FORM 10-Q
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 1998
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OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
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Commission file number 1-10506
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Essex Bancorp, Inc.
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(Exact name of registrant as specified in its charter)
Delaware 54-1721085
----------------------- ------------------
(State of organization) (I.R.S. Employer
Identification No.)
The Koger Center
Building 9, Suite 200
Norfolk, Virginia 23502
----------------- ----------
(Address of principal (Zip Code)
executive offices)
Registrant's telephone number, including area code (757) 893-1300
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Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No .
--- ---
Shares outstanding as of November 10, 1998: 1,060,642 shares of Common
Stock, par value $.01 per share.
Essex Bancorp, Inc.
Quarterly Report on Form 10-Q for the
Quarter Ended September 30, 1998
Table of Contents
Page
----
Part I FINANCIAL INFORMATION
Item 1. Financial Statements 3
Consolidated Balance Sheets (unaudited)
as of September 30, 1998 and December 31, 1997 3
Consolidated Statements of Operations (unaudited)
for the three months and nine months ended
September 30, 1998 and 1997 5
Consolidated Statement of Shareholders' Equity
(unaudited) for the nine months ended
September 30, 1998 7
Consolidated Statements of Cash
Flows (unaudited) for the nine months
ended September 30, 1998 and 1997 8
Notes to Consolidated Financial
Statements (unaudited) 10
Item 2. Management's Discussion and Analysis
of Financial Condition and Results of
Operations 12
Item 3. Quantitative and Qualitative Disclosures
About Market Risk 20
Part II OTHER INFORMATION
Item 1. Legal Proceedings 21
Item 2. Changes in Securities 21
Item 3 Defaults Upon Senior Securities 21
Item 4. Submission of Matters to a Vote
of Security Holders 21
Item 5. Other Information 21
Item 6 Exhibits and Reports on Form 8-K 21
2
Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (unaudited)
September 30, December 31,
1998 1997
---- ----
ASSETS
Cash............................................................... $ 4,692,785 $ 2,023,197
Interest-bearing deposits.......................................... 8,863,270 6,261,686
Federal funds sold and securities purchased under
agreements to resell............................................. 2,131,497 2,748,000
-------------- --------------
Cash and cash equivalents..................................... 15,687,552 11,032,883
Federal Home Loan Bank stock....................................... 1,548,800 1,431,000
Securities available for sale - cost approximates market........... 18,179 17,451
Securities held for investment - market value of
$2,265,000 in 1998 and $2,217,000 in 1997........................ 2,299,715 2,299,120
Mortgage-backed securities held for investment - market
value of $1,902,000 in 1998 and $1,886,000 in 1997............... 1,904,625 1,904,989
Loans, net of allowance for loan losses of $1,814,000
in 1998 and $2,382,000 in 1997................................... 178,310,284 167,440,733
Loans held for sale................................................ 3,669,963 2,165,074
Mortgage servicing rights.......................................... 836,842 1,169,766
Foreclosed properties, net......................................... 519,697 1,511,629
Accrued interest receivable........................................ 1,284,707 1,196,980
Excess of cost over net assets acquired............................ 113,208 159,754
Advances for taxes, insurance, and other........................... 1,215,427 633,053
Premises and equipment............................................. 3,232,282 1,926,729
Other assets....................................................... 2,483,523 2,198,598
-------------- --------------
Total Assets.............................................. $ 213,124,804 $ 195,087,759
============== ==============
See notes to consolidated financial statements.
3
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (unaudited)
September 30, December 31,
1998 1997
---- ----
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest-bearing........................................... $ 8,892,281 $ 5,055,545
Interest-bearing.............................................. 166,193,721 148,871,154
------------ ------------
Total deposits............................................ 175,086,002 153,926,699
Federal Home Loan Bank advances.................................... 19,729,167 23,546,667
Notes payable...................................................... - 72,102
Capitalized lease obligations...................................... 285,183 331,970
Other liabilities.................................................. 2,837,622 2,393,814
------------ ------------
Total Liabilities......................................... 197,937,974 180,271,252
SHAREHOLDERS' EQUITY
Preferred stock, authorized - 10,000,000 shares:
Series B preferred stock, $6.67 stated value:
Issued and outstanding shares - 2,125,000..................... 14,173,750 14,173,750
Series C preferred stock, $6.67 stated value:
Issued and outstanding shares - 125,000....................... 833,750 833,750
Common stock, $.01 par value:
Authorized shares - 20,000,000
Issued and outstanding shares - 1,060,642 in 1998
and 1,058,136 in 1997......................................... 10,606 10,581
Capital in excess of par........................................... 8,687,772 8,681,739
Accumulated deficit................................................ (8,519,048) (8,883,313)
------------ ------------
Total Shareholders' Equity................................ 15,186,830 14,816,507
------------ ------------
Total Liabilities and Shareholders' Equity................ $213,124,804 $195,087,759
============ ============
See notes to consolidated financial statements.
