EXHIBIT 13
ESSEX
BANCORP, INC.
1998 ANNUAL REPORT
ESSEX
BANCORP, INC.
Table of Contents
Page
----
Report to Our Stockholders 1
Five Year Financial Summary 4
Management's Discussion and Analysis 5
Report of Independent Accountants 24
Consolidated Financial Statements 25
Notes to Consolidated Financial Statements 33
Investor Information 54
Directors and Officers 55
Corporate Information 56
Forward-Looking Statements
From time to time, the Company may publish forward-looking statements, such as
the ones included in this Annual Report, relating to such matters as anticipated
financial performance, business prospects, and similar matters. The Private
Securities Litigation Reform Act of 1995 provides a safe harbor for
forward-looking statements. In order to comply with the terms of the safe
harbor, the Company notes that a variety of factors could cause the Company's
actual results and experience to differ materially from the anticipated results
or other expectations expressed in the Company's forward-looking statements.
Some of the risks and uncertainties that may affect the operations, performance,
development and results of the Company's business include but are not limited to
the following:
a. Deterioration in local economic conditions;
b. Deterioration in national or global economic conditions;
c. Significant changes in laws and regulations affecting the financial
services industry; and
d. Significant changes in the markets in which our businesses compete.
ESSEX BANCORP, INC. LOGO
MESSAGE TO OUR STOCKHOLDERS
To Our Stockholders:
I am pleased to report that Essex Bancorp, Inc. ("Essex") reported earnings of
$1.0 million in 1998. This is the first year, since the change in management in
1992, that Essex has achieved core profitability from operations and recognized
a portion of the tax benefits associated with historical losses because of
favorable expectations in the near term. While we are pleased with the progress,
we will not be satisfied until Essex is identified as a high performance
financial institution when compared with similar-type franchises and core
profitability exceeds the accrued dividends on our preferred stock.
During 1998, Essex experienced improved fundamentals in many areas. For example,
(i) total assets of $231 million at December 31, 1998 reflects an increase of
approximately 19% from 1997, (ii) non-performing assets declined by
approximately 44% to a ratio to total assets of .79% - the lowest in Essex's
history, (iii) our Suffolk, Virginia full-service branch, reported in last
year's message, accomplished growth in deposits of $11 million or 94%, and (iv)
Essex's regulatory relationship and overall risk profile, discussed frequently
in previous years, has strengthened and improved significantly from 1997. 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
Essex's performance during 1998.
1
Management's ability to concentrate on developing business opportunities without
being distracted by past problems is contributing to the overall franchise value
and a more productive company. Essex Savings Bank grew its deposit base $34
million, representing 22% growth, from its four existing branches. Both our
mortgage division and loan servicing operations also had excellent years. Essex
First Mortgage originated residential mortgage loans totaling $78.1 million and
construction permanent loan commitments of $27.7 million and funded $19.6
million for builder construction loans. Essex Home Mortgage Servicing
Corporation increased its third-party loan servicing portfolio from 5,480 loans
with principal balances of $354 million at the end of 1997 to 12,155 loans with
principal balances of $1.1 billion. The 122% increase in total loans serviced
for nonaffiliates is especially notable in view of the loss in 1997 of Essex's
largest contract, representing 7,400 loans.
1999 will be a challenging year for Essex's management. Our business plan calls
for continued emphasis on each of our three principal lines of business: retail
community banking, mortgage banking, and loan servicing. However, within each of
those areas we are developing strategies to enhance existing revenues and at the
same time pursue new sources of revenues. While the business plan provides for a
sluggish first quarter in 1999, it is anticipated that projected loan growth in
higher- yielding loan products, such as construction loans, will ultimately
enhance Essex's core profitability in 1999. Management is focused on the future
and the opportunities that a rapidly changing marketplace creates. In this
regard, Essex is well positioned in growth markets and should benefit from
further consolidations in the financial services industry and the increasing
disenchantment of consumers with large banking institutions. We have worked hard
to transition to community banking over the past several years and our
deliberateness in targeting our markets is reflected in our growing customer
bases. Soon we will break ground on another new full-service branch in Ashland,
Virginia. We are excited about opportunities in this market because we have
already established a presence through our retail deposit products and our
builder construction loan relationships in our Richmond, Virginia branch.
Looking back, 1998 was clearly a year of performance and accomplishments.
