate single-family residential loans with
terms to maturity in excess of seven years are being sold by Essex First in the
secondary market). Moreover, in order to provide a full range of services to its
customers and in accordance with the Company's asset and liability management
policies, the Company recently has increased its emphasis of the origination of
various types of consumer loans. In addition, the Company generates fee income
by providing to third parties residential mortgage loan servicing and
subservicing through Essex Home. Furthermore, the Company invests in
mortgage-backed securities which are insured or guaranteed by the U.S.
Government and agencies thereof and other similar investments permitted by
applicable laws and regulations.
Lending Activities
General. At December 31, 1997, the Company's net loan portfolio
(excluding loans classified as held for sale) totaled $167.4 million,
representing approximately 85.8% of its $195.1 million of total assets at that
date. The principal categories of loans in the Company's portfolio are
residential real estate loans, which are secured by single-family (one-to-four
units) residences; loans for the construction of single-family properties;
commercial real estate loans, which are secured by multi-family (over five
units) residential and commercial real estate; commercial business loans; and
consumer loans. Substantially all of the Company's mortgage loan portfolio
consists of conventional mortgage loans, which are loans that are neither
insured by the Federal Housing Administration ("FHA") nor partially guaranteed
by the Veterans Administration ("VA").
As a federally chartered savings institution, the Bank has general
authority to originate and purchase loans secured by real estate located
throughout the United States. The Company currently originates substantially all
of its loans within Virginia and North Carolina. Nevertheless, the Company
continues to purchase from time to time loans secured by properties located
outside of its market area and continues to hold a relatively diversified
portfolio.
Federal regulations permit the Bank to invest without limitation in
residential mortgage loans and up to four times its capital in loans secured by
non-residential or commercial real estate. The Bank is also permitted to invest
in secured and unsecured consumer loans in an amount not exceeding 35% of the
Bank's total assets; however, such 35% limit may be exceeded for certain types
of consumer loans, such as home equity, property improvement and education
loans. In addition, the Bank is permitted to invest up to 20% of its total
10
assets in secured (by other than real estate) and unsecured loans for
commercial, corporate, business or agricultural purposes, provided that any
investments which in the aggregate total 10% may only be used for small business
loans.
Since the enactment of the Financial Institutions Reform, Recovery and
Enforcement Act of 1989 ("FIRREA"), a savings institution generally may not make
loans to one borrower and related entities in an amount which exceeds 15% of its
unimpaired capital and surplus, although loans in an amount equal to an
additional 10% of unimpaired capital and surplus may be made to a borrower if
the loans are fully secured by readily marketable securities. See "Regulation -
Regulation of the Bank - General." At December 31, 1997, the Bank's limit on
loans-to-one borrower was $2.5 million. The loans-to-one borrower limitation may
restrict the Bank's ability to do business with certain existing customers.
At December 31, 1997, the Bank's five largest commercial loans-to-one
borrower and their related entities amounted to $1.4 million, $1.2 million,
$565,000, $515,000 and $448,000. In addition, as of December 31, 1997, the
Bank's largest lines of credit with unaffiliated home builders consisted of one
in the amount of $2.0 million (of which $716,000 had been drawn upon as of such
date), another in the amount of $1.5 million (of which $959,000 had been drawn
upon as of such date), another in the amount of $1.5 million (of which $214,000
had been drawn upon as of such date), another in the amount of $1.5 million (of
which $185,000 had been drawn upon as of such date) and another in the amount of
$1.3 million (of which $29,000 had been drawn upon as of such date). At December
31, 1997, the $1.4 million loan was classified based on a rating system adopted
by the Company. Refer to "-Asset Quality - Classified Assets" for a description
of the classifications for problem assets.
The $1.4 million group of loans consists of (i) a commercial real
estate loan of $955,000 as of December 31, 1997, which was originated in October
1987 in the amount of $1.0 million for the purpose of refinancing a
mini-storage/office facility (76 mini-storage units and 38 office units) located
in Virginia Beach, Virginia, and (ii) a line of credit in the amount of $600,000
with an outstanding balance of $440,000 as of December 31, 1997. The Company
occupies approximately 12,000 square feet of the office facility. The lease
payments largely service the principal and interest on the two loans. The term
of the lease coincides with the maturity of the loans, which are scheduled to
mature on December 31, 2001. In addition, as of December 31, 1997, the Bank and
its subsidiaries leased ten of the mini-storage units. The property was most
recently appraised in November 1992 for $915,000. As of December 31, 1997, the
Bank had established a $300,000 specific reserve with respect to the loans and
the remaining $1.1 million was classified as substandard.
11
Loan Portfolio Composition. The following table sets forth information
concerning the Company's loan portfolio (excluding loans held for sale) by type
of loan at the dates indicated:
December 31,
------------------------------------------------------------------
1997 1996 1995
---- ---- ----
$ % $ % $ %
- - - - - -
(dollars in thousands)
Real estate:
Single-family residential:
First mortgages................ $130,486 76.8% $103,643 70.0% $223,531 82.1%
Second mortgages............... 8,699 5.1 12,384 8.3 13,398 4.9
Construction and development..... 16,583 9.8 17,190 11.6 15,078 5.5
Commercial real estate........... 5,970 3.5 6,313 4.3 10,611 3.9
-------- ---- -------- ---- -------- ----
Total real estate loans........ 161,738 95.2 139,530 94.2 262,618 96.4
Commercial business loans........... 1,883 1.1 1,915 1.3 2,171 .8
Consumer loans:
Other............................ 5,426 3.2 5,828 3.9 6,488 2.4
Secured by deposits.............. 805 .5 842 .6 994 .
-------- ---- -------- ---- -------- ----
Total consumer loans........... 6,231 3.7 6,670 4.5 7,482 2.8
-------- ---- -------- ---- -------- ----
Total Loans.............. 169,852 100.0% 148,115 100.0% 272,271 100.0%
===== ===== =====
Less:
Unearned loan fees and discounts. 29 8 388
Allowance for loan losses........ 2,382 2,556 5,251
--------- --------- ---------
2,411 2,564 5,639
--------- --------- ---------
Net Loans................ $167,441 $145,551 $266,632
======= ======= =======
1994 1993
---- ----
$ % $ %
- - - -
Real estate:
Single-family residential:
First mortgages................ $187,607 77.7% $159,398 75.8%
Second mortgages............... 18,717 7.8 24,851 11.8
Construction and development..... 15,501 6.4 9,137 4.4
Commercial real estate........... 11,499 4.8 10,781 5.1
-------- ---- -------- ----
Total real estate loans........ 233,324 96.7 204,167 97.1
Commercial business loans........... 1,824 .8 1,946 .9
Consumer loans:
Other............................ 5,320 2.2 2,884 1.4
Secured by deposits.............. 835 .3 1,263 .6
-------- ---- -------- ----
Total consumer loans........... 6,155 2.5 4,147 2.0
-------- ---- -------- ----
Total Loans.............. 241,303 100.0% 210,260 100.0%
===== =====
Less:
Unearned loan fees and discounts. 482 440
Allowance for loan losses........ 3,429 3,039
--------- ---------
3,911 3,479
--------- ---------
Net Loans................ $237,392 $206,781
======= =======
12
Total loans decreased by an aggregate of $40.5 million or 19.3% from
December 31, 1993 to December 31, 1997 primarily due to sales of second mortgage
loans, the sale of loans in connection with the sale of the Bank's Florida
branches in 1994 and the sale of loans in connection with the sale of the
Branches in 1996. The acquisition of $22.2 million of adjustable rate first
mortgage loans in 1997 partially offsets the decline and reflects the Company's
strategy of investing proceeds from the maturities of investment securities and
funds provided by the growth in deposits into higher yielding loans. Since 1992,
the Company has placed increased emphasis on single-family first mortgage loans,
which, together with construction loans secured by single-family residences,
increased from 80.2% of total loans held for investment at December 31, 1993 to
86.6% of total loans held for investment at December 31, 1997. Single-family
second mortgage loans declined substantially from 11.8% of total loans held for
investment at December 31, 1993 to 5.1% of total loans held for investment at
December 31, 1997. The decline in second mortgage loans resulted from loan sales
undertaken to reduce the regulatory risk-weighting of the Bank's assets and,
thus, improve its risk-based capital ratio, while at the same time reducing
earnings volatility associated with the amortization of deferred premiums and
the increased credit risk associated with second mortgage loans. Commercial real
estate loans decreased from 5.1% of total loans held for investment at December
31, 1993 to 3.5% of total loans held for investment at December 31, 1997, while
commercial business loans increased slightly from .9% of total loans held for
investment at December 31, 1993 to 1.1% of total loans held for investment at
December 31, 1997. Consumer loans increased from 2.0% of total loans held for
investment at December 31, 1993 to 3.7% of total loans held for investment at
December 31, 1997. The Company increased its emphasis during 1997 and 1996 on
the origination and purchase of various types of consumer loans and,
consequently, expects the balance of such loans to increase.
The following table presents the maturity distribution and interest
sensitivity of selected loan categories (excluding residential mortgage and
consumer loans) at December 31, 1997. Maturities are presented on a contractual
basis. Loans having no stated schedule of repayments and no stated maturity are
reported as due in one year or less. Scheduled contractual principal repayments
do not reflect the actual maturities of loans.
Commercial Commercial
Construction Real Estate Business Total
------------ ----------- -------- -----
(dollars in thousands)
Amounts due:
One year or less $15,876 $ 268 $1,102 $17,246
After one year through
five years 157 3,773 781 4,711
Beyond five years 550 1,929 - 2,479
-------- ----- -------- -------
Total $16,583 $5,970 $1,883 $24,436
Interest rate terms on
amounts due after one
year:
Fixed $ 339 $1,418 $ 678 $ 2,435
======= ===== ===== =======
Adjustable $ 368 $4,284 $ 103 $ 4,755
======= ===== ===== =======
Origination, Purchase and Sale of Loans. In earlier years, the Bank
operated as a wholesale financial institution and conducted its deposit
gathering activities through a network of limited service branches that were
designed to primarily accumulate large non-transactional deposit accounts. The
Bank's lending activities were not generally conducted through its branch
offices. Instead, substantially all of the Company's loan product was either
originated by Essex First or purchased in the secondary market.
As part of management's efforts to reposition the Bank's activities
along the lines of a more traditional financial institution, the Bank converted
its existing branch offices into full-service retail facilities, which has
13
enabled the Bank to, among other things, increase its origination of both
consumer and mortgage loans directly through its branch network. Nevertheless,
substantially all of the Company's mortgage loan product is expected to continue
to be either originated by Essex First or purchased in the secondary market.
Mortgage Banking Activities. Since 1992, Essex First has significantly
expanded its mortgage banking operations in order to, among other things,
increase the Company's level of loan originations that generate fee income. At
December 31, 1997, Essex First conducted its operations out of four offices,
which are located in Norfolk, Richmond, and Chester, Virginia, and Elizabeth
City, North Carolina. Essex First also currently accepts applications through
the Bank's branch office in Emporia, Virginia. During the years ended December
31, 1997, 1996, and 1995, Essex First originated $65.6 million, $104.2 million
and $101.8 million of loans (consisting primarily of both permanent and
construction loans secured by single-family residential real estate). During
such periods, $25.9 million, $29.3 million and $26.3 million of such loans,
respectively, were sold by Essex First to the Bank, with the remainder being
sold by Essex First primarily to other private investors in the secondary
market.
Although the majority of the Bank's loan product is currently
originated by Essex First, Essex First was established primarily to increase the
volume of loans being originated for sale to private investors in the secondary
market. Such loan sales generate fee income, while avoiding the interest rate
and credit risk associated with holding long-term fixed-rate mortgage loans in
its portfolio. Loans originated by Essex First for sale in the secondary market
are originated in accordance with terms, conditions and documentation prescribed
by the Freddie Mac, Fannie Mae and Ginnie Mae. However, Essex First does not
generally sell mortgage loans to such government agencies and, instead, sells
loans to private investors in the secondary market. Consequently, loans
originated by Essex First for sale in the secondary market must also comply with
any particular requirements of such private investors. Upon approval of a
particular loan, Essex First provides an independent title company or attorney
instructions to close the loan. Loan proceeds are disbursed and funded at the
closing by Essex First. The loan documents are generally delivered to the
private investor within 10 days of the closing and the price paid by the private
investor for purchasing the loan is generally remitted within five to 10 days
after such delivery. Although Essex First currently sells substantially all
conventional loans without recourse (so that losses incurred as a result of
nonperformance with respect to the loan become the responsibility of the
purchaser of the loan as of the date of the closing), Essex First has in the
past occasionally sold conventional loans in the secondary market with recourse,
and may continue to sell certain conventional loans in the secondary market with
recourse. However, as of December 31, 1997 there were no loans outstanding which
were previously originated and sold by Essex First in the secondary market with
recourse.
A majority of all residential mortgage loans originated by Essex First
for sale in the secondary market are sold with servicing released to third party
investors. Substantially all of the loans originated by Essex First and not sold
with servicing released to third party investors are sold to the Bank, which
enables the Company to retain the servicing. When loans are sold with servicing
rights released to the buyer, the Company recognizes current income from receipt
of servicing release fees. Alternatively, when loans are sold with servicing
retained, the Company recognizes additional gains based on the estimated fair
value of the servicing retained. For additional information, see "- Loan
Servicing" and "- Loan Fee Income."
Management of the Bank and Essex First believe that "pipeline risk,"
which is created by offering loan applicants agreed-upon interest rates for a
future closing, is currently being minimized because Essex First's loan officers
are compensated in accordance with pricing guidelines which are based on the
purchase price received from the third party investors purchasing the loans.
Therefore, in most cases, the loan officer will lock-in a purchase price with
the third party investor simultaneously with making the rate commitment to the
borrower and therefore eliminate any interest rate risk. If the loan is not
14
locked-in simultaneously with the commitment to the borrower, any market
movement that occurs prior to the third party investor locking-in the purchase
price is reflected in the loan officer's compensation and not absorbed by Essex
First or the Bank.
Loan Purchases and Sales. The Bank purchases from Essex First
single-family mortgage loans which generally have adjustable rates or a term to
maturity of seven years or less. In addition, the Bank continues to purchase
first mortgage loans secured by single-family residential properties from
selected financial institutions and mortgage banking companies in the secondary
market. Such loans generally consist of ARMs or fixed-rate loans with terms of
five, seven, or to a lesser extent, 15 years. Such loan purchases are secured by
properties located both within and outside the Bank's primary markets. During
the years ended December 31, 1997 and 1995, the Bank purchased $22.2 million and
$50.7 million of loans, respectively, from various financial institutions and
mortgage banking companies (other than Essex First) in the secondary market.