4
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
1998 1997 1998 1997
---- ---- ---- ----
INTEREST INCOME
Loans, including fees................................. $3,735,039 $3,475,437 $10,843,295 $10,028,224
Federal funds sold and securities purchased
under agreements to resell.......................... 24,504 38,739 92,215 112,372
Investment securities, including
dividend income..................................... 57,440 89,845 166,326 297,090
Mortgage-backed securities............................ 31,488 31,552 94,463 93,071
Other................................................. 104,487 105,933 238,821 235,546
---------- ---------- ------------ ------------
Total Interest Income........................ 3,952,958 3,741,506 11,435,120 10,766,303
INTEREST EXPENSE
Deposits ............................................. 2,167,654 1,999,927 6,220,323 5,643,931
Federal Home Loan Bank advances....................... 364,773 369,672 954,456 1,130,097
Notes payable......................................... - 2,303 792 6,883
Other................................................. 13,495 16,651 42,614 53,204
---------- ---------- ------------ ------------
Total Interest Expense....................... 2,545,922 2,388,553 7,218,185 6,834,115
---------- ---------- ------------ ------------
Net Interest Income.......................... 1,407,036 1,352,953 4,216,935 3,932,188
PROVISION FOR LOAN LOSSES................................. - 29,539 - 114,246
---------- ---------- ------------ ------------
Net Interest Income After
Provision for Loan Losses.................... 1,407,036 1,323,414 4,216,935 3,817,942
NONINTEREST INCOME
Loan servicing fees................................... 330,919 278,345 893,516 1,038,957
Mortgage banking income, including
gain on sale of loans............................... 214,707 133,166 540,404 317,124
Other service charges and fees........................ 124,538 73,174 316,535 286,644
Net gain on sale of loans............................. - 14 - 14
Other................................................. 95,132 36,716 186,525 287,671
---------- ---------- ------------ ------------
Total Noninterest Income..................... 765,296 521,415 1,936,980 1,930,410
See notes to consolidated financial statements.
5
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
Three Months Nine Months
Ended September 30, Ended September 30,
------------------- -------------------
1998 1997 1998 1997
---- ---- ---- ----
NONINTEREST EXPENSE
Salaries and employee benefits........................ 915,553 1,290,666 2,499,519 2,751,430
Net occupancy and equipment........................... 249,617 261,628 728,855 800,394
Deposit insurance premiums............................ 123,265 119,904 367,069 350,598
Amortization of intangible assets..................... 112,019 135,310 379,470 401,878
Service bureau........................................ 146,058 108,142 370,072 349,785
Professional fees..................................... 76,710 86,989 229,910 231,504
Foreclosed properties, net............................ 59,629 88,902 139,942 142,672
Other................................................. 331,144 244,322 1,045,287 803,524
---------- ---------- ---------- -----------
Total Noninterest Expense.................... 2,013,995 2,335,863 5,760,124 5,831,785
---------- ---------- ---------- -----------
Income (Loss) Before Income Taxes............ 158,337 (491,034) 393,791 (83,433)
Provision for income taxes................................ 29,526 - 29,526 -
---------- ---------- ---------- -----------
Net Income (Loss)............................ $ 128,811 $ (491,034) $ 364,265 $ (83,433)
========== ========== ========== ===========
Loss available to common
shareholders (Note 2)............................ $ (320,807) $ (902,981) $ (959,603) $(1,294,289)
========== ========== ========== ===========
Basic and diluted loss per
common share (Note 2)............................ $ (.30) $ (.85) $ (.91) $ (1.23)
========== ========== ========== ===========
See notes to consolidated financial statements.
6
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY (unaudited)
For the nine months ended September 30, 1998
Series B Series C
Common Preferred Preferred Capital in
Stock, $.01 Stock, $6.67 Stock, $6.67 Excess Accumulated
Par Value Stated Value Stated Value of Par Deficit Total
--------- ------------ ------------ ------ ------- -----
Balance at January 1, 1998................ $10,581 $14,173,750 $833,750 $8,681,739 $(8,883,313) $14,816,507
Common stock issued under
Employee Stock Purchase
Plan................................... 25 - - 6,033 - 6,058
Net income................................ - - - - 364,265 364,265
------- ----------- -------- ---------- ----------- -----------
Balance at September 30, 1998............. $10,606 $14,173,750 $833,750 $8,687,772 $(8,519,048) $15,186,830
======= =========== ======== ========== =========== ===========
See notes to consolidated financial statements.