Successes don't just happen; they are the result of planning and the hard work
of Essex's directors, officers and
2
employees. We appreciate their dedication and the support of our customers and
shareholders.
/s/ Gene D. Ross
Gene D. Ross
President and CEO
Essex Bancorp, Inc.
March 31, 1999
3
FIVE YEAR FINANCIAL SUMMARY
(Dollars in Thousands, Except Per Share)
At or For the Year Ended December 31,
1998 1997 1996 1995 1994
---- ---- ---- ---- ----
BALANCE SHEET DATA:
Total assets......................... $231,040 $195,088 $174,267 $338,724 $296,231
Net loans ........................... 192,668 167,441 145,551 266,632 237,392
Deposits ........................... 187,632 153,927 131,033 283,497 222,462
Federal Home Loan Bank advances...... 24,908 23,547 25,690 29,833 58,952
Notes payable........................ - 72 96 120 2,691
Shareholders' equity and total
partners' capital.................. 15,835 14,817 15,106 22,630 8,140
Nonperforming assets................. 1,835 3,298 5,215 11,257 13,652
Allowance for loan losses............ 1,845 2,382 2,556 5,251 3,429
OPERATIONS DATA:
Interest income...................... $ 15,430 $ 14,547 $ 19,872 $ 22,547 $ 22,966
Interest expense..................... 9,778 9,230 13,764 16,627 15,956
Net interest income.................. 5,652 5,317 6,108 5,920 7,010
Provision for loan losses............ 13 113 1,411 2,477 1,604
Noninterest income................... 2,713 2,463 4,282 3,172 4,068
Noninterest expense:
Amortization....................... 503 531 7,011 956 1,360
Other.............................. 7,354 7,433 9,345 9,814 15,619
Income (loss) before cumulative
effect of change in accounting
principle, extraordinary items,
and income taxes................... 495 (297) (7,377) (4,155) (7,505)
Cumulative effect of change in
accounting principle............... - - - - 179
Extraordinary items, net of tax...... - - - 2,945 (1) 20,416 (2)
Provision for (benefit from) income
taxes.............................. (518) - - - -
Net income (loss).................... 1,013 (297) (7,377) (1,210) 13,090
Net income (loss) available to
common stockholders................ (777) (1,932) (8,824) (1,578) 13,090
Basic and diluted net loss per
common share....................... (.73) (1.83) (8.39) (1.50) -
Pro forma basic and diluted net
income (loss) per common
share.............................. - - - - 12.47
OTHER DATA:
Return on average assets............. .49% (.16)% (2.73)% (.39)% (1) 3.88% (2)
Return on average capital............ 6.71% (1.96)% (39.51)% (10.59)% (3)
Average capital to average assets.... 7.28% 8.13% 6.92% 3.67% (4)
Net interest spread.................. 2.54% 2.69% 2.20% 2.00% 2.46%
Net interest margin.................. 2.93% 3.01% 2.41% 2.01% 2.20%
Nonperforming assets as a percent
of total assets at end of year..... .79% 1.69% 2.99% 3.32% 4.61%
Allowance for loan losses as a
percent of total loans at end
of year ........................... .95% 1.40% 1.73% 1.93% 1.42%
Net charge-offs as a percent of
average total loans................ .32% .18% 1.89% .46% .55%
Retail banking offices............... 4 4 4 12 8
(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) Ratio exceeds (100.00)%. (4) Ratio is less than 0.00%.
4
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 (i) four
retail banking branches in North Carolina and Virginia and (ii) Essex First, a
division that engages principally in the origination and sale of residential
mortgage loans. The Company's other principal operating subsidiary is Essex Home
Mortgage Servicing Corporation ("Essex Home"), a majority-owned subsidiary of
the Bank that is engaged primarily in the servicing of mortgage loans owned by
the Bank, governmental agencies, and third party investors. Essex Mortgage
Corporation ("EMC") is also a subsidiary of the Company that was formerly
engaged in mortgage banking activities and, at December 31, 1998, 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, the Company sold nine of the
Bank's 13 branches. 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 positioned itself to maintain 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 post-1996 operating expenses were reduced due to the elimination of
the amortization of goodwill and the operating expenses associated with the
Branches.