However, the amount of loans purchased during 1995 was predominantly
attributable to the Home Acquisition. The Company purchased less than $600,000
of loans in the secondary market during 1996 because of its emphasis on loan
sales to accommodate the sale of the Branches.
At December 31, 1997, 1996, and 1995, loans classified by the Company
as held for sale amounted to $2.2 million, $2.5 million and $3.3 million,
respectively. Except for loans originated for sale in the secondary market by
Essex First, it is generally management's intention to hold originated and
purchased loans for investment. Under certain circumstances, however, the
Company may sell loans originally acquired for investment in order to address
needs regarding liquidity, regulatory capital, interest rate risk, or other
objectives. During 1996, the Bank sold first mortgage loans totaling $118.3
million in order to provide funds for the sale of the Branches. See Note 5 on
pages 37 and 38 of the Notes to Consolidated Financial Statements of the 1997
Annual Report to Stockholders, which is attached hereto as Exhibit 13 and
incorporated herein by reference.
Loan Underwriting. Applications for all types of loans offered by the
Bank are taken at all of the Bank's branch offices. Applications for residential
mortgage loans are taken at all of Essex First's offices. Residential mortgage
loan applications are generally attributable to referrals from real estate
brokers and builders, existing customers and, to a lesser extent, walk-in
customers. Essex First also obtains applications for residential mortgage loans
through several loan officers who solicit and refer mortgage loan applications
to Essex First. These loan officers are compensated in part on a commission
basis and provide convenient origination services during banking and nonbanking
hours. During 1996, Essex First established a wholesale lending program, which
consists primarily of construction/permanent ("C/P") lending. Approved brokers
are responsible for originating and processing C/P loans and submitting them to
the Bank for underwriting approval.
Loans purchased by the Bank from Essex First or other financial
institutions and mortgage banking companies in the secondary market are
underwritten by the Bank in accordance with its underwriting guidelines and
procedures (which generally follow Freddie Mac and Fannie Mae guidelines) and
may be approved by various lending officers of the Bank within designated
limits, which are established and modified from time to time to reflect an
individual's expertise and experience. All loans in excess of an individual's
designated limits are referred to an officer with the requisite authority.
Specifically, when acting individually, the Chief Executive Officer and the
Senior Underwriter are authorized to approve secured loans of up to $250,000 and
unsecured loans of up to $25,000. When the Senior Underwriter acts together with
the Chief Executive Officer, they are authorized to approve secured loans of up
to $500,000 and unsecured loans of up to $50,000. All secured loans greater than
$500,000 but not exceeding $750,000 require approval by the Bank's loan
committee, which consists of the aforementioned officers and the Chief Executive
Officer of Essex First. All secured loans greater than $750,000 and all
unsecured loans greater than $50,000 must be approved by the Bank's loan
committee and the Board of Directors of the Bank. In addition, all loans
15
committed or approved by the Bank's loan committee are reported to the Board of
Directors on a monthly basis. Management of the Bank believes that its
relatively centralized approach to approving loan applications ensures strict
adherence to the Bank's underwriting guidelines while still allowing the Bank to
approve loan applications on a timely basis.
Loan Servicing. Essex Home services or subservices residential real
estate loans owned by the Bank as well as for other private mortgage investors.
Loan servicing includes collecting and remitting loan payments, accounting for
principal and interest, making advances to cover delinquent payments, making
inspections as required of mortgaged premises, contacting delinquent mortgagors,
supervising foreclosures and property dispositions in the event of unremedied
defaults and generally administering the loans. Funds that have been escrowed by
borrowers for the payment of mortgage related expenses, such as property taxes
and hazard and mortgage insurance premiums, are maintained in
noninterest-bearing accounts at the Bank or at nonaffiliated banks if so
required by the mortgage investors.
Essex Home receives fees for servicing and/or subservicing mortgage
loans. Such fees serve to compensate Essex Home for the costs of performing the
servicing/subservicing function. Other sources of loan servicing revenues
include late charges and other ancillary fees. Servicing and subservicing fees
are collected by Essex Home out of the monthly mortgage payments made by
borrowers. For additional information concerning Essex Home and its servicing
and subservicing portfolio, see "- Loan Fee Income."
Real Estate Lending Standards. Effective March 19, 1993, all financial
institutions were required to adopt and maintain comprehensive written real
estate lending policies that are consistent with safe and sound banking
practices. These lending policies must reflect consideration of the Interagency
Guidelines for Real Estate Lending Policies adopted by the federal banking
agencies, including the OTS, in December 1992 ("Lending Guidelines"). The
Lending Guidelines set forth, pursuant to the mandates of the Federal Deposit
Insurance Corporation Improvement Act of 1991 ("FDICIA"), uniform regulations
prescribing standards for real estate lending. Real estate lending is defined as
extensions of credit secured by liens on interests in real estate or made for
the purpose of financing the construction of a building or other improvements to
real estate, regardless of whether a lien has been taken on the property.
The policies must address certain lending considerations set forth in
the Lending Guidelines, including supervisory loan-to-value ("LTV") limits, loan
portfolio management, loan administration procedures and underwriting standards.
These policies must also be appropriate to the size of the institution and the
nature and scope of its operations, and must be reviewed and approved by the
institution's board of directors at least annually. The LTV ratio, which is the
total amount of credit to be extended divided by the appraised value of the
property at the time the credit is originated, must be established for each
category of real estate loans. If not a first lien, the lender must include all
senior liens when calculating this ratio. The Lending Guidelines, among other
things, establish the following supervisory LTV limits: raw land (65%); land
development (75%); construction (commercial, multi-family and nonresidential)
(80%); improved property (85%); and one-to-four family residential (owner
occupied) (no maximum ratio; however any LTV ratio in excess of 90% should
require appropriate mortgage insurance or readily marketable collateral). In
most cases, the Company's loan underwriting guidelines with respect to LTV
ratios are more stringent than the Lending Guidelines set forth above.
Single-Family Residential Real Estate Loans. As part of management's
efforts to reposition the Bank along the lines of a more traditional thrift
institution, the Bank has increased its emphasis on loans secured by first liens
on single-family residential real estate. At December 31, 1997, $130.4 million
or 76.8% of the Company's total loans held for investment consisted of such
loans.
16
In recent years, the Company has been emphasizing for its portfolio
single-family residential mortgage adjustable-rate loans which provide for
periodic adjustments to the interest rate. These loans have up to 30-year terms
and interest rates which adjust annually in accordance with a designated index
after a specified period has elapsed. Depending on the loan product selected by
the borrower, this period can range from one year to seven years. In order to be
competitive and generate production, the ARMs offered by the Company provide for
initial rates of interest below the rates which would prevail when the index
used for repricing is applied. However, the Company underwrites certain loans
(i.e., ARMs with 95% LTV) on a basis that is no less stringent than the
underwriting guidelines of the Fannie Mae. The Company has not engaged in the
practice of using a cap on the payments that could allow the loan balance to
increase rather than decrease, resulting in negative amortization. Approximately
56.4% of the permanent single-family residential loans in the Company's loan
portfolio held for investment at December 31, 1997 had adjustable interest
rates.
The demand for adjustable-rate loans in the Company's primary market
area has been a function of several factors, including the level of interest
rates, the expectations of changes in the level of interest rates and the
difference between the interest rates and loan fees offered for fixed-rate loans
and adjustable-rate loans. The relative amount of fixed-rate and adjustable-rate
residential loans that can be originated at any time is largely determined by
the demand for each in a competitive environment.
Adjustable-rate loans decrease the risks associated with changes in
interest rates but involve other risks, primarily because as interest rates rise
and the loan rates adjust upward, the payment by the borrower rises to the
extent permitted by the terms of the loan, thereby increasing the potential for
default. At the same time, the marketability of the underlying property may be
adversely affected by higher interest rates. The Company believes that these
risks, which have not had a material adverse effect on the Company to date,
generally are less than the risks associated with holding fixed-rate loans in an
increasing interest rate environment. In addition, depending on the LTV and the
initial repricing frequency of the ARMs, the Company underwrites certain of
these loans based on a borrower's qualification at a fully-indexed interest
rate.
The Company continues to originate long-term, fixed-rate loans in order
to provide a full range of products to its customers, but generally only under
terms, conditions and documentation which permit the sale thereof in the
secondary market. Currently, fixed-rate single-family residential loans with
terms to maturity of seven years or less are generally retained in the Company's
portfolio while fixed-rate single-family residential loans with terms to
maturity of over seven years are generally sold in the secondary market as
market conditions permit. At December 31, 1997, approximately 43.6% of the
permanent single-family residential loans held by the Company for investment
consisted of loans which provide for fixed rates of interest. Although these
loans provide for repayments of principal over a fixed period of up to 30 years,
it is the Company's experience that such loans remain outstanding for a
substantially shorter period of time.
The Company is generally permitted to lend up to 100% of the appraised
value of the real property securing a residential loan (referred to as the LTV
ratio); however, if the amount of a residential loan originated or refinanced
exceeds 90% of the appraised value, the Company is required by federal
regulations to obtain appropriate credit enhancement in the form of either
mortgage insurance or readily marketable collateral. Pursuant to underwriting
guidelines adopted by the Board of Directors, the Company will lend up to 95% of
the appraised value of the property securing an owner-occupied single-family
residential loan, and generally requires borrowers to obtain private mortgage
insurance on loans which have a principal amount that exceeds 80% of the
appraised value of the security property. The extent of coverage is dependent
upon the LTV ratio at the time of origination.
17
The Company generally requires title insurance insuring the priority of
its mortgage lien, as well as fire and extended coverage casualty insurance in
order to protect the properties securing its residential and other mortgage
loans. Borrowers may be required to advance funds, with each monthly payment of
principal and interest, to a loan escrow account from which the Company makes
disbursements for items such as real estate taxes, hazard insurance premiums and
mortgage insurance premiums as they become due. Substantially all of the
properties securing all of the Company's mortgage loans originated or closed by
the Bank and/or Essex First are appraised by independent appraisers that conform
to guidelines established pursuant to FIRREA and regulations promulgated
thereunder.
Home equity line of credit loans have a maximum commitment of five
years, which may be extended within the sole discretion of the Bank, and the
interest rate is set at the Bank's prime rate plus a margin. The Company will
lend up to a 90% LTV ratio and the loan can be secured by a primary or
subordinate mortgage on the property. The Company will originate the loan even
if another institution holds the first mortgage. At December 31, 1997, home
equity lines of credit totaled $417,000 ($248,000 of which had been utilized by
borrowers as of such date).
Construction Loans. In recent years, the Company has been increasingly
active in originating loans to construct primarily single-family residences.
These construction lending activities generally are limited to the Company's
primary market, with particular emphasis in the greater Richmond, Virginia
market, the Tidewater, Virginia area and counties in northeastern North
Carolina. At December 31, 1997, construction loans amounted to $16.6 million or
9.8% of the Company's total loans held for investment. As of such date, the
Company's entire portfolio of construction loans consisted of loans for the
construction of single-family residences.
The Company offers construction loans to individual borrowers as well
as to local real estate builders, contractors and developers for the purpose of
constructing single-family residences. Substantially all of the Company's
construction lending to individuals is originated on a C/P mortgage loan basis.
C/P loan originations are made by Essex First loan officers or through the
wholesale C/P lending program, which is a network of 68 approved brokers. C/P
loans are made to individuals who hold a contract with a licensed general
contractor to construct their personal residence. The construction phase of the
loan currently provides for monthly payments on an interest only basis at a
designated prime rate (plus 100 basis points) for up to six months. Upon
completion of construction, the loan converts to a permanent loan at either an
adjustable or fixed interest rate, consistent with the Company's policies with
respect to residential real estate financing. Essex First's construction loan
department approves the proposed contractors and administers the loan during the
construction phase. The Company's C/P loan program has been successful due to
its ability to offer borrowers a single closing and, consequently, reduced
costs. At December 31, 1997, the Company's C/P portfolio included 60 C/P loans
with an aggregate principal balance of $7.1 million (and an additional $10.9
million was subject to legally binding commitments but had not been advanced as
of such date).
The Company also offers construction loans to real estate builders,
contractors and developers for the construction of single-family residences on
both a presold and speculative basis. Construction loans to builders generally
have a three-year note with annual renewals throughout the term, with payments
being made monthly on an interest only basis (at 100 basis points to 200 basis
points over a designated prime rate). Upon application, credit review and
analysis of personal and corporate financial statements, the Company will grant
builders lines of credit up to designated amounts. The Company will generally
limit the number of homes that may be built by any individual builder or
developer on a speculative basis depending on the builder's financial strength
18
and total exposure to other lenders. Although at December 31, 1997, the Company
did not have any real estate acquisition and development loans in its portfolio,
the Company may in the future, on a case-by-case basis, grant a limited amount
of real estate acquisition and development loans. At December 31, 1997, the
Company's construction loan portfolio included 101 loans to 39 different
builders with an aggregate principal balance of $8.5 million (and an additional
$26.3 million was subject to legally binding commitments but had not been
advanced as of such date). Of this $8.5 million of builder loans, approximately
$6.8 million consisted of construction loans for which there were no contracts
for sale at the time of origination.
The Company intends to continue to increase its involvement in
construction lending. Such loans afford the Company the opportunity to increase
the interest rate sensitivity of its loan portfolio. Construction lending is
generally considered to involve a higher level of risk as compared to
single-family residential lending, due to the concentration of principal in a
limited number of loans and borrowers and the effects of general economic
conditions on real estate developers and managers. Moreover, a construction loan
can involve additional risks because of the inherent difficulty in estimating
both a property's value at completion of the project and the estimated cost
(including interest) of the project. The nature of these loans is such that they
are generally more difficult to evaluate and monitor. In addition, speculative
construction loans to a builder are not necessarily pre-sold and thus pose a
greater potential risk to the Company than construction loans to individuals on
their personal residences.
The Company has taken steps to minimize the foregoing risks by, among
other things, limiting its construction lending primarily to residential
properties. In addition, the Company has adopted underwriting guidelines which
impose stringent LTV (80% during the construction phase with respect to
single-family residential real estate), debt service and other requirements for
loans which are believed to involve higher elements of credit risk, by limiting
the geographic area in which the Company will do business and by working with
builders with whom it has established relationships or knowledge thereof.
Commercial Real Estate Loans. The Company has also originated mortgage
loans secured by multi-family residential and commercial real estate. At
December 31, 1997, $6.0 million or 3.5% of the Company's total loans held for
investment consisted of such loans.
