EXHIBIT 13
ESSEX BANCORP, INC.
1997 ANNUAL REPORT
ESSEX BANCORP, INC.
Table of Contents
Page
----
Report to Our Stockholders 1
Five Year Financial Summary 3
Management's Discussion and Analysis 4
Report of Independent Accountants 23
Consolidated Financial Statements 24
Notes to Consolidated Financial Statements 32
Investor Information 56
Directors and Officers 57
Corporate Information 58
[LOGO]
BANCORP, INC.
MESSAGE TO OUR STOCKHOLDERS
To Our Stockholders:
In our past reports to our stockholders we have extensively chronicled the
problems of Essex Bancorp, Inc. (the "Company") and the many restructuring
activities that we have undergone. All of these efforts were undertaken to
better position the Company for growth and profitability. During 1997 our
investor base changed dramatically as a result of the volatility in the
Company's common stock. We surmise that such investors are more interested in
the potential of their investment rather than the history of the Company, which
is reflected in our current and previous public filings. It is important for you
to know that we are singularly focused on achieving profitability and looking
forward.
Following a material downsizing of the Company during 1996 through the sale of
nine non-strategic branches in three separate transactions, 1997 was a year of
improving our financial fundamentals, leveraging our capital with 17.5% deposit
growth in our retail branch banking franchise, reducing nonperforming assets by
36.8%, and increasing total assets by 11.9%, thereby better positioning
ourselves to be profitable in 1998.
In 1997 we began to execute many of the strategies that were developed out of
prior year strategic planning sessions and the work of the Strategic Evaluation
Committee. The fundamentals of the Company have changed dramatically since 1992
when combined losses from operations at Essex
1
Bancorp, Inc. for the five years through 1996 following the change in management
in 1992 amounted to $45.5 million. Our 1997 loss of $297,000 represents a major
improvement; however, we recognize that nothing short of profitability above and
beyond the amounts we must earn to cover the accruing dividends on our preferred
stock will be satisfactory. I encourage you to read the Management's Discussion
and Analysis of Financial Condition and Results of Operations in order to
enhance your perspective of the Company's performance during 1997.
1998 is a critical year in which we must achieve profitability and demonstrate
that we do have the ability to leverage our capital through growth, and achieve
sufficient returns for common and preferred shareholders. The outlook appears to
present many favorable market opportunities for us. We believe our mortgage
company can succeed in a lower rate environment in which mortgage production,
both residential and construction, should be active. Our servicing company has
the capacity to expand by attracting new subservicing contracts, and we believe
our costs are low and our pricing very competitive. Finally, with the April 1998
relocation of our Suffolk, Virginia branch into its newly constructed
full-service branch, we will have four excellent retail bank branch locations
that have growing market share in expanding markets. In view of the significant
consolidation of financial institutions in Virginia through merger, we are
reviewing opportunities to expand our banking franchise.
In summary, we believe Essex has accomplished a great deal and we have employees
who are capable and motivated to achieve much greater successes in 1998. The
management of the Company and the Board of Directors are committed to expanding
the business and achieving profitability. We appreciate your support and welcome
hearing from you.
/s/ Gene D. Ross
Gene D. Ross
President and CEO
Essex Bancorp, Inc.
March 31, 1998
2
FIVE YEAR FINANCIAL SUMMARY
(Dollars in Thousands, Except Per Share)
At or For the Year Ended December 31,
1997 1996 1995 1994 1993
---- ---- ---- ---- ----
BALANCE SHEET DATA:
Total assets......................... $195,088 $174,267 $338,724 $296,231 $390,958
Net loans ........................... 167,441 145,551 266,632 237,392 206,781
Deposits ........................... 153,927 131,033 283,497 222,462 328,781
Federal Home Loan Bank advances...... 23,547 25,690 29,833 58,952 41,661
Notes payable........................ 72 96 120 2,691 21,891
Shareholders' equity and total
partners' capital (deficit)........ 14,817 15,106 22,630 8,140 (4,950)
Nonperforming assets................. 3,298 5,215 11,257 13,652 18,090
Allowance for loan losses............ 2,382 2,556 5,251 3,429 3,039
OPERATIONS DATA:
Interest income...................... $ 14,547 $ 19,872 $ 22,547 $ 22,966 $ 27,727
Interest expense..................... 9,230 13,764 16,627 15,956 19,027
Net interest income.................. 5,317 6,108 5,920 7,010 8,700
Provision for loan losses............ 113 1,411 2,477 1,604 1,085
Noninterest income................... 2,463 4,282 3,172 4,068 7,372
Noninterest expense:
Amortization....................... 531 7,011 956 1,360 6,420
Other.............................. 7,433 9,345 9,814 15,619 17,048
Income (loss) before cumulative
effect of change in accounting
principle, extraordinary items,
and income taxes................... (297) (7,377) (4,155) (7,505) (8,481)
Cumulative effect of change in
accounting principle............... - - - 179 -
Extraordinary items, net of tax...... - - 2,945 (1) 20,416 (2) -
Net income (loss).................... (297) (7,377) (1,210) 13,090 (8,481)
Net income (loss) available to common
stockholders....................... (1,932) (8,824) (1,578) 13,090 (8,481)
Basic and diluted net loss per
common share (3)................... (1.83) (8.39) (1.50) - -
Pro forma basic and diluted net
income (loss) per common
share (3).......................... - - - 12.47 (8.08)
OTHER DATA:
Return on average assets............. (.16)% (2.73)% (.39)% (1) 3.88% (2) (2.12)%
Return on average capital............ (1.96)% (39.51)% (10.59)% (4) (4)
Average capital to average assets.... 8.13% 6.92% 3.67% (5) (5)
Net interest spread.................. 2.69% 2.20% 2.00% 2.46% 2.73%
Net interest margin.................. 3.01% 2.41% 2.01% 2.20% 2.34%
Nonperforming assets as a percent
of total assets at end of year..... 1.69% 2.99% 3.32% 4.61% 4.63%
Allowance for loan losses as a
percent of total loans at end
of year ........................... 1.40% 1.73% 1.93% 1.42% 1.45%
Net charge-offs as a percent of
average total loans................ .18% 1.89% .46% .55% .95%
Retail banking offices............... 4 4 12 8 11
(1) The Company recognized a $2.9 million extraordinary credit to earnings
related to the forgiveness of debt during 1995. The return on average
assets excluding the impact of this extraordinary item was (1.33)% for
the year ended December 31, 1995.
(2) The Company recognized a $20.4 million extraordinary credit (net of
income taxes) to earnings related to a litigation settlement during
1994. The return on average assets excluding the impact of this
extraordinary item was (2.17)% for the year ended December 31, 1994.
(3) The Company adopted Statement of Financial Accounting Standards No. 128
- Earnings Per Share during 1997 and has restated per share data
accordingly for all periods presented.
(4) Ratio exceeds (100.00)%.
(5) Ratio is less than 0.00%.
3
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Essex Bancorp, Inc. (the "Company") is a Delaware corporation that was
formed in 1994 to be the single thrift holding company for Essex Savings Bank,
F.S.B. (the "Bank"), a federally-chartered savings bank which operates four
branches in North Carolina and Virginia. The Company is the successor by merger
to Essex Financial Partners, L.P. (the "Partnership"), a Delaware limited
partnership which was formed in 1988 in order to acquire the former holding
company of the Bank. The Partnership and 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. In addition, the Company's
other principal operating subsidiaries are Essex First Mortgage Corporation
("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
Mortgage Servicing Corporation ("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. Essex Mortgage Corporation ("EMC") is also a direct subsidiary of the
Company that was formerly engaged in various mortgage banking activities and, at
December 31, 1997, held loans and other assets as a result of its past
activities.
In January 1996, the Company's Board of Directors formed a special
committee of the Board, the Strategic Evaluation Committee (the "Committee").
Although the Bank exceeded all regulatory capital requirements after the Bank's
acquisition of Home Bancorp, Inc. ("Home Bancorp") and its wholly-owned
subsidiary Home Savings Bank, F.S.B. ("Home Savings") on September 15, 1995 (the
"Home Acquisition"), the core operations of the Company since the Home
Acquisition had not been profitable and the retail banking branches acquired
from Home Savings required additional capital in order to be successful
full-service facilities. In early 1996, the Committee began exploring the
possible benefits of further expansion or contraction by branch sales. In May
1996, an independent consultant retained by the Company issued a report that
validated the Committee's conclusions 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 the
preferred shareholders of the Company. Accordingly, in addition to completing
the already-negotiated sales of the Bank's Charlotte, Raleigh, Greensboro and
Wilmington, North Carolina branches, the Company proceeded to negotiate the sale
of the Bank's Norfolk, Portsmouth, Hampton, Newport News and Grafton, Virginia
branches, which were completed during the last two quarters of 1996.
Collectively, the nine branches sold during 1996 are referred to as the
"Branches." The outcome of the strategy to downsize is that the Company has
retained the most strategic branches with the greatest potential for significant
market share growth, has achieved a "well capitalized" status for regulatory
capital purposes and has removed goodwill associated with the Home Acquisition
from its balance sheet. In addition, the Company's operating expenses in 1997
were reduced due to the elimination of the amortization of goodwill and the
operating expenses associated with the Branches.
As part of the Home Acquisition, 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 bearing
cumulative annual dividend rates of either 8% or 9.5%. Cumulative but undeclared
dividends and accrued interest thereon for the Series B and Series C preferred
stock approximated $3.5 million at December 31, 1997. The Bank's core and
risk-based regulatory capital ratios were 7.86% and 14.33%, respectively, at
December 31, 1997 resulting in excess core capital of $7.5 million and excess
risk-based capital of $7.4 million over the minimum regulatory requirements.
While management is of the opinion that capital compliance will be maintained
4
throughout 1998, until the Company's core profitability is restored, management
cannot provide assurances that compliance with all regulatory capital
requirements can be sustained beyond that horizon. Moreover, the Company's
losses and continuing inability to generate income sufficient to cover the
cumulative dividends on the Series B and C preferred stock will continue to
affect the equity of the holders of the Company's common and preferred stock.
The Committee will continue to evaluate strategic alternatives to enhance
shareholder value.
The following discussion and analysis of financial condition and
results of operations should also be read in conjunction with the "Five Year
Financial Summary" and the Consolidated Financial Statements and related Notes
included herein.
Financial Condition
General. Total assets of the Company at December 31, 1997 were $195.1
million as compared to $174.3 million at December 31, 1996, an increase of
approximately $20.8 million or 11.9%. The increase in assets was primarily
attributable to a $21.9 million increase in loans held for investment, which
reflected 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.
Cash and Cash Equivalents. Cash and cash equivalents (consisting of
cash, interest-bearing deposits in other banks, federal funds sold and
securities purchased under agreements to resell) increased by $4.8 million or
78.1% during 1997 due to the excess liquidity maintained at December 31, 1997 in
order to fund upcoming deposit maturities. In addition, the level of cash and
cash equivalents was lower at December 31, 1996 because a portion of the Bank's
excess liquidity had been used to complete the sale of the Branches during 1996.
Investment Securities. As a matter of policy, the Company generally
emphasizes lending activities (as opposed to investing activities) in order to
enhance the weighted average yield on its interest-earning assets and, thus, its
results of operations. Investment securities (including securities classified as
available for sale) consist of U.S. Government and agency obligations, Federal
Home Loan Bank ("FHLB") stock, and mutual fund investments. During the year
ended December 31, 1997, investment securities declined by $4.8 million or
56.2%. The decrease during 1997 was attributable to (i) the redemption of $1.2
million of FHLB stock resulting from the FHLB's policy regarding stock holdings
in excess of membership requirements, which limits any FHLB member's excess
stock to no more than $500,000 and (ii) the maturity of $4.0 million in U.S.
Treasury and U.S. government agency securities. Funds obtained from the decline
in investment securities were used to fund the acquisition of higher yielding
loans.
Mortgage-Backed Securities. Mortgage-backed securities increase the
credit quality of the Company's assets by virtue of the insurance or guarantees
of federal agencies that back them, generally require less capital under
risk-based regulatory capital requirements than non-insured or non-guaranteed
mortgage loans, are more liquid than individual mortgage loans, and may be used
to collateralize borrowings or other obligations of the Company. Because the
Company is emphasizing lending and the investment of the proceeds from the
maturities of securities into higher yielding loans, there were no new
investments in mortgage-backed securities in 1997.
Loans. Net loans (including loans classified as held for sale)
increased by $21.6 million or 14.6% during 1997 resulting from purchases of
adjustable-rate first mortgage loan portfolios totaling $22.2 million and
mortgage loan originations by Essex First. The Company relied on acquisitions of
adjustable-rate portfolios during 1997 because customer demand during the period
of low interest rates has emphasized fixed rate loans, which the Company sells
in the secondary market.
5
Nonperforming Assets. The Company's nonperforming assets, net of
specific reserves for collateral-dependent real estate loans ("CDRELs") and
foreclosed properties, decreased from $5.2 million at December 31, 1996 to $3.3
million at December 31, 1997, and consisted of the following (dollars in
thousands):
1997 1996
---- ----
% of % of
Total Total
Amount Loans Amount Loans
------ ----- ------ -----
Nonaccrual loans, net:
First and second mortgages................ $1,203 .71% $2,513 1.70%
Construction and development.............. 133 .08 220 .15
Commercial................................ 132 .08 22 .01
Consumer.................................. 88 .05 153 .10
Accruing loans 90 days or more past due..... 21 .01 30 .02
Troubled debt restructurings................ 209 .12 223 .15
------ --- ------ ---
Total nonperforming loans............... 1,786 1.05 3,161 2.13
Foreclosed properties, net.................. 1,512 .89 2,054 1.39
----- ----- ----- ----
Total nonperforming assets.............. $3,298 1.94% $5,215 3.52%
===== ==== ===== ====
Nonperforming assets to total assets........ 1.69% 2.99%
Nonperforming loans to total loans.......... 1.05 2.13
Allowance for loan losses to
total loans............................... 1.40 1.73
Allowance for loan losses to
nonaccrual loans.......................... 153.09 87.90
Allowance for loan losses to
nonperforming loans....................... 133.37 80.86
The decrease in nonperforming assets consisted of a $1.4 million
decline in nonperforming loans and a $542,000 decline in foreclosed properties.
The decrease in nonaccrual loans was attributable to the improvement in asset
quality evidenced by the decline in delinquencies from $1.5 million at December
31, 1996 to $940,000 at December 31, 1997. The decline in delinquent loans was
attributable to a decline in the number of delinquent residential mortgage loans
and the restructuring of a $288,000 loan secured by an apartment complex in
Suffolk, Virginia, which had been delinquent at December 31, 1996.
Gross interest income that would have been recognized for the years
ended December 31, 1997, 1996 and 1995 if nonaccrual loans at the respective
dates had been performing in accordance with their original terms approximated
$171,000, $291,000 and $678,000, respectively. The Company's future results of
operations will be favorably affected if it is able to achieve a further
reduction in nonperforming assets without incurring additional material losses.
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. The $1.5 million of foreclosed properties
included in nonperforming assets at December 31, 1997 is reported net of related
reserves totaling $155,000. In addition, approximately $334,000 of losses and
write-downs have been previously recognized on foreclosed properties held at
December 31, 1997.
6
The following table sets forth the types of properties which comprise
the Company's foreclosed properties (net of related reserves) at December 31 (in
thousands):
1997 1996
---- ----
Residential real estate development
projects $ 485 $ 390
Single-family residential real estate 770 1,300
Land and subdivisions 257 364
------ ------
$1,512 $2,054
===== =====
In addition to the $3.3 million of nonperforming assets at December 31,
1997, as of such date the Company had classified for regulatory purposes an
additional $1.8 million of assets (including accrued interest and advances and
net of specific loss reserves) based on a rating system adopted by the Company,
as compared to $5.2 million of nonperforming assets and $2.3 million of
classified assets at December 31, 1996. These classified loans evidence one or
more weaknesses or potential weaknesses and, depending on the regional economy
and other factors, may become nonperforming assets in future periods. There can
be no assurance that the regulatory examiners would agree with the Company's
classification of its assets.
Mortgage Servicing Rights and Loan Premiums. As of December 31, 1997
and 1996, the Company reported $1.2 million and $1.3 million, respectively, of
purchased and originated mortgage servicing rights (collectively, "MSRs") and
$668,000 and $565,000, respectively, of capitalized loan premiums. The increases
in MSRs and loan premiums were attributable to purchases of servicing rights and
adjustable-rate loan portfolios during 1997. The carrying value of the Company's
MSRs and loan premiums are dependent upon the cash flows from the underlying
mortgage loans and their carrying value may be impaired if prepayment activity
exceeds expectations. At December 31, 1997, no assurance can be made that
further significant amortization or impairment adjustments will not be necessary
with respect to the Company's MSRs or capitalized loan premiums if the lower
interest rate environment results in the acceleration of prepayment activity in
excess of expectations.
Deposits. Deposits, the primary source of the Company's funds,
increased by $22.9 million or 17.5% during the year ended December 31, 1997. The
increase in deposits was attributable to increases in money market accounts and
certificates of deposit. While deposits grew at each of the Bank's branches, the
most significant growth occurred at the Suffolk and Richmond, Virginia branches,
which experienced deposit growth of 49.4% and 35.8%, respectively. In addition,
because of the improvement in the Bank's overall financial condition, Essex Home
transferred a portion of its servicing escrow accounts from a nonaffiliated
financial institution to the Bank. This transfer was reflected in the increase
in noninterest-bearing deposits.