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, 1998 were $231.0
million as compared to $195.1 million at December 31, 1997, an increase of
approximately $35.9 million or 18.4%. The increase in assets was primarily
attributable to (i) a $6.9 million increase in cash and cash equivalents
resulting primarily from an increase in escrow deposits maintained by Essex Home
at the Bank, (ii) a $25.2 million increase in loans held for investment, which
reflected the Company's strategy of investing funds provided by the growth in
deposits into higher yielding loans, (iii) a $2.3 million increase in loans held
for sale, which reflected the impact of the lower interest rate environment on
5
the production of residential loans held for sale in the secondary market and
(iv) a $1.3 million increase in premises and equipment resulting from the Bank's
completion of a newly-constructed branch in Suffolk, Virginia for the relocation
of an existing branch, the acquisition of the Bank's previously-leased branch in
Richmond, Virginia and the acquisition of land for the Bank's expansion into
Ashland, Virginia, as well as the Company's investment in technology
enhancements such as the implementation of a wide area network.
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 $6.9 million or
62.7% during 1998 due to the excess liquidity maintained at December 31, 1998
resulting from an increase in noninterest-bearing escrow deposits maintained by
Essex Home at the Bank.
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 agency obligations, Federal Home
Loan Bank ("FHLB") stock, and mutual fund investments. During the year ended
December 31, 1998, investment securities increased $570,000 or 15.2%. The
increase during 1998 was attributable to (i) the purchase of $118,000 of FHLB
stock in order to satisfy the minimum investment requirements for FHLB
membership, which increased because of the Bank's loan growth in 1998 and (ii)
the utilization of funds from the maturity of a $300,000 callable U.S.
government agency security in 1998 for the acquisition of a $750,000 U.S.
government agency security, which has been pledged to secure public deposits at
December 31, 1998.
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 1998.
Loans. Net loans (including loans classified as held for sale)
increased by $27.5 million or 16.2% during 1998 resulting from secondary market
purchases of adjustable-rate first mortgage loan portfolios totaling $32.3
million and fixed-rate home improvement loans totaling $3.2 million, which were
partially offset by a decline in the Company's fixed-rate first and second
mortgage loans. The Company relied on acquisitions of adjustable-rate portfolios
during 1998 because customer demand during the period of low interest rates has
emphasized fixed rate loans, which the Company sells in the secondary market.
6
Nonperforming Assets. The Company's nonperforming assets, net of
specific reserves for collateral-dependent real estate loans ("CDRELs") and
foreclosed properties, decreased from $3.3 million at December 31, 1997 to $1.8
million at December 31, 1998, and consisted of the following (dollars in
thousands):
1998 1997
---- ----
% of % of
Total Total
Amount Loans Amount Loans
------ ----- ------ -----
Nonaccrual loans, net:
First and second mortgages................ $ 697 .36% $1,203 .71%
Construction and development.............. - - 133 .08
Commercial................................ 328 .17 132 .08
Consumer.................................. 141 .07 88 .05
Accruing loans 90 days or more past due..... - - 21 .01
Troubled debt restructurings................ 98 .05 209 .12
------- --- ------ ----
Total nonperforming loans............... 1,264 .65 1,786 1.05
Foreclosed properties, net.................. 571 .29 1,512 .89
------- --- ------ ----
Total nonperforming assets.............. $1,835 .94% $3,298 1.94%
===== === ===== ====
Nonperforming assets to total assets........ .79% 1.69%
Nonperforming loans to total loans.......... .65 1.05
Allowance for loan losses to
total loans............................... .95 1.40
Allowance for loan losses to
nonaccrual loans.......................... 158.23 153.09
Allowance for loan losses to
nonperforming loans....................... 145.97 133.37
The decrease in nonperforming assets consisted of a $522,000 decline in
nonperforming loans and a $941,000 decline in foreclosed properties. The
decrease in nonaccrual loans was attributable to the improvement in asset
quality evidenced by the decline in delinquencies from $940,000 at December 31,
1997 to $708,000 at December 31, 1998. Gross interest income that would have
been recognized for the years ended December 31, 1998, 1997 and 1996 if
nonaccrual loans at the respective dates had been performing in accordance with
their original terms approximated $115,000, $171,000 and $291,000, 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 continuing decline in nonperforming and delinquent loans during 1998 and the
sale of 12 of the 13 properties held at December 31, 1997. The $571,000 of
foreclosed properties included in nonperforming assets at December 31, 1998 is
reported net of related reserves totaling $114,000. In addition, approximately
$246,000 of losses and write-downs have been previously recognized on foreclosed
properties held at December 31, 1998.