Commercial real estate loans originated by the Company are primarily
secured by office buildings, retail stores, warehouses and general purpose
industrial space. Commercial real estate loans also include multi-family
residential loans, substantially all of which are secured by small apartment
buildings. At December 31, 1997, $1.3 million or 21.7% of the Company's total
commercial real estate loans were comprised of multi-family residential loans.
Although terms vary, commercial real estate loans generally are
amortized over a period of up to 20 years and mature in seven years or less. The
Company will originate these loans either with fixed interest rates or with
interest rates which adjust in accordance with a designated index, which
generally is negotiated at the time of origination. LTV ratios on the Company's
commercial real estate loans are currently limited to 80% or lower. As part of
the criteria for underwriting commercial real estate loans, the Company
generally imposes a specified debt coverage ratio (the ratio of net cash from
operations before payment of debt service to debt service). It is also the
Company's general policy to seek additional protection to mitigate any
weaknesses identified in the underwriting process. Additional strength may be
provided via mortgage insurance, secondary collateral and/or personal guarantees
from the principals of the borrower.
Commercial real estate lending entails different and significant risks
when compared to single-family residential lending because such loans typically
involve large loan balances to single borrowers and because the payment
experience on such loans is typically dependent on the successful operation of
the project or the borrower's business. These risks can also be significantly
affected by supply and demand conditions in the local market for apartments,
19
offices, warehouses or other commercial space. The Company attempts to minimize
its risk exposure by limiting the extent of its commercial lending. In addition,
the Company imposes stringent LTV ratios, requires conservative debt coverage
ratios, and continually monitors the operation and physical condition of the
collateral.
Commercial Business Loans. From time to time, and in connection with
its community bank activities, the Company has originated secured or unsecured
loans for commercial, corporate, business and agricultural purposes. At December
31, 1997, $1.9 million or 1.1% of the Company's total loans held for investment
consisted of commercial business loans. The Company's commercial business loans
consist primarily of loans and lines of credit secured by various equipment,
machinery and other corporate assets.
Consumer Loans. Subject to restrictions contained in applicable federal
laws and regulations, the Company is authorized to make loans for a wide variety
of personal or consumer purposes. The Company has recently begun to emphasize
the origination and purchase of consumer loans in order to provide a full range
of financial services to its customers and because such loans generally have
shorter terms and higher interest rates than mortgage loans. At December 31,
1997, $6.2 million or 3.7% of the Company's total loans held for investment
consisted of consumer loans. The consumer loans offered by the Company include
automobile loans, boat and recreational vehicle loans, mobile home loans, loans
secured by deposit accounts and unsecured personal loans.
The Company currently offers loans secured by deposit accounts, which
amounted to $805,000 at December 31, 1997. Such loans are originated for up to
90% of the account balance, with a hold placed on the account restricting the
withdrawal of the account balance. At December 31, 1997, the Company's loan
portfolio also included $1.5 million of automobile loans, $384,000 of mobile
home loans and $41,000 of boat and recreational vehicle loans.
Consumer loans generally have shorter terms and higher interest rates
than mortgage loans and generally involve more credit risk than mortgage loans
because of the type and nature of the collateral and, in certain cases, the
absence of collateral. In addition, consumer lending collections are dependent
on the borrower's continuing financial stability, and thus are more likely to be
adversely effected by job loss, divorce, illness and personal bankruptcy. In
many cases, any repossessed collateral for a defaulted consumer loan will not
provide an adequate source of repayment of the outstanding loan balance because
of improper repair and maintenance of the underlying security. The remaining
deficiency may not warrant further substantial collection efforts against the
borrower.
Loan Fee Income. In addition to interest earned on loans, the Company
receives income through servicing of loans, unamortized loan fees in connection
with loan sales and fees in connection with loan modifications, late payments,
prepayments and miscellaneous services related to its loans. Income from these
activities varies from period to period with the volume and types of loans made
and competitive conditions.
In connection with its loan origination activities, the Company often
charges loan origination fees that are calculated as a percentage of the amount
borrowed. The Company generally charges a borrower on a single-family home loan
a loan origination fee based on the principal amount of the loan, with the
actual amount being dependent upon, among other things, the interest rate and
market conditions at the time the loan application is taken. These fees are in
addition to appraisal and other fees paid by the borrower to the Company at the
time of the application. The Company's policy is to defer all loan origination
20
fees net of direct origination costs and amortize those fees over the
contractual lives of the related loans. Amortization of loan fees is included in
interest income. Nevertheless, the predominant portion of the Company's loans
are originated for resale and, consequently, related net loan fees are
recognized as mortgage banking income upon consummation of the loan sales.
When loans are sold with servicing rights released to the buyer, the
Company also recognizes current income from receipt of servicing release fees in
addition to receiving a premium or deducting a discount based on the market
value of the loan, which is dependent upon, among other things, the interest
rate and market conditions at the time the sales price is locked-in with the
buyer. Sales prices for loans originated for resale are generally locked-in with
a buyer at the time of origination in order to minimize the Company's interest
rate risk. When loans are sold with servicing retained, the Company recognizes
additional gains based on the estimated fair value of the servicing retained.
Recognition of such gains creates originated mortgage servicing rights ("OMSRs")
for the Company, which are capitalized and amortized in proportion to, and over
the period of, the estimated future net servicing income stream of the
underlying mortgage loans. OMSRs amounted to $782,000, $1.1 million and $1.6
million at December 31, 1997, 1996 and 1995, respectively. For additional
information regarding the Company's servicing assets, see Note 2 of the Notes to
Consolidated Financial Statements on pages 32 through 35 of the 1997 Annual
Report to Stockholders, which is attached hereto as Exhibit 13 and incorporated
herein by reference.
Through Essex Home, the Company services loans that are owned by the
Bank and other investors. At December 31, 1997, approximately 8,400 loans with
principal balances of $482.7 million were serviced or subserviced by Essex Home
as compared to approximately 13,300 loans with principal balances of $1.1
billion as of December 31, 1996. On February 28, 1997, the Company was notified
by its largest subservicing client (with approximately 7,000 loans totaling
$858.9 million as of December 31, 1996) of its intention not to renew its
contract beyond June 1, 1997. As a result, during 1997 the Company's management
intensified its marketing efforts and initiated cost reductions in order to
minimize the impact of this loss on the earnings performance of Essex Home and
the Company. Essex Home has replaced a portion of the lost servicing volume by
entering into 18 new subservicing contracts consisting of approximately 2,100
loans with an aggregate principal balance of $201.4 million as of December 31,
1997 and, to a lesser extent, by acquiring mortgage servicing rights. However,
no assurances can be made that the lost servicing volume can be replaced in its
entirety in the near term.
Asset Quality
Delinquent Loans. When a borrower fails to make a required payment on a
loan, the Company attempts to cure the deficiency by contacting the borrower and
seeking payment. Contacts are generally made on the 15th day after a payment is
due and a late charge is assessed at such time. In most cases, deficiencies are
cured promptly. If a delinquency extends beyond 30 days, the loan and payment
history is carefully reviewed, additional notices are sent to the borrower and
additional efforts are made to collect the loan. While the Company generally
prefers to work with borrowers to resolve such problems, when the account
becomes 90 days delinquent, the Company institutes foreclosure or other
proceedings, as necessary, to minimize any potential loss.
21
The following table sets forth information concerning the principal
balances and percent of the total loan portfolio held for investment represented
by delinquent loans at the dates indicated:
December 31,
-----------------------------------------------------------------
1997 1996 1995
------------------- ------------------- --------------------
Amount Percent Amount Percent Amount Percent
(dollars in thousands)
30-59 days (1)................. $ 645 .38% $1,156 .78% $2,222 .82%
60-89 days (1)................. 295 .17 335 .23 942 .34
90 or more days (1), (2)....... 1,577 .93 2,938 1.98 6,258 2.30
----- ----- ----- ----- ----- ----
$2,517 1.48% $4,429 2.99% $9,422 3.46%
===== ===== ===== ===== ====== ====
(1) Includes at December 31, 1997, $217,000, $16,000 and $305,000 of
loans delinquent 30-59 days, 60-89 days and 90 days or more,
respectively, which were acquired in connection with the Home
Acquisition. Includes at December 31, 1996, $185,000, $70,000 and
$611,000 of loans delinquent 30-59 days, 60-89 days and 90 days or
more, respectively, which were acquired in connection with the
Home Acquisition. Includes at December 31, 1995, $977,000,
$381,000 and $1.2 million of loans delinquent 30-59 days, 60-89
days and 90 days or more, respectively, which were acquired in
connection with the Home Acquisition.
(2) Includes $21,000, $30,000 and $177,000 of loans that were accruing
interest at December 31, 1997, 1996, and 1995, respectively.
Nonperforming Assets. All loans are reviewed on a regular basis and are
placed in nonaccrual status based on the loan's delinquency status, an
evaluation of the related collateral, and the borrower's ability to repay the
loan. Generally, loans past due more than 90 days are placed in nonaccrual
status; however, in instances where the borrower has demonstrated an ability to
make timely payments, loans past due more than 90 days are returned to an
accruing status. Such loans may be returned to accruing status, even though the
loans have not been brought fully current, provided two criteria are met: (i)
all principal and interest amounts contractually due (including arrearages) are
reasonably assured of repayment within a reasonable period, and (ii) there is a
sustained period of repayment performance (generally a minimum of six months) by
the borrower. Consumer loans generally are charged-off or fully reserved for
when the loan becomes over 120 days delinquent. When a loan is placed in
nonaccrual status, interest accruals cease and uncollected accrued interest is
reversed and charged against current income. Additional interest income on such
loans is recognized only when received.
In certain circumstances, for reasons related to a borrower's financial
difficulties, the Company may grant a concession to the borrower that it would
not otherwise consider. Such restructuring of troubled debt may include a
modification of loan terms and/or a transfer of assets (or equity interest) from
the borrower to the Company.
If a foreclosure action is instituted with respect to a particular loan
and the loan is not reinstated, paid in full or refinanced, the property is sold
at a foreclosure sale in which the Company may participate as a bidder. If the
Company is the successful bidder, the acquired property is classified as
foreclosed property until it is sold. Properties acquired in settlement of loans
are initially recorded at fair value less estimated costs to sell. Valuations
are periodically performed by management, and an allowance for losses is
established by a charge to operations if the carrying value of a property
exceeds its fair market value less the estimated costs to sell. Costs incurred
in connection with ownership of the property, including interest on senior
22
indebtedness, are expensed to the extent not previously allowed for in
calculating fair value less estimated costs to sell. Costs relating to the
development or improvement of the property are capitalized to the extent these
costs increase fair value less estimated costs to sell. Sales of foreclosed
properties are recorded under the accrual method of accounting. Under this
method, a sale is not recognized unless the buyer has assumed the risks and
rewards of ownership, including an adequate cash down payment. Until the
contract qualifies as a sale, all collections are recorded as deposits.
The following table sets forth information regarding nonperforming
assets held by the Company at the dates indicated (dollars in thousands):
December 31,
-----------------------------------------------------------------
1997 1996 1995
---- ---- ----
% of % of % of
Total Total Total
Amount Loans Amount Loans Amount Loans
------ ----- ------ ----- ------ -----
Nonaccrual loans, net:
Single-family residential................ $1,203 .71% $2,513 1.70% $ 2,959 1.09%
Construction............................. 133 .08 220 .15 378 .14
Commercial............................... 132 .08 22 .01 2,636 .97
Consumer................................. 88 .05 153 .10 108 .04
----- ----- ----- ---- ------- ----
Total nonaccrual loans................. 1,556 .92 2,908 1.96 6,081 2.24
Accruing loans 90 days or more past due..... 21 .01 30 .02 177 .06
Troubled debt restructurings................ 209 .12 223 .15 143 .05
----- ----- ----- ---- ------- ----
Total nonperforming loans.............. 1,786 1.05 3,161 2.13 6,401 2.35
Foreclosed properties, net.................. 1,512 .89 2,054 1.39 4,856 1.78
----- ----- ----- ---- ------- ----
Total nonperforming assets............. $3,298 1.94% $5,215 3.52% $11,257 4.13%
===== ==== ===== ==== ====== ====
Nonperforming loans to total loans.......... 1.05% 2.13% 2.35%
Nonperforming assets to total assets........ 1.69 2.99 3.32
Allowance for loan losses to total loans.... 1.40 1.73 1.93
Allowance for loan losses to nonaccrual
loans.................................... 153.09 87.90 86.35
Allowance for loan losses to nonperforming
loans.................................... 133.37 80.86 82.03
1994 1993
---- ----
% of % of
Total Total
Amount Loans Amount Loans
Nonaccrual loans, net: ------ ----- ------ -----
Single-family residential................ $ 3,158 1.31% $ 4,801 2.28%
Construction............................. 1,253 .52 17 .01
Commercial............................... 2,306 .96 513 .25
Consumer................................. 57 .02 93 .04
------- ---- ------- ----
Total nonaccrual loans................. 6,774 2.81 5,424 2.58
Accruing loans 90 days or more past due..... 539 .22 1,136 .54
Troubled debt restructurings................ 1,049 .44 2,948 1.40
------- ---- ------- ----
Total nonperforming loans.............. 8,362 3.47 9,508 4.52
Foreclosed properties, net.................. 5,290 2.19 8,582 4.08
------- ---- ------- ----
Total nonperforming assets............. $13,652 5.66% $18,090 8.60%
====== ==== ====== ====
Nonperforming loans to total loans.......... 3.47% 4.52%
Nonperforming assets to total assets........ 4.61 4.63
Allowance for loan losses to total loans.... 1.42 1.45
Allowance for loan losses to nonaccrual
loans.................................... 50.62 56.03
Allowance for loan losses to nonperforming
loans.................................... 41.01 31.96
23
Gross interest income that would have been recorded during the years
ended December 31, 1997, 1996, and 1995 if the Company's nonaccrual loans at the
end of such periods had been performing in accordance with their terms during
such periods was $171,000, $291,000 and $678,000, respectively.
The $1.6 million of nonaccrual loans at December 31, 1997 consisted of
$1.2 million of loans secured by single-family residential property, $133,000 of
construction loans (which were secured by residential property), $132,000 of
loans secured by commercial property and $88,000 of consumer loans. The $21,000
of accruing loans 90 days or more past due at December 31, 1997 consisted of one
loan secured by single-family residential property. The $209,000 of troubled
debt restructurings at December 31, 1997 consisted of three loans secured by
single-family residential property, one secured commercial loan and one
unsecured loan.