Borrowings. The Company's borrowings consist of advances from the FHLB
and notes payable. FHLB advances decreased by $2.1 million or 8.3% during the
year ended December 31, 1997 as a result of scheduled maturities. At December
31, 1997, the unused lendable collateral value for additional FHLB advances was
$20.9 million. The Company's notes payable totaled $72,000 and $96,000 at
December 31, 1997 and 1996, respectively, and consisted solely of a note payable
to the former president of Home Bancorp and Home Savings. In conjunction with a
severance settlement with the former employee, the Company repaid this note in
its entirety in February 1998.
Other Liabilities. As of December 31, 1997, other liabilities 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. For additional information about the Company's stock option plans,
see Note 19 of the Notes to Consolidated Financial Statements.
7
Shareholders' Equity. Total shareholders' equity at December 31, 1997
was $14.8 million, a decrease of $289,000 from shareholders' equity of $15.1
million at December 31, 1996. This change reflects the Company's net loss of
$297,000 for the year ended December 31, 1997, which is further described below.
As previously mentioned, the Series B and Series C preferred stock issued by the
Company in connection with the Home Acquisition has a stated value and
liquidation preference of $15.0 million, exclusive of cumulative but undeclared
dividends and accrued interest thereon of $3.5 million at December 31, 1997. To
the extent that the Company's income is not sufficient to cover the cumulative
dividends and accrued interest on the Series B and C preferred stock, the equity
of the Company's common shareholders will continue to decline. Accordingly, the
Company's Board of Directors and the Committee continue to evaluate
profitability enhancements and possibilities for corporate restructurings.
Results of Operations
Overview of Business Activity. The Company's results of operations
depend substantially on its net interest income, which is the difference between
interest income on interest-earning assets, primarily loans and investment
securities, and interest expense on interest-bearing liabilities, primarily
deposits and borrowings. Net interest income is also impacted by normal
amortization and impairment adjustments with respect to loan premiums. The
Company's results of operations are also significantly affected by provisions
for loan losses, resulting from the Company's assessment of the adequacy of the
allowance for loan losses; the level of its noninterest income, including loan
servicing and other fees and mortgage banking income; the level of its
noninterest expenses, such as salaries and employee benefits, net occupancy and
equipment costs, normal amortization and impairment adjustments with respect to
MSRs, deposit insurance premiums and expenses associated with the administration
of nonperforming and other classified assets.
The Company's major business segments consist of (i) attracting
deposits from the general public and using such deposits, together with
borrowings in the form of advances from the FHLB and other sources of funds, for
reinvestment in real estate mortgages, other loans, investments and
mortgage-backed securities (the "Retail Banking Segment"), and (ii) the
origination by Essex First of real estate mortgage loans for sale to third
parties with Essex Home providing servicing in certain instances (the "Mortgage
Banking Segment"). The Retail Banking Segment depends on the difference between
interest earned on loans and investments over interest paid on deposits and
borrowings to fund operating activities and generate a profit. Historically, the
Company's branch activities resulted in less reliance on deposit service charges
and other ancillary income. However, this strategy is in transition as the
Company moves to more traditional banking, albeit through a smaller community
branch network.
The Mortgage Banking Segment depends on gains from the sale of loans in
the secondary market and loan servicing income to fund operating expenses.
During the years ended December 31, 1997, 1996, and 1995, the predominant
percentage of loans originated for resale by the Company were sold on a
servicing released basis in order to recognize gains to supplement the core
capital of the Bank. The Mortgage Banking Segment also depends on the fees
generated by Essex Home in connection with its mortgage loan servicing
activities. As of December 31, 1997, the Company serviced approximately 5,500
loans totaling $354.2 million for nonaffiliated servicing clients.
See Note 23 of the Notes to Consolidated Financial Statements for the
mix of the major business segments based on the allocation of total revenue,
loss before income taxes, depreciation and amortization of premises and
equipment, and identifiable assets between the Retail Banking Segment and the
Mortgage Banking Segment. The segment information in Note 23 indicates a loss
before income taxes for the Mortgage Banking Segment for the year ended December
8
31, 1997. However, intersegment income received from the Retail Banking Segment
for loan servicing and loan originations has been eliminated from the Mortgage
Banking Segment's loss before income taxes and total revenue. If the Mortgage
Banking Segment did not perform these servicing and loan origination functions
for the Retail Banking Segment, the Company would incur costs associated with
third party processors and capitalized loan premiums.
General. The Company's net loss for the year ended December 31, 1997
totaled $297,000, compared to a net loss of $7.4 million for the year ended
December 31, 1996 and a net loss of $1.2 million for the year ended December 31,
1995. The Home Acquisition, which occurred on September 15, 1995, was accounted
for using the purchase method of accounting. Therefore, results of operations
for the year ended December 31, 1995 have not been restated to reflect the Home
Acquisition.
As detailed below, the Company's operating results for the year ended
December 31, 1996 included nonrecurring transactions associated with the sale of
the Branches. Excluding the impact of these transactions, the Company incurred a
net loss of $2.8 million during 1996 resulting in an effective $2.5 million
increase in operating results during the year ended December 31, 1997. This
improvement in operating results during 1997 reflected the impact of (i) an
increase in the net interest margin on interest earning assets, (ii) a $1.3
million decrease in the provision for loan losses resulting from a decline in
nonperforming assets and (iii) a decrease in noninterest expenses resulting from
the elimination of $1.7 million of operating expenses associated with the
Branches sold during 1996. These favorable impacts were partially offset by the
loss of net interest income on interest-earning assets sold in connection with
the sale of the Branches.
During 1996, the Company's operating results benefited from a $3.9
million total premium on deposits sold and a $216,000 gain on sale of premises
and equipment in connection with the sale of the Branches described in Note 5 of
the Notes to Consolidated Financial Statements. In addition, operating results
were favorably impacted by a $153,000 gain on sale of mortgage-backed securities
available for sale related to the sale of the Branches. However, the Company's
operating results were adversely impacted by a $1.0 million loss on the sale of
loans in connection with funding the sale of the Branches and a $7.8 million
write down in goodwill associated with the Branches. Excluding the impact of
these nonrecurring transactions, the Company incurred a net loss of $2.8 million
during 1996, which was a $1.4 million improvement over the $4.2 million loss
from continuing operations for the year ended December 31, 1995. This
improvement in 1996 was the result of a $1.1 million reduction in loan loss
provisions, a $188,000 increase in net interest income and a $294,000 reduction
in noninterest expense as a result of gains realized on the sale of foreclosed
properties.
During 1995, the Company's operating results benefited from the
recognition of income from extraordinary items attributable to $2.9 million of
debt forgiveness. Refer to Note 3 of the Notes to Consolidated Financial
Statements for a description of the components of these extraordinary items.
Exclusive of the nonrecurring income from extraordinary items during 1995, the
Company incurred a loss from continuing operations of $4.2 million for the year
ended December 31, 1995. Operating results benefited from a $500,000 settlement
with the Resolution Trust Corporation ("RTC") to satisfy the RTC's recourse
obligations as servicer of record for a balloon second mortgage loan portfolio
for which the Bank had previously established reserves in 1995. However, the
Company's operating results were adversely impacted by loan loss provisions of
$2.5 million and lower levels of net interest income and mortgage banking
income.
Net Interest Income. Net interest income totaled $5.3 million, $6.1
million and $5.9 million for the years ended December 31, 1997, 1996, and 1995,
respectively. In addition, the net interest margin was 3.01%, 2.41% and 2.01%
for the years ended December 31, 1997, 1996, and 1995, respectively. The
decrease from 1996 to 1997 in net interest income reflects the loss of net
interest income associated with assets and deposits sold in connection with the
sale of the Branches during 1996. However, the net interest margin on
9
interest-earning assets increased 60 basis points from 2.41% during 1996 to
3.01% during 1997 as a result of an increase in the ratio of interest-earning
assets to interest-bearing liabilities from 103.98% during 1996 to 106.13%
during 1997, along with an increase in the yield on loans from 8.08% during 1996
to 8.53% during 1997, which reflected the Bank's emphasis on investment in
adjustable-rate single-family residential loans. The net interest margin during
1997 also benefited from a decline in the Company's cost of funds resulting from
the generally lower interest rate environment during 1997 as compared to 1996.
Typically, declining interest rates favorably impact the Company's earnings due
to the repricing of deposits with shorter maturities as compared to
interest-earning assets, predominantly loans, which have either fixed interest
rates or interest rates that adjust over longer periods. However, in an extended
period of lower interest rates, the Company can also expect pressure on the net
interest margin resulting from an increase in the volume of refinancings to
lower fixed rate loans.
The increase from 1995 to 1996 in net interest income and the net
interest margin on interest-earning assets reflects the impact of improvement in
the ratio of interest-earning assets to interest-bearing liabilities, which
increased from 100.24% during 1995 to 103.98% during 1996. The most significant
factors impacting the improvement in net interest income were (i) the improved
yield on loans resulting from repricing of adjustable-rate mortgages while
interest rates paid on deposits remained constant and (ii) the reduction in
higher-costing FHLB advances and notes payable. Offsetting such improvements
were the impact of selling higher-yielding first mortgage loans and
mortgage-backed securities and maintaining excess liquidity in lower-yielding
interest earning assets in anticipation of funding the sales of the Branches.
The following table presents for the periods indicated the total dollar
amount of interest from average interest-earning assets and the resultant
yields, as well as the interest expense on average interest-bearing liabilities,
expressed both in dollars and rates, and the net interest margin. All average
balances are based on month-end balances adjusted for branch sales occurring at
or near the end of a month.
[intentionally blank]
10
1997 1996
-------------------------------- -------------------------------
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
(dollars in thousands)
Interest-earning assets:
Loans (1)...................... $159,370 $13,588 8.53% $221,215 $17,882 8.08%
Investment securities.......... 6,457 354 5.48 11,012 615 5.59
Mortgage-backed securities (2). 1,905 124 6.54 6,320 498 7.95
Federal funds sold and securities
purchased under agreements
to resell.................... 2,757 151 5.48 6,094 319 5.24
Other.......................... 6,024 330(3)
5.48 10,094 558(3) 5.38
-------- -------- -------- --------
Total interest-earning assets 176,513 14,547(3) 8.24 254,735 19,872(3) 7.80
Cash.............................. 2,065 3,083
Other, less allowance for loan losses 7,831 11,944
-------- --------
Total assets................... $186,409 $269,762
======= =======
Interest-bearing liabilities:
Time deposits.................. $111,394 6,381 5.73% $183,710 10,620 5.78%
Other deposits................. 29,584 1,298 4.39 33,218 1,325 3.99
-------- ------- -------- -------
Total deposits.............. 140,978 7,679 5.45 216,928 11,945 5.51
Notes payable.................. 96 9 9.50 113 11 9.50
FHLB advances.................. 24,885 1,474 5.92 27,137 1,626 5.99
Subordinated capital notes..... - - - 399 52 13.15
Other.......................... 360 68(4)18.29 405 130(4)18.32
--------- -------- ---------- -------- -
Total interest-bearing
liabilities.............. 166,319 9,230(4) 5.55 244,982 13,764(4) 5.60
------- ------
Demand deposits................... 3,143 1,433
Other............................. 1,795 4,675
--------- ---------
Total liabilities.............. 171,257 251,090
Redeemable preferred stock........ - -
Shareholders' equity.............. 15,152 18,672
-------- --------
Total liabilities and
shareholders' equity........ $186,409 $269,762
======= =======
Net interest earnings............. $ 5,317 $ 6,108
======= =======
Net interest spread (2)(3)(4)..... 2.69% 2.20%
==== ====
Net interest margin (2)(3)(4)(5).. 3.01% 2.41%
==== ====
Average interest-earning assets
to average interest-bearing
liabilities.................... 106.13% 103.98%
====== ======
1995
---------------------------------
Average Yield/
Balance Interest Rate
------- -------- ----
Interest-earning assets:
Loans (1)...................... $254,548 $19,779 7.77%
Investment securities.......... 14,694 836 5.69
Mortgage-backed securities (2). 16,991 1,286 7.57
Federal funds sold and securities
purchased under agreements
to resell.................... 4,011 280 6.98
Other.......................... 5,210 366(3) 6.69
--------- --------
Total interest-earning assets 295,454 22,547(3) 7.63
Cash.............................. 2,739
Other, less allowance for loan losses 13,242
--------
Total assets................... $311,435
=======
Interest-bearing liabilities:
Time deposits.................. $213,605 12,284 5.75%
Other deposits................. 32,084 1,221 3.81
-------- -------
Total deposits.............. 245,689 13,505 5.50
Notes payable.................. 1,360 131 9.61
FHLB advances.................. 46,617 2,798 6.00
Subordinated capital notes..... 621 73 11.78
Other.......................... 459 120(4)17.94
---------- --------
Total interest-bearing
liabilities.............. 294,746 16,627(4) 5.63
------
Demand deposits................... 1,285
Other............................. 3,365
----------
Total liabilities.............. 299,396
Redeemable preferred stock........ 615
Shareholders' equity.............. 11,424
--------
Total liabilities and
shareholders' equity........ $311,435
=======
Net interest earnings............. $ 5,920
=======
Net interest spread (2)(3)(4)..... 2.00%
====
Net interest margin (2)(3)(4)(5).. 2.01%
====
Average interest-earning assets
to average interest-bearing
liabilities.................... 100.24%
======
(1) Nonaccrual loans and loans classified as held for sale are included in the
average balance of loans.
(2) Calculation is based on historical cost balances of mortgage-backed
securities available for sale and does not give effect to changes in fair
value that are reflected as a component of shareholders' equity.
(3) Yield calculation in 1997, 1996, and 1995 includes the accretion of net
deferred loan fees and excludes $15,140 and $17,378 in 1996 and 1995,
respectively, which consists primarily of interest earned on custodial
accounts maintained for servicing investors.
(4) Rate calculation in 1997, 1996, and 1995 excludes $1,873, $56,004 and
$37,995, respectively, which consists primarily of interest paid on escrow
accounts.
(5) Net interest margin is net interest income divided by average
interest-earning assets.
11
The following table presents the extent to which changes in interest
rates and changes in volume of interest-related assets and liabilities have
affected the Company's interest income and expense during the periods indicated.
For each category of interest-earning assets and interest-bearing liabilities,
information is provided on changes attributable to (i) changes in volume (change
in volume multiplied by prior year rate), (ii) changes in rate (change in rate
multiplied by prior year volume), and (iii) total change in rate and volume. The
combined effect of changes in both rate and volume has been allocated
proportionately to the change due to rate and the change due to volume.
Increase (Decrease) From Increase (Decrease) From
1996 to 1997 Due to 1995 to 1996 Due to
------------------------------- -------------------------------
Rate Volume Net Rate Volume Net
---- ------ --- ---- ------ ---
(dollars in thousands)
Interest income on:
Loans (1) $934 $(5,228) $(4,294) $773 $(2,670) $(1,897)
Investment securities (11) (250) (261) (15) (206) (221)
Mortgage-backed securities (77) (297) (374) 62 (850) (788)
Federal funds sold and securities
purchased under agreements
to resell 14 (182) (168) (82) 121 39
Other interest-earning assets 9 (237) (228) (82) 274 192
---- ------- -------- ---- -------- ---------
Total interest income (2) 869 (6,194) (5,325) 656 (3,331) (2,675)
---- ------- -------- ---- -------- ---------
Interest expense on:
Time deposits (96) (4,143) (4,239) 64 (1,728) (1,664)
Other deposits 126 (153) (27) 60 44 104
Notes payable - (2) (2) (2) (118) (120)
FHLB advances (18) (134) (152) (5) (1,167) (1,172)
Subordinated capital notes (26) (26) (52) 8 (29) (21)
Other interest-bearing
liabilities - (62) (62) 20 (10) 10
---- ------- -------- ---- -------- ---------
Total interest expense (14) (4,520) (4,534) 145 (3,008) (2,863)
---- ------- -------- ---- -------- ---------
Net interest income $883 $(1,674) $ (791) $511 $ (323) $ 188
==== ======= ======== ==== ======== =========
(1) Includes loans classified as held for sale.
(2) Includes the amortization of premiums.
Provision for Loan Losses. The provision for loan losses represents the
charge against earnings that is required to fund the allowance for loan losses.
The level of the allowance for loan losses is determined by management of the
Company based upon its evaluation of the inherent risks within the Company's
loan portfolio. This evaluation consists of an ongoing analysis of individual
loans and the overall risk characteristics, size and composition of the loan
portfolio. The Company also considers, among other things, present and
prospective industry trends and regional and national economic conditions, past
estimates of loan losses as compared to actual losses, potential problems with
sizable loans, large loan concentrations and historical losses on loans. As
adjustments become identified through this ongoing managerial assessment, they
are reported in the earnings of the period in which they become known.
For the years ended December 31, 1997, 1996, and 1995, provisions for
loan losses amounted to $113,000, $1.4 million and $2.5 million, respectively.