7
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
Nine Months Ended September 30,
-------------------------------
1998 1997
---- ----
OPERATING ACTIVITIES
Net income (loss).................................................... $ 364,265 $ (83,433)
Adjustments to reconcile net income (loss) to cash
provided by (used in) operating activities:
Provisions for:
Losses on loans, foreclosed properties and other.............. 107,195 247,445
Depreciation and amortization of premises
and equipment............................................. 284,468 317,732
Amortization (accretion) of:
Premiums and discounts on:
Loans................................................... 120,950 65,440
Mortgage-backed securities held to maturity............. 364 172
Securities held to maturity............................. (584) 2,687
Mortgage servicing rights................................. 332,924 355,330
Excess of costs over equity in net assets
acquired................................................ 46,546 46,546
Mortgage banking activities:
Net increase in loans originated for resale................... (1,022,024) 585,598
Realized gains from sale of loans.............. (482,865) (286,327)
Realized gains from sales of:
Loans.......................................... - (14)
Premises and equipment......................... (525) (75,005)
Foreclosed properties.......................... (23,933) (69,724)
Changes in operating assets and liabilities:
Accrued interest receivable................................... (87,727) (113,307)
Other assets.................................................. (885,299) (643,330)
Other liabilities............................................. 443,808 173,373
------------ -------------
Net cash provided by (used in) operating activities.................. (802,437) 523,183
See notes to consolidated financial statements.
8
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
Nine Months Ended September 30,
-------------------------------
1998 1997
---- ----
INVESTING ACTIVITIES
Purchase of certificates of deposit in other
financial institutions........................................... (4,000,000) (5,000,000)
Proceeds from maturities of certificates of deposit in
other financial institutions..................................... 4,000,000 5,000,000
Purchase of Federal Home Loan Bank stock............................. (117,800) (95,800)
Proceeds from sales of Federal Home Loan Bank stock.................. - 1,204,800
Purchase of securities held to maturity.............................. (11) (298,406)
Proceeds from maturities of securities held to maturity.............. - 1,000,000
Purchase of securities available for sale............................ (728) (2,508,049)
Proceeds from sales of securities available for sale................. - 2,500,000
Net increase net loans............................................... (11,486,205) (16,001,005)
Proceeds from sales of foreclosed properties......................... 1,483,718 1,659,756
Increase in foreclosed properties.................................... (61,344) (309,625)
Purchase of mortgage servicing rights................................ - (289,251)
Purchase of premises and equipment................................... (1,590,021) (311,212)
Proceeds from sales of premises and equipment........................ 525 601,714
------------ -----------
Net cash used in investing activities................................ (11,771,866) (12,847,078)
FINANCING ACTIVITIES
Net increase in NOW, money market and savings deposits............... 4,859,139 11,759,901
Net increase in certificates of deposit.............................. 16,300,164 8,170,844
Proceeds from Federal Home Loan Bank advances........................ 36,500,000 18,500,000
Repayment of Federal Home Loan Bank advances......................... (40,317,500) (20,857,500)
Payments on notes payable............................................ (72,102) -
Payments on capital lease obligations................................ (46,787) (39,044)
Payments on mortgages payable on foreclosed properties............... - (10,391)
Net proceeds from common stock issued under
Employee Stock Purchase Plan...................................... 6,058 5,936
------------ -----------
Net cash provided by financing activities............................ 17,228,972 17,529,746
------------ -----------
Increase in cash and cash equivalents................................ 4,654,669 5,205,851
Cash and cash equivalents at beginning of period..................... 11,032,883 6,195,251
------------ -----------
Cash and cash equivalents at end of period........................... $ 15,687,552 $ 11,401,102
============ ============
NONCASH INVESTING AND FINANCING ACTIVITIES:
Real estate acquired in settlement of loans.......................... $ 495,704 $ 1,278,955
SUPPLEMENTAL CASH FLOW INFORMATION:
Cash paid during the period for:
Interest......................................................... $ 7,266,424 $ 6,806,249
Net income taxes................................................. - -
See notes to consolidated financial statements.
9
ESSEX BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (unaudited)
September 30, 1998
NOTE 1 - BASIS OF PRESENTATION
The accompanying unaudited consolidated financial statements of Essex Bancorp,
Inc. and subsidiaries ("EBI") have been prepared in accordance with generally
accepted accounting principles for condensed interim financial statements and,
therefore, do not include all information required by generally accepted
accounting principles for complete financial statements. The notes included
herein should be read in conjunction with the "Management's Discussion and
Analysis of Financial Condition and Results of Operations" contained in this
report, and the notes to EBI's financial statements for the year ended December
31, 1997 included in the EBI 1997 Annual Report.
In the opinion of management, the accompanying unaudited financial statements
include all adjustments (including normal recurring entries) necessary for a
fair presentation of EBI's financial condition and interim results of
operations. 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 estimates.