The Company's decrease in nonaccrual loans during 1997 occurred
primarily in loans secured by single-family residential property. This $1.4
million decrease was attributable to the improvement in asset quality as
evidenced by the decline in delinquencies.
The $1.5 million of foreclosed properties at December 31, 1997
consisted of $1.3 of single-family residential properties and $257,000 of land.
The Company's decrease in foreclosed properties reflected the impact of the
decline in nonperforming and delinquent loans during 1997 and prior years. In
addition, during 1997 the Company completed the sale of residential lots located
in the Outer Banks of North Carolina, which had a carrying value of $164,000 at
December 31, 1996.
For additional information about the Company's nonperforming assets,
see "Management's Discussion and Analysis of Financial Condition and Results of
Operations - Financial Condition - Nonperforming Assets" on pages 6 and 7 and
Notes 8 and 9 of the Notes to Consolidated Financial Statements on pages 39
through 41 of the 1997 Annual Report to Stockholders, which is attached hereto
as Exhibit 13 and incorporated herein by reference.
Classified Assets. Federal regulations require that each insured
savings institution classify its assets on a regular basis. In addition, in
connection with examinations of insured institutions, federal examiners have
authority to identify problem assets and, if appropriate, classify them. There
are three classifications for problem assets: "substandard," "doubtful" and
"loss." Substandard assets have one or more defined weaknesses and are
characterized by the distinct possibility that the insured institution will
sustain some loss if the deficiencies are not corrected. Doubtful assets have
the weaknesses of substandard assets with the additional characteristic that the
weaknesses make collection or liquidation in full on the basis of currently
existing facts, conditions and values questionable, and there is a high
possibility of loss. An asset classified as loss is considered uncollectible and
of such little value that continuance as an asset of the institution is not
warranted. Another category designated "special mention" also must be
established and maintained for assets which do not currently expose an insured
institution to a sufficient degree of risk to warrant classification as
substandard, doubtful or loss. Assets classified as substandard or doubtful
require the institution to establish general allowances for loan losses. If an
asset or portion thereof is classified as loss, the insured institution must
either establish specific allowances for loan losses in the amount of 100% of
the portion of the asset classified loss, or charge-off such amount. General
loss allowances established to cover possible losses related to assets
classified substandard or doubtful may be included in determining an
institution's risk-based capital, while specific valuation allowances for loan
losses do not qualify as regulatory capital. Federal examiners may disagree with
an insured institution's classifications and amounts reserved.
24
In addition to the nonperforming assets discussed above, at December
31, 1997, the Company had classified for regulatory and internal purposes an
additional $2.1 million of assets, $1.6 million of which were classified
substandard, $149,000 of which were classified doubtful and $350,000 of which
were classified loss.
Allowance for Losses on Loans and Foreclosed Properties. An allowance
for loan losses is maintained at a level that management considers adequate to
provide for potential losses based upon an evaluation of the inherent risks in
the loan portfolio. Management's determination of the adequacy of the allowance
is based on an evaluation of the portfolio, past loss experience, current
economic conditions, volume, growth and composition of the portfolio, and other
relevant factors. The allowance is increased by provisions for loan losses which
are charged against income. While management uses the best information available
to make such evaluations, future adjustments to the allowance may be necessary
if economic conditions differ substantially from the assumptions used in making
the evaluations. For additional information, see Notes 8 and 9 of the Notes to
Consolidated Financial Statements on pages 39 through 41 of the 1997 Annual
Report to Stockholders, which is attached hereto as Exhibit 13 and incorporated
herein by reference.
The following table sets forth information concerning the activity in
the Company's allowance for loan losses during the years indicated:
Year Ended December 31,
-------------------------------------------------------------
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
(dollars in thousands)
Loans, net of unearned fees and discounts:
Year-end.................................. $169,823 $148,107 $271,883 $240,821 $209,820
Average outstanding during period......... 156,217 216,803 251,108 218,806 267,143
Allowance for loan losses:
Balance, beginning of year................ $2,556 $5,251 $ 3,429 $ 3,039 $ 4,489
Allowance transferred in connection
with the Home Acquisition............. - - 500 - -
Provision for loan losses................. 113 1,411 2,477 1,604 1,085
------ ----- --------- --------- ---------
2,669 6,662 6,406 4,643 5,574
Charge-offs, net of recoveries (1):
Commercial (2)........................ (366) 2,892 644 - 82
Real estate - mortgage................ 535 894 494 1,255 2,248
Consumer ....................... 118 320 17 (41) 205
------ ----- --------- --------- ---------
Total (2)........................ 287 4,106 1,155 1,214 2,535
------ ----- --------- --------- ---------
Balance, end of year...................... $2,382 $2,556 $ 5,251 $ 3,429 $ 3,039
===== ===== ========= ========= =========
Ratio of net charge-offs to average
outstanding loans (2)........................ .18% 1.89% .46% .55% .95%
Allowance for loan losses to year-end
total nonperforming loans.................... 133.37% 80.86% 82.03% 41.01% 31.96%
Allowance for loan losses to year-end
loans, net of unearned fees and discounts.... 1.40% 1.73% 1.93% 1.42% 1.45%
(1) Except as noted in (2) below, recoveries of prior loan charge-offs
were not significant for the periods presented.
(2) Charge-offs during 1997 include a $329,000 recovery on a loan
guarantee associated with the Richmond Apartments loan and a $39,000
recovery associated with claims against the estate of a deceased
borrower. Excluding the impact of these recoveries, the ratio of net
charge-offs to average outstanding loans for 1997 was .42%.
Charge-offs during 1996 include the $2.8 million write-off of the
Richmond Apartments loan. Excluding the impact of this charge-off,
the ratio of net charge-offs to average outstanding loans for 1996
was .59%.
25
The following table sets forth information concerning the allocation of
the Company's allowance for loan losses by loan categories at the dates
indicated.
December 31,
----------------------------------------------------------------------------------------------
1997 1996 1995 1994 1993
---------------- ---------------- ---------------- ---------------- ----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
------- ------- ------- ------- ------ ------- ------ ------- ------ -------
(dollars in thousands)
Residential mortgage $1,139 91.7% $1,636 89.9% $2,607 92.5% 2,068 91.9% $2,080 92.0%
Commercial (1) 545 4.6 505 5.6 1,530 4.7 861 5.6 387 6.0
Consumer 254 3.7 299 4.5 323 2.8 467 2.5 424 2.0
Unallocated 444 - 116 - 791 - 33 - 148 -
------ ---- ------ ---- ------ ---- ----- ---- ------ ----
$2,382 100.0% $2,556 100.0% $5,251 100.0% $3,429 100.0% $3,039 100.0%
====== ===== ====== ===== ====== ===== ====== ===== ====== =====
(1) Includes commercial real estate and commercial business loans.
The Company also maintains an allowance for losses on foreclosed
properties. The following table sets forth information concerning the activity
in the Company's allowance for losses on foreclosed properties during the
periods indicated:
Year Ended December 31,
----------------------------------------
1997 1996 1995
---- ---- ----
(dollars in thousands)
Balance at beginning of year..................... $ 179 $199 $ 418
Provision for losses on
foreclosed properties.......................... 159 (21) 79
---- ---- -----
338 178 497
Charge-offs, net of recoveries................... (183) 1 (298)
---- ----- ----
Balance at end of year........................... $ 155 $179 $ 199
==== === ====
Investment Activities
Mortgage-Backed Securities. Mortgage-backed securities (which also are
known as mortgage participation certificates or pass-through certificates)
represent a participation interest in a pool of single-family or multi-family
mortgages, the principal and interest payments on which are passed from the
mortgage originators, through intermediaries (generally U.S. Government agencies
and government sponsored enterprises) that pool and repackage the participation
interests in the form of securities, to investors such as the Company. Such U.S.
Government agencies and government sponsored enterprises, which guarantee the
payment of principal and interest to investors, primarily include Freddie Mac,
Fannie Mae and Ginnie Mae.
Freddie Mac is a public corporation chartered by the U.S. Government
and owned by the 12 Federal Home Loan Banks and federally-insured member
institutions of the Federal Home Loan Bank system. Freddie Mac issues
participation certificates backed principally by conventional mortgage loans.
Freddie Mac guarantees the timely payment of interest and the ultimate return of
principal. Fannie Mae is a private corporation chartered by the U.S. Congress
with a mandate to establish a secondary market for conventional mortgage loans.
Fannie Mae guarantees the timely payment of principal and interest on Fannie Mae
securities. Freddie Mac and Fannie Mae securities are not backed by the full
faith and credit of the United States, but because Freddie Mac and Fannie Mae
are quasi-Government and U.S. Government-sponsored enterprises, respectively,
these securities are considered to be among the highest quality investments with
minimal credit risks. Ginnie Mae is a government agency within the Department of
Housing and Urban Development which is intended to help finance
government-assisted housing programs. Ginnie Mae securities are backed by
26
FHA-insured and VA-guaranteed loans, and the timely payment of principal and
interest on Ginnie Mae securities are guaranteed by Ginnie Mae and backed by the
full faith and credit of the U.S. Government. Because Freddie Mac, Fannie Mae
and Ginnie Mae were established to provide support for low- and middle-income
housing, there are limits to the maximum size of loans that qualify for these
programs. To accommodate larger-sized loans, and loans that, for other reasons,
do not conform to the agency programs, a number of independent companies have
established their own home-loan origination and securitization programs.
Mortgage-backed securities typically are issued with stated principal
amounts, and the securities are backed by pools of mortgages that have loans
with interest rates that are within a range and have varying maturities. The
characteristics of the underlying pool of mortgages, i.e., fixed-rate or
adjustable-rate, as well as prepayment risk, are passed on to the certificate
holder. The life of a mortgage-backed pass-through security thus approximates
the life of the underlying mortgages.
The Company's mortgage-backed securities include collateralized
mortgage obligations ("CMOs"), which include securities issued by entities which
have qualified under the Internal Revenue Code (the "Code") as Real Estate
Mortgage Investment Conduits ("REMICs"). CMOs and REMICs (collectively, CMOs)
have been developed in response to investor concerns regarding the uncertainty
of cash flows associated with the prepayment option of the underlying mortgagor
and are typically issued by government agencies, government sponsored
enterprises and special purpose entities, such as trusts, corporations or
partnerships, established by financial institutions or other similar
institutions. A CMO can be collateralized by loans or securities which are
insured or guaranteed by Fannie Mae, Freddie Mac or Ginnie Mae. In contrast to
pass-through mortgage-backed securities, in which cash flow is received pro rata
by all security holders, the cash flow from the mortgages underlying a CMO is
segmented and paid in accordance with a predetermined priority to investors
holding various CMO classes. By allocating the principal and interest cash flows
from the underlying collateral among the separate CMO classes, different classes
of bonds are created, each with its own stated maturity, estimated average life,
coupon rate and prepayment characteristics.
Mortgage-backed securities generally increase the quality of the
Company's assets by virtue of the insurance or guarantees that back them, are
more liquid than individual mortgage loans and may be used to collateralize
borrowings or other obligations of the Company.
The following table sets forth the activity in the Company's
mortgage-backed securities portfolio during the periods indicated:
At or For the Year Ended December 31,
---------------------------------------
1997 1996 1995
---- ---- ----
(dollars in thousands)
Balance at beginning of year............ $1,905 $15,650 $18,223
Sales................................... - (9,915) (1) -
Repayments.............................. - (3,668) (2) (2,724)
Amortization............................ - (8) (3)
Valuation adjustments................... - (154) 154
-------- ------- --------
Balance at end of year.................. $1,905 $ 1,905 $15,650 (3)
====== ======= =======
Weighted average coupon at end
of year.............................. 6.65% 6.40% 7.25%
====== ======= =======
(1) Represents sale of mortgage-backed securities in connection with
the sale of branches during 1996.
(2) Includes the termination and reclassification of a Company-issued
second mortgage REMIC totaling $2.7 million from mortgage-backed
securities to loans.
(3) Includes $13.7 million of mortgage-backed securities classified as
available for sale at December 31, 1995.
The Company's investment in mortgage-backed securities at December 31,
1997 consists solely of a $1.9 million Fannie Mae guaranteed adjustable rate
REMIC. The Company does not currently own and does not anticipate investing in
27
mortgage-backed securities that would be deemed "high risk" securities pursuant
to OTS Thrift Bulletin 52. The Company's mortgage-backed securities are carried
in accordance with generally accepted accounting principles. See Note 7 of the
Notes to Consolidated Financial Statements on page 39 of the 1997 Annual Report
to Stockholders, which is attached hereto as Exhibit 13 and incorporated herein
by reference.
Investment Securities. Federally-chartered savings institutions have
authority to invest in various types of liquid assets, including United States
Treasury obligations, securities of various Federal agencies and of state and
municipal governments, certificates of deposit at federally-insured banks and
savings and loan associations, certain bankers' acceptances and Federal funds.
Subject to various restrictions, federally-chartered savings institutions may
also invest a portion of their assets in commercial paper, corporate debt
securities and mutual funds, the assets of which conform to the investments that
federally-chartered savings institutions are otherwise authorized to make
directly.
The Bank's investment securities portfolio is managed by the Treasurer
of the Bank in accordance with a comprehensive investment policy which addresses
strategies, types and levels of allowable investments and which is reviewed and
approved by the Board of Directors on an annual basis and by the Asset and
Liability Management Committee as circumstances warrant. The Bank currently
emphasizes lending activities in order to increase the weighted average yield on
the Bank's interest-earning assets. The Bank's investment securities are carried
in accordance with generally accepted accounting principles. See Note 6 of the
Notes to Consolidated Financial Statements on page 38 of the 1997 Annual Report
to Stockholders, which is attached hereto as Exhibit 13 and incorporated herein
by reference.
The following table sets forth certain information relating to the
Company's investment securities held for investment at the dates indicated:
December 31,
1997 1996 1995
----------------------- ----------------------- -----------------------
Carrying Market Carrying Market Carrying Market
Value Value Value Value Value Value
----- ----- ----- ----- ----- -----
(dollars in thousands)
U.S. Government securities...... $ - $ - $1,003 $1,003 $ 1,000 $ 999
U.S. Government agency
securities (1)............... 2,299 2,217 5,000 4,887 6,998 6,841
FHLB stock...................... 1,431 1,431 2,540 2,540 3,603 3,603
----- ----- ----- ----- ------- -------
Total (2)................... $3,730 $3,648 $8,543 $8,430 $11,601 $11,443
===== ===== ===== ===== ====== ======
(1) Of the $2.3 million of U.S. Government agency securities held for
investment at December 31, 1997, $2.0 million consisted of a note
issued by the FHLB and $299,000 consisted of a note issued by Fannie
Mae. The $2.0 million FHLB note adjusts semi-annually based on the
yield of three-year constant maturity treasury notes. The $299,000
Fannie Mae note earns interest at a fixed rate.