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):
1998 1997
---- ----
Residential real estate development
projects $ - $ 485
Single-family residential real estate 486 770
Land and subdivisions 85 257
------ ------
$571 $1,512
=== =====
7
In addition to the $1.8 million of nonperforming assets at December 31,
1998, the Company had classified for regulatory purposes an additional $1.6
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
$3.3 million of nonperforming assets and $1.8 million of classified assets at
December 31, 1997. 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. However, during the third quarter of 1998, the Office of Thrift
Supervision ("OTS") completed its safety and soundness examination of the
Company and the Bank and did not require any changes to the classification of
assets.
Mortgage Servicing Rights and Loan Premiums. As of December 31, 1998
and 1997, the Company reported $831,000 and $1.2 million, respectively, of
purchased and originated mortgage servicing rights (collectively, "MSRs") and
$951,000 and $668,000, respectively, of capitalized loan premiums. The increase
in loan premiums was attributable to secondary market purchases of loan
portfolios during 1998. The decrease in MSRs was attributable to amortization
during 1998, which included a $54,000 increase in the valuation allowance in
order to reduce the carrying value of MSRs to the estimated fair value at
December 31, 1998. 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, 1998, 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
current expectations.
Deposits. Deposits, the primary source of the Company's funds,
increased by $33.7 million or 21.9% during the year ended December 31, 1998. The
increase in deposits was attributable to (i) an $11.7 million increase in
noninterest-bearing accounts largely because of the increase in Essex Home's
servicing escrow accounts maintained at the Bank and (ii) an $18.5 million
increase in certificates of deposit predominantly at the Suffolk and Richmond,
Virginia branches, which experienced deposit growth of 91.5% and 25.5%,
respectively.
Borrowings. The Company's borrowings consist primarily of advances from
the FHLB. FHLB advances increased by $1.4 million or 5.8% during the year ended
December 31, 1998. At December 31, 1998, the unused lendable collateral value
for additional FHLB advances was $31.6 million.
Shareholders' Equity. Total shareholders' equity at December 31, 1998
was $15.8 million, an increase of $1.0 million from shareholders' equity of
$14.8 million at December 31, 1997. This change reflects the Company's net
income of $1.0 million for the year ended December 31, 1998, which is further
described under Results of Operations.
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 $5.2 million at December 31, 1998. Because the Company's
income is not yet sufficient to cover the cumulative dividends on the Series B
and C preferred stock, the equity of the holders of the Company's common and
preferred stock will continue to be affected. Accordingly, the Company's Board
of Directors and the Committee continue to evaluate profitability enhancements
and possibilities for corporate restructurings.
On May 28, 1998, the Company's shareholders approved an amendment of
the Company's Certificate of Incorporation whereby the total authorized
8
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 the Company's flexibility to issue
additional shares of common stock and preferred stock to enable the Company to
engage in strategic transactions, such as possible mergers or share exchanges
with other entities. However, the Company has no present plans to issue shares
in connection with any particular transaction.
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 (including the amortization of purchased loan premiums) on
interest-earning assets, primarily loans, and interest expense on
interest-bearing liabilities, primarily deposits and FHLB advances. 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 and the level of its
noninterest expenses, such as salaries and employee benefits, net occupancy and
equipment costs, amortization of MSRs, deposit insurance premiums and expenses
associated with the administration of nonperforming and other classified assets.
The Company's major business activities 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, (ii) the origination by Essex First of real estate
mortgage loans for sale to third parties predominantly on a servicing-released
basis in order to generate higher income and (iii) the servicing of mortgage
loans by Essex Home in order to generate fee income. As of December 31, 1998,
Essex Home serviced approximately 12,200 loans totaling $1.1 billion for
nonaffiliated servicing clients. For additional segment information, refer to
Note 23 of the Notes to Consolidated Financial Statements.
General. The Company's net income for the year ended December 31, 1998
totaled $1.0 million, compared to a net loss of $297,000 for the year ended
December 31, 1997 and a net loss of $7.4 million for the year ended December 31,
1996.