The lower provision for loan losses during 1997 reflected the impact of the
improvement in asset quality. In addition, a $329,000 recovery on a loan
guarantee during 1997 was used to increase the loan loss allowance. The level of
the provision for loan losses during 1996 and 1995 was necessary to maintain the
allowance for loan losses at an adequate level after it was reduced by net
charge-offs of $4.1 million and $1.2 million, respectively. Net charge-offs
during 1997 totaled $288,000. The ratio of the allowance for loan losses to
12
total nonperforming loans was 133% at December 31, 1997, 81% at December 31,
1996 and 82% at December 31, 1995. In addition, the ratio of the allowance for
loan losses to total loans held for investment was 1.4% at December 31, 1997,
1.7% at December 31, 1996 and 1.9% at December 31, 1995.
Although management utilizes its best judgment in providing for
possible losses, there can be no assurance that the Company will not have to
increase its provision for loan losses in the future as a result of unforeseen
changes in the portfolio. Any such increase could adversely affect the Company's
results of operations. In addition, the Office of Thrift Supervision ("OTS"), as
an integral part of its regulatory examination process, periodically reviews the
Company's allowance for loan losses and the carrying value of its other
nonperforming assets. The OTS may require the Company to recognize additions to
its allowance for losses on loans and allowance for losses on foreclosed
properties based on the OTS's judgment about information available to it at the
time of its examination.
Noninterest Income. The following table sets forth information
regarding noninterest income for the years ended December 31:
1997 1996 1995
---- ---- ----
Loan servicing fees......................... $1,312,476 $1,665,768 $1,765,617
Mortgage banking income..................... 458,520 577,130 504,715
Other service charges and fees.............. 368,671 497,316 428,811
Net gain (loss) on sales of:
Securities............................. - 153,188 -
Loans.................................. (1,458) (1,018,185) 115,538
Deposits............................... - 1,940,010 -
Other....................................... 324,596 466,519 357,309
---------- ---------- ----------
$2,462,805 $4,281,746 $3,171,990
========= ========= =========
Total noninterest income amounted to $2.5 million during the year ended
December 31, 1997, a $1.8 million or 42.5% decrease from the $4.3 million
recognized during the year ended December 31, 1996. Noninterest income during
1997 included (i) an aggregate gain of $97,000 on the sale of the Bank's former
Newport News and Portsmouth, Virginia branch facilities, which had been vacant
since the sale of related deposits in September 1996 and (ii) termination fees
approximating $113,000 received in connection with the cancellation of Essex
Home's largest subservicing client's contract effective May 31, 1997.
Noninterest income in 1996 included the gains on sales of securities, deposits,
and premises and equipment, which totaled $2.3 million, associated with the sale
of the Branches, which were partially offset by a $1.0 million loss on loans
sold to partially fund the sale of the Branches. Exclusive of the impacts of
these transactions during 1997 and 1996, the effective decline in noninterest
income during the year ended December 31, 1997 was $738,000. This decline was
primarily attributable to (i) lower loan servicing fees resulting from
fluctuations in loan servicing volume including the impact of the subservicing
contract cancellation effective May 31, 1997, (ii) lower mortgage banking income
resulting from fewer loans originated for sale in the secondary market as Essex
First focused on expanding its construction lending programs and (iii) lower
service charges and fees resulting primarily from the Bank's sale of the
Branches during 1996.
Total noninterest income amounted to $4.3 million during the year ended
December 31, 1996, a $1.1 million or 35.0% increase from the $3.2 million
recognized during the year ended December 31, 1995. The increase resulted from
the gains on sales of securities, deposits and premises and equipment, which
totaled $2.3 million, associated with the sale of the Branches described in Note
5 of the Notes to Consolidated Financial Statements, which were partially offset
by a $1.0 million loss on loans sold to partially fund the sale of the Branches.
Exclusive of these transactions related to the sale of the Branches, noninterest
13
income decreased $181,000 during the year ended December 31, 1996, which
resulted from a $107,000 decrease in other noninterest income during 1996 and
the nonrecurrence of the $115,000 gain on sale of loans recognized during 1995
as a result of a loan sale required to ensure compliance with regulatory growth
restrictions in effect prior to the Home Acquisition.
Noninterest Expense. The following table sets forth information
regarding noninterest expense for the years ended December 31:
1997 1996 1995
---- ---- ----
Salaries and employee benefits.............. $3,788,695 $4,554,540 $ 4,387,760
Net occupancy and equipment................. 1,084,593 1,470,284 1,671,352
Deposit insurance premiums.................. 478,684 674,730 722,106
Amortization of intangible assets........... 530,707 7,011,288 956,257
Service bureau fees......................... 461,217 599,207 523,526
Professional fees........................... 349,218 507,031 476,224
Foreclosed properties, net.................. 182,880 (175,055) 187,715
Other....................................... 1,087,362 1,713,958 1,845,102
--------- ----------- -----------
$7,963,356 $16,355,983 $10,770,042
========= ========== ==========
Total noninterest expense amounted to $8.0 million during the year
ended December 31, 1997, a decrease of $8.4 million or 51.3% from the $16.4
million recognized during the year ended December 31, 1996. The sale of the
Branches during 1996 had a pervasive impact on noninterest expense. In addition
to the $5.9 million write down in the net asset value of certain of the sold
Branches, total noninterest expense associated with the sold Branches, including
normal amortization of goodwill, approximated $1.7 million during the year ended
December 31, 1996. Noninterest expense as a percent of average assets was 4.3%
for the year ended December 31, 1997, as compared to 3.9% (excluding the $5.9
million write down of goodwill) for the year ended December 31, 1996.
Salaries and employee benefits declined $766,000 or 16.8% during 1997.
This decrease resulted primarily from nonrecurring personnel expenses during
1996 totaling $367,000 associated with the sold Branches and the impact of the
Company's downsizing efforts, which resulted in a decline in the number of the
Company's full-time and part-time employees from 114 as of December 31, 1996 to
99 as of December 31, 1997. These decreases were partially offset by an $82,000
increase in compensation expense associated with certain of the Company's stock
options and a $136,500 severance settlement with the former president of Home
Bancorp and Home Savings.
Net occupancy and equipment expense declined $386,000 or 26.2% during
1997. This decrease resulted primarily from nonrecurring occupancy and equipment
expenses during 1996 totaling $227,000 associated with the sold Branches and the
relocation of the Company's corporate headquarters to a smaller more economical
facility. These decreases were partially offset by a $28,000 estimated lease
termination penalty in connection with the relocation of the Bank's Suffolk,
Virginia retail bank branch.
Deposit insurance premiums declined $196,000 or 29.1% during 1997. This
decrease reflects the reduction in the deposit assessment base resulting from
the sale of the Branches, as well as the improvement in the Bank's risk
classification for assessment purposes. Refer to "Regulatory Matters" below for
a discussion of matters impacting the Company's deposit assessment in the
future. Likewise, service bureau fees declined $138,000 or 23.0% during 1997.
This decrease was primarily attributable to the reduction in deposits which
occurred in connection with the sale of the Branches.
Amortization of intangible assets declined $6.5 million or 92.4% during
1997. This decrease was attributable to nonrecurring expense during 1996 arising
from the $541,000 amortization of goodwill and the $5.9 million write down of
goodwill associated with certain of the sold Branches.
14
Professional fees declined $158,000 or 31.1% during 1997. This decrease
was attributable to the cancellation of a consulting contract that had been
entered into in connection with the Home Acquisition.
Foreclosed properties expense increased $358,000 during 1997, which was
attributable to nonrecurring gains recognized in 1996 in connection with the
sale of the Bank's largest foreclosed property consisting originally of 2,554
acres of farmland located in Currituck, North Carolina and the sale of lots and
townhouse pads associated with a townhouse development in Richmond.
The significant components of other miscellaneous noninterest expense
for the years ended December 31, 1997 and 1996 are presented below:
Change
1997 1996 Amount Percent
---- ---- ------ -------
Loan expense....................... $ 150,457 $ 280,041 $(129,584) (46.3)%
Telephone.......................... 175,474 225,599 (50,125) (22.2)
Postage and courier................ 153,349 200,300 (46,951) (23.4)
Stationery and supplies............ 99,545 131,572 (32,027) (24.3)
Advertising and marketing.......... 155,654 185,191 (29,537) (15.9)
Corporate insurance................ 116,882 182,009 (65,127) (35.8)
Travel............................. 47,453 76,301 (28,848) (37.8)
Provision for servicing losses..... 24,000 26,000 (2,000) (7.7)
Other.............................. 164,548 406,945 (242,397) (59.6)
---------- ---------- --------
$1,087,362 $1,713,958 $(626,596) (36.6)
========= ========= ========
Total noninterest expense amounted to $16.4 million during the year
ended December 31, 1996, an increase of $5.6 million or 51.9% from the $10.8
million recognized during the year ended December 31, 1995. The largest portion
of the increase in noninterest expense was attributable to the $6.1 million
increase in the amortization of intangible assets. The Company recorded goodwill
of approximately $8.6 million in connection with the Home Acquisition, which was
being amortized on an accelerated basis over 15 years. For the year ended
December 31, 1996, normal amortization of this goodwill totaled $541,000. As a
result of the Bank's decision to sell certain of the branches acquired in the
Home Acquisition, the Bank recognized additional amortization of $5.9 million
during the second quarter of 1996. Exclusive of the write down of goodwill,
noninterest expense declined $294,000 during the year ended December 31, 1996.
The decline was primarily attributable to (i) a $201,000 decrease in net
occupancy and equipment expense resulting from the downsizing of the Company's
leased corporate facilities and the closure of Essex First's loan production
offices in Chesapeake and Manassas, Virginia and (ii) a $363,000 decrease in
foreclosed properties expense resulting from gains on the sale of foreclosed
properties. These declines were partially offset by a $167,000 increase in
salaries and employee benefits resulting from an increase in compensation
expense associated with certain of the Company's stock options.
15
The significant components of other miscellaneous noninterest expense
for the years ended December 31, 1996 and 1995 are presented below:
Change
1996 1995 Amount Percent
---- ---- ------ -------
Loan expense....................... $ 280,041 $ 208,747 $71,294 34.2%
Telephone.......................... 225,599 279,228 (53,629) (19.2)
Postage and courier................ 200,300 198,993 1,307 .7
Stationery and supplies............ 131,572 198,086 (66,514) (33.6)
Advertising and marketing.......... 185,191 237,628 (52,437) (22.1)
Corporate insurance................ 182,009 157,364 24,645 15.7
Travel............................. 76,301 80,682 (4,381) (5.4)
Provision for servicing losses..... 26,000 9,000 17,000 188.9
Other.............................. 406,945 475,374 (68,429) (14.4)
---------- ---------- ---------
$1,713,958 $1,845,102 $(131,144) (7.1)
========= ========= ========
Provision For Income Taxes. There was no income tax provision
recognized for financial reporting purposes during the years ended December 31,
1997, 1996, or 1995 because the Company has significant net tax operating loss
carryforwards, which approximated $19.9 million at December 31, 1997. Also,
until consistent profitability is demonstrated, deferred income tax assets
related to the Company's net tax operating loss carryforwards and temporary
differences will not be recognized. For additional information, see Note 14 of
the Notes to Consolidated Financial Statements.
Market Risk Management
The Bank, like other thrift institutions, is vulnerable to an increase
in interest rates to the extent that interest-bearing liabilities mature or
reprice more rapidly than interest-earning assets. The lending activities of
thrift institutions, including the Bank, have historically emphasized the
origination of long-term loans secured by single-family residences, and the
primary source of funds for such institutions has been deposits. The deposit
accounts of thrift institutions largely mature or are subject to repricing
within a short period of time. This factor, in combination with substantial
investments in long-term loans, has historically caused the income earned by
thrift institutions, including the Bank, on their loan portfolios to adjust more
slowly to changes in interest rates than their cost of funds. While having
liabilities that reprice more frequently than assets is generally beneficial to
net interest income in times of declining interest rates, such an
asset/liability mismatch is generally unfavorable during periods of rising
interest rates. To reduce the effect of adverse changes in interest rates on its
operations, the Bank has implemented the asset and liability management policies
described below.
The Bank has established an Asset and Liability Management Committee
that meets quarterly to structure and price the Bank's assets and liabilities in
order to maintain an acceptable interest rate spread while reducing the effects
of changes in interest rates.
The Bank's Asset and Liability Management Committee, following its
formation in 1992, implemented asset and liability management policies designed
to better match the maturities and repricing terms of the Bank's
interest-earning assets and interest-bearing liabilities in order to minimize
the adverse effects of material and prolonged increases in interest rates on the
Bank's results of operations. The Bank has undertaken a variety of strategies to
reduce its exposure to interest rate fluctuations, including (i) emphasizing
investment in adjustable-rate single-family residential loans ("ARMs") or
shorter-term (seven years or less), fixed-rate single-family residential loans;
(ii) selling longer-term (over seven years), fixed-rate single-family
residential loans in the secondary market; (iii) purchasing adjustable-rate
16
mortgage-backed securities; (iv) maintaining higher liquidity by holding
short-term investments and cash equivalents; and (v) increasing the average
maturity of the Bank's interest-bearing liabilities by utilizing long-term
advances and attempting to attract longer-term retail deposits.
The effect of interest rate changes on a financial institution's assets
and liabilities may be analyzed by examining the extent to which such assets and
liabilities are "interest rate sensitive" and by monitoring an institution's
interest rate sensitivity "gap." An asset or liability is said to be interest
rate sensitive within a specific time period if it will mature or reprice within
that time period. The interest rate sensitivity "gap" is defined as the
difference between interest-earning assets and interest-bearing liabilities
maturing or repricing within a given time period. A gap is considered positive
when the amount of interest rate sensitive assets exceeds the amount of interest
rate sensitive liabilities. A gap is considered negative when the amount of
interest rate sensitive liabilities exceeds interest rate sensitive assets.
During a period of falling interest rates, a positive gap would tend to
adversely affect net interest income, while a negative gap would tend to result
in an increase in net interest income. During a period of rising interest rates,
a positive gap would tend to result in an increase in net interest income while
a negative gap would tend to affect net interest income adversely.
The following table presents the difference between the Bank's
interest-earning assets and interest-bearing liabilities within specified
maturities at December 31, 1997. Data for this table was obtained from the FHLB
Interest Rate Risk Service Sensitivity Report, adjusted in some cases where
management was able to use more detailed information than was available to the
FHLB. Using the Bank's Thrift Financial Report, which details scheduled maturity
and interest rates, the FHLB applies asset prepayment rates and deposit
retention rates which management believes to be reasonable in determining the
interest rate sensitivity gaps. This table does not necessarily indicate the
impact of general interest rate movements on the Bank's net interest income
because the repricing of certain assets and liabilities is subject to
competition and other limitations. As a result, certain assets and liabilities
indicated as maturing or otherwise repricing within a stated period may in fact
mature or reprice at different times and at different volumes. In addition, the
following table presents information as of December 31, 1997 and is not
necessarily indicative of the Bank's interest rate sensitivity at any other
time.
[intentionally blank]
17
Anticipated Period Until Maturity or Repricing
---------------------------------------------------------------------------------
0 to 7 months 1-3 3-5 Over 5 Total % of
6 months to 1 year years years years Balance Total
-------- --------- ----- ----- ----- ------- -----
(dollars in thousands)
Interest-earning assets:
Loans receivable and
mortgage-backed securities:
First mortgage:
Adjustable-rate $ 32,586 $ 25,954 $ 8,088 $ 15,393 $ - $ 82,021 44.9%
Fixed-rate 5,638 5,069 15,857 16,854 21,698 65,116 35.6
Second mortgage 4,427 606 1,886 1,231 337 8,487 4.6
All other 7,046 1,303 5,153 21 339 13,862 7.6
Investments 12,947 - 299 - - 13,246 7.3
------ ----------- --------- ----------- ---------- -------- -----
Total 62,644 32,932 31,283 33,499 22,374 $182,732 100.0%
======= =====
Interest-bearing liabilities:
Deposits 66,980 33,183 36,512 10,992 5,345 $153,012 86.5
Fixed-rate borrowings 12,582 6,567 2,625 100 - 21,874 12.4
Variable-rate borrowings 2,000 - - - - 2,000 1.1
------- ----------- ----------- ----------- ---------- --------- ----
Total 81,562 39,750 39,137 11,092 5,345 $176,886 100.0%
======= =====
Effect of off-balance sheet
items (1) (7,782) 4,398 779 605 1,991
-------- -------- --------- --------- -------
Maturity gap $(26,700) $ (2,420) $ (7,075) $ 23,012 $19,020
======= ======== ======== ======= ======
Cumulative gap $(26,700) $(29,120) $(36,195) $(13,183) $ 5,837
======= ======= ======= ======= =======
Cumulative gap as a percent
of total assets (13.7)% (14.9)% (18.6)% (6.8)% 3.0%
===== ===== ===== ==== ===
Cumulative ratio of interest-
earning assets to interest-
bearing liabilities 76.8% 78.8% 79.1% 93.5% 103.3%
==== ==== ==== ==== =====
(1) Reflects the effect of entering into commitments with third parties to
originate and sell loans.
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 FHLB advances. The Company
will benefit from the lower cost of funds as these FHLB advances 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 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.