(2) Does not include investment securities classified as available for sale
which consisted of a $17,000, $9,000 and $1.5 million investment in a
money market mutual fund at December 31, 1997, 1996 and 1995,
respectively.
28
Information regarding the carrying values, contractual maturities and
weighted average yield of the Company's investment securities held for
investment (excluding FHLB stock) at December 31, 1997 is presented below. FHLB
stock is neither a debt nor an equity security because its ownership is
restricted and it lacks a market. FHLB stock can be sold at its par of $100 per
share only to the FHLBs or to another member institution.
One Year After One to After Five to Over 10
or Less Five Years 10 Years Years Total
(dollars in thousands)
U.S. Government agency securities...... $ - $2,299 $ - $ - $2,299
======= ====== ======= ======== ======
Weighted average yield................. -% 4.98% -% -% 4.98%
======= ====== ======= ======== ======
Sources of Funds
General. Deposits are the primary source of the Company's funds for
lending and other investment purposes. In addition to deposits, the Company
derives funds from loan principal repayments, prepayments, advances from the
FHLB and other borrowings. Loan repayments are a relatively stable source of
funds, while deposits inflows and outflows are significantly influenced by
general interest rates and money market conditions. Borrowings may be used on a
short-term basis to compensate for reductions in the availability of funds from
other sources. They may also be used on a longer term basis for general business
purposes, including market risk management.
Deposits. Deposits obtained through bank branch offices of the Company
have traditionally been the principal source of the Company's funds for use in
lending and for other general business purposes. The Company's current deposit
products include regular passbook and statement savings accounts, negotiable
order of withdrawal ("NOW") accounts, money market accounts, fixed-rate,
fixed-maturity retail certificates of deposit ranging in terms from 90 days to
60 months, mini-jumbo (generally $25,000 - $99,999) and jumbo (generally equal
to or greater than $100,000) certificates of deposit and individual retirement
accounts.
The Bank's deposits are currently obtained primarily from residents in
its primary market area. The principal methods currently used by the Company to
attract deposit accounts include offering a wide variety of services and
accounts and competitive interest rates. The Company utilizes traditional
marketing methods to attract new customers and savings deposits, including print
media advertising. Currently, the Company does not advertise for retail deposits
outside of its local market area or utilize the services of deposit brokers.
Management estimates that as of December 31, 1997, deposit accounts totaling
$4.1 million or 2.7% of the Bank's total deposits were held by nonresidents of
Virginia or North Carolina. These out-of-market deposits include jumbo
certificates of deposits owned largely by financial institutions which totaled
$1.9 million at December 31, 1997, and represented a decline from the $2.8
million of such certificates at December 31, 1996. These jumbo certificates of
deposit were obtained through the posting of deposit rates on national
computerized bulletin boards at no cost to the Company and were not obtained
through deposit brokers.
29
The following table sets forth the average balances and rates of the
Company's deposits for the periods indicated:
Year Ended December 31,
---------------------------------------------------------------------
1997 1996 1995
------------------- ------------------ ------------------
Average Average Average
Balance Rate Balance Rate Balance Rate
------- ---- ------- ---- ------- ----
(dollars in thousands)
Noninterest-bearing deposits... $3,143 -% $ 1,433 -% $ 1,285 -%
Passbook savings............... 3,839 3.48 6,782 3.33 5,465 3.33
NOW accounts................... 4,344 2.83 5,332 2.80 4,859 2.85
Money market accounts.......... 21,401 4.87 21,104 4.50 21,760 4.14
Certificates of deposit:
Consumer................... 53,256 5.78 92,771 5.83 95,363 5.99
Mini-jumbo................. 44,932 5.65 71,269 5.69 90,216 5.60
Jumbo...................... 13,206 5.78 19,670 5.86 28,026 5.46
-------- -------- --------
$144,121 $218,361 $246,974
======= ======= =======
The following table shows the interest rate and maturity information
for the Company's time deposits at December 31, 1997:
Maturity Date
--------------------------------------------------------------------------
One Year Over
or Less 1-2 Years 2-3 Years 3 Years Total
------- --------- --------- ------- -----
(dollars in thousands)
4.01% to 5.00%............. $ 1,125 $ 2 $ - $ - $ 1,127
5.01% to 6.00%............. 67,575 12,574 3,179 2,923 86,251
6.01% to 7.00%............. 7,388 5,477 6,035 5,187 24,087
7.01% to 8.00%............. 600 251 2,906 - 3,757
8.01% to 9.00%............. 32 - 6 - 38
--------- ----------- ---------- --------- ----------
$76,720 $18,304 $12,126 $8,110 $115,260
====== ====== ====== ===== =======
The following table shows the Company's certificates of deposit of
$100,000 or more outstanding at the dates indicated:
December 31,
--------------------------------------------------
1997 1996 1995
---- ---- ----
(dollars in thousands)
3 months or less........................ $ 4,624 $ 2,709 $ 6,638
Over 3 through 6 months................. 4,785 3,505 11,270
Over 6 through 12 months................ 3,747 2,625 12,834
Over 12 months ......................... 5,365 5,919 10,489
-------- -------- --------
Total.......................... $ 18,521 $ 14,758 $ 41,231
======== ======== ========
The ability of the Company to attract and maintain deposits and the
Company's cost of funds on these deposit accounts have been, and will continue
to be, significantly affected by economic and competitive conditions.
Borrowings. The Bank is a member of the FHLB System, which consists of
12 regional FHLBs subject to supervision and regulation by the Federal Housing
Finance Board. The FHLBs provide a central credit facility primarily for member
institutions. The Bank, as a member of the FHLB of Atlanta, is required to hold
shares of common stock in that FHLB in an amount at least equal to 1% of the
aggregate principal amount of its unpaid residential mortgage loans and
mortgage-backed securities, 3/10 of 1% of total assets at the end of the
30
calendar year, or 5% of its advances (borrowings) from the FHLB, whichever is
greater. The Bank had a $1.4 million investment in stock of the FHLB at December
31, 1997, which was in compliance with this requirement. At December 31, 1997,
the Bank had $23.5 million of advances outstanding from the FHLB.
The following table presents certain information regarding the
Company's FHLB advances at the dates and for the periods indicated:
At or For the Year Ended December 31,
-------------------------------------------------
1997 1996 1995
---- ---- ----
(dollars in thousands)
Balance at end of period.................. $23,547 $25,690 $29,833
Weighted average interest rate
at end of period..................... 5.75% 6.14% 6.00%
Maximum amount outstanding
at any month's end................... $28,118 $29,833 $59,952
Average amount outstanding
during the period.................... $24,885 $27,137 $46,617
Weighted average interest rate
during the period.................... 5.92% 5.99% 6.00%
The outstanding FHLB advances at December 31, 1997 mature as follows
(in thousands):
1998.................................... $21,139
1999.................................... 1,808
2000.................................... 600
--------
$23,547
The Company's notes payable amounted to $72,000, $96,000 and $120,000
at December 31, 1997, 1996, and 1995, respectively. Notes payable on these dates
consisted solely of a note payable to the former president of Home Bancorp and
Home Savings. The note accrues interest at 9.50% per annum. The note is due in
five equal annual installments, plus accrued interest thereon. However, in
conjunction with a severance settlement with the former employee, the Company
repaid this note in its entirety in February 1998. See "Item 3. - Legal
Proceedings."
During 1989 and 1990, the Bank sold $3.3 million of subordinated
capital notes with a ten-year maturity. The notes were issued in minimum
denominations of $2,500 at interest rates ranging between 11.5% and 12.0%. In
July 1993, the Bank redeemed $2.8 million of the subordinated capital notes. The
Company's subordinated capital notes amounted to $628,000 at December 31, 1995.
In August 1996, the Bank redeemed the remaining subordinated capital notes at
par in their entirety
Other Liabilities. As of December 31, 1997, other liabilities of the
Company included a $703,000 obligation to the Company's Chief Executive Officer
resulting from the exercise of his stock appreciation rights in November 1997. A
determination has not yet been made as to the date and method of payment to
satisfy this obligation. See Note 19 of the Notes to Consolidated Financial
Statements on pages 47 and 48 of the 1997 Annual Report to Stockholders, which
is attached hereto as Exhibit 13 and incorporated herein by reference.
Year 2000 Costs
For information about the Company's Year 2000 readiness and associated
costs, see "Management's Discussion and Analysis of Financial Condition and
Results of Operations - Year 2000 Costs" on page 21 of the 1997 Annual Report to
Stockholders, which is attached hereto as Exhibit 13 and incorporated herein by
reference.
31
Competition
The Company faces strong competition both in attracting deposits and
making real estate and other loans. Its most direct competition for deposits has
historically come from other savings institutions, credit unions and commercial
banks located in Virginia and North Carolina, including many large financial
institutions which have greater financial and marketing resources available to
them. In addition, the Company has faced additional significant competition for
investors' funds from short-term money market securities and other corporate and
government securities. The ability of the Company to attract and retain savings
deposits depends on its ability to generally provide a rate of return, liquidity
and risk comparable to that offered by competing investment opportunities.
The Company experiences strong competition for real estate and other
loans principally from other savings institutions, commercial banks, mortgage
banking companies, insurance companies and other institutional lenders. The
Company competes for loans principally through the interest rates and loan fees
it charges and the efficiency and quality of services it provides borrowers.
Competition may increase as a result of the continuing reduction of restrictions
on the interstate operations of financial institutions.
Employees
As of December 31, 1997, the Company employed 99 full-time employees
and 12 part-time employees.
Regulation of the Company
General. The Company is a savings and loan holding company within the
meaning of the Home Owners' Loan Act ("HOLA"). As such, the Company is subject
to OTS regulations, examinations, supervision and reporting requirements. As a
subsidiary of a savings and loan holding company, the Bank is subject to certain
restrictions in its dealings with the Company and affiliates thereof.
Activities Restrictions. There are generally no restrictions on the
activities of a savings and loan holding company which holds only one subsidiary
savings association. However, if the Director of the OTS determines that there
is reasonable cause to believe that the continuation by a savings and loan
holding company of an activity constitutes a serious risk to the financial
safety, soundness or stability of its subsidiary savings association, the
Director may impose such restrictions as deemed necessary to address such risk,
including limiting (i) payment of dividends by the savings association; (ii)
transactions between the savings association and its affiliates; and (iii) any
activities of the savings association that might create a serious risk that the
liabilities of the holding company and its affiliates may be imposed on the
savings association. Notwithstanding the above rules as to permissible business
activities of unitary savings and loan holding companies, if the savings
association subsidiary of such a holding company fails to meet a qualified
thrift lender ("QTL") test, then such unitary holding company also shall become
subject to the activities restrictions applicable to multiple savings and loan
holding companies and, unless the savings association requalifies as a QTL
within one year thereafter, shall register as, and become subject to, the
restrictions applicable to, a bank holding company. See "- Regulation of the
Bank - Qualified Thrift Lender Test."
Limitations on Transactions with Affiliates. Transactions between
savings associations and any affiliate are governed by Sections 23A and 23B of
the Federal Reserve Act. An affiliate of a savings association is any company or
entity which controls, is controlled by or is under common control with the
savings association. In a holding company context, the parent holding company of
a savings association (such as the Company) and any companies which are
32
controlled by such parent holding company are affiliates of the savings
association. Generally, Sections 23A and 23B (i) limit the extent to which the
savings association or its subsidiaries may engage in "covered transactions"
with any one affiliate to an amount equal to 10% of such association's capital
stock and surplus, and contain an aggregate limit on all such transactions with
all affiliates to an amount equal to 20% of such capital stock and surplus and
(ii) require that all such transactions be on terms substantially the same, or
at least as favorable, to the association or subsidiary as those provided to a
non-affiliate. The term "covered transaction" includes the making of loans,
purchase of assets, issuance of a guarantee and similar other types of
transactions. In addition to the restrictions imposed by Sections 23A and 23B,
no savings association may (i) loan or otherwise extend credit to an affiliate,
except for any affiliate which engages only in activities which are permissible
for bank holding companies, or (ii) purchase or invest in any stocks, bonds,
debentures, notes or similar obligations of any affiliate, except for affiliates
which are subsidiaries of the savings association.
In addition, Sections 22(h) and (g) of the Federal Reserve Act place
restrictions on loans to executive officers, directors and principal
stockholders. Under Section 22(h), loans to a director, an executive officer and
to a greater than 10% stockholder of a savings association, and certain
affiliated interests of either, may not exceed, together with all other
outstanding loans to such person and affiliated interests, the association's
loans to one borrower limit (generally equal to 15% of the institution's
unimpaired capital and surplus). Section 22(h) also requires that loans to
directors, executive officers and principal stockholders be made on terms
substantially the same as offered in comparable transactions to other persons
and also requires prior board approval for certain loans. In addition, the
aggregate amount of extensions of credit by a savings association to all
insiders cannot exceed the association's unimpaired capital and surplus.
Furthermore, Section 22(g) places additional restrictions on loans to executive
officers. At December 31, 1997, the Bank was in compliance with the above
restrictions.
Restrictions on Acquisitions. Except under limited circumstances,
savings and loan holding companies are prohibited from acquiring, without prior
approval of the Director of the OTS, (i) control of any other savings
association or savings and loan holding company or substantially all the assets
thereof or (ii) more than 5% of the voting shares of a savings association or
holding company thereof which is not a subsidiary. Except with the prior
approval of the Director of the OTS, no director or officer of a savings and
loan holding company or person owning or controlling by proxy or otherwise more
than 25% of such company's stock, may acquire control of any savings
association, other than a subsidiary savings association, or of any other
savings and loan holding company.
Regulation of the Bank
General. The OTS has extensive authority over the operations of savings
associations. As part of this authority, savings associations are required to
file periodic reports with the OTS and are subject to periodic examinations by
the OTS and the FDIC. The investment and lending authority of savings
associations are prescribed by federal laws and regulations and they are
prohibited from engaging in any activities not permitted by such laws and
regulations. Those laws and regulations generally are applicable to all
federally chartered savings associations and may also apply to state-chartered
savings associations. Such regulation and supervision is primarily intended for
the protection of depositors.
FIRREA imposed limitations on the aggregate amount of loans that a
savings association could make to any one borrower, including related entities.
See "- Lending Activities - General" for a discussion of such limitations.