NOTE 2 - EARNINGS PER SHARE
EBI calculates its basic and diluted earnings per share ("EPS") in accordance
with Statement of Financial Accounting Standards No. 128 - Earnings Per Share.
Accordingly, the components of EBI's EPS calculations are as follows:
Three Months Ended Nine Months Ended
September 30, September 30,
------------------------------- --------------------------------
1998 1997 1998 1997
---- ---- ---- ----
Net income (loss) $ 128,811 $(491,034) $ 364,265 $ (83,433)
Preferred stock dividends (449,618) (411,947) (1,323,868) (1,210,856)
--------- --------- ----------- -----------
Net loss available to
common shareholders $(320,807) $(902,981) $ (959,603) $(1,294,289)
========= ========= =========== ===========
Weighted average common
shares outstanding 1,059,219 1,057,198 1,058,631 1,055,118
========= ========= ========= =========
Basic and diluted loss per
common share $(.30) $(.85) $(.91) $(1.23)
===== ===== ===== ======
EBI's common stock equivalents are antidilutive with respect to the net loss
available to common shareholders for all periods presented; therefore, basic and
diluted EPS are the same.
10
NOTE 3 - ACCOUNTING FOR DERIVATIVES
On June 15, 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133 Accounting for Derivative Instruments and
Hedging Activities ("FAS 133"). FAS 133 is effective for all fiscal quarters of
all fiscal years beginning after June 15, 1999 (January 1, 2000 for EBI). FAS
133 requires that all derivative instruments be recorded on the balance sheet at
their fair value. Changes in the fair value of derivatives are recorded each
period in current earnings or other comprehensive income, depending on whether a
derivative is designated as part of a hedge transaction and, if it is, the type
of hedge transaction. EBI's management anticipates that, due to its limited used
of derivative instruments, the adoption of FAS 133 will not have a significant
effect on EBI's results of operations or its financial position.
[intentionally blank]
11
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations
Financial Condition
Total assets of Essex Bancorp, Inc. ("EBI") at September 30, 1998 were
$213.1 million as compared to $195.1 million at December 31, 1997, an increase
of approximately $18.0 million or 9.3%. The increase in total assets resulted
primarily from (i) the acquisition of $18.8 million of residential mortgage
loans and $1.1 million of consumer loans, (ii) increased production of
residential loans held for sale in the secondary market, (iii) the acquisition
of Essex Savings Bank, F.S.B.'s (the "Bank") previously-leased branch in
Richmond, Virginia in September 1998 and the acquisition of land for expansion
of the Bank into Ashland, Virginia and (iv) an increase in escrow deposits
maintained by Essex Home Mortgage Servicing Corporation ("Essex Home") at the
Bank.
Deposits, the primary source of EBI's funds, totaled $175.1 million at
September 30, 1998 as compared to $153.9 million at December 31, 1997, an
increase of $21.2 million or 13.8%. The increase in noninterest-bearing deposits
reflected the impact of the transfer of escrow accounts maintained by Essex Home
from nonaffiliated financial institutions. The increase in interest-bearing
deposits occurred in certificates of deposit primarily at EBI's Suffolk,
Virginia retail banking branch, which was relocated from a leased facility to a
newly-constructed Bank-owned branch in April 1998, and at EBI's Richmond,
Virginia retail banking branch.
On May 28, 1998, EBI's shareholders approved an amendment of EBI's
Certificate of Incorporation whereby EBI's total authorized capitalization
increased to 30 million shares, consisting of 20 million shares of common stock
and 10 million shares of preferred stock. The increase in authorized
capitalization increases EBI's flexibility to issue additional shares of common
stock and preferred stock to enable EBI to engage in strategic transactions,
such as possible mergers or share exchanges with other entities. However, EBI
has no present plans to issue shares in connection with any particular
transaction.
Results of Operations
First Nine Months of 1998 Compared to First Nine Months of 1997
EBI's net income for the nine months ended September 30, 1998 totaled
$364,000, compared to a net loss of $83,000 for the nine months ended September
30, 1997. EBI's net loss for the first nine months of 1997 included a charge of
$368,000 associated with stock option compensation expense, which was partially
offset by an aggregate gain of $97,000 on the sale of vacant branch facilities
and termination fees approximating $113,000 received by Essex Home in connection
with the cancellation of a subservicing client's contract. Excluding the impact
of these transactions in 1997, EBI's net income for the first nine months of
1998 effectively improved $289,000 over the first nine months of 1997. This
improvement in 1998 resulted from (i) an increase in net interest income, which
reflected an increase in interest-earning assets, the benefit of which was
partially offset by a decline in the net interest margin reflecting the impact
of the lower interest rate environment on EBI's yield on loans, (ii) a decrease
in the provision for loan losses resulting from a reduction in nonperforming
assets and (iii) an increase in mortgage banking income resulting from an
increase in residential loan originations coupled with sales in the secondary
market. These increases were partially offset by a decline in mortgage loan
servicing fees resulting from the nonrenewal of a significant subservicing
contract effective May 1997.