In addition to monitoring its interest rate sensitivity gap, the Bank
utilizes interest rate sensitivity analyses, as developed by the OTS, to measure
the changes in net portfolio value ("NPV"), expressed as a percentage of the
Bank's market value of assets, assuming certain percentage changes in interest
rates. NPV is the difference between incoming and outgoing discounted cash flows
from assets, liabilities, and off-balance sheet contracts. The following table
presents the Bank's NPV at December 31, 1997.
18
Net Portfolio Value NPV as % of PV of Assets
Change in ---------------------------------------- --------------------------
Interest Rates $ Amount $ Change % Change NPV Ratio Change
-------------- -------- -------- -------- --------- ------
+400bp $ 7,069 $(10,816) (60.48)% 3.86% (519)bp
+300bp 10,322 (7,563) (42.29) 5.51 (353)bp
+200bp 13,407 (4,477) (25.04) 7.01 (204)bp
+100bp 16,039 (1,846) (10.32) 8.23 (81)bp
Base Scenario 17,885 9.05
-100bp 18,779 894 5.00 9.41 36bp
-200bp 18,957 1,073 5.99 9.43 38bp
-300bp 19,395 1,510 8.44 9.57 52bp
-400bp 20,234 2,349 13.13 9.88 83bp
The Bank's Asset and Liability Management Committee has established
limits for the impact of changes in interest rates on NPV. As of December 31,
1997, the Bank is more at risk to rising interest rate environments than
declining interest rate environments, which reflects the Bank's
liability-sensitive position. As of December 31, 1997, the Bank is outside its
NPV policy limits for increases in interest rates of 200 basis points or more.
However, computation of prospective effects of hypothetical interest rate
changes are based on many assumptions, including relative levels of market
interest rates, loan prepayments and deposits decay. They should not be relied
upon as indicative of actual results. Further, the computations do not
contemplate certain actions management could undertake in response to change in
interest rates.
Liquidity and Commitments
Liquidity refers to the Company's ability to generate sufficient cash
to meet the funding needs of current loan demand, deposit withdrawals, and to
pay operating expenses. The Company generally has no significant source of
income other than dividends from its subsidiaries. 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 holding company.
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%.
The Bank monitors its liquidity in accordance with internal guidelines
and applicable regulatory requirements. The Bank's need for liquidity is
affected by loan demand and net changes in deposit levels. The Bank can minimize
the cash required during the times of strong loan demand by modifying its credit
policies or reducing its marketing efforts. Liquidity demand caused by net
reductions in deposits are usually caused by factors over which the Bank has
limited control. The Bank derives its liquidity from both its assets and
liabilities. Liquidity is derived from assets by receipt of interest and
principal payments and prepayments, by the ability to sell assets at market
prices and by utilizing assets as collateral for borrowings. Liquidity is
derived from liabilities by maintaining a variety of funding sources, including
deposits and advances from the FHLB.
The Bank's liquidity management is both a daily and long-term function
of funds management. Liquidity is generally invested in short-term investments
such as federal funds sold, certificates of deposit, and in U.S. Treasury and
U.S. Government agency securities of maturities of five years or less. If the
19
Bank requires funds which cannot be generated internally, borrowings from the
FHLB may provide an additional source of funds. At December 31, 1997, the Bank
had $23.5 million in outstanding borrowings from the FHLB. The Bank has not
relied upon brokered deposits as a source of new liquidity, and does not
anticipate a change in this practice in the foreseeable future.
The Bank anticipates that it will have sufficient funds available to
meet its current loan commitments. At December 31, 1997, the Bank had
outstanding commitments (including unused lines of credit) to originate and/or
purchase mortgage and non-mortgage loans of $404,000. Certificates of deposit
which are scheduled to mature within one year totaled $76.7 million at December
31, 1997, and borrowings from the FHLB that are scheduled to mature within the
same period amounted to $21.1 million. The undisbursed portions of Essex First's
construction builder loans and construction/permanent loans in process totaled
$2.9 million and $7.5 million, respectively, as of December 31, 1997.
Regulatory Capital
The Bank is required pursuant to the Financial Institutions Reform,
Recovery and Enforcement Act of 1989 ("FIRREA") and OTS regulations promulgated
thereunder to have (i) tangible capital equal to 1.5% of adjusted total assets,
(ii) core capital equal to 3.0% of adjusted total assets, and (iii) total
capital equal to 8.0% of risk-weighted assets. As of December 31, 1997, the
Bank's tangible and core capital amounted to 7.86% of adjusted total assets and
the Bank's total capital amounted to 14.33% of risk-weighted assets and,
consequently, the Bank was in compliance with its core and risk-based capital
requirements as of such date.
Furthermore, the federal regulations under the Federal Deposit
Insurance Corporation ("FDIC") Improvement Act of 1991 classify savings
institutions based on four separate requirements of specified capital as a
percent of the appropriate asset base: tangible equity, Tier I core capital,
Tier I risk-based capital, and total risk-based capital. At December 31, 1997,
the Bank's Tier I core, Tier I risk-based, and total risk-based capital ratios
were 7.86%, 13.08%, and 14.33%, respectively, compared to the minimum capital
standards to be "well capitalized" under the FDIC Improvement Act of 1991
("FDICIA") of =>5%, =>6%, and =>10%, respectively. As a result, the dollar
amount of the excess in the Bank's Tier I core, Tier I risk-based, and
risk-based regulatory capital under FDICIA totaled $5.6 million, $8.3 million,
and $5.1 million, respectively, at December 31, 1997.
Deposits of the Bank are currently insured by the Savings Association
Insurance Fund ("SAIF"). 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 has 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
to recapitalize the SAIF. Pursuant to this legislation, the FDIC promulgated a
20
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 will continue to pay 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 in effect for "well capitalized" savings
institutions).
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 requires 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. In addition, although a merger of the insurance funds will not
become effective until 1999, insured depository institutions began paying in
1997 a portion of the interest due annually on the Financing Corporation
("FICO") bonds issued in the 1980s to provide funding for the SAIF. Accordingly,
an additional assessment approximating 6.4 basis points is added to the regular
SAIF-assessment until December 31, 1999 in order to cover FICO debt service
payments.
Year 2000 Costs
As the millennium approaches, a company-wide task force has been
assembled to assess business risks associated with the Year 2000. These risks
arise primarily from the inability of older computer software systems to
properly recognize the year 2000 because of a predominant convention within
computer programs to shorten dates to the last two digits of any year.
Accordingly, the Company will review all internal systems and operations, as
well as strategic relationships with others (i.e., service bureaus for deposit
processing and loan servicing, forms vendors, commercial borrowers), to ensure
that any malfunction as a result of the Year 2000 will not critically impair the
Company's ability to deliver products and services to its business partners. As
a result of this assessment, the Company expects to both replace some systems
and upgrade some others. The Company is utilizing both internal and external
resources to identify, correct or reprogram and test the systems for Year 2000
compliance. It is anticipated that all reprogramming and replacement efforts
will be complete by December 31, 1998, allowing adequate time for testing and
contingency plan implementation as needed. The total cost of the project is
estimated to be $350,000 and is being funded through operating cash flows.
Maintenance or modification costs will be expensed as incurred, while the costs
of new hardware and software will be capitalized and amortized over their useful
lives. Management believes that most of the capitalized costs are associated
with technology changes that will enable the Company to provide competitive
services. The expenses incurred during the year ended December 31, 1997 were not
material. Management believes the Company can incur these costs without
adversely affecting future operating results. However, because of the complexity
of the issue and possible unidentified risks, actual costs may vary from the
estimate. Management has discussed its assessment and plans with the Board of
Directors. In addition, the OTS will periodically perform evaluations of the
Company's Year 2000 readiness.
Safe Harbor Statement under the Private Securities Litigation Reform Act of 1995
The above discussion contains certain forward-looking statements that
involve potential risks and uncertainties. The Company's future results could
differ materially from those discussed herein. Readers should not place undue
reliance on these forward-looking statements, which are applicable only as of
the date hereof.
21
Quarterly Results of Operations
Quarterly unaudited financial data for the years ended December 31,
1997 and 1996 is presented below (dollars in thousands, except per unit data).
Year Ended December 31, 1997
-------------------------------------------------------------
1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Net interest income $1,212 $1,367 $1,353 $1,385
Provision for loan losses (22) 107 30 (1)
------- ------ ------ -------
Net interest income after
provision for loan losses 1,234 1,260 1,323 1,386
Noninterest income 603 806 521 532
Noninterest expenses 1,819 1,676 2,335 2,131
----- ----- ----- -----
Net income (loss) $ 18 $ 390 $ (491) $ (213)
======= ====== ===== =====
Net loss available to common
stockholders $ (378) $ (14) $ (903) $ (638)
====== ======= ===== =====
Basic and diluted net loss per
common share $ (.36) $ (.01) $ (.85) $ (.60)
====== ======= ===== =====
Year Ended December 31, 1996
-------------------------------------------------------------
1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Net interest income $1,767 $ 1,651 $1,477 $1,213
Provision for loan losses - 803 575 33
--------- ------- ------ -------
Net interest income after
provision for loan losses 1,767 848 902 1,180
Noninterest income 2,007 682 833 760
Noninterest expenses 3,178 9,047 2,488 1,643
----- ------ ----- -----
Net income (loss) $ 596 $(7,517) $ (753) $ 297
====== ====== ====== ======
Net income (loss) available to
common stockholders $ 243 $(7,870) $(1,107) $ (90)
====== ====== ====== =======
Basic net income (loss) per
common share $ .23 $ (7.49) $ (1.05) $ (.09)
======= ======= ====== =======
Diluted net income (loss) per
common share equivalent $ .04 $ (7.49) $ (1.05) $ (.09)
======= ======= ====== =======
22
Report of Independent Accountants
February 18, 1998
To the Board of Directors and Shareholders of
Essex Bancorp, Inc.
In our opinion, the accompanying consolidated balance sheets and the related
consolidated statements of operations, of shareholders' equity, and of cash
flows present fairly, in all material respects, the financial position of Essex
Bancorp, Inc. and its subsidiaries at December 31, 1997 and 1996, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1997, in conformity with generally accepted
accounting principles. These financial statements are the responsibility of the
Company's management; our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these
statements in accordance with generally accepted auditing standards which
require that we plan and perform the audit to obtain reasonable assurance about
whether the financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements, assessing the accounting principles
used and significant estimates made by management, and evaluating the overall
financial statement presentation. We believe that our audits provide a
reasonable basis for the opinion expressed above.
PRICE WATERHOUSE LLP
23
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 1997 and 1996
1997 1996
---- ----
ASSETS
Cash..................................................................... $ 2,023,197 $ 1,824,160
Interest-bearing deposits................................................ 6,261,686 1,727,091
Federal funds sold and securities purchased under agreements to resell... 2,748,000 2,644,000
------------ ------------
Cash and cash equivalents....................................... 11,032,883 6,195,251
Federal Home Loan Bank stock............................................. 1,431,000 2,540,000
Securities available for sale - cost approximates market................. 17,451 9,162
Securities held for investment - market value of $2,217,000 in 1997
and $5,890,000 in 1996................................................. 2,299,120 6,003,219
Mortgage-backed securities held for investment - market value of
$1,886,000 in 1997 and $1,869,000 in 1996.............................. 1,904,989 1,905,327
Loans, net of allowance for loan losses of $2,382,000 in 1997 and
$2,556,000 in 1996..................................................... 167,440,733 145,550,845
Loans held for sale...................................................... 2,165,074 2,462,525
Mortgage servicing rights................................................ 1,169,766 1,349,160
Foreclosed properties, net............................................... 1,511,629 2,054,213
Accrued interest receivable.............................................. 1,196,980 1,147,933
Excess of cost over net assets acquired, less accumulated
amortization of $2,078,000 in 1997 and $2,016,000 in 1996.............. 159,754 221,815
Advances for taxes, insurance, and other................................. 633,053 790,928
Premises and equipment, net.............................................. 1,926,729 2,485,122
Other assets............................................................. 2,198,598 1,551,352
------------ ------------
Total Assets.................................................... $195,087,759 $174,266,852
============ ============
(Continued)
24
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (continued)
December 31, 1997 and 1996
1997 1996
---- ----
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest-bearing.................................................... $ 5,055,545 $ 1,070,037
Interest-bearing....................................................... 148,871,154 129,963,341
------------ ------------
Total deposits.................................................. 153,926,699 131,033,378
Federal Home Loan Bank advances.......................................... 23,546,667 25,690,000
Notes payable............................................................ 72,102 96,142
Capital lease obligations................................................ 331,970 385,251
Mortgages payable on foreclosed properties............................... - 10,391
Other liabilities........................................................ 2,393,814 1,945,988
------------- -------------
Total Liabilities............................................... 180,271,252 159,161,150
Commitments and contingencies
SHAREHOLDERS' EQUITY
Series B preferred stock, $6.67 stated value (Note 18):
Authorized shares - 2,250,000
Issued and outstanding shares - 2,125,000 in 1997 and 1996............. 14,173,750 14,173,750
Series C preferred stock, $6.67 stated value (Note 18):
Authorized shares - 125,000
Issued and outstanding shares - 125,000 in 1997 and 1996............... 833,750 833,750
Common stock, $.01 par value:
Authorized shares - 10,000,000
Issued and outstanding shares - 1,058,136 in 1997 and 1,053,379
in 1996............................................................. 10,581 10,534
Additional paid-in capital............................................... 8,681,739 8,674,333
Accumulated deficit...................................................... (8,883,313) (8,586,665)
------------ ------------
Total Shareholders' Equity...................................... 14,816,507 15,105,702
------------ ------------
Total Liabilities and Shareholders' Equity...................... $195,087,759 $174,266,852
============ ============
See notes to consolidated financial statements.
25
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 1997, 1996 and 1995
1997 1996 1995
---- ---- ----
INTEREST INCOME
Loans, including fees............................ $13,588,215 $17,881,529 $19,778,781
Federal funds sold and securities purchased
under agreements to resell..................... 150,972 319,298 279,909
Investment securities, including dividend
income......................................... 353,957 615,429 836,637
Mortgage-backed securities....................... 124,515 497,879 1,285,889
Other............................................ 329,846 558,139 365,821
---------- ---------- ----------
Total Interest Income................... 14,547,505 19,872,274 22,547,037
---------- ---------- ----------
INTEREST EXPENSE
Deposits ........................................ 7,679,314 11,945,273 13,504,940
Federal Home Loan Bank advances.................. 1,473,949 1,625,574 2,797,688
Notes payable.................................... 9,079 10,750 130,705
Subordinated capital notes....................... - 52,444 73,183
Other............................................ 67,793 130,297 120,284
---------- ---------- ----------
Total Interest Expense.................. 9,230,135 13,764,338 16,626,800
---------- ---------- ----------
Net Interest Income..................... 5,317,370 6,107,936 5,920,237
PROVISION FOR LOAN LOSSES............................ 113,467 1,410,710 2,476,903
---------- ---------- ----------
Net Interest Income After
Provision for Loan Losses............... 5,203,903 4,697,226 3,443,334
NONINTEREST INCOME
Loan servicing fees.............................. 1,312,476 1,665,768 1,765,617
Mortgage banking income, including
gain on sale of loans.......................... 458,520 577,130 504,715
Other service charges and fees................... 368,671 497,316 428,811
Net gain (loss) on sale of:
Securities..................................... - 153,188 -
Loans.......................................... (1,458) (1,018,185) 115,538
Deposits....................................... - 1,940,010 -
Other............................................ 324,596 466,519 357,309
---------- ---------- ----------
Total Noninterest Income................ 2,462,805 4,281,746 3,171,990
---------- ---------- ----------
(Continued)
26
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (continued)
For the years ended December 31, 1997, 1996 and 1995
1997 1996 1995
---- ---- ----
NONINTEREST EXPENSE
Salaries and employee benefits................... 3,788,695 4,554,540 4,387,760
Net occupancy and equipment...................... 1,084,593 1,470,284 1,671,352
Deposit insurance premiums....................... 478,684 674,730 722,106
Amortization of intangible assets................ 530,707 7,011,288 956,257
Service bureau fees.............................. 461,217 599,207 523,526
Professional fees................................ 349,218 507,031 476,224
Foreclosed properties, net....................... 182,880 (175,055) 187,715
Other............................................ 1,087,362 1,713,958 1,845,102
----------- ----------- -----------
Total Noninterest Expense............... 7,963,356 16,355,983 10,770,042
----------- ---------- ----------
Loss Before Extraordinary
Items and Income Taxes.................. (296,648) (7,377,011) (4,154,718)
PROVISION FOR INCOME TAXES........................... - - -
EXTRAORDINARY ITEMS - FORGIVENESS
OF DEBT ........................................ - - 2,945,064
----------- ----------- -----------
Net Loss................................ $ (296,648) $(7,377,011) $(1,209,654)
=========== ========== ==========
Loss before extraordinary items available
to common shareholders (Note 2)............... $(1,932,136) $(8,823,879) $(4,522,740)
Extraordinary items.............................. - - 2,945,064
----------- ----------- -----------
Net loss available to common shareholders........ $(1,932,136) $(8,823,879) $(1,577,676)
=========== =========== ===========
Basic and diluted income (loss) per common share (Note 2):
Loss before extraordinary item................ $(1.83) $(8.39) $(4.31)
Extraordinary items........................... - - 2.81
----------- ----------- -----------
Net loss...................................... $(1.83) $(8.39) $(1.50)
=========== =========== ===========
See notes to consolidated financial statements.