The Company's net income for the year ended December 31, 1998 included
a $550,000 tax benefit resulting from the recognition of a deferred tax asset
for a portion of the Company's net operating tax loss ("NOL") carryforwards. The
recognition of this NOL benefit was made possible by the Company's return to and
projected maintenance of core profitability. Excluding this NOL benefit
recognized in 1998 and excluding nonrecurring items in 1997 for the aggregate
gain of $97,000 on the sale of vacant branch facilities, termination fees
approximating $113,000 received by Essex Home in connection with the
cancellation of a subservicing client's contract and a $498,000 charge for stock
option compensation, the Company's net income effectively improved $472,000 in
1998. This improvement occurred as a result of (i) an increase in net interest
income resulting from an increase in interest-earning assets, the benefit of
which was partially offset by a decline in the net interest margin, (ii) a
decline in the provision for loan losses resulting from a reduction in
nonperforming assets during 1998, (iii) an increase in mortgage banking income
resulting from an increase in residential loan originations coupled with sales
in the secondary market and (iv) an increase in other noninterest income
resulting from service charges and fees on the higher servicing volume at Essex
Home and higher deposit levels at the Bank. These increases were partially
offset by (i) a decrease in loan servicing fees resulting from a lower average
servicing portfolio in the first half of 1998, (ii) an increase in noninterest
expenses associated with the increase in the Company's loan origination and
servicing volumes and deposit levels and (iii) state income tax expense.
9
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.
Refer to Note 5 of the Notes to Consolidated Financial Statements for a detailed
description of the sale of the Branches.
Net Interest Income. Net interest income totaled $5.7 million, $5.3
million and $6.1 million for the years ended December 31, 1998, 1997 and 1996,
respectively. In addition, the net interest margin was 2.93%, 3.01% and 2.41%
for the years ended December 31, 1998, 1997 and 1996, respectively.
The increase in net interest income from 1997 to 1998 reflected the
favorable impact of the increase in the ratio of average interest-earning assets
to average interest-bearing liabilities coupled with a decline in the Company's
cost of funds resulting from the lower interest rate environment during 1998.
However, there was an eight basis point decline in the net interest margin
resulting from the impact of the lower interest rate environment in 1998 on the
volume of refinancings to lower fixed rate loans, rate decreases on
adjustable-rate mortgages and secondary market purchases at lower market yields.
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. 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, balloon payment and adjustable-rate loans
with longer initial adjustment terms predominate.
The decrease in net interest income from 1996 to 1997 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
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 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.
10
1998 1997
-------------------------------- -------------------------------
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
------- -------- ---- ------- -------- ----
(dollars in thousands)
Interest-earning assets:
Loans (1)...................... $178,078 $14,608 8.20% $159,370 $13,588 8.53%
Investment securities.......... 3,902 226 5.79 6,457 354 5.48
Mortgage-backed securities (2). 1,871 122 6.50 1,905 124 6.54
Federal funds sold and securities
purchased under agreements
to resell.................... 2,069 111 5.37 2,757 151 5.48
Other.......................... 6,835 363 5.29 6,024 330 5.48
-------- -------- -------- --------
Total interest-earning assets 192,755 15,430 8.00 176,513 14,547 8.24
Cash.............................. 4,615 2,065
Other, less allowance for loan losses 9,866 7,831
-------- --------
Total assets................... $207,236 $186,409
======= =======
Interest-bearing liabilities:
Time deposits.................. $121,752 6,904 5.67% $111,394 6,381 5.73%
Other deposits................. 35,431 1,587 4.48 29,584 1,298 4.39
-------- ------- -------- -------
Total deposits.............. 157,183 8,491 5.40 140,978 7,679 5.45
Notes payable.................. 8 1 9.32 96 9 9.50
FHLB advances.................. 21,553 1,230 5.71 24,885 1,474 5.92
Subordinated capital notes..... - - - - - -
Other.......................... 303 56 18.30 360 68 18.29
--------- --------- --------- -------- --
Total interest-bearing
liabilities.............. 179,047 9,778 5.46 166,319 9,230 5.55