12
Net Interest Income. The table below presents weighted average balances
for interest-earning assets and interest-bearing liabilities, as well as related
average yields earned and rates paid for the nine months ended September 30:
1998 1997
-------------------------------- -------------------------------
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
(dollars in thousands)
Interest-earning assets:
Loans (1)...................... $175,515 $10,843 8.24% $156,287 $10,028 8.56%
Investment securities.......... 3,788 166 5.85 7,315 297 5.45
Mortgage-backed
securities................. 1,905 95 6.61 1,905 93 6.51
Federal funds sold and
securities purchased under
agreements to resell......... 2,247 92 5.47 2,759 112 5.43
Other.......................... 5,829 239 5.46 5,767 236 5.45
-------- ------- -------- -------
Total interest-earning
assets.................... $189,284 11,435 8.06 $174,033 10,766 8.25
======== ========
Interest-bearing liabilities:
Deposits....................... $153,596 6,220 5.41 $138,718 5,644 5.44
FHLB advances.................. 22,378 954 5.70 25,317 1,130 5.97
Notes payable.................. 11 1 9.32 96 7 9.50
Other.......................... 311 43 18.33 367 53 18.34
-------- ------- -------- -------
Total interest-bearing
liabilities............... $176,296 7,218 5.47 $164,498 6,834 5.55
======== ------- ======== -------
Net interest earnings............. $ 4,217 $ 3,932
======= ========
Net interest spread............... 2.59% 2.70%
==== ====
Net yield on interest-earning
assets......................... 2.97% 3.02%
==== ====
(1) Nonaccrual loans are included in the average balance of loans.
[intentionally blank]
13
The table below sets forth certain information regarding changes in
EBI's interest income and interest expense between the periods indicated.
Increase (Decrease) From the First Nine Months
of 1997 to the First Nine Months of 1998 Due to
-----------------------------------------------
Volume (1) Rate (1) Net
---------- -------- ---
(in thousands)
Interest income on:
Loans (2)................................ $1,198 $(383) $ 815
Investment securities.................... (153) 22 (131)
Mortgage-backed securities............... - 2 2
Federal funds sold and
securities purchased under
agreements to resell.................. (21) 1 (20)
Other interest-earning assets............ 3 - 3
------- ------- ------
Total interest income (2)............. 1,027 (358) 669
Interest expense on:
Deposits................................. 581 (5) 576
FHLB advances............................ (175) (1) (176)
Notes payable............................ (6) - (6)
Other interest-bearing liabilities....... (10) - (10)
------- ------- ------
Total interest expense................ 390 (6) 384
------- ------- ------
Net interest income................... $ 637 $(352) $ 285
======= ===== =====
(1) Changes attributable to the combined impact of volume and rate have
been allocated proportionately to changes due to volume and changes
due to rate.
(2) Interest income includes the amortization of premiums and the
amortization of net deferred loan origination costs.
Net interest income increased from $3.9 million for the first nine
months of 1997 to $4.2 million for the first nine months of 1998, which
reflected the favorable impact of the increase in the ratio of average
interest-earning assets to average interest-bearing liabilities. However, there
was a decline in the net interest spread resulting from the impact of the lower
interest rate environment in 1998 on the volume of refinancings to lower fixed
rate loans. Typically, declining interest rates favorably impact EBI'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, EBI can expect an increase in the volume of
refinancings to lower fixed-rate loans. While EBI 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, EBI's net interest spread and net interest margin have
been negatively impacted in 1998 by the recognition of accelerated amortization
totaling $47,000 on loan acquisition premiums resulting from prepayment
activity.
Provision for Loan Losses. Changes in the allowance for loan losses for
the nine months ended September 30 are as follows (in thousands):
1998 1997
---- ----
Balance at beginning of period................... $2,382 $2,556
Provision for loan losses........................ - 114
------ ------
2,382 2,670
Loans charged-off, net of recoveries............. (568) (580)
------ ------
Balance at end of period......................... $1,814 $2,090
====== ======
14
Management reviews the adequacy of the allowance for loan losses on a
continual basis to ensure that amounts provided are reasonable. At September 30,
1998, nonperforming assets as a percentage of total assets was .83% as compared
to 1.69% at December 31, 1997. In addition, nonperforming assets totaled $1.8
million at September 30, 1998 as compared to $3.3 million at December 31, 1997.