27
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the years ended December 31, 1997, 1996 and 1995
Series B Series C
Common Preferred Preferred Additional
Stock, $.01 Stock, $6.67 Stock, $6.67 Paid-in Accumulated
Par Value Stated Value Stated Value Capital Deficit
--------- ------------ ------------ ------- -------
Transfer of partners' capital in
connection with the merger of
Essex Financial Partners, L.P.
into Essex Bancorp, Inc................ $10,497 $ - $ - $8,129,135 $ -
Issuance of preferred stock in connection
with the merger of Home Bancorp, Inc.
and Essex Bancorp, Inc................. - 14,173,750 833,750 538,000 -
Net increase in holding gain on
securities available for sale.......... - - - - -
Net loss.................................. - - - - (1,209,654)
------- ----------- --------- ---------- -----------
Balance, December 31, 1995................ 10,497 14,173,750 833,750 8,667,135 (1,209,654)
Common stock issued under the
Employee Stock Purchase Plan........... 37 - - 7,198 -
Net decrease in holding gain on
securities available for sale.......... - - - - -
Net loss.................................. - - - - (7,377,011)
------- ----------- --------- ---------- -----------
Balance December 31, 1996................. 10,534 14,173,750 833,750 8,674,333 (8,586,665)
Common stock issued under the
Employee Stock Purchase Plan........... 47 - - 7,406 -
Net loss.................................. - - - - (296,648)
------- ----------- --------- ---------- -----------
Balance, December 31, 1997................ $10,581 $14,173,750 $833,750 $8,681,739 $(8,883,313)
======= =========== ======== ========== ===========
Holding Gain
on Securities
Available
for Sale Total
-------- -----
Transfer of partners' capital in
connection with the merger of
Essex Financial Partners, L.P.
into Essex Bancorp, Inc................ $ - $ 8,139,632
Issuance of preferred stock in connection
with the merger of Home Bancorp, Inc.
and Essex Bancorp, Inc................. - 15,545,500
Net increase in holding gain on
securities available for sale.......... 154,174 154,174
Net loss.................................. - (1,209,654)
---------- -----------
Balance, December 31, 1995................ 154,174 22,629,652
Common stock issued under the
Employee Stock Purchase Plan........... - 7,235
Net decrease in holding gain on
securities available for sale.......... (154,174) (154,174)
Net loss.................................. - (7,377,011)
---------- -----------
Balance December 31, 1996................. - 15,105,702
Common stock issued under the
Employee Stock Purchase Plan........... - 7,453
Net loss.................................. - (296,648)
---------- -----------
Balance, December 31, 1997................ $ - $14,816,507
========== ===========
See notes to onsolidated financial statements.
28
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 1997, 1996 and 1995
1997 1996 1995
---- ---- ----
OPERATING ACTIVITIES
Net loss.................................................. $ (296,648) $ (7,377,011) $ (1,209,654)
Adjustments to reconcile net loss to cash
provided by (used in) operating activities:
Forgiveness of debt before income taxes................. - - (2,945,064)
Provision for:
Losses on loans, foreclosed properties, and
servicing...................................... 296,808 1,415,365 2,565,297
Depreciation and amortization of premises
and equipment.................................. 419,829 538,561 490,249
Amortization (accretion) of:
Premiums and discounts on loans, investments
and mortgage-backed securities............... 77,038 211,642 376,334
Mortgage servicing rights...................... 468,647 528,444 580,295
Excess of costs over net assets acquired....... 62,061 6,482,843 375,962
Other.......................................... - (94,399) (27,576)
Mortgage banking activities:
Proceeds from loan sales........................... 40,717,559 56,311,191 50,828,101
Loan originations and purchases.................... (39,725,806) (54,961,912) (52,881,403)
Realized gains from sale of loans.................. (414,902) (548,744) (492,493)
Realized (gains) and losses from sales of:
Mortgage-backed securities available for sale...... - (153,188) -
Loans.............................................. 1,458 1,018,185 (115,538)
Deposits........................................... - (1,940,011) -
Other.............................................. (185,283) (599,062) (64,021)
Changes in operating assets and liabilities
exclusive of business acquisitions:
Accrued interest receivable.................... (49,047) 1,000,846 200,354
Other assets................................... (513,371) 325,152 372,536
Other liabilities.............................. 453,828 483,325 (771,319)
------------ ------------ -----------
Net cash provided by (used in) operating activities....... 1,312,171 2,641,227 (2,717,940)
------------ ------------ -----------
(Continued)
29
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
For the years ended December 31, 1997, 1996 and 1995
1997 1996 1995
---- ---- ----
INVESTING ACTIVITIES
Purchase of certificates of deposit in other
financial institutions................................ (5,000,000) (17,000,000) -
Proceeds from maturities of certificates of deposit
in other financial institutions....................... 5,000,000 17,000,000 -
Purchase of Federal Home Loan Bank stock.................. (95,800) - -
Redemption of Federal Home Loan Bank stock................ 1,204,800 1,062,800 1,823,100
Purchase of securities held to maturity................... (298,406) (1,020,625) -
Proceeds from maturities of securities held to maturity... 4,000,000 3,000,000 3,000,000
Purchase of securities available for sale................. (2,508,289) (5,165,516) (9,240,201)
Proceeds from sale of securities available for sale....... 2,500,000 6,650,000 8,575,000
Principal remittances on mortgage-backed securities....... - - 2,723,925
Principal remittances on mortgage-backed securities
available for sale.................................... - 990,065 -
Proceeds from sales of mortgage-backed securities
available for sale.................................... - 10,068,189 -
Purchases of loans........................................ (22,224,143) - -
Proceeds from sales of loans.............................. - 117,509,060 8,215,597
Net (increase) decrease in net loans...................... (1,428,880) 1,834,572 8,095,445
Proceeds from sales of foreclosed properties.............. 2,146,555 5,270,509 3,797,022
Additions to foreclosed properties........................ (358,419) (174,753) (318,471)
Increase in mortgage servicing rights..................... (289,253) (243,297) -
Purchase of premises and equipment........................ (388,145) (197,281) (1,489,856)
Proceeds from sales of premises and equipment............. 601,714 1,414,705 1,984
Cash and cash equivalents of Home Bancorp
at date of acquisition................................. - - 7,459,288
----------- ----------- -----------
Net cash provided by (used in) investing activities....... (17,138,266) 140,998,428 32,642,833
----------- ----------- -----------
FINANCING ACTIVITIES
Decrease in deposits attributable to branch sales:
NOW and savings deposits............................... - (18,937,078) -
Certificates of deposit................................ - (144,669,198) -
Net increase (decrease) in NOW and savings deposits....... 13,305,806 4,898,050 (9,592,820)
Net increase in certificates of deposit................... 9,587,515 10,211,469 18,831,588
Proceeds from Federal Home Loan Bank advances............. 25,500,000 4,000,000 14,500,000
Repayment of Federal Home Loan Bank advances.............. (27,643,333) (8,143,333) (43,618,334)
Proceeds from notes payable............................... - - 1,003,893
Payments on credit facility............................... - - (894,377)
Payments on notes payable................................. (24,040) (24,061) -
Redemptions of subordinated notes......................... - (627,858) -
Payments on capital lease obligation...................... (53,281) (39,705) (56,030)
Repayments of mortgages payable on foreclosed
properties............................................. (10,391) (25,258) (164,743)
Redemption of Settlement Preferred Stock.................. (6,002) (103,385) (831,511)
Common stock issued under the Employee Stock
Purchase Plan.......................................... 7,453 7,235 -
----------- ------------ -----------
Net cash provided by (used in) financing activities....... 20,663,727 (153,453,122) (20,822,334)
----------- ------------ -----------
Increase (decrease) in cash and cash equivalents....... 4,837,632 (9,813,467) 9,102,559
Cash and cash equivalents at beginning of period....... 6,195,251 16,008,718 6,906,159
----------- ------------ -----------
Cash and cash equivalents at end of period............. $ 11,032,883 $ 6,195,251 $ 16,008,718
============ =============== ============
(Continued)
30
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (continued)
For the years ended December 31, 1997, 1996 and 1995
1997 1996 1995
---- ---- ----
NONCASH INVESTING AND FINANCING ACTIVITIES
Transfer from loans to foreclosed properties.............. $ 1,294,615 $ 1,865,227 $ 2,929,567
Termination of Essex Mortgage Trust I REMIC............... - 2,678,222 -
Transfer of investment securities and mortgage-backed
securities held for investment to available for sale.. - - 13,590,296
Increase (decrease) in mortgages payable on
foreclosed properties................................. - 10,391 (7,630)
Acquisition of Home Bancorp:
Increase in assets:
Net loans.......................................... - - 50,498,727
Excess of cost over net assets acquired............ - - 8,607,098
Other.............................................. - - 2,100,783
Increase in liabilities:
Deposits........................................... - - 51,826,331
Other.............................................. - - 814,909
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid (received) during the year for:
Interest.............................................. $ 9,199,677 $ 13,814,733 $ 16,628,737
Income taxes, net of refunds.......................... - (109,244) (6,252)
See notes to consolidated financial statements.
31
ESSEX BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 1997, 1996 and 1995
NOTE 1 - ORGANIZATION
Essex Bancorp, Inc. ("EBI") is a Delaware corporation that was formed in 1994 to
be the single thrift holding company for Essex Savings Bank, F.S.B. (the
"Bank"), a federally-chartered savings bank which at December 31, 1997 operates
four branches in North Carolina and Virginia. EBI is the successor by merger to
Essex Financial Partners, L.P. (the "Partnership"), a Delaware limited
partnership which was formed in 1988 to acquire the former holding company of
the Bank. The Partnership and Essex Bancorp. ("Bancorp"), the Bank's former
holding company, were merged into EBI in January 1995. In addition to the Bank,
EBI's other principal operating subsidiaries are Essex First Mortgage
Corporation ("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 Mortgage Servicing Corporation ("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. Essex Mortgage Corporation ("EMC") is also a direct
subsidiary of EBI that was formerly engaged in various mortgage banking
activities and, at December 31, 1997, held loans and other assets as a result of
its past activities.
Pursuant to approvals received from the Office of Thrift Supervision ("OTS") on
August 25, 1994 and the Partnership's unitholders at a special meeting on
January 17, 1995, the Partnership and Bancorp were merged into EBI on January
18, 1995 and January 31, 1995, respectively. The Merger was accounted for in a
manner similar to a pooling of interests. As a result of the Merger, the
Partnership's unitholders and the general partner became stockholders of EBI,
whose common stock is listed on the American Stock Exchange. Partnership
unitholders received one share of EBI common stock in exchange for every two
limited partnership units ("LPUs"). In addition, the general partner received
shares of EBI common stock equivalent to one percent of total shares outstanding
after the exchange.
NOTE 2 - SIGNIFICANT ACCOUNTING POLICIES
Principles of Consolidation: The consolidated financial statements include the
accounts of EBI and its subsidiaries (collectively, the "Company"). Significant
intercompany accounts and transactions have been eliminated in consolidation.
The preparation of the financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect reported amounts of assets and liabilities and the
disclosures of contingent assets and liabilities at the date of the financial
statements and that affect the reported amounts of income and expenses during
the reporting period. Actual results could differ from those estimated.
Cash and Cash Equivalents: Cash equivalents include interest-bearing deposits,
federal funds sold and securities purchased under agreements to resell.
Generally, federal funds sold and securities purchased under agreements to
resell are purchased for one-day periods. Securities purchased under agreements
to resell are purchased from a commercial bank and collateralized by
32
mortgage-backed securities issued by the Government National Mortgage
Association ("Ginnie Mae"), the Federal Home Loan Mortgage Corporation ("Freddie
Mac"), or the Federal National Mortgage Association ("Fannie Mae").
Investments and Mortgage-Backed Securities: Investment securities and
mortgage-backed securities are classified upon acquisition as held for
investment or available for sale. Those securities designated as held for
investment are carried at cost adjusted for amortization of premiums and
accretion of discounts. Interest income, including amortization of premiums and
accretion of discounts, is recognized by the interest method, adjusted for
effects of changes in prepayments and other assumptions.
Those securities designated as available for sale are carried at fair value, and
unrealized gains and losses are reported as a component of shareholders' equity.
If securities are sold, the adjusted cost of the specific security sold is used
to compute the gain or loss on the sale. The market value of securities
available for sale is based upon valuations obtained from brokers and their
market analyses and management estimates.
Loans and Foreclosed Properties: Loans held for investment are stated at the
principal amount outstanding with adjustments for related premiums or discounts,
net deferred loan fees, participations sold, and an allowance for loan losses.
The allowance for loan losses is maintained to absorb potential losses in the
loan portfolio. Management's determination of the adequacy of the allowance is
based on an evaluation of the portfolio, past loan loss experience, current
economic conditions, volume, growth and composition of the loan portfolio, and
other relevant factors. The allowance is increased by provisions for loan losses
charged against income. Actual future losses may differ from estimates as a
result of unforeseen events.
Statement of Financial Accounting Standards No. 114 - Accounting by Creditors
for Impairment of a Loan ("SFAS 114"), as amended by SFAS 118, requires certain
loans to be adjusted for impairment. A loan is impaired when, based on current
information and events, it is probable that the Company will be unable to
collect all contractual interest and principal payments as scheduled in the loan
agreement.
The impaired value of collateral-dependent loans is generally determined based
on the fair value of the collateral when it is determined that foreclosure is
probable. Generally, it is management's policy to charge-off the impaired
portion of any collateral-dependent loan where supported by appraisals or other
evidence of value. Otherwise, the impairment is determined based on the present
value of the expected cash flows and deficiencies are provided for through the
allowance for loan losses. Any change in the carrying value of the impaired loan
is reported as an addition or a reduction in the related allowance.
Properties acquired in settlement of loans are recorded at fair value less
estimated selling costs upon acquisition and thereafter are carried at the lower
of cost or fair value less estimated selling costs. Revised estimates to the
fair value less selling costs are reported as adjustments to the carrying amount
of the asset provided that such adjusted value is not in excess of the carrying
amount at acquisition. Gains or losses on the sale of and revaluation
adjustments to foreclosed properties are credited or charged to expense. Costs
incurred in connection with ownership of the property, including interest on
senior indebtedness, are expensed to the extent not previously allowed for in
calculating fair value less estimated selling costs. Costs relating to the
development or improvement of the property are capitalized to the extent these
costs increase fair value less estimated selling costs.
Management believes that the allowances for losses on loans and foreclosed
properties are adequate. While management uses available information to
recognize losses on loans and foreclosed properties, future additions to the
allowances may be necessary based on changes in economic conditions. In
33
addition, the OTS, as an integral part of its examination process, periodically
reviews the Bank's allowances for losses on loans and foreclosed properties, and
may require the Bank to recognize additions to the allowances.
Loan Income: Income on loans is derived from interest, the sale of loans and
various fees. Interest on loans, including amortization of premiums and
accretion of discounts, is computed using methods that result in level rates of
return on principal amounts outstanding. Loan origination fees and direct loan
origination costs are deferred and amortized over the contractual lives of the
related loans using methods that result in a constant effective yield on
principal amounts outstanding.
The accrual of interest on loans is discontinued based on delinquency status, an
evaluation of the related collateral, and on 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 may be returned to an
accruing status provided two criteria are met: (1) all principal and interest
amounts contractually due (including arrearages) are reasonably assured of
repayment within a reasonable period, and (2) there is a sustained period of
repayment performance (generally a minimum of six months) by the borrower. The
receipt of interest payments from an impaired loan is generally recognized as
interest income when received, except in cases where impairment adjustments have
been material, in which case the interest payments are treated as principal
reductions.
Mortgage Banking Activities: Loans held for sale are valued at the lower of
aggregate cost or market. The market value of loans held for sale is determined
by commitment agreements with investors or estimates by management based on
comparable loan sales in the secondary market. Gains or losses on loan sales are
recognized for financial reporting purposes at the time of sale and are
determined by the difference between the sales proceeds and the carrying value
of the loans, with an adjustment for recourse provisions or an allocation of the
basis to the estimated fair value of servicing rights if servicing is retained.
Capitalized mortgage servicing assets consist of both purchased and originated
servicing rights (collectively, "MSRs"). MSRs are amortized in proportion to,
and over the period of, the estimated future net servicing revenues of the
underlying mortgage loans. The Company's policy for assessing impairment of MSRs
is based on their fair values and is evaluated by stratifying the MSRs based on
predominant risk characteristics of the underlying loans, primarily interest
rate. Fair value is estimated based on discounted anticipated future cash flows,
taking into consideration market-based prepayment estimates.
Fees for servicing loans are credited to mortgage servicing income when the
related mortgage payments are collected. Depending on the terms of the servicing
contracts, such fees are normally based upon either the outstanding principal
balance of such loans or the number of loans processed. Servicing expenses are
charged to operations when incurred.
Premises and Equipment: Premises and equipment are stated at cost, less
accumulated depreciation and are being depreciated over their estimated useful
lives, using the straight-line method of depreciation.
Long-Lived Assets: The Company periodically evaluates the carrying value of
long-lived assets in accordance with the provisions of Statement of Financial
Accounting Standards No. 121 - Accounting for the Impairment of Long-Lived
Assets and for Long-Lived Assets to be Disposed Of.