33
The OTS's enforcement authority over all savings associations and their
holding companies was substantially enhanced by FIRREA. This enforcement
authority includes, among other things, the ability to assess civil money
penalties, to issue cease and desist or removal orders and to initiate
injunctive actions. In general, these enforcement actions may be initiated for
violations of laws and regulations and unsafe or unsound practices. Other
actions or inactions may provide the basis for enforcement action, including
misleading or untimely reports filed with the OTS. FIRREA significantly
increased the amount of and grounds for civil money penalties. FIRREA requires,
except under certain circumstances, public disclosure of final enforcement
actions by the OTS.
Insurance of Accounts. The deposits of the Bank are insured up to
$100,000 per insured member (as defined by law and regulation) by the SAIF
administered by the FDIC and are backed by the full faith and credit of the
United States Government. As insurer, the FDIC is authorized to conduct
examinations of, and to require reporting by, FDIC-insured institutions. It also
may prohibit any FDIC-insured institution from engaging in any activity the FDIC
determines by regulation or order to pose a serious threat to the FDIC. The FDIC
also has the authority to initiate enforcement actions against savings
associations, after giving the OTS an opportunity to take such action.
The FDIC may terminate the deposit insurance of any insured depository
institution, including the Bank, if it determines after a hearing that the
institution has engaged or is engaging in unsafe or unsound practices, is in an
unsafe or unsound condition to continue operations, or has violated any
applicable law, regulation, order or any condition imposed by an agreement with
the FDIC. It also may suspend deposit insurance temporarily during the hearing
process for the permanent termination of insurance, if the institution has no
tangible capital. If insurance of accounts is terminated, the accounts at the
institution at the time of the termination, less subsequent withdrawals, shall
continue to be insured for a period of six months to two years, as determined by
the FDIC. Management is aware of no existing circumstances which could result in
termination of the Bank's deposit insurance.
Under FDIC regulations, institutions are assigned to one of three
capital groups for insurance premium purposes - "well capitalized," "adequately
capitalized" and "undercapitalized" - which are defined in the same manner as
the regulations establishing the prompt corrective action system under Section
38 of the Federal Deposit Insurance Act ("FDIA"), as discussed under "-Prompt
Corrective Action" below. These three groups are then divided into subgroups
which are based on supervisory evaluations by the institution's primary federal
regulator, resulting in nine assessment classifications. Effective January 1,
1998, assessment rates for SAIF-insured institutions range (except as described
below) from 0 basis points of insured deposits for well-capitalized institutions
with minor supervisory concerns to 27 basis points of insured deposits for
undercapitalized institutions with substantial supervisory concerns. In
addition, an additional assessment approximating 6.4 basis points is added to
the regular SAIF-assessment until December 31, 1999 in order to cover Financing
Corporation ("FICO") debt service payments.
Both the SAIF and the Bank Insurance Fund ("BIF"), the deposit
insurance fund that covers most commercial bank deposits, are statutorily
required to be recapitalized to a ratio of 1.25% of insured reserve deposits.
The BIF previously achieved the required reserve ratio, and as a result, the
FDIC reduced the average deposit insurance premium paid by BIF-insured banks to
a level substantially below the average premium paid by savings institutions.
Banking legislation was enacted on September 30, 1996 to eliminate the premium
differential between SAIF-insured institutions and BIF-insured institutions. The
legislation provided that all insured depository institutions with
SAIF-assessable deposits as of March 31, 1995 pay a special one-time assessment
34
to recapitalize the SAIF. Pursuant to this legislation, the FDIC promulgated a
rule that established the special assessment necessary to recapitalize the SAIF
at 65.7 basis points of SAIF-assessable deposits held by affected institutions
as of March 31, 1995. However, as a result of the Bank's financial condition, on
November 8, 1996, the Bank was notified by the FDIC that its application for
exemption had been approved. As a result, the Bank was exempt from paying the
special one-time assessment (which would have amounted to $1.8 million).
Instead, the Bank is continuing to pay future assessments through 1999 at the
assessment rate schedule in effect as of June 30, 1995. Therefore, as of
December 31, 1997, the Bank's annual assessment for deposit insurance was 26
basis points of insured deposits as opposed to three basis points of insured
deposits (the assessment rate otherwise charged to "well capitalized" savings
institutions such as the Bank).
Another component of the SAIF recapitalization plan provides for the
merger of the SAIF and the BIF on January 1, 1999, provided no insured
depository institution is a savings association on that date. If legislation is
enacted which required the Bank to convert to a bank charter, the Company would
become a bank holding company subject to the more restrictive activity limits
imposed on bank holding companies unless special grandfather provisions are
included in the legislation. The Company does not believe that its activities
would be materially affected in the event that it was required to become a bank
holding company.
Regulatory Capital Requirements. Federally insured savings associations
are required to maintain minimum levels of regulatory capital. The OTS has
established capital standards applicable to all savings associations. These
standards generally must be as stringent as the comparable capital requirements
imposed on national banks. The OTS also is authorized to impose capital
requirements in excess of these standards on individual associations on a
case-by-case basis.
Current OTS capital standards require savings associations to satisfy
three different capital requirements. Under these standards, savings
associations must maintain "tangible" capital equal to at least 1.5% of adjusted
total assets, "core" capital equal to at least 3% of adjusted total assets and
"total" capital (a combination of core and "supplementary" capital) equal to at
least 8.0% of "risk-weighted" assets. For purposes of the regulation, core
capital generally consists of common stockholders' equity (including retained
earnings), noncumulative perpetual preferred stock and related surplus, minority
interests in the equity accounts of fully consolidated subsidiaries, certain
nonwithdrawable accounts and pledged deposits and "qualifying supervisory
goodwill." Tangible capital is given the same definition as core capital but
does not include qualifying supervisory goodwill and is reduced by the amount of
all the savings association's intangible assets, with only a limited exception
for mortgage servicing rights. Both core and tangible capital are further
reduced by an amount equal to a savings association's debt and equity
investments in subsidiaries engaged in activities not permissible to national
banks (other than subsidiaries engaged in activities undertaken as agent for
customers or in mortgage banking activities and subsidiary depository
institutions or their holding companies). A savings association is allowed to
include both core capital and supplementary capital in the calculation of its
total capital for purposes of the risk-based capital requirement, provided that
the amount of supplementary capital does not exceed the savings association's
core capital. Supplementary capital generally consists of hybrid capital
instruments; perpetual preferred stock which is not eligible to be included as
core capital; subordinated debt and intermediate-term preferred stock; and,
subject to limitations, general allowances for loan losses. Assets are adjusted
under the risk-based guidelines to take into account different risk
characteristics, with the categories ranging from 0% (requiring no additional
capital) for assets such as cash to 100% for repossessed assets or loans more
than 90 days past due. Single-family residential first mortgage loans which are
not past-due or non-performing and which have been made in accordance with
prudent underwriting standards are assigned a 50% level in the risk-weighting
system, as are certain privately-issued mortgage-backed securities representing
indirect ownership of such loans. Off-balance sheet items also are adjusted to
take into account certain risk characteristics.
35
An association which is not in capital compliance or which is otherwise
deemed to require more than normal supervision is subject to restrictions on its
ability to grow pursuant to OTS Regulatory Bulletin 3a-1. In addition, a
provision of the HOLA generally provides that, among other restrictions, the
Director of OTS must restrict the asset growth of savings institutions not in
regulatory capital compliance, subject to a limited exception for growth not
exceeding interest credited.
Any savings association that fails any of the capital requirements is
subject to possible enforcement actions by the OTS or the FDIC. Such actions
could include a capital directive, a cease and desist order, civil money
penalties, the establishment of restrictions on an association's operations,
termination of federal deposit insurance and the appointment of a conservator or
receiver. The OTS's capital regulation provides that such actions, through
enforcement proceedings or otherwise, could require one or more of a variety of
corrective actions. For additional information, see "- Prompt Corrective
Action."
In August 1993, the OTS adopted a final rule incorporating an
interest-rate risk component into the risk-based capital regulation. Under the
rule, an institution with a greater than "normal" level of interest rate risk
will be subject to a deduction of its interest rate risk component from total
capital for purposes of calculating its risk-based capital requirement. As a
result, such an institution will be required to maintain additional capital in
order to comply with the risk-based capital requirement. The final rule was
effective January 1, 1994. However, the date that institutions are first
required to deduct the interest rate risk component has been postponed
indefinitely until a final rule is published by the OTS. Pursuant to the rule,
the Bank would have not been subject to the interest rate risk component as of
December 31, 1997.
At December 31, 1997, the Bank's actual capital ratios and the minimum
requirements under FIRREA were as follows (dollars in thousands):
Minimum
Actual Requirement Excess
------ ----------- ------
Tangible capital $15,298 7.86% $2,921 1.5% $12,377
Core capital 15,298 7.86 7,790 4.0 7,508
Risk-based capital 16,762 14.33 9,354 8.0 7,408
For further information regarding the Bank's actual capital ratios and
minimum requirements under FDICIA, see Note 21 of the Notes to Consolidated
Financial Statements on pages 50 and 51 of the 1997 Annual Report to
Stockholders, which is attached hereto as Exhibit 13 and incorporated herein by
reference. At December 31, 1997, the Bank exceeded its core capital and
risk-based capital requirements under FDICIA.
Prompt Corrective Action. Under Section 38 of the FDIA, as added by the
FDICIA, each federal banking agency is required to implement a system of prompt
corrective action for institutions which it regulates. The federal banking
agencies, including the OTS, adopted substantially similar regulations to
implement Section 38 of the FDIA, effective as of December 19, 1992. Under the
regulations, an institution is deemed to be (i) "well capitalized" if it has
total risk-based capital of 10.0% or more, has a Tier I risk-based capital ratio
of 6.0% or more, has a Tier I leverage capital ratio of 5.0% or more and is not
subject to any order or final capital directive to meet and maintain a specific
capital level for any capital measure, (ii) "adequately capitalized" if it has a
total risk-based capital ratio of 8.0% or more, a Tier I risk-based capital
ratio of 4.0% or more and a Tier I leverage capital ratio of 4.0% or more (3.0%
under certain circumstances) and does not meet the definition of "well
capitalized," (iii) "undercapitalized" if it has a total risk-based capital
ratio that is less than 8.0%, a Tier I risk-based capital ratio that is less
than 4.0% or a Tier I leverage capital ratio that is less than 4.0% (3.0% under
36
certain circumstances), (iv) "significantly undercapitalized" if it has a total
risk-based capital ratio that is less than 6.0%, a Tier I risk-based capital
ratio that is less than 3.0% or a Tier I leverage capital ratio that is less
than 3.0% and does not meet the definition of "critically undercapitalized," and
(v) "critically undercapitalized" if it has a ratio of tangible equity to total
assets that is equal to or less than 2.0%. Section 38 of the FDIA and the
regulations promulgated thereunder also specify circumstances under which a
federal banking agency may reclassify a well capitalized institution as
adequately capitalized and may require an adequately capitalized institution or
an undercapitalized institution to comply with supervisory actions as if it were
in the next lower category (except that the FDIC may not reclassify a
significantly undercapitalized institution as critically undercapitalized). At
December 31, 1997, the Bank was considered a "well capitalized" institution
under the prompt correction action provisions of FDIA.
Liquidity Requirements. All savings associations are required to
maintain an average daily balance of liquid assets (including cash, certain time
deposits and savings accounts, bankers' acceptances, certain government
obligations and certain other investments) equal to a certain percentage of the
sum of its average daily balance of net withdrawable deposit accounts and
borrowings payable in one year or less. The liquidity requirement may vary from
time to time (between 4% and 10%) depending upon economic conditions and savings
flows of all savings associations. At the present time, the required minimum
liquid asset ratio is 4%. The Bank has consistently exceeded such regulatory
liquidity requirement and, at December 31, 1997, had a liquidity ratio of 8.72%.
Qualified Thrift Lender Test. All savings associations are required to
meet a QTL test set forth in Section 10(m) of HOLA and regulations of the OTS
thereunder in order to avoid certain restrictions on their operations. A savings
association that does not meet the QTL test set forth in the HOLA and
implementing regulations must either convert to a bank charter or comply with
the following restrictions on its operations: (i) the association may not engage
in any new activity or make any new investment, directly or indirectly, unless
such activity or investment is permissible for a national bank; (ii) the
branching powers of the association shall be restricted to those of a national
bank; (iii) the association shall not be eligible to obtain any advances from
its FHLB; and (iv) payment of dividends by the association shall be subject to
the rules regarding payment of dividends by a national bank. Upon the expiration
of three years from the date the association ceases to be a QTL, it must cease
any activity and not retain any investment not permissible for a national bank
and immediately repay any outstanding FHLB advances (subject to safety and
soundness considerations).
Under applicable regulations, any savings institution is a QTL if (i)
it qualifies as a domestic building and loan association under Section
7701(a)(19) of the Code (which generally requires that at least 60% of the
institution's assets constitute housing-related and other qualifying assets) or
(ii) at least 65% of the institution's "portfolio assets" (as defined) consist
of certain housing and consumer-related assets on a monthly average basis in at
least nine out of every 12 months. At December 1997, the Bank was in compliance
with the QTL test.
Restrictions on Capital Distributions. OTS regulations govern capital
distributions by savings associations, which include cash dividends, stock
redemptions or repurchases, cash-out mergers, interest payments on certain
convertible debt and other transactions charged to the capital account of a
savings association to make capital distributions. Generally, the regulation
creates a safe harbor for specified levels of capital distributions from
associations meeting at least their minimum capital requirements, so long as
such associations notify the OTS and receive no objection to the distribution
from the OTS. Savings institutions and distributions that do not qualify for the
safe harbor are required to obtain prior OTS approval before making any capital
distributions.
Generally, savings associations that before and after the proposed
distribution meet or exceed their fully phased-in capital requirements, or Tier
1 associations, may make capital distributions during any calendar year equal to
the higher of (i) 100% of net income for the calendar year-to-date plus 50% of
its "surplus capital ratio" at the beginning of the calendar year or (ii) 75% of
net income over the most recent four-quarter period. The "surplus capital ratio"
37
is defined to mean the percentage by which the association's ratio of total
risk-based capital to assets exceeds the ratio of its fully phased-in capital
requirement to assets. "Fully phased-in capital requirement" is defined to mean
an association's capital requirement under the statutory and regulatory
standards applicable on December 31, 1994, as modified to reflect any applicable
individual minimum capital requirement imposed upon the association.
Tier 2 associations (such as the Bank), which are associations that
before and after the proposed distribution meet or exceed their minimum capital
requirements, may make capital distributions during any calendar year up to 75%
of net income over the most recent four-quarter period.