Based on these favorable trends in nonperforming assets and the coverage of the
general loan loss reserves, management considered the loan loss allowance
sufficient to absorb losses and did not provide for additional losses during the
first nine months of 1998.
Noninterest Income. Noninterest income for the first nine months of
1998 and 1997 totaled $1.9 million. However, noninterest income during the first
nine months of 1997 included (i) an aggregate gain of $97,000 on the sale of
vacant branch facilities and (ii) termination fees approximating $113,000
received by Essex Home in connection with the cancellation of a subservicing
client's contract effective May 31, 1997. Excluding the impact of these
transactions in 1997, noninterest income effectively increased $217,000 during
1998 as a result of a $223,000 increase in mortgage banking income and a
$108,000 increase in other noninterest income. The increase in mortgage banking
income resulted from the impact of the lower interest rate environment in 1998
on Essex First Mortgage Corporation's ("Essex First") production of residential
loans sold in the secondary market. The increase in other noninterest income
resulted from higher insurance commissions and administrative fees at Essex
Home, which has more than doubled its mortgage loan subservicing portfolio since
December 31, 1997.
The increases in noninterest income were partially offset by lower loan
servicing fees during the first and second quarters of 1998 resulting from the
nonrenewal of a significant subservicing contract in 1997. However, new
contracts negotiated in 1998 provide for servicing a substantial number of
loans, which have begun to generate servicing and ancillary fee income in 1998
to significantly mitigate the impact of the lost servicing volume in 1997.
Noninterest Expense. Noninterest expense for the first nine months of
1998 and 1997 totaled $5.8 million. However, noninterest expense during 1997
included a charge of $368,000 associated with stock option compensation expense.
Excluding the impact of this charge in 1997, noninterest expense effectively
increased $296,000 as a result of the increase in other noninterest expenses
associated with the increase in EBI's loan origination and servicing volumes and
deposit levels. The significant components of other noninterest expense for the
nine months ended September 30 are presented below:
Increase
1998 1997 (Decrease)
---- ---- ----------
Loan expense............................ $ 136,523 $ 99,901 $ 36,622
Telephone............................... 154,065 132,277 21,788
Postage and courier..................... 133,978 121,844 12,134
Stationery and supplies................. 82,663 77,461 5,202
Advertising and marketing............... 146,776 119,255 27,521
Corporate insurance..................... 75,362 87,646 (12,284)
Travel.................................. 52,709 30,774 21,935
Franchise and other taxes............... 36,494 37,223 (729)
Bank charges............................ 49,857 22,700 27,157
Year 2000 compliance.................... 31,866 260 31,606
Other................................... 144,994 74,183 70,811
---------- -------- --------
$1,045,287 $803,524 $241,763
========= ======= =======
Income Taxes. EBI recognized a $29,000 state income tax provision in
1998 resulting from 1997 taxable income at Essex Home and Essex First. There was
no federal income tax provision recognized for financial reporting purposes
during the nine months ended September 30, 1998 or 1997, because EBI had
significant net operating loss carryforwards, which approximated $19.9 million
15
at December 31, 1997. Also, deferred income tax assets related to EBI's net
operating loss carryforwards and temporary differences were not recognized in
the comparable periods.
Third Quarter of 1998 Compared to Third Quarter of 1997
EBI's net income for the three months ended September 30, 1998 totaled
$129,000, compared to a net loss of $491,000 for the three months ended
September 30, 1997. However, the net loss for the third quarter of 1997 included
a charge of $566,000 associated with stock option compensation expense.
Excluding the impact of this expense in 1997, EBI's net income effectively
improved $54,000 during the third quarter of 1998. Factors contributing to the
third quarter improvement in 1998 parallel the factors described in the
nine-month comparison.
Net Interest Income. The table below presents weighted average balances
for interest-earning assets and interest-bearing liabilities, as well as related
average yields earned and rates paid for the three months ended September 30:
1998 1997
-------------------------------- -------------------------------
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
(dollars in thousands)
Interest-earning assets:
Loans (1)...................... $182,067 $3,735 8.21% $161,791 $3,475 8.59%
Investment securities.......... 3,866 57 5.94 6,735 90 5.34
Mortgage-backed
securities................. 1,905 32 6.61 1,905 32 6.62
Federal funds sold and
securities purchased under
agreements to resell......... 1,776 25 5.52 2,771 39 5.59
Other.......................... 7,602 104 5.50 7,779 106 5.55
-------- ------ -------- ------
Total interest-earning
assets.................... $197,216 3,953 8.02 $180,981 3,742 8.28
======== ========
Interest-bearing liabilities:
Deposits....................... $159,477 2,168 5.39 $145,126 2,000 5.47
FHLB advances.................. 25,278 365 5.73 24,917 370 5.89
Notes payable.................. - - - 96 2 9.50
Other.......................... 295 13 18.15 355 17 18.13
-------- ------ -------- ------
Total interest-bearing
liabilities............... $185,050 2,546 5.45 $170,494 2,389 5.62
======== ----- ======== -----
Net interest earnings............. $1,407 $1,353
====== ======
Net interest spread............... 2.57% 2.66%
==== ====
Net yield on interest-earning
assets......................... 2.86% 3.00%
==== ====
(1) Nonaccrual loans are included in the average balance of loans.