Income Taxes: Consolidated corporate income tax returns are filed for EBI and
its subsidiaries. In February 1992, the Financial Accounting Standards Board
issued Statement No. 109 - Accounting for Income Taxes ("SFAS 109"), which
34
requires an asset and liability approach for determining income taxes. The new
standard was adopted during 1993, but will not have a significant effect on the
Company's operating results unless the Company demonstrates consistent
profitability.
Stock-Based Compensation Plans: Effective January 1, 1997, the Company adopted
Statement of Financial Accounting Standards No. 123 - Accounting for Stock Based
Compensation ("SFAS 123"). SFAS 123 permits either the recognition of cost for
the estimated fair value of employee stock-based compensation arrangements on
the date of grant, or disclosure in the notes to the financial statements of the
pro forma effects on net income and earnings per share, determined as if the
fair value-based method had been applied in measuring compensation cost. The
Company has adopted the disclosure option and continues to apply APB Opinion No.
25 - Accounting for Stock Issued to Employees ("APB 25") in accounting for its
plans using the intrinsic-value-based method.
Accordingly, no compensation cost has been recognized for the Company's stock
options granted during 1997.
Earnings Per Share: The Company calculates its basic and diluted earnings per
share ("EPS") in accordance with Statement of Financial Accounting Standards No.
128 - Earnings Per Share ("SFAS 128"). Accordingly, the components of the
Company's EPS calculations for the years ended December 31 are as follows:
1997 1996 1995
---- ---- ----
Loss before extraordinary items $ (296,648) $(7,377,011) $(4,154,718)
Preferred stock dividends (Note 18) (1,635,488) (1,446,868) (368,022)
---------- ---------- -----------
Loss before extraordinary items
available to common shareholders (1,932,136) (8,823,879) (4,522,740)
Extraordinary items - - 2,945,064
---------- ---------- ----------
Net loss available to common shareholders $(1,932,136) $(8,823,879) $(1,577,676)
========== ========== ==========
Weighted average common shares
outstanding 1,055,776 1,051,180 1,049,684
========= ========= =========
The Company's common stock equivalents are antidilutive with respect to loss
available to common shareholders for each of the years presented; therefore,
basic and diluted EPS are the same.
Reclassification: Certain 1996 and 1995 amounts have been reclassified to
conform to 1997 presentations.
NOTE 3 - EXTRAORDINARY ITEMS
Extraordinary items for the year ended December 31, 1995 consisted of the
following transactions:
o EBI issued $1.0 million in nonvoting, noncumulative preferred stock (the
"Settlement Preferred Stock") in January 1995 in accordance with a
stipulation of settlement (the "Settlement") related to litigation in which
the Partnership was a settling defendant in 1994 (the "Litigation"). The
Settlement Preferred Stock was distributed on January 9, 1995 to qualifying
members of the settlement class who suffered trading losses in the
Partnership's LPUs prior to July 27, 1994, the date on which the Settlement
was announced. Contemporaneously with the acquisition described in Note 4,
PaineWebber Capital Inc. ("PWC") and PaineWebber Inc. ("PWI"), also
35
settling defendants in the Litigation, agreed to loan the funds necessary
to enable EBI to redeem the Redeemable Preferred Stock for $1.0 million
(the "Redemption Loan") plus accrued dividends. The effective date of this
redemption was September 18, 1995, and the Redemption Loan was forgiven
effective that date. The Company recognized an extraordinary gain of $1.0
million during the third quarter of 1995 in connection with the forgiveness
of this debt.
o EBI contributed $1.3 million to a settlement fund established by the
defendants in the Litigation. The court provided for a portion of this
settlement fund to be distributed in cash to the same class members who
were to receive the Settlement Preferred Stock, and the remaining portion
of the fund was to be used to pay fees and expenses of plaintiffs' counsel
and to make certain payments to named plaintiffs. Neither the Partnership
nor EBI had sufficient liquidity to fund this contribution to the
Settlement. Accordingly, PWC made a $1.3 million loan (the "Settlement
Note") to EBI in order to facilitate the completion of the Settlement. In
addition, PWC made a $39,000 loan (the "Litigation Note") to EBI in order
for EBI to pay legal expenses associated with the Settlement.
Contemporaneously with the acquisition described in Note 4, PWC forgave the
Settlement Note and the Litigation Note, plus accrued interest thereon. The
Company recognized an extraordinary gain of $1.5 million during the third
quarter of 1995 in connection with the forgiveness of this debt.
o PWC made a $200,000 loan (the "Merger Note") to EBI in order to fund the
expenses associated with the Merger because neither the Partnership nor EBI
had sufficient liquidity to fund such expenses. Contemporaneously with the
acquisition described in Note 4, PWC forgave the Merger Note and the
accrued interest thereon. EBI recognized an extraordinary gain of $217,000
during the third quarter of 1995 in connection with the forgiveness of this
debt.
NOTE 4 - ACQUISITION
On September 15, 1995, EBI and the Bank merged 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 (the "Home
Acquisition"). The transaction 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") of approximately $8.6 million was being
amortized using an accelerated method over a period of 15 years. However, as a
result of the 1996 sale of four of the five Home Savings branches acquired,
goodwill associated with the Home Acquisition was written off in 1996.
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 EBI with an aggregate redemption and liquidation value of $15.0 million and
warrants to purchase 7,949,000 shares of EBI common stock at a price of $0.9375
per share, which was the price of EBI common stock as of June 30, 1995. The
warrants are exercisable beginning in September 1998. 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 issuance. Following the completion of
the transaction, two representatives designated by Home Bancorp joined the Board
of Directors of EBI, and two joined the Board of Directors of the Bank, filling
existing vacancies on those Boards.
36
The following unaudited pro forma financial information for the year ended
December 31, 1995 assumes the acquisition was consummated on January 1, 1995 (in
thousands, except per share data):
Total interest income $25,859
Net interest income 7,568
Provision for loan losses 2,477
Noninterest income 3,195
Noninterest expense 13,218
Loss before extraordinary items (4,932)
Net loss (2,096)
Basic and diluted loss per common share
before extraordinary items (6.04)
Basic and diluted net loss per common
share (3.34)
NOTE 5 - SALES OF BRANCHES
In January 1996, the Company formed a Strategic Evaluation Committee (the
"Committee") to explore the possible benefits 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 the preferred
shareholders of the Company. Accordingly, in addition to completing the
already-negotiated sales of the Bank's Charlotte, Raleigh, Greensboro and
Wilmington, North Carolina branches, the Company proceeded to negotiate the sale
of the Bank's Norfolk, Portsmouth, Hampton, Newport News and Grafton, Virginia
branches, which were completed during the last two quarters of 1996.
Collectively, the nine branches sold during 1996 are referred to as the
"Branches" and each sale is detailed below.
Effective March 15, 1996, the Bank sold the deposits and related accrued
interest of its Charlotte, North Carolina retail bank branch, which totaled
$28.1 million, along with loans and related accrued interest totaling $64,000,
premises and equipment totaling $586,000, and other assets totaling $69,000. In
connection with the sale of the Charlotte branch, the Bank recognized a $1.1
million net gain on the sale of deposits and a $64,000 gain on the sale of
premises and equipment. The sale of the Charlotte branch required cash of $26.3
million, which was funded by the sale of fixed-rate first mortgage loans
totaling $7.3 million and mortgage-backed securities available for sale totaling
$9.9 million, as well as the utilization of a portion of the Bank's excess
liquidity. The Bank recognized a gain of $1,000 and $153,000 from the sale of
loans and mortgage-backed securities, respectively. In the aggregate, the Bank
recognized a net gain of $1.3 million on the sale of the Charlotte branch.
Effective July 25, 1996, the Bank sold the deposits and related accrued interest
of its Raleigh, Wilmington and Greensboro, North Carolina retail bank branches,
which totaled $71.2 million, along with deposit loans and related accrued
interest totaling $72,000. In connection with the sale of the Branches, the Bank
recognized a $701,000 net gain on the sale of deposits. The sale of these
branches required cash of $70.3 million, which was funded by the sale of
fixed-rate and adjustable-rate first mortgage loans totaling $60.9 million, as
well as the utilization of a portion of the Bank's excess liquidity. The Bank
recognized a loss of $186,000 on the sale of loans. In the aggregate, the Bank
recognized a net gain of $516,000 on the sale of the Raleigh, Wilmington and
Greensboro branches.
37
Effective September 26, 1996, the Bank sold the deposits and related accrued
interest of its Norfolk, Portsmouth, Hampton and Newport News, Virginia retail
bank branches, which totaled $62.9 million, along with deposit loans and related
accrued interest totaling $68,000 and premises and equipment totaling $600,000.
The Bank concluded its branch sales on November 7, 1996 with the sale of its
Grafton, Virginia retail bank branch with deposits and related accrued interest
totaling $5.3 million. In connection with these sales, the Bank recognized a
$174,000 net gain on the sale of deposits and a $152,000 gain on the sale of
premises and equipment. In addition to transaction costs, the gain on the sale
of deposits was reduced by a $1.9 million write-off of the remaining goodwill
associated with the branches. Prior to the consummation of the sale of these
branches, the Company recognized a $5.9 million write down in the net asset
value of certain of these branches. The sale of these branches required cash of
$65.4 million, which was funded by the sale of fixed-rate and adjustable-rate
first mortgage loans totaling $50.1 million, as well as the utilization of a
portion of the Bank's excess liquidity. The Bank recognized a loss of $833,000
on the sale of loans. In the aggregate, the Bank recognized a net loss of
$507,000 on the sale of the Norfolk, Portsmouth, Hampton, Newport News, and
Grafton branches.
NOTE 6 - INVESTMENT SECURITIES
The amortized cost and fair value of securities held for investment at December
31 were as follows (in thousands):
1997 1996
------------------------------------------ ------------------------------------------
Gross Unrealized Gross Unrealized
Amortized ---------------- Fair Amortized ---------------- Fair
Cost Gains Losses Value Cost Gains Losses Value
---- ----- ------ ----- ---- ----- ------ -----
U.S. Treasury securities $ - $ - $ - $ - $1,003 $ - $ - $1,003
Securities of other U.S.
government agencies 2,299 - 82 2,217 5,000 - 113 4,887
----- -------- ------- ----- ----- -------- ------ -----
$2,299 $ - $ 82 $2,217 $6,003 $ - $ 113 $5,890
===== ======== ======= ===== ===== ======== ====== =====
The $2.3 million of U.S. government agency securities held for investment at
December 31, 1997 consisted of a $2.0 million note issued by the Federal Home
Loan Bank ("FHLB") which matures in the year 2000 and a $299,000 note issued by
the FNMA which matures in the year 1999. No securities held for investment were
sold prior to maturity in 1997, 1996, and 1995. The U.S. government agency
security with a book value of $299,000 and a fair value of $298,000 is pledged
as collateral for public depository accounts over $100,000 at December 31, 1997.
Securities available for sale at December 31, 1997 and 1996 consisted of a
mutual fund investment that is designed for use as an overnight liquid
investment. The mutual fund portfolio is invested in federal funds and
repurchase agreements, which are fully collateralized by U.S. Government and/or
agency obligations. The fund is managed to have an average maturity of one to
seven days, and to maintain a stable net asset value of $1.00 per share.
Proceeds from the sale of securities available for sale totaled $2,500,000,
$6,650,000 and $8,575,000 in 1997, 1996 and 1995, respectively. No gains or
losses were realized on these sales.
38
NOTE 7 - MORTGAGE-BACKED SECURITIES
The amortized cost and fair value of mortgage-backed securities ("MBS") held for
investment, which consisted solely of the Company's interests in a real estate
mortgage investment conduit ("REMIC"), at December 31 were as follows (in
thousands):
1997 1996
------------------------------------------ ----------------------------------------
Gross Unrealized Gross Unrealized
Amortized ---------------- Fair Amortized ---------------- Fair
Cost Gains Losses Value Cost Gains Losses Value
---- ----- ------ ----- ---- ----- ------ -----
U.S. government agencies:
Floating-rate REMIC $1,905 $ - $ 19 $1,886 $1,905 $ - $ 36 $1,869
===== ======== ======= ===== ===== ======== ======= =====
There were no sales of MBS held for investment in 1997, 1996 and 1995.
Effective November 15, 1995, the Financial Accounting Standards Board ("FASB")
provided a one-time opportunity for institutions to reassess the appropriateness
of the designations of all securities held upon initial application of the FASB
Special Report, "A Guide to Implementation of Statement 115 on Accounting for
Certain Investments in Debt and Equity Securities" (the "Special Report"). Any
resulting redesignations were required to occur no later than December 31, 1995
and such redesignations were required to be accounted for at fair value in
accordance with SFAS 115. Accordingly, on December 31, 1995, the Bank
transferred MBS with a total amortized cost of $13.6 million and a total fair
value of $13.7 million from the "held to maturity" designation to the "available
for sale" designation. In accordance with SFAS 115, the transfer was accounted
for at fair value and the Company recorded a holding gain of $154,000 as a
separate component of its shareholders' equity. These MBS were sold in 1996 to
partially fund the sale of the Branches. Accordingly, the holding gain component
of shareholders' equity was reversed in 1996. No MBS were classified as
available for sale at December 31, 1997 and 1996.
During 1996, the Essex Mortgage Trust I REMIC, a Company-issued second mortgage
REMIC, was terminated, at which time $2.7 million of mortgage-backed securities
were reclassified to loans. Proceeds from the sale of MBS available for sale
totaled $10,068,189 in 1996. Gross gains of $196,525 and gross losses of $43,337
were realized in 1996.
NOTE 8 - LOANS
Net loans at December 31 include (in thousands):
1997 1996
---- ----
Real estate:
First mortgages $130,486 $103,643
Second mortgages 8,699 12,384
Construction and development 16,583 17,190
Commercial 5,970 6,313
Consumer 5,426 5,828
Commercial - other 1,883 1,915
Secured by deposits 805 842
--------- ---------
Total Loans 169,852 148,115
Less:
Unearned loan fees and discounts 29 8
Allowance for loan losses 2,382 2,556
-------- --------
Net Loans $167,441 $145,551
======= =======
39
Included in total loans at December 31, 1997 and 1996 are unamortized premiums
of $668,000 and $565,000, respectively.
At December 31, net loans included the following collateral-dependent real
estate loans (in thousands):
1997 1996
---- ----
First mortgages $611 $539
Second mortgages 79 122
Construction and development - 17
---- ----
Total collateral-dependent real estate loans 690 678
Less:
Allowance for loan losses 130 69
--- ----
Net collateral-dependent real estate loans $560 $609
=== ===
As of December 31, 1997, the Bank had outstanding commitments (including
unfunded portions of lines of credit and construction loan commitments) to fund
approximately $13.9 million in mortgage loans and $222,000 in nonmortgage loans.
In addition, the Bank's construction loan portfolio includes loans to
individuals that will convert to permanent loans upon completion of
construction. As of December 31, 1997, such commitments aggregated $2.6 million
of fixed rate mortgage loans and $15.4 million of adjustable rate mortgage
loans. Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Because it is possible that the commitments
can expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. The Company evaluates each
customer's creditworthiness on a case-by-case basis. The amount of collateral
obtained, if deemed necessary by the Company upon extension of credit, is based
on management's credit evaluation of the counterparty. Collateral held generally
consists of real estate.
The Bank originates first and second mortgage and consumer loans primarily in
North Carolina and Virginia. The Bank will also acquire residential mortgage
loans from third parties. Loans previously acquired comprised approximately 42%
and 43% of total loans at December 31, 1997 and 1996, respectively. The Bank
requires collateral on all residential mortgage loans and, at origination,
generally requires that loan-to-value ratios be no greater than 80%, unless
private mortgage insurance has been obtained, in which case higher loan-to-value
ratios may be maintained.
At December 31, 1997 and 1996, the Company had $1.6 million and $2.9 million,
respectively, in nonaccrual loans. Interest income which would have been
recorded in accordance with the original terms of the nonaccrual loans amounted
to approximately $171,000, $291,000 and $678,000 for the years ended December
31, 1997, 1996 and 1995, respectively.
40
Changes in the allowance for loan losses for the years ended December 31 are as
follows:
1997 1996 1995
---- ---- ----
Balance at beginning of period $2,555,688 $ 5,251,295 $ 3,429,365
Allowance transferred in connection
with the Home Acquisition - - 500,000
Provision for loan losses 113,467 1,410,710 2,476,904
---------- ---------- ----------
2,669,155 6,662,005 6,406,269
Loans charged-off, net of recoveries (287,516) (4,106,317) (1,154,974)
---------- ---------- ----------
Balance at end of period $2,381,639 $ 2,555,688 $5,251,295
========= ========== =========
Loans held for sale at December 31, 1997 and 1996 consisted of first mortgage
loans originated by Essex First. As of December 31, 1997, Essex First had
outstanding commitments to fund mortgage loans totaling approximately $944,000,
which were committed for sale to unaffiliated third parties.