------ -------
Demand deposits................... 9,504 3,143
Other............................. 3,589 1,795
--------- --------- -
Total liabilities.............. 192,140 171,257
Shareholders' equity.............. 15,096 15,152
-------- --------
Total liabilities and
shareholders' equity........ $207,236 $186,409
======= =======
Net interest earnings............. $ 5,652 $ 5,317
====== =======
Net interest spread............... 2.54% 2.69%
==== ====
Net interest margin (3)........... 2.93% 3.01%
==== ====
Average interest-earning assets
to average interest-bearing
liabilities.................... 107.66% 106.13%
====== ======
1996
-------------------------------
Average Yield/
Balance Interest Rate
------- -------- ----
(dollars in thousands)
Interest-earning assets:
Loans (1)...................... $221,215 $17,882 8.08%
Investment securities.......... 11,012 615 5.59
Mortgage-backed securities (2). 6,320 498 7.95
Federal funds sold and securities
purchased under agreements
to resell.................... 6,094 319 5.24
Other.......................... 10,094 558 5.38
-------- --------
Total interest-earning assets 254,735 19,872 7.80
Cash.............................. 3,083
Other, less allowance for loan losses 11,944
--------
Total assets................... $269,762
=======
Interest-bearing liabilities:
Time deposits.................. $183,710 10,620 5.78%
Other deposits................. 33,218 1,325 3.99
-------- -------
Total deposits.............. 216,928 11,945 5.51
Notes payable.................. 113 11 9.50
FHLB advances.................. 27,137 1,626 5.99
Subordinated capital notes..... 399 52 13.15
Other.......................... 405 130 18.32
--------- --------
Total interest-bearing
liabilities.............. 244,982 13,764 5.60
------
Demand deposits................... 1,433
Other............................. 4,675
---------
Total liabilities.............. 251,090
Shareholders' equity.............. 18,672
--------
Total liabilities and
shareholders' equity........ $269,762
=======
Net interest earnings............. $ 6,108
=======
Net interest spread............... 2.20%
====
Net interest margin (3)........... 2.41%
====
Average interest-earning assets
to average interest-bearing
liabilities.................... 103.98%
======
(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) 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
1997 to 1998 Due to 1996 to 1997 Due to
------------------- -------------------
Rate Volume Net Rate Volume Net
---- ------ --- ---- ------ ---
(dollars in thousands)
Interest income on:
Loans (1) $(529) $1,549 1,020 $934 $(5,228) $(4,294)
Investment securities 19 (147) (128) (11) (250) (261)
Mortgage-backed securities - (2) (2) (77) (297) (374)
Federal funds sold and securities
purchased under agreements
to resell (3) (37) (40) 14 (182) (168)
Other interest-earning assets (11) 44 33 9 (237) (228)
----- ------- ------- ----- ------- -------
Total interest income (2) (524) 1,407 883 869 (6,194) (5,325)
---- ----- ------ --- ------ ------
Interest expense on:
Time deposits (65) 588 523 (96) (4,143) (4,239)
Other deposits 27 262 289 126 (153) (27)
Notes payable - (8) (8) - (2) (2)
FHLB advances (53) (191) (244) (18) (134) (152)
Subordinated capital notes - - - (26) (26) (52)
Other interest-bearing
liabilities - (12) (12) - (62) (62)
------- ------- ------- ------- -------- --------
Total interest expense (91) 639 548 (14) (4,520) (4,534)
----- ------ ------ ----- ------ ------
Net interest income $(433) $ 768 $ 335 $883 $(1,674) $ (791)
==== ====== ====== === ====== =======
(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, 1998, 1997 and 1996, provisions for
loan losses amounted to $13,000, $113,000 and $1.4 million, respectively. At
December 31, 1998, total nonperforming assets as a percentage of total assets
were .79% as compared to 1.69% at December 31, 1997. In addition, nonperforming
assets totaled $1.8 million at December 31, 1998 as compared to $3.3 million at
December 31, 1997. These measures reflect the highest level of credit quality in
the Company's history as a public company. Based on the favorable trends in
12
nonperforming assets and the coverage of the general loan loss reserves,
management considered the loan loss allowance sufficient to absorb losses and
provided for minimal additional losses during the year ended December 31, 1998.
The lower provision for loan losses during 1997 as compared to 1996 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.
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 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.
However, upon the completion of its safety and soundness examination during the
third quarter of 1998, the OTS did not require any adjustments to loss
allowances.