16
The table below sets forth certain information regarding changes in
EBI's interest income and interest expense between the periods indicated.
Increase (Decrease) From the Third Quarter of
1997 to the Third Quarter of 1998 Due to
----------------------------------------
Volume (1) Rate (1) Net
---------- -------- ---
(in thousands)
Interest income on:
Loans (2)................................ $421 $(161) $260
Investment securities.................... (42) 9 (33)
Mortgage-backed securities............... - - -
Federal funds sold and
securities purchased under
agreements to resell.................. (14) - (14)
Other interest-earning assets............ (2) - (2)
---- ----- ----
Total interest income (2) 363 (152) 211
Interest expense on:
Deposits................................. 195 (27) 168
FHLB advances............................ 5 (10) (5)
Notes payable............................ (1) (1) (2)
Other interest-bearing liabilities....... (4) - (4)
---- ----- ----
Total interest expense................ 195 (38) 157
---- ----- ----
Net interest income................... $168 $(114) $ 54
==== ===== =====
(1) Changes attributable to the combined impact of volume and rate have
been allocated proportionately to changes due to volume and changes
due to rate.
(2) Interest income includes the amortization of premiums and the
amortization of net deferred loan origination costs.
Net interest income increased from $1.35 million for the third quarter
of 1997 to $1.41 million for the third quarter of 1998, primarily as a result of
the slight increase in the ratio of average interest-earning assets to average
interest-bearing liabilities. However, there was a decline in the net interest
spread resulting from a 38 basis decrease in yield on loans. This decline
reflected the impact of the lower interest rate environment in 1998 on the
volume of refinancings to lower fixed rate loans and accelerated amortization of
$38,000 on loan acquisition premiums in the third quarter of 1998.
Provision for Loan Losses. Changes in the allowance for loan losses for
the three months ended September 30 are as follows (in thousands):
1998 1997
---- ----
Balance at beginning of period................... $2,064 $2,128
Provision for loan losses........................ - 30
------ ------
2,064 2,158
Loans charged-off, net of recoveries............. (250) (68)
------ ------
Balance at end of period......................... $1,814 $2,090
====== ======
As previously described, based on the improving trends in nonperforming
assets and the coverage of general loss reserves, management determined that a
provision for loan losses was not necessary during the third quarter of 1998 in
order to maintain the loan loss reserves at adequate levels to absorb losses.
17
Noninterest Income. Noninterest income for the third quarter of 1998
totaled $765,000 as compared to $521,000 for the third quarter of 1997. The
increase in noninterest income was attributable to increases in (i) loan
servicing fees resulting from Essex Home more than doubling its mortgage loan
subservicing portfolio since December 31, 1997, (ii) mortgage banking income
resulting from an increase in Essex First's residential loan originations
coupled with sales in the secondary market and (iii) other noninterest income
resulting from service charges and fees on the higher servicing volume at Essex
Home and deposit levels at the Bank.
Noninterest Expense. Noninterest expense decreased from $2.3 million in
the third quarter of 1997 to $2.0 million in the third quarter of 1998.
Noninterest expense during 1997 included a charge of $566,000 associated with
stock option compensation expense. Excluding the impact of this expense in 1997,
noninterest expense effectively increased $244,000 as a result of the increase
EBI's loan origination and servicing volumes and deposit levels, the impact of
which was evidenced by the increases in salaries and employee benefits, deposit
insurance expense, service bureau expense and other noninterest expense, the
most significant components of which for the three months ended September 30 are
presented below.