NOTE 9 - FORECLOSED PROPERTIES
Foreclosed properties at December 31 consist of the following:
1997 1996
---- ----
Properties acquired through foreclosure $1,666,381 $2,233,150
Less allowance for losses 154,752 178,937
---------- ----------
$1,511,629 $2,054,213
========= =========
Changes in the allowance for losses on foreclosed properties for the year ended
December 31 are as follows:
1997 1996 1995
---- ---- ----
Balance at beginning of year $ 178,937 $199,145 $ 417,805
Provision for losses on
foreclosed properties 159,341 (21,345) 79,393
-------- -------- ---------
338,278 177,800 497,198
Charge-offs, net of recoveries (183,526) 1,137 (298,053)
-------- -------- ---------
Balance at end of year $ 154,752 $178,937 $ 199,145
======== ======= ========
NOTE 10 - PREMISES AND EQUIPMENT
Premises and equipment at December 31 include:
1997 1996
---- ----
Land $ 573,675 $ 591,766
Buildings 1,046,570 1,230,819
Furniture and equipment 2,681,370 2,675,397
Leasehold improvements 192,556 183,497
Property under capitalized lease 537,737 537,737
---------- ----------
5,031,908 5,219,216
Less accumulated depreciation
and amortization 3,105,179 2,734,094
--------- ---------
$1,926,729 $2,485,122
========= =========
41
Certain premises are occupied under noncancelable operating lease agreements.
Leases having contractual attributes of purchased premises or equipment are
capitalized and shown in the table above along with related amortization.
Future minimum lease commitments with terms in excess of one year at December
31, 1997, including cost escalation provisions, are as follows:
Capital Noncancelable
Lease Operating Leases
----- ----------------
1998 $119,201 $236,033
1999 119,201 243,762
2000 119,201 239,356
2001 119,201 214,754
2002 - -
Later years - -
------- -------
Total minimum lease payments 476,804 $933,905
=======
Amount representing interest 144,834
-------
Present value of net minimum capitalized
payments $331,970
=======
Rent expense for the years ended December 31, 1997, 1996, and 1995 amounted to
$435,147, $602,190 and $903,922, respectively.
NOTE 11 - DEPOSITS
Deposits at December 31 include (dollars in thousands):
1997 1996
------------------------ -----------------------
Amount Percent Amount Percent
------ ------- ------ -------
NOW accounts -
noninterest-bearing $ 5,056 3.28% $ 1,070 .82%
Passbook and Christmas
Club 3,948 2.57 3,765 2.87
NOW accounts 3,965 2.58 4,175 3.19
Money market 25,698 16.69 16,350 12.48
Certificate accounts -
4.01% to 6.00% 87,378 56.77 80,203 61.20
6.01% to 8.00% 27,844 18.09 25,433 19.41
8.01% to 10.00% 38 .02 37 .03
------- ------ -------- ------
$153,927 100.00% $131,033 100.00%
======= ====== ======= ======
A summary of certificate accounts by scheduled maturity at December 31, 1997 is
as follows (in thousands):
1998 $ 76,720
1999 18,304
2000 12,126
2001 2,750
2002 and thereafter 5,360
--------
$115,260
42
Certificate accounts of $100,000 or more at December 31, 1997 and 1996 amounted
to $18.5 million and $14.8 million, respectively.
Interest and weighted average rates on interest-bearing deposits for the years
ended December 31 are as follows:
1997 1996 1995
---------------------- ---------------------- ---------------------
Interest Rate Interest Rate Interest Rate
-------- ---- -------- ---- -------- ----
Passbook and
Christmas Club $ 133,737 3.48% $ 225,525 3.33% $ 181,926 3.33%
NOW accounts 122,773 2.83 149,324 2.80 138,251 2.85
Money Market
accounts 1,041,566 4.87 949,835 4.50 900,719 4.14
Certificate accounts 6,381,238 5.73 10,620,589 5.78 12,284,044 5.75
---------- ----------- -----------
$7,679,314 5.45 $11,945,273 5.51 $13,504,940 5.50
========== =========== ===========
NOTE 12 - FEDERAL HOME LOAN BANK ADVANCES
Borrowings from the Federal Home Loan Bank ("FHLB") at December 31 consist of
the following (in thousands):
Maturity Interest Rate 1997 1996
- -------- ------------- ----------- ----------
1997 4.01% to 8.00% $ - $16,144
1998 4.01% to 7.00% 21,139 7,138
1999 5.01% to 6.00% 1,808 1,808
2000 5.01% to 6.00% 600 600
-------- --------
$23,547 $25,690
====== ======
Weighted average rate at end of period 5.75% 6.14%
==== ====
With the exception of $2.0 million and $3.0 million of FHLB advances outstanding
at December 31, 1997 and 1996, respectively, all FHLB advances outstanding at
December 31, 1997 and 1996 carried fixed rates of interest. The $2.0 million
adjustable rate FHLB advances outstanding at December 31, 1997 will mature in
1998 and the applicable rate is indexed to the FHLB overnight deposit rate. The
$3.0 million adjustable rate FHLB advance at December 31, 1996 matured in 1997.
Advances from the FHLB at December 31, 1997 are collateralized by mortgage loans
with a total principal balance of approximately $53.8 million. The unused
lendable collateral value was $20.9 million at December 31, 1997.
NOTE 13 - SUBORDINATED CAPITAL NOTES
During 1989 and January 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 of 11.5% to 12%, the rates prevailing at the time of
issuance. In July 1993, the Bank redeemed $2.8 million of the subordinated
capital notes. In August 1996, the Bank redeemed the remaining subordinated
capital notes at par in their entirety.
43
NOTE 14 - INCOME TAXES
The Company is subject to federal income taxes, and files a consolidated federal
income tax return with its subsidiaries. The Company's provision for income
taxes for financial reporting purposes differs from the amount computed by
applying the statutory federal tax rate to loss before extraordinary items and
income taxes for the years ended December 31 as follows:
1997 1996 1995
------------------------ ----------------------- ----------------------
Amount % Amount % Amount %
------ - ------ - ------ -
Provision for income taxes at
statutory federal tax rate $(100,860) (34.0)% $(2,508,184) (34.0)% $(1,412,604) (34.0)%
Increase (decrease) resulting from:
Unrecognized tax benefits 91,443 30.8 991,196 13.4 1,407,828 33.9
Amortization of excess of cost
over net assets acquired 21,101 7.1 1,507,950 20.5 76,717 1.8
Other (11,684) (3.9) 9,038 0.1 (71,941) (1.7)
--------- ----- ----------- ----- ----------- -----
$ - -% $ - -% $ - -%
========= ===== =========== ===== =========== =====
Significant components of the Company's deferred tax assets and liabilities as
of December 31 were as follows:
1997 1996
---- ----
Deferred tax liabilities
FHLB stock $ 92,297 $ 231,880
Basis in acquired loans 2,114,303 2,430,234
Premises and equipment 32,331 67,610
Other 26,362 -
------------ -------------
Total deferred liabilities 2,265,293 2,729,724
Deferred tax assets
Federal net operating loss ("NOL") carryforwards 7,562,091 8,007,145
Alternative minimum tax ("AMT")
credit carryover 330,000 330,000
MSRs 78,280 97,849
Allowance for losses on loans and
foreclosed properties 596,417 659,128
Core deposit intangible 1,049,306 1,130,022
Other 383,524 137,941
------------ -------------
Total deferred assets 9,999,618 10,362,085
------------ -------------
Net deferred tax assets before valuation
allowance 7,734,325 7,632,361
Valuation allowance for net deferred tax
assets (7,734,325) (7,632,361)
------------ -------------
Net deferred tax assets $ - $ -
============ =============
The Company applies an asset and liability approach for determining income taxes
as required by SFAS 109. A valuation allowance has been established for the
Company's deferred tax assets and liabilities because, based on management's
assessment, their ultimate realization cannot be assured.
The Bank and its subsidiaries qualify under provisions of the Internal Revenue
Code that permit federal income taxes to be computed after deductions for
additions to bad debt reserves. These deductions may be computed using either
actual charge-offs or additions to its reserves based on the Bank's historical
experience. If the amounts which have qualified as bad debt deductions
(approximately $525,000 at December 31, 1997) are used for purposes other than
to absorb bad debt losses, they will be subject to federal income tax at the
then applicable rates.
44
At December 31, 1997, the Company had NOL carryforwards for income tax purposes
of approximately $19.9 million expiring in the years 2007 through 2011. The
utilization of such NOL carryforwards may be limited by the Internal Revenue
Code in certain circumstances, including a change in ownership of the Company's
stock. In addition, the Company had an AMT credit carryover of $330,000 at
December 31, 1997, which can be carried forward indefinitely.
NOTE 15 - MORTGAGE LOAN SERVICING
At December 31, 1997, 1996, and 1995, EBI through its subsidiaries serviced or
subserviced approximately 8,400, 13,300 and 12,400 loans, respectively, with the
following outstanding principal balances (in thousands) at December 31 and
related servicing fee income during the respective years ended December 31:
1997 1996 1995
-------------------------- ------------------------- ------------------------
Loan Loan Loan Loan Loan Loan
Principal Servicing Principal Servicing Principal Servicing
Balances Fee Income Balances Fee Income Balances Fee Income
-------- ---------- -------- ---------- -------- ----------
Loans owned by the
Company $128,430 $ - $ 126,373 $ - $194,736 $ -
Servicing and sub-
servicing rights owned/
participated in by the
Company 354,245 1,312,476 997,279 1,665,768 796,103 1,765,617
-------- ---------- ---------- ---------- -------- ----------
$482,675 $1,312,476 $1,123,652 $1,665,768 $990,839 $1,765,617
======== ========== ========== ========== ======== ==========
Servicing fee income is net of $858,992 in 1997, $1,878,725 in 1996 and
$1,459,570 in 1995 paid to unaffiliated subservicing clients.
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. Servicing
fee income for 1997 and 1996 included approximately $196,000 and $409,000,
respectively, attributable to servicing activities performed for this client. In
addition, the Company received termination fees of approximately $113,000 in
1997 related to this contract.
As agent for investors for whom loans are serviced, the Company maintains escrow
and custodial accounts in which borrower payments for principal, interest, taxes
and insurance are deposited. At December 31, 1997, approximately $1.8 million of
such accounts were on deposit at unaffiliated banks and $4.2 of such accounts
were on deposit at the Bank.
45
The fair value of MSRs was $1.2 million and $1.7 million at December 31, 1997
and 1996, respectively. There were no valuation allowances for impairment of
MSRs at December 31, 1997 and 1996. Following is an analysis of the changes in
the Company's MSRs for the years ended December 31:
Balance at January 1, 1995 $2,214,602
Amortization (580,295)
----------
Balance at December 31, 1995 1,634,307
Purchases 243,297
Amortization (528,444)
----------
Balance at December 31, 1996 1,349,160
Purchases 289,253
Amortization (468,647)
----------
Balance at December 31, 1997 $1,169,766
=========
NOTE 16 - NOTES PAYABLE
Notes payable at December 31, 1997 and 1996 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, EBI agreed to repay this note in its
entirety in February 1998.
NOTE 17 - EMPLOYEE BENEFIT PLANS
Employees of EBI's subsidiaries participate in a 401(k) retirement plan
administered by EBI. Annual contributions to the plan are discretionary, as
authorized by the boards of directors of EBI and its subsidiaries. The Company
made "qualified non-elective" contributions of $38,379 and $17,635 for the plan
years ended December 31, 1997 and 1995, respectively, in order to maintain the
plan's qualified tax status. The Company did not make a contribution to the plan
for 1996.
Certain employees of EBI's subsidiaries participate in a Supplemental Executive
Retirement Plan ("SERP"). An expense of $37,808, $38,836 and $28,738 was
recognized in 1997, 1996 and 1995, respectively, in connection with employee
vesting in the SERP. The SERP provides deferred compensation of 5% to 10% of a
covered employee's salary and vests at a rate of 20% per year. Participants in
the SERP as of December 31, 1997 are 100% vested. Deferred compensation in
excess of 5% is discretionary and subject to the approval of EBI's Executive
Compensation Committee.
NOTE 18 - PREFERRED STOCK
As described in Note 4, on September 15, 1995, EBI merged with Home Bancorp. 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
EBI with a redemption and liquidation value of $14.2 million for the Series B
preferred stock and $834,000 for the Series C preferred stock. 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 the
redemption value) and the 125,000 shares of Series C preferred stock bear a
cumulative annual dividend rate of 8.0% (based on the 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
46
such shares of Series C preferred stock into a like amount of Series B Preferred
Stock. Cumulative but undeclared dividends and accrued interest thereon for the
Series B and Series C preferred stock were $3,289,386 and $160,992,
respectively, as of December 31, 1997.
NOTE 19 - COMMON STOCK
Warrants: In connection with the Home Acquisition, the stockholders of Home
Bancorp received warrants to purchase 7,949,000 shares of EBI common stock at a
price of $0.9375 per share, which was the price of EBI common stock as of June
30, 1995. The warrants are exercisable beginning in September 1998 and expire in
September 2005.
Stock Options: In 1995, the Company adopted the Essex Bancorp, Inc. Stock Option
Plan (the "Option Plan"), which was submitted to and approved by the
shareholders of EBI in May 1995. In June 1995, EBI's Board of Directors approved
the First Amendment to the Option Plan which reduced the number of options and
rights which can be granted with respect to EBI's common stock under the Option
Plan to 930,000 shares. Stock appreciation rights ("SARs") may be issued in
tandem with options granted under the Plan. These SARs entitle the holder to
receive, without any payment to EBI, either cash or shares of EBI common stock,
or a combination thereof, in an amount, or having a fair market value determined
as of the date of exercise, equal to the excess of the fair market value per
share on the date of exercise of the SAR over the price of the related option.
SARs become exercisable only in the event of a change of control as defined in
the Second Amendment to the Option Plan. Such a change in control occurred
during 1996 as a result of the sale of the Branches, thus accelerating the
vesting of all of the Company's employee stock options granted June 30, 1995 and
their related SARs. All options granted June 30, 1995 were exercised during 1997
and 1996 under the SAR provisions of the options. The options outstanding as of
December 31, 1997 will become exercisable on May 28, 2000 and will expire on May
28, 2007.
In 1995, the Company also adopted the Essex Bancorp, Inc. Non-Employee Directors
Stock Option Plan (the "Directors Option Plan"), which was submitted to and
approved by the shareholders of EBI in May 1995. In June 1995, EBI's Board of
Directors approved the First Amendment to the Directors Option Plan. The First
Amendment reduced the maximum number of options and rights which can be granted
with respect to EBI common stock under the Directors Option Plan to 20,000
shares. Similar to the Option Plan, SARs may be issued in tandem with options
granted under the Directors Option Plan.
47
The following table summarizes activity under the option plans for years ended
December 31, 1997, 1996 and 1995 and the status at December 31, 1997.
Option Plan Directors Option Plan
--------------------- -----------------------
Number of Option Number of Option
Options Price Options Price
------- ----- ------- -----
Options granted, June 30, 1995 498,233 $0.9375 2,000 $0.9375
Granted - - 900 3.8750
Canceled (56,692) 0.9375 - -
-------- ------
Options outstanding, December 31, 1995 441,541 0.9375 2,900 0.9375-3.8750
Granted 40,398 3.2500 1,350 2.0625
Exercised (210,955) 0.9375 (1,000) 0.9375
Canceled (10,000) 3.2500 - -
Canceled (46,294) 0.9375 - -
-------- ------
Options outstanding, December 31, 1996 214,690 0.9375-3.2500 3,250 0.9375-3.8750
Granted 110,200 1.3750 1,350 5.6250
Exercised (184,292) 0.9375 -
Canceled (8,000) 1.3750 -
Rescinded for replacement (30,398) 3.2500 -
-------- ------
Options outstanding as of December 31, 1997 102,200 1.3750 4,600 0.9375-5.6250
======== =======
Options exercisable as of December 31, 1997 - 3,250 0.9375-3.8750
======== ======
Options available for future grant
as of December 31, 1997 432,553 14,400
======== ======
The Company recognized $498,051, $412,743 and $37,631 during the years ended
December 31, 1997, 1996 and 1995, respectively, for the options granted June 30,
1995 under the Option Plan, which were exercised in their entirety under the SAR
provisions of the options. As of December 31, 1997, the Company had recognized
an obligation of $703,000 to its Chief Executive Officer resulting from the
exercise of his SARs in November 1997. A determination has not yet been made as
to the date and method of payment to satisfy this obligation.
Had compensation cost of the Option Plan been determined based on the fair value
at the grant date for awards made under the plan, consistent with the method of
SFAS 123, the Company's net loss and loss per share would have been $312,000 and
$1.84, respectively, for the year ended December 31, 1997 and the fair value of
the options granted during 1997 would have been $0.71 per share. The fair value
of each option granted under the Option Plan during 1997 was estimated on the
date of grant using the Black-Scholes option pricing model with the following
assumptions: risk-free rate of return of 6.29%, dividend yield of zero, expected
life of five years and volatility of 50%.
Stock Purchase Plan. In 1995, the Company adopted the Essex Bancorp, Inc.
Employee Stock Purchase Plan (the "Stock Purchase Plan"), which was submitted
and approved by the shareholders of EBI in May 1995. The Stock Purchase Plan
permits all eligible employees of the Company to purchase through after-tax
payroll deductions, at a 15% discount, shares of the Company's common stock.
During the years ended December 31, 1997 and 1996 employees acquired
approximately 4,757 and 3,694, respectively, newly-issued shares of the
Company's common stock under the Stock Purchase Plan.