In order to make distributions under these safe harbors, Tier 1 and
Tier 2 associations must submit written notice to the OTS 30 days prior to
making the distribution. The OTS may object to the distribution during that
30-day period based on safety and soundness concerns. In addition, a Tier 1
association deemed to be in need of more than normal supervision by the OTS may
be downgraded to a Tier 2 or Tier 3 association as a result of such a
determination.
Tier 3 associations, which are associations that do not meet current
minimum regulatory capital requirements, or that have capital in excess of
either their fully phased-in capital requirement or minimum capital requirement
but which have been notified by the OTS that they will be treated as Tier 3
associations because they are in need of more than normal supervision, cannot
make any capital distribution without obtaining OTS approval prior to making
such distributions.
The OTS has proposed to amend its capital distribution regulation to
bring such regulations into greater conformity with the other bank regulatory
agencies. Under the proposed regulation, certain savings associations would not
be required to file with the OTS. Specifically, savings associations that remain
at least adequately capitalized following a capital distribution, under the
proposed regulation, would not be subject to any requirement for notice or
application unless the total amount of all capital distributions, including any
proposed capital distribution, for the applicable calendar year would exceed an
amount equal to the savings association's net income for that year to date plus
the savings association's retained net income for the preceding two years.
Federal Home Loan Bank System. The Bank is a member of the FHLB of
Atlanta, which is one of 12 regional FHLBs that administers the home financing
credit function of savings associations. Each FHLB serves as a reserve or
central bank for its members within its assigned region. It is funded primarily
from proceeds derived from the sale of consolidated obligations of the FHLB
System. It makes loans to members (i.e., advances) in accordance with policies
and procedures established by the Board of Directors of the FHLB.
As a member, the Bank is required to purchase and maintain stock in the
FHLB in an amount equal to at least 1% of its aggregate unpaid residential
mortgage loans, home purchase contracts or similar obligations at the beginning
of each year. At December 31, 1997, the Bank had $1.4 million in FHLB stock,
which was in compliance with this requirement.
Federal Reserve System. The FRB requires all depository institutions to
maintain reserves against their transaction accounts (primarily NOW and Super
NOW checking accounts) and non-personal time deposits. At December 31, 1997, the
Bank was in compliance with applicable requirements. However, because required
38
reserves must be maintained in the form of vault cash or a noninterest-bearing
account at a Federal Reserve Bank, the effect of this reserve requirement is to
reduce an institution's earning assets.
Safety and Soundness. Effective August 9, 1995, the federal banking
regulatory agencies jointly implemented Interagency Guidelines Establishing
Standards for Safety and Soundness ("Guidelines") for all insured depository
institutions relating to internal controls, information systems and internal
audit systems, loan documentation, credit underwriting, interest rate risk
exposure, asset growth, compensation, fees and benefits, and employment
contracts and other compensation arrangements of executive officers, employees,
directors and principal stockholders of insured depository institutions that
would prohibit compensation and benefits and arrangements that are excessive or
that could lead to a material financial loss for the institution. In addition,
the federal banking regulatory agencies adopted asset quality and earnings
standards, which became effective October 1, 1996. If an insured depository
institution fails to meet any of its prescribed standards as described above, it
may be required to submit to the appropriate federal banking agency a compliance
plan specifying the steps that will be taken to cure the deficiency and the time
within which these steps will be taken. If an institution fails to submit an
acceptable plan or fails to implement the plan, the appropriate federal banking
agency will require the institution or holding company to correct the deficiency
and until corrected, may impose restrictions on the institution or holding
company, including any of the restrictions applicable under the prompt
corrective action provisions of FDICIA. At December 31, 1997, the Bank was in
compliance with the Guidelines.
Taxation
Federal Taxation. The Company and its subsidiaries are subject to those
rules of federal income taxation generally applicable to corporations under the
Code. The Company and its principal subsidiary, the Bank, as members of an
affiliated group of corporations within the meaning of Section 1504 of the Code,
file a consolidated federal income tax return, which has the effect of
eliminating or deferring the tax consequences of intercompany transactions and
distributions, including dividends, in the computation of consolidated taxable
income.
In addition to regular corporate income tax, corporations are subject
to an alternative minimum tax which generally is equal to 20% of alternative
minimum taxable income (taxable income, increased by certain tax preference
items and determined with adjustments to certain regular tax items). The
adjustments which are generally applicable include an amount equal to a
percentage of the amount by which a financial institution's adjusted current
earnings (generally alternative minimum taxable income computed without regard
to this adjustment and prior to reduction for alternative tax net operating
losses) exceeds its alternative minimum taxable income without regard to this
adjustment. Alternative minimum tax paid can be credited against regular tax due
in later years. See Note 14 of the Notes to Consolidated Financial Statements on
pages 44 and 45 of the 1997 Annual Report to Stockholders, which is attached
hereto as Exhibit 13 and incorporated herein by reference.
State Taxation. The Commonwealth of Virginia imposes a tax at the rate
of 6.0% on the combined "Virginia taxable income" of the Bank, EMC and its
subsidiaries. Virginia taxable income is equal to federal taxable income with
certain adjustments. Significant modifications include the subtraction from
federal taxable income of interest or dividends on obligations or securities of
the United States that are exempt from state income taxes, and a recomputation
of the bad debt reserve deduction on reduced modified taxable income.
39
Because consolidated or combined income tax returns are not allowed
under North Carolina law, the Bank and its subsidiaries that conduct business in
North Carolina are separately subject to an annual corporate income tax of 7.75%
of their federal taxable income as computed under the Code, subject to certain
prescribed adjustments. In addition to the state corporate income tax, the Bank
and its subsidiaries are subject to an annual state franchise tax, which is
imposed at a rate of .15% applied to the greater of the Company's and the Bank's
respective (i) capital stock, surplus, and undivided profits, (ii) investments
in tangible property in North Carolina; or (iii) appraised valuation of property
in North Carolina.
Furthermore, the Company is separately subject to income taxes and an
annual state franchise tax in Delaware.
[intentionally blank]
40
Item 2. Properties
The following table sets forth information with respect to offices of
the Company and its subsidiaries as of December 31, 1997.
Lease Date Total Net Book
Owned/ Expiration Date Acquired/ Office Value at
Location Leased Including Options Leased Square Ft. (1) 12/31/97 (2)
- -------- ------ ----------------- ------ -------------- ------------
The Company
Executive Office:
The Koger Center Leased 01/31/02 10/96 7,328 $ 26,121
Building 9, Suite 200
Norfolk, VA 23502
The Bank
Main Office:
400 W. Ehringhaus Street Owned - 11/78 3,805 201,750
Elizabeth City, NC 27906
Branch Offices:
520 South Main Street Owned - 05/86 6,517 685,326
Emporia, VA 23847
1401 Gaskins Road Leased 09/07/98 05/95 5,876 11,184
Richmond, VA 23233
1455 N. Main Street Leased (3) 12/31/99 09/95 1,200 -
Suffolk, VA 23434
Essex First
The Koger Center Leased 01/31/02 10/96 5,554 -
Building 9, Suite 200
Norfolk, VA 23502
1401 Gaskins Road Leased (4) 09/07/98 05/95 3,078 -
Richmond, VA 23233
2430 Southland Drive, 3rd Floor Leased 05/31/98 06/93 2,000 -
Chester, VA 23831
400 W. Ehringhaus Street Leased (4) - 07/94 750 -
Elizabeth City, NC 27906
Essex Home
2420 Virginia Beach Blvd. Leased 12/31/01 12/91 11,950 8,780
Virginia Beach, VA 23454
(1) Total office square feet excludes leased common area.
(2) Consists of the net book value of land and buildings if owned, or
leasehold improvements if leased.
(3) The Company has begun construction of a retail bank branch at a new
Suffolk, Virginia location. As of December 31, 1997, the land had a
carrying value of $215,000 and building construction-in-process had a
carrying value of $83,000. The Company has recognized an estimated lease
termination penalty of $28,000 during the year ended December 31, 1997.
The Company anticipates completion of construction in April 1998.
(4) Leased or subleased from the Bank.
Item 3. Legal Proceedings
The Company and its subsidiaries are involved in routine legal
proceedings occurring in the ordinary course of business which in the aggregate
are believed by management to be immaterial to the financial condition of the
Company.
41
As of December 31, 1997, the Company and the Bank were parties to
litigation pending in the Circuit Court of the City of Norfolk, Virginia under
the style of Roger E. Early v. Essex Bancorp, Inc., Essex Savings Bank, F.S.B.,
Home Bancorp, Inc. and Home Savings, F.S.B. (the "Early Litigation"). The
plaintiff in this action, Roger E. Early, was the former President and Chief
Executive Officer of Home Bancorp and Home Savings prior to the Home
Acquisition. Immediately prior to the Home Acquisition, Home Bancorp and Home
Savings terminated Mr. Early's Employment Agreement. Mr. Early claimed that the
Company and the Bank became liable for severance payments by operation of law
upon consummation of the Home Acquisition.
On February 13, 1998, all parties to the Early Litigation entered into
a Settlement and Agreement and Mutual Release whereby the Company agreed to pay
$136,500 to Mr. Early. This amount was recognized as an expense during the year
ended December 31, 1997. In addition, the Company agreed to pay its note
obligation to Mr. Early totaling $72,102 as of December 31, 1997, plus accrued
interest thereon, in its entirety in February 1998.
Item 4. Submission of Matters to a Vote of Security Holders
No matters were submitted to a vote of the stockholders of the Company
through the solicitation of proxies, or otherwise, during the fourth quarter of
the year ended December 31, 1997.
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
The Common Stock is currently traded on the American Stock Exchange
("AMEX") under the symbol "ESX." The information contained on page 56 of the
1997 Annual Report to Stockholders, which is attached hereto as Exhibit 13,
under the caption "Stock Price Information," is incorporated herein by
reference. As a company listed on the AMEX, the Company is subject to the AMEX
rules regarding continued listing, and does not fully satisfy those continued
listing guidelines. Accordingly, there can be no assurance that the listing of
the Common Stock on the AMEX will be continued. In this regard, however, the
Company believes that its recently improved operating results will favorably
impact the AMEX's evaluation.
As of March 25, 1998, there were 1,058,136 shares of Common Stock
outstanding, which were held by approximately 2,100 persons. The number of
persons holding shares of Common Stock reflects an estimate of the number of
persons or entities holding their stock in nominee or "street" name through
various brokerage firms or other entities.
Dividends
Neither the Company nor its predecessor (the Partnership) has declared
any capital distributions since the fourth quarter of 1991. The Company does not
anticipate the payment of dividends on the Common Stock in the foreseeable
future.
The Company's ability to pay dividends on the Common Stock will depend
primarily on the receipt of dividends from the Bank. While the Company and the
Bank are no longer operating under any supervisory agreements, the Bank must
seek a letter of nonobjection from the OTS prior to making dividend payments to
the Company.
42
In connection with the Home Acquisition, the Company issued 2,250,000
shares of nonvoting perpetual preferred stock with an aggregate redemption and
liquidation value of $15.0 million in exchange for all of the outstanding stock
of Home Bancorp. The preferred stock is redeemable at the option of the Company.
The 2,125,000 shares of Series B preferred stock bear a cumulative annual
dividend rate of 9.5% (based on redemption value) and the 125,000 shares of
Series C preferred stock bear a cumulative annual dividend rate of 8.0% (based
on redemption value). The Series C preferred stock is senior to Series B
preferred stock with respect to the payment of dividends, and the holders of the
Series C preferred stock may, in their discretion, from time to time in whole or
in part, elect to convert such shares of Series C preferred stock into a like
amount of Series B preferred stock. At December 31, 1997, dividends and accrued
interest thereon in arrears on the Series B and Series C preferred stock were
$3,289,386 and $160,992, respectively.
Also in connection with the Home Acquisition, the stockholders of Home
Bancorp received warrants to purchase 7,949,000 shares of Common Stock at a
price of $0.9375 per share, which was the price of the Common Stock as of June
30, 1995. The warrants are exercisable beginning in September 1998 and expire in
September 2005.
Item 6. Selected Financial Data
The selected financial data for the five years ended December 31, 1997,
which appears on page 3 of the 1997 Annual Report to Stockholders attached
hereto as Exhibit 13, is incorporated by reference in this Form 10-K Annual
Report.
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations
The information contained on pages 4 through 22 of the 1997 Annual
Report to Stockholders, which is attached hereto as Exhibit 13, under the
caption "Management's Discussion and Analysis of Financial Condition and Results
of Operations" is incorporated herein by reference.
Item 8. Financial Statements and Supplementary Data
The consolidated balance sheets of the Company as of December 31, 1997
and 1996 and the related consolidated statements of operations, shareholders'
equity and cash flows for each of the years in the three-year period ended
December 31, 1997, along with the related notes to consolidated financial
statements and the report of Price Waterhouse LLP, independent accountants, are
incorporated herein by reference from pages 23 through 55 of the Company's 1997
Annual Report to Stockholders, which is attached hereto as Exhibit 13.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Not applicable.
43
PART III
Item 10. Directors and Executive Officers of the Registrant
Information regarding the directors of the Company is included in the
Company's Proxy Statement for the Annual Meeting to be held on May 28, 1998
under the heading "Information with Respect to Continuing Directors," and the
information included therein is incorporated herein by reference.
Set forth below is information with respect to the executive officers
of the Company and its subsidiaries who do not serve as directors of the
Company.
Name Age Title
---- --- -----
Earl C. McPherson 44 President and Chief Executive Officer of
Essex First and Executive Vice President
of Loan Production and Secondary
Marketing of the Bank
Roy H. Rechkemmer, Jr. 35 Senior Vice President of Finance and Treasurer
of the Company and the Bank
Mary-Jo Rawson 44 Vice President and Chief Accounting
Officer of the Company and the Bank
Earl C. McPherson. Mr. McPherson presently serves as a director as well
as President and Chief Executive Officer of Essex First and as Executive Vice
President of Loan Production and Secondary Marketing of the Bank. Mr. McPherson
served as President of Essex Industrial Loan Association/Virginia Beach from
January 1992 through May 1992. From January 1990 through December 1991, Mr.
McPherson served as President of Mortgage Centers, Inc. ("MCI"). Prior to his
employment with MCI, Mr. McPherson served as Divisional, Regional, and Training
Director for Security Pacific Financial Services, Inc. Mr. McPherson has a
Bachelor of Arts from the University of Richmond. Mr. McPherson also attended
the American Financial Services Association Management program at the University
of North Carolina at Chapel Hill.