Increase
1998 1997 (Decrease)
---- ---- ----------
Loan expense............................ $ 63,133 $ 27,844 $35,289
Telephone............................... 60,380 43,973 16,407
Postage and courier..................... 46,599 33,689 12,910
Stationery and supplies................. 24,610 26,233 (1,623)
Advertising and marketing............... 44,036 31,851 12,185
Corporate insurance..................... 26,154 28,110 (1,956)
Travel.................................. 18,260 8,542 9,718
Franchise and other taxes............... (3,299) 3,619 (6,918)
Bank charges............................ 107 10,172 (10,065)
Year 2000 compliance.................... 11,850 260 11,590
Other................................... 39,314 30,029 9,285
-------- -------- -------
$331,144 $244,322 $86,822
======== ======== =======
Year 2000 Readiness
As previously described in its 1997 Annual Report, EBI has established
a company-wide task force to assess and remediate business risks associated with
the Year 2000. This task force has developed and implemented a seven-phase Year
2000 plan consisting of the following components:
o Awareness - communication of the Year 2000 issue throughout EBI, including
EBI's board of directors and senior management;
o Assessment - development of inventories and analysis and evaluation of
hardware, software, services, forms, agencies and business partnerships and
the assignment of rankings of business risk (the highest being
"mission-critical") associated with each;
o Planning - development of comprehensive strategies and timelines for
correcting non-compliant items, testing and documenting results,
implementing and migrating enhancements and monitoring implementation
results;
o Renovation - implementation of the required software and hardware changes,
systems and interface modifications and conversions to replacement systems;
18
o Validation - completion of formal unit, system and integration testing and
documentation of results;
o Implementation - integration of all corrected and validated items into the
production environment;
o Post-Implementation - monitoring implementation results and responding to
situations that invalidate corrections as implemented.
EBI has completed the awareness, assessment and planning phases of its
Year 2000 plan and is now proceeding with the renovation phase. It is
anticipated that all reprogramming and replacement efforts will be substantially
complete by December 31, 1998. Because EBI outsources substantially all of its
data processing for loans, deposits and loan servicing, a significant component
of the Year 2000 plan entails working with external vendors to test and certify
their systems as Year 2000 compliant. EBI plans to complete its validation of
mission-critical internal and external systems and operations by March 31, 1999.
Concurrently with the readiness measures described above, EBI is developing
contingency plans intended to mitigate the possible disruption in business
operations that may result from the Year 2000 issue.
The total cost of the Year 2000 project (including the capitalized cost
of new hardware and software) is estimated to be $350,000 and is being funded
through operating cash flows. This estimate does not include any costs
associated with the implementation of contingency plans, which are in the
process of being developed. Management believes that most of the capitalized
costs are associated with technology changes that will enable EBI to provide
competitive services. During the nine months ended September 30, 1998, EBI
recognized $32,000 of expense associated with this project. This amount does not
include the implicit costs associated with the reallocation of internal staff
hours to the Year 2000 project. Management believes EBI can incur Year 2000
project 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.
Liquidity
The Office of Thrift Supervision ("OTS") has established minimum
liquidity requirements for savings associations. These regulations provide, in
part, that members of the FHLB system maintain daily average balances of liquid
assets equal to a certain percentage of net withdrawable deposits plus current
borrowings. Current regulations require a liquidity level of at least 4%. The
Bank has consistently exceeded such regulatory liquidity requirement and, at
September 30, 1998, had a liquidity ratio of 11.88%.
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
19
specified capital as a percent of the appropriate asset base. At September 30,
1998, 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 Federal
Deposit Insurance Corporation 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. As of September 30, 1998, the Bank was
"well capitalized" for PCA purposes.
The Bank's capital amounts and ratios as of September 30, 1998 are
presented below (in thousands):
To Be Well
For Capital Capitalized Under
Actual Adequacy Purposes PCA Provisions
------------------ -------------------- --------------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
Total capital (to
risk-weighted assets) $16,983 13.65% $9,956 8.0% $12,445 =>10.0%
Tier I capital (to
risk-weighted assets) 15,681 12.60% 4,978 4.0% 7,467 =>6.0%
Tier I capital (to
total assets) 15,681 7.37% 8,509 4.0% 10,637 =>5.0%
Tangible capital (to
total assets) 15,681 7.37% 3,191 1.5% - -
Item 3. Quantitative and Qualitative Disclosures About Market Risk
There have been no material changes in market risk exposures that
affect the quantitative or qualitative disclosures presented as of the preceding
year end in the EBI 1997 Annual Report.
[intentionally blank]
20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings -- Not Applicable
Item 2. Changes in Securities -- Not Applicable
Item 3. Defaults Upon Senior Securities -- Not Applicable
Item 4. Submission of Matters to a Vote of Security Holders -- Not Applicable
Item 5. Other Information -- Not Applicable
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits -- The following exhibits are filed as part of this Part
II:
Exhibit No. Description
----------- -----------
27 Financial Data Schedule
(b) Reports on Form 8-K -- Not Applicable
[intentionally blank]
21
SIGNATURE
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned, thereunto duly authorized.
Essex Bancorp, Inc.
November 10, 1998 By: /s/ Gene D. Ross
----------------- ---------------------
(Date) Gene D. Ross
Chairman, President,
and Chief Executive
Officer
November 10, 1998 By: /s/ Mary-Jo Rawson
----------------- ---------------------
(Date) Mary-Jo Rawson
Chief Accounting Officer
22