NOTE 20 - FAIR VALUE OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107 - Disclosure About Fair
Value of Financial Instruments ("SFAS 107"), requires the disclosure of
estimated fair values for financial instruments. Quoted market prices, if
available, are utilized as an estimate of the fair value of financial
instruments. Because no quoted market prices exist for a significant part of the
Company's financial instruments, the fair value of such instruments has been
based on assumptions, which management believes to be reasonable, with respect
to future economic conditions, the amount and timing of future cash flows and
48
estimated discount rates. Different assumptions could significantly affect these
estimates. Because these estimates do not necessarily represent actual purchases
or sales of financial instruments, the market value could be materially
different from the estimates presented below. In addition, the estimates are
only indicative of individual financial instruments' value and should not be
considered an indication of the fair value of the Company taken as a whole.
The following summary presents the methodologies and assumptions used to
estimate the fair value of the Company's financial instruments. Much of the
information used to determine fair value is highly subjective and judgmental in
nature, and therefore, the results may not be precise. The subjective factors
utilized include, among other things, estimates of cash flows, risk
characteristics, credit quality, and interest rates, all of which are subject to
change. In addition, the calculation of estimated fair values is based on market
conditions at December 31, 1997 and 1996 and may not be reflective of current or
future fair values.
Financial Assets. The carrying amounts reported for cash and cash equivalents,
FHLB stock, loans held for sale, and securities available for sale approximate
those assets' fair values. Fair values for securities and mortgage-backed
securities held for investment are based on quoted market prices or dealer
quotes. The fair value of residential and consumer loans held for investment is
based on the Sensitivity Report produced for the Bank by the FHLB. The fair
values in this Sensitivity Report are determined by discounted cash flows based
upon yield, maturity, repricing, and current rate data reported by the Bank to
the OTS. Commercial real estate and construction and development loans are
valued based upon discounted cash flows with discount rates approximating rates
that would be offered those individual borrowers to extend their credits as of
December 31, 1997 and 1996. For nonperforming loans, the estimated fair value is
not greater than the estimated fair value of the underlying collateral.
Financial Liabilities. The fair value of demand deposits, savings accounts, and
money market deposits is the amount payable on demand at the reporting date. The
fair values of fixed maturity certificates of deposit, FHLB advances, and
subordinated capital notes are based on the Sensitivity Report produced for the
Bank by the FHLB. The fair values in this Sensitivity Report are determined by
discounted cash flows based upon maturity, cost, and current rate data as
reported by the Bank to the OTS. The carrying amount of notes payable
approximates the fair value for those liabilities.
The Company has off-balance sheet financial instruments in the form of
commitments to extend credit, recourse on MSRs acquired from third parties, and
recourse on loans sold to third parties. Because commitments to extend credit
approximate current market commitment terms, their fair value is not considered
significant. The fair value of recourse on MSRs acquired from third parties and
loans sold to third parties is the estimated loss allocated to off-balance sheet
recourse.
49
December 31, 1997 December 31, 1996
---------------------------- --------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Value Value Value Value
----- ----- ----- -----
(in thousands)
Financial Assets
Cash and cash equivalents..................... $ 11,033 $ 11,033 $ 6,195 $ 6,195
FHLB stock.................................... 1,431 1,431 2,540 2,540
Securities available for sale................. 17 17 9 9
Securities held for investment................ 2,299 2,217 6,003 5,890
Mortgage-backed securities held for
investment................................. 1,905 1,886 1,905 1,869
Loans held for sale........................... 2,165 2,165 2,463 2,463
Loans held for investment, net................ 167,441 169,843 145,551 147,123
Financial Liabilities
Deposits with no stated maturity.............. $ 38,667 $ 38,667 $ 25,360 $ 25,361
Time deposits................................. 115,260 115,624 105,673 105,977
FHLB advances................................. 23,547 23,558 25,690 25,767
Notes payable................................. 72 72 96 96
Capital lease obligations..................... 332 332 385 386
Off-balance sheet commitments
and recourse obligations................... - 62 - 89
NOTE 21 - REGULATORY MATTERS
Regulatory Capital. The Bank is required pursuant to the Financial Institutions
Reform, Recovery and Enforcement Act of 1989 ("FIRREA") and OTS regulations
promulgated thereunder to satisfy three separate requirements of specified
capital as a percent of the appropriate asset base: a tangible capital
requirement, a core capital requirement, and a risk-based capital requirement.
At December 31, 1997, the Bank was in compliance with the capital requirements
established by FIRREA.
Section 38 of the Federal Deposit Insurance Act, as added by the FDIC
Improvement Act ("FDICIA"), requires each appropriate agency and the FDIC to,
among other things, take prompt corrective action ("PCA") to resolve the
problems of insured depository institutions that fall below certain capital
ratios. Federal regulations under FDICIA classify savings institutions based on
four separate requirements of specified capital as a percent of the appropriate
asset base: tangible equity, Tier I core capital, Tier I risk-based capital, and
total risk-based capital. As of December 31, 1997 and 1996, the Bank was "well
capitalized" for PCA purposes.
50
The Bank's capital amounts and ratios as of December 31, 1997 and 1996 are
presented in the following tables (dollars in thousands):
To Be Well
For Capital Capitalized Under
Actual Adequacy Purposes PCA Provisions
------------------ -------------------- --------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
As of December 31, 1997
Total capital (to
risk-weighted assets) $16,762 14.33% $9,354 8.0% $11,692 =>10.0%
Tier I capital (to
risk-weighted assets) 15,298 13.08% 4,677 4.0% 7,015 =>6.0%
Tier I capital (to
total assets) 15,298 7.86% 7,790 4.0% 9,738 =>5.0%
Tangible capital (to
total assets) 15,298 7.86% 2,921 1.5% - -
To Be Adequately
For Capital Capitalized Under
Actual Adequacy Purposes PCA Provisions
------ ----------------- --------------
As of December 31, 1996
Total capital (to
risk-weighted assets) $16,495 14.73% $8,959 8.0% $11,198 =>10.0%
Tier I capital (to
risk-weighted assets) 15,090 13.48% 4,480 4.0% 6,719 =>6.0%
Tier I capital (to
total assets) 15,090 8.66% 6,969 4.0% 8,711 =>5.0%
Tangible capital (to
total assets) 15,090 8.66% 2,613 1.5% - -
Regulatory Compliance. During the third quarter of 1997, the OTS completed its
safety and soundness examination of EBI and the Bank and concluded that no
adjustments to loss allowances were required. Moreover, the Bank is no longer
considered to be an institution requiring more-than-normal supervision and EBI
and the Bank are no longer operating under any supervisory agreements.
51
NOTE 22 - PARENT COMPANY ONLY FINANCIAL INFORMATION
Condensed financial information of EBI is presented below. While EBI and the
Bank are no longer operating under any supervisory agreements with the OTS, the
Bank must seek a letter of nonobjection from the OTS prior to making dividend
payments to EBI.
Balance Sheets
December 31, 1997 and 1996
(in thousands)
1997 1996
---- ----
ASSETS
Cash $ 190 $ 117
Investment in subsidiaries 15,638 15,458
Other 257 1
------- -------
$16,085 $15,576
======= =======
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Notes payable $ 72 $ 96
Redeemable Preferred Stock redemption proceeds payable 85 90
Other 1,111 284
------- -------
Total Liabilities 1,268 470
SHAREHOLDERS' EQUITY 14,817 15,106
------- -------
$16,085 $15,576
======= =======
Statements of Operations
For the years ended December 31, 1997, 1996 and 1995
(in thousands)
1997 1996 1995
---- ---- ----
Interest expense on notes payable $ (9) $ (11) $ (113)
Stock option compensation (601) - -
Net operating income (expenses) 25 60 686
----- ------- -------
Net income (loss) before undistributed loss
of subsidiaries and extraordinary items (585) 49 573
Undistributed income (loss) of subsidiaries 288 (7,426) (4,466)
----- ------- -------
Loss before extraordinary items (297) (7,377) (3,893)
Extraordinary items - - 2,683
----- ------- -------
Net loss $(297) $ (7,377) $(1,210)
===== ======== =======
52
Statements of Cash Flows
For the years ended December 31, 1997, 1996 and 1995
(in thousands)
1997 1996 1995
---- ---- ----
OPERATING ACTIVITIES
Net loss $(297) $(7,377) $ (1,210)
Adjustments to reconcile net loss to
cash provided by operating activities:
Extraordinary items - forgiveness of debt - - (2,683)
Equity in (income) loss of subsidiaries (288) 7,426 4,466
Dividends from subsidiaries 108 - -
Decrease (increase) in other assets (256) 1 (432)
Increase (decrease) in other liabilities 827 (7) (118)
------ ------- --------
NET CASH PROVIDED BY
OPERATING ACTIVITIES 94 43 23
------ ------- --------
FINANCING ACTIVITIES
Proceeds from notes payable - - 1,004
Payments on notes payable (24) (24) -
Redemption of Settlement Preferred Stock (5) (104) (832)
Common stock issued under the Employee Stock
Purchase Plan 8 7 -
------ ------- --------
NET CASH (USED IN) PROVIDED BY
FINANCING ACTIVITIES (21) (121) 172
------ ------- --------
NET INCREASE (DECREASE) IN CASH 73 (78) 195
CASH AT BEGINNING OF PERIOD 117 195 -
------ ------- --------
CASH AT END OF PERIOD $ 190 $ 117 $ 195
===== ====== ========
NONCASH FINANCING ACTIVITIES
Valuation of preferred stock and warrants issued
in connection with the Home Acquisition $ - $ - $15,545
SUPPLEMENTAL CASH FLOW INFORMATION
Cash interest paid $ - $ 11 $ -
As of December 31, 1997, other liabilities included a $703,000 obligation to the
Company's Chief Executive Officer resulting from the exercise of his SARs in
November 1997. A determination has not yet been made as to the date and method
of payment to satisfy this obligation. EBI's stock option compensation during
1997 reflects expense recognized at the holding company for the SARs held by the
Chief Executive Officer after the obligation was transferred from the Bank to
EBI in March 1997.
53
NOTE 23 - SEGMENT DATA
The Company's major business segments consist of (i) attracting deposits from
the general public and using such deposits, together with borrowings in the form
of advances from the FHLB and other sources of funds, for reinvestment in real
estate mortgages, other loans, investments, and mortgage-backed securities (the
"Retail Banking Segment"), and (ii) the origination of real estate mortgage
loans for sale to third parties with servicing retained in certain instances
(the "Mortgage Banking Segment"). The Retail Banking Segment depends on the
difference between interest earned on loans and investments over interest paid
on deposits and other borrowings to fund operating activities and generate a
profit. Historically, the nature of the Company's branch activities resulted in
less reliance on deposit service charges and other ancillary income. However,
this strategy is in transition as the Company moves to more traditional banking.
The Mortgage Banking Segment depends on gains from the sale of loans in the
secondary market and loan servicing income to fund operating expenses. During
the years ended December 31, 1997, 1996, and 1995, predominantly all loans
originated for resale by the Company were sold on a servicing released basis in
order to supplement the regulatory capital of the Bank.
The following table summarizes the mix of the major business segments (in
thousands):
Retail Mortgage
Banking Banking
Segment Segment Consolidated
------- ------- ------------
1997
Total revenue $ 5,559 $ 2,221 $ 7,780
Income (loss) before income taxes 798 (1,095) (297)
Depreciation and amortization of
premises and equipment 238 182 420
Identifiable assets 188,962 6,126 195,088
1996
Total revenue $ 7,652 $ 2,738 $ 10,390
Loss before income taxes (6,187) (1,190) (7,377)
Depreciation and amortization of
premises and equipment 313 226 539
Identifiable assets 169,457 4,810 174,267
1995
Total revenue $ 6,402 $ 2,690 $ 9,092
Loss before extraordinary items
and income taxes (2,452) (1,703) (4,155)
Depreciation and amortization of
premises and equipment 262 228 490
Identifiable assets 332,454 6,270 338,724
Revenue is defined as net interest income before loan loss provisions plus
noninterest income. Revenue by major business segment represents revenue from
unaffiliated customers.
The Mortgage Banking Segment consists of the operations of Essex First, a
wholly-owned subsidiary of the Bank engaged primarily in the origination and
sale of residential mortgage loans; Essex Home and its subsidiary, indirect
subsidiaries of EBI and the Bank that are engaged primarily in the servicing of
mortgage loans owned by the Bank, various governmental agencies, and various
third party investors; and EMC, a direct subsidiary of EBI that has been engaged
54
in various mortgage banking activities. Furthermore, the Mortgage Banking
Segment includes the MSRs held by the Bank, in addition to income and expenses
associated with these servicing assets, such as the Bank's loan servicing fees
and related amortization of the MSRs.
The Retail Banking Segment consists of all interest-earning assets,
interest-bearing liabilities, and related net interest income after provision
for loan losses of EBI and its subsidiaries, in addition to the operations of
EBI, the Bank (excluding the impact of servicing assets and related income and
expenses), and Essex Capital Corporation.
[intentionally blank]
55
INVESTOR INFORMATION
Annual Meeting of Stockholders
The Annual Meeting of Stockholders of Essex Bancorp, Inc. will be held at
The Koger Center, Building 5, First Floor Conference Room, Norfolk, Virginia on
May 28, 1998 at 1:00 p.m.
Stock Price Information
Essex Bancorp, Inc.'s common stock is listed on the American Stock Exchange
("AMEX") under the symbol "ESX." The table below sets forth the high and low
sales prices of the common stock, as reported by the AMEX during 1997 and 1996.
1997 1996
------------------- -----------------
Quarter High Low High Low
- ------- ---- --- ---- ---
First $ 2.1875 $1.0000 $5.0000 $2.0000
Second 1.8750 1.0000 3.2500 2.0000
Third 10.0000 1.0000 2.8125 1.5000
Fourth 7.3750 3.5000 2.3750 1.7500
Stock Transfer Agent
Stockholders who have questions about their accounts or who wish to change
ownership or address of stock; to report lost, stolen or destroyed certificates;
or to consolidate accounts, should contact:
Service Data Corporation
2424 South 130th Circle
Omaha, Nebraska 68144
Telephone (800) 223-3464
Annual Report on Form 10-K and Additional Information
A copy of Form 10-K as filed with the Securities and Exchange Commission is
available without charge to stockholders upon written request. Requests for this
or other financial information about Essex Bancorp, Inc. should be directed to:
Jennifer L. DeAngelo, Corporate Secretary
Essex Bancorp, Inc.
The Koger Center, Building 9, Suite 200
Norfolk, Virginia 23502
Telephone (757) 893-1326
Independent Accountants
Price Waterhouse LLP
700 World Trade Center
Norfolk, Virginia 23510-9916
Telephone (757) 622-5005
56
DIRECTORS AND OFFICERS
EXECUTIVE OFFICERS
Gene D. Ross
Chairman, President and Chief Executive Officer
Essex Bancorp, Inc.,
Essex Savings Bank, F.S.B. and
Essex Home Mortgage Servicing
Corporation
Roy H. Rechkemmer, Jr.
Senior Vice President-Finance/Treasurer
Essex Bancorp, Inc. and
Essex Savings Bank, F.S.B.
Mary-Jo Rawson
Vice President/Chief Accounting Officer
Essex Bancorp, Inc. and
Essex Savings Bank, F.S.B.
Earl C. McPherson
President and Chief Executive Officer
Essex First Mortgage Corporation
DIRECTORS
Gene D. Ross
Chairman, President and Chief Executive Officer
Essex Bancorp, Inc.
Roscoe D. Lacy, Jr.
Vice President and General Manager
Miles Jennings, Inc.
Elizabeth City, North Carolina
(industrial supply company)
Robert G. Hecht
Chief Executive Officer
Trumbull Corporation
Pittsburgh, Pennsylvania
(highway construction company)
Harry F. Radcliffe
President and Chief Executive Officer
Fort Pitt Capital Management
Pittsburgh, Pennsylvania
(investment management company)
57
CORPORATE INFORMATION
Executive Offices
The Koger Center
Building 9, Suite 200
Norfolk, Virginia 23502
Telephone (757) 893-1300
Subsidiaries of Essex Bancorp, Inc.
Essex Savings Bank, F.S.B.
The Koger Center
Building 9, Suite 200
Norfolk, Virginia 23502
Telephone (757) 893-1300
Essex Home Mortgage Servicing Corporation
2420 Virginia Beach Boulevard, Suite 109
Virginia Beach, Virginia 23454
Telephone (757) 631-4240
Subsidiary of Essex Savings Bank, F.S.B.
Essex First Mortgage Corporation
The Koger Center
Building 9, Suite 200
Norfolk, Virginia 23502
Telephone (757) 893-1300
Essex Savings Bank, F.S.B.
Retail Banking Offices
Virginia
520 South Main Street
Emporia, Virginia 23847
1401 Gaskins Road
Richmond, Virginia 23233
1455 N. Main Street
Suffolk, Virginia 23434
North Carolina
400 W. Ehringhaus Street
Elizabeth City, North Carolina 27909
Essex First Mortgage Corporation
Mortgage Loan Production Offices
Virginia
1401 Gaskins Road
Richmond, Virginia 23233
2430 Southland Drive, 3rd Floor
Chester, Virginia 23831
The Koger Center, Building 9, Suite 100
Norfolk, Virginia 23502
North Carolina
400 W. Ehringhaus Street
Elizabeth City, North Carolina 27909
58