Roy H. Rechkemmer, Jr. Mr. Rechkemmer presently serves as Senior Vice
President of Finance and Treasurer of the Company and the Bank. Mr. Rechkemmer
also serves as chairman of the Bank's Asset and Liability Management Committee,
manager of the Bank's investment portfolio and administrator of the Bank's
branches. Mr. Rechkemmer received a Bachelor of Science Degree in Finance from
the University of Wisconsin-La Crosse in 1985. He has been employed by the Bank
and subsidiaries since 1987.
Mary-Jo Rawson. Ms. Rawson presently serves as Vice President and Chief
Accounting Officer of the Company and the Bank. Prior to her employment with the
Company, Ms. Rawson served in various accounting officer positions at
NationsBank Corporation and its predecessor institution C&S/Sovran. Ms. Rawson's
primary responsibilities emphasized regulatory reporting and accounting policies
and procedures. At the time of her departure from NationsBank in 1992, Ms.
Rawson was a Senior Vice President and the controller of the Bankcard Division.
Ms. Rawson received a Bachelor of Science Degree in Business Administration from
Old Dominion University in 1976.
Information regarding compliance with Section 16(a) of the Securities
Exchange Act is included in the Company's Proxy Statement for the Annual Meeting
44
to be held on May 28, 1998 under the heading "Compliance with Section 16(a) of
the Exchange Act," and the information included therein is incorporated herein
by reference.
Item 11. Executive Compensation
Information regarding compensation of executive officers and directors
is incorporated herein by reference to the Company's Proxy Statement for the
Annual Meeting to be held on May 28, 1998 under the headings "Directors Fees"
and "Executive Compensation."
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information regarding security ownership of certain beneficial owners
and management is included in the Company's Proxy Statement for the Annual
Meeting to be held on May 28, 1998 under the headings "Securities Ownership of
Certain Beneficial Owners" and "Information with Respect to Continuing
Directors," and the information included therein is incorporated herein by
reference.
Item 13. Certain Relationships and Related Transactions
Information regarding certain relationships and related transactions is
included in the Company's Proxy Statement for the Annual Meeting to be held on
May 28, 1998 under the heading "Transactions with Certain Related Persons," and
the information included therein is incorporated herein by reference.
45
PART IV
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) 1. Financial Statements:
Page in
Annual
Report*
-------
The following documents are filed as part of this report:
Report of Independent Accountants ................................. 23
Consolidated Balance Sheets at December 31, 1997
and 1996......................................................... 24
Consolidated Statements of Operations for the three
years ended December 31, 1997.................................... 26
Consolidated Statements of Shareholders' Equity for
the three years ended December 31, 1997.......................... 28
Consolidated Statements of Cash Flows for the three
years ended December 31, 1997.................................... 29
Notes to Consolidated Financial Statements.......................... 32
*Incorporated by reference from the indicated pages of the 1997
Annual Report to Stockholders.
The financial statements, together with the report thereon of
Price Waterhouse LLP dated February 18, 1998, appearing on
pages 23 through 55 of the accompanying 1997 Annual Report to
Stockholders are incorporated by reference in this Form 10-K
Annual Report. With the exception of the aforementioned
information and the information incorporated in Items 1, 6, 7
and 8, the 1997 Annual Report to Stockholders is not to be
deemed filed as part of this Form 10-K Annual Report.
2. Financial Statement Schedules:
All schedules are omitted because they are not required or are
not applicable or the required information is shown in the
consolidated financial statements or notes thereto.
46
3. Exhibits:
The following exhibits are either filed as part of
this Part IV or are incorporated herein by reference:
Exhibit No. Description
----------- -----------
3.1* Certificate of Incorporation of Essex Bancorp,
Inc., dated June 21, 1994. Filed as Exhibit 3.1 to
the Registrant's Form S-4 Registration Statement
under the Securities Act of 1933 as filed on
August 15, 1994.
3.2* Certificate of Amendment of Essex Bancorp, Inc.,
dated August 10, 1994. Filed as Exhibit 3.2 to the
Registrant's Form S-4 Registration Statement under
the Securities Act of 1933 as filed on August 15,
1994.
3.3* Bylaws of Essex Bancorp, Inc., effective July 25,
1994. Filed as Exhibit 3.3 to the Registrant's
Form S-4 Registration Statement under the
Securities Act of 1933 as filed on August 15,
1994.
4.1* Certificate of Designation of the Series A
Preferred Stock of Essex Bancorp, Inc. Filed as
Exhibit 4.1 to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1995.
4.2* Certificate of Designations of Cumulative
Perpetual Preferred Stock, Series B of Essex
Bancorp, Inc. Filed as Exhibit 4.1 to the
Registrant's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1995.
4.3* Certificate of Designations of Cumulative
Perpetual Preferred Stock, Series C of Essex
Bancorp, Inc. Filed as Exhibit 4.2 to the
Registrant's Quarterly Report on Form 10-Q for the
quarter ended September 30, 1995.
4.4* Form of Common Stock Purchase Warrant Certificate.
Filed as Exhibit 4.3 to the Registrant's Quarterly
Report on Form 10-Q for the quarter ended
September 30, 1995.
4.5* Specimen Common Stock Certificate of Essex
Bancorp, Inc. Filed as Exhibit 4.1 to the
Registrant's Pre-Effective Amendment No. 1 to Form
S-4 Registration Statement under the Securities
Act of 1933, as filed on October 12, 1994.
* Not filed herewith. In accordance with Rule 12b-32 of the General Rules and
Regulations under the Securities Exchange Act of 1934, reference is made to
the document previously filed with the Commission.
47
4.6* Specimen Series B 9.5% Cumulative Preferred Stock
Certificate of Essex Bancorp, Inc. Filed as
Exhibit 4.6 to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1995.
4.7* Specimen Series C 8% Cumulative Preferred Stock
Certificate of Essex Bancorp, Inc. Filed as
Exhibit 4.7 to the Registrant's Annual Report on
Form 10-K for the year ended December 31, 1995.
10.1 Essex Savings Bank, F.S.B. Supplemental Executive
Retirement Plan dated August 26, 1993. Filed as an
exhibit to this report.
10.2 First Amendment to the Essex Savings Bank, F.S.B.
Supplemental Executive Retirement Plan dated June
5, 1997. Filed as an exhibit to this report.
10.3 Second Amendment to the Essex Savings Bank, F.S.B.
Supplemental Executive Retirement Plan dated
November 1, 1997. Filed as an exhibit to this
report.
10.4* Fannie Mae/Freddie Mac/Private Investor Mortgage
Servicing Purchase and Sale Agreement by and
between Essex Mortgage Corporation and Chase Home
Mortgage Corporation dated June 8, 1993. Filed as
Exhibit 10.19 to Essex Financial Partners, L.P.'s
Annual Report on the Second Amended and Restated
Form 10-K for the year ended December 31, 1992.
10.5* Essex Bancorp, Inc. Non-Employee Directors Stock
Option Plan. Filed as Exhibit 10.18 to the
Registrant's Form 10-K for the year ended December
31, 1994.
10.6* First Amendment to the Essex Bancorp, Inc.
Non-Employee Directors Stock Option Plan dated
July 29, 1995. Filed as Exhibit 10.6 to the
Registrant's Annual Report on Form 10-K for the
year ended December 31, 1995.
10.7* Essex Bancorp, Inc. Stock Option Plan. Filed as
Exhibit 10.19 to the Registrant's Form 10-K for
the year ended December 31, 1994.
10.8* First Amendment to the Essex Bancorp, Inc. Stock
Option Plan dated June 29, 1995. Filed as Exhibit
10.8 to the Registrant's Annual Report on Form
10-K for the year ended December 31, 1995.
* Not filed herewith. In accordance with Rule 12b-32 of the General Rules and
Regulations under the Securities Exchange Act of 1934, reference is made to
the document previously filed with the Commission.
48
10.9* Second Amendment to the Essex Bancorp, Inc. Stock
Option Plan dated May 23, 1996. Filed as Exhibit
10.6 to the Registrant's Annual Report on Form
10-K for the year ended December 31, 1996.
10.10* Essex Bancorp, Inc. Employee Stock Purchase Plan.
Filed as Exhibit 10.20 to the Registrant's Form
10-K for the year ended December 31, 1994.
10.11* First Amendment to the Essex Bancorp, Inc.
Employee Stock Purchase Plan dated June 29, 1995.
Filed as Exhibit 10.10 to the Registrant's Annual
Report on Form 10-K for the year ended December
31, 1995.
10.12 Restated Employment Agreement dated January 1,
1998 by and among Essex Bancorp, Inc., Essex
Savings Bank, F.S.B., Essex Mortgage Corporation
and Gene D. Ross. Filed as an exhibit to this
report.
10.13 Restated Executive Services Agreement dated
January 1, 1998 by and among Essex Savings Bank,
F.S.B., Essex First Mortgage Corporation and Earl
C. McPherson. Filed as an exhibit to this report.
10.14* Branch Purchase and Deposit Assumption Agreement
between Essex Savings Bank, F.S.B. and Centura
Bank dated as of April 11, 1996. Filed as Exhibit
10.1 to the Registrant's Quarterly Report on Form
10-Q for the quarter ended March 31, 1996.
10.15* Branch Purchase and Deposit Assumption Agreement
between Essex Savings Bank, F.S.B. and CENIT Bank,
FSB dated as of July 2, 1996. Filed as Exhibit
10.1 to the Registrant's Current Report on Form
8-K dated July 3, 1996.
13 The 1997 Annual Report is attached as Exhibit 13.
Portions of the 1997 Annual Report are
incorporated by reference into this Form 10-K.
21* Subsidiaries of the Registrant. Filed as Exhibit
21 to the Registrant's Annual Report on Form 10-K
for the year ended December 31, 1995.
27 Financial Data Schedule.
* Not filed herewith. In accordance with Rule 12b-32 of the General Rules and
Regulations under the Securities Exchange Act of 1934, reference is made to
the document previously filed with the Commission.
49
(b) Reports on Form 8-K Filed in the Fourth Quarter of 1997
Not applicable.
(c) Exhibits
See Exhibit Index contained herein.
(d) Financial Statements Excluded from Annual Report to
Shareholders Pursuant to Rule 14a3(b)
Not applicable.
[intentionally blank]
50
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Essex Bancorp, Inc.
By: /s/ Gene D. Ross
--------------------------
Gene D. Ross
Chairman, President,
and Chief Executive
Officer
March 31, 1998
--------------
(Date)
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
Registrant and in the capacities and on the dates indicated.
By: /s/ Gene D. Ross March 31, 1998
- -------------------- --------------
Gene D. Ross (Date)
Chairman, President, Chief
Executive Officer and
Principal Financial Officer
By: /s/ Mary-Jo Rawson March 31, 1998
- ---------------------- --------------
Mary-Jo Rawson (Date)
Chief Accounting Officer
By: /s/ Roscoe D. Lacy, Jr. March 31, 1998
- --------------------------- --------------
Roscoe D. Lacy, Jr. (Date)
Director
By: /s/ Harry F. Radcliffe March 31, 1998
- -------------------------- --------------
Harry F. Radcliffe (Date)
Director
51
Exhibit Index
Exhibit No. Description
----------- -----------
3.1* Certificate of Incorporation of Essex Bancorp,
Inc., dated June 21, 1994.
3.2* Certificate of Amendment of Essex Bancorp, Inc.,
dated August 10, 1994.
3.3* Bylaws of Essex Bancorp, Inc., effective July 25,
1994.
4.1* Certificate of Designation of the Series A
Preferred Stock of Essex Bancorp, Inc.
4.2* Certificate of Designations of Cumulative
Perpetual Preferred Stock, Series B of Essex
Bancorp, Inc.
4.3* Certificate of Designations of Cumulative
Perpetual Preferred Stock, Series C of Essex
Bancorp, Inc.
4.4* Form of Common Stock Purchase Warrant Certificate
4.5* Specimen Common Stock Certificate of Essex
Bancorp, Inc.
4.6* Specimen Series B 9.5% Cumulative Preferred Stock
Certificate of Essex Bancorp, Inc.
4.7* Specimen Series C 8% Cumulative Preferred Stock
Certificate of Essex Bancorp, Inc.
10.1 Essex Savings Bank, F.S.B Supplemental Executive
Retirement Plan.
10.2 First Amendment to the Savings Bank, F.S.B
Supplemental Executive Retirement Plan.
10.3 Second Amendment to the Savings Bank, F.S.B
Supplemental Executive Retirement Plan.
10.4* Fannie Mae/Freddie Mac/Private Investor Mortgage
Servicing Purchase and Sale Agreement by and
between Essex Mortgage Corporation and Chase Home
Mortgage Corporation dated June 8, 1993.
* For exhibit reference see Item 14(c) for statement of location of exhibits
incorporated by reference.
E-1
10.5* Essex Bancorp, Inc. Non-Employee Directors Stock
Option Plan.
10.6* First Amendment to the Essex Bancorp, Inc.
Non-Employee Directors Stock Option Plan dated
July 29, 1995.
10.7* Essex Bancorp, Inc. Stock Option Plan.
10.8* First Amendment to the Essex Bancorp, Inc. Stock
Option Plan dated June 29, 1995.
10.9* Second Amendment to the Essex Bancorp, Inc. Stock
Option Plan dated May 23, 1996.
10.10* Essex Bancorp, Inc. Employee Stock Purchase Plan.
10.11* First Amendment to the Essex Bancorp, Inc.
Employee Stock Purchase Plan dated June 29, 1995.
10.12 Restated Employment Agreement dated January 1,
1998 by an among Essex Bancorp, Inc., Essex
Savings Bank, F.S.B., Essex Mortgage Corporation
and Gene D. Ross.
10.13 Restated Executive Services Agreement dated
January 1, 1998 by and among Essex Savings Bank,
F.S.B., Essex First Mortgage Corporation and Earl
C. McPherson.
10.14* Branch Purchase and Deposit Assumption Agreement
between Essex Savings Bank, F.S.B. and Centura
Bank dated as of April 11, 1996.
10.15* Branch Purchase and Deposit Assumption Agreement
between Essex Savings Bank, F.S.B. and CENIT Bank,
FSB dated as of July 2, 1996.
13 The 1997 Annual Report is attached as Exhibit 13.
Portions of the 1997 Annual Report are
incorporated by reference into this Form 10-K.
21* Subsidiaries of the Registrant, as updated.
27 Financial Data Schedule
* For exhibit reference see Item 14(c) for statement of location of exhibits
incorporated by reference.
E-2