Noninterest Income. The following table sets forth information
regarding noninterest income for the years ended December 31:
1998 1997 1996
---- ---- ----
Loan servicing fees......................... $1,222,478 $1,312,476 $ 1,665,768
Mortgage banking income..................... 755,450 458,520 577,130
Other service charges and fees.............. 466,135 368,671 497,316
Net gain (loss) on sales of:
Securities............................. - - 153,188
Loans.................................. - (1,458) (1,018,185)
Deposits............................... - - 1,940,010
Other....................................... 268,890 324,596 466,519
---------- ---------- -----------
$2,712,953 $2,462,805 $ 4,281,746
========= ========= ==========
Total noninterest income amounted to $2.7 million during the year ended
December 31, 1998, a $250,000 or 10.2% increase from the $2.5 million recognized
during the year ended December 31, 1997. However, 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. Excluding
the impact of these nonrecurring transactions in 1997, noninterest income
effectively increased $460,000 or 20.4% during 1998 as a result of a $297,000
increase in mortgage banking income, a $97,000 increase in other service charges
and fees and a $154,000 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's production of residential loans sold in the
secondary market. The increase in other service charges and fees occurred
primarily at the Bank in service charges on deposit accounts, which reflected
the impact of a 19.1% growth in the number of deposit accounts. 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 during 1998.
The increases in noninterest income for the year ended December 31,
1998 were partially offset by lower loan servicing fees during the first half 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.
13
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. As previously described,
noninterest income during 1997 included $210,000 of nonrecurring income.
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.
Noninterest Expense. The following table sets forth information
regarding noninterest expense for the years ended December 31:
1998 1997 1996
---- ---- ----
Salaries and employee benefits.............. $3,476,785 $3,788,695 $ 4,554,540
Net occupancy and equipment................. 954,804 1,084,593 1,470,284
Deposit insurance premiums.................. 497,081 478,684 674,730
Amortization of intangible assets........... 503,148 530,707 7,011,288
Service bureau fees......................... 513,826 461,217 599,207
Professional fees........................... 296,295 349,218 507,031
Foreclosed properties, net.................. 150,461 182,880 (175,055)
Other....................................... 1,464,473 1,087,362 1,713,958
--------- --------- -----------
$7,856,873 $7,963,356 $16,355,983
========= ========= ==========
Total noninterest expense declined $1065,000 or 1.3% from $7.96 million
during the year ended December 31, 1997 to $7.86 million during the year ended
December 31, 1998. Noninterest expense as a percent of average assets was 3.8%
for 1998 as compared to 4.3% for 1997. The improvement in this ratio reflects
the impact of asset growth coupled with cost containment.
Salaries and employee benefits declined $312,000 or 8.2% during 1998.
This decrease resulted primarily from nonrecurring personnel expenses during
1997 for (i) a $136,500 severance settlement with the former president of an
acquired savings institution and its holding company and (ii) $498,000 of stock
option compensation. Excluding these nonrecurring transactions, salaries and
benefits increased $323,000 during 1998. This increase was attributable to an
increase in total full-time and part-time employees from 99 as of December 31,
1997 to 119 as of December 31, 1998. The growth in personnel positions occurred
as loan origination and servicing volumes increased.
Net occupancy and equipment expense declined $130,000 or 12.0% during
1998. This decrease reflected the impact of the Bank (i) opening a Bank-owned
retail bank branch in Suffolk, Virginia, which had previously been located in a
leased facility and (ii) exercising a purchase option for the Richmond, Virginia
retail bank branch, which had previously been a leased facility. Occupancy and
equipment expense also benefited from lower depreciation expense in 1998.
However, depreciation in future periods will reflect the impact of the Company's
investment in technology enhancements such as the implementation of a wide area
network.
Deposit insurance premiums increased $18,000 or 3.8% during 1998. This
increase reflects an increase in the deposit assessment base resulting from
14
deposit growth. Refer to "Regulatory Capital" below for a discussion of matters
impacting the Company's deposit assessment in the future. Likewise, service
bureau fees increased $53,000 or 11.4% during 1998. This increase was primarily
attributable to the increases in (i) loan servicing volume from 8,400 loans at
December 31, 1997 to 15,100 loans at December 31, 1998 and (ii) the number of
deposit accounts, which increased 19.1% during 1998.
Amortization of intangible assets declined $28,000 or 5.2% during 1998.
Notwithstanding this decrease, amortization during 1998 included a $54,000
increase in the MSR valuation allowance in order to reduce the carrying value of
the Company's MSRs to the estimated fair value at December 31, 1998. No
assurance can be made that further adjustments to the MSR valuation allowance
will not be required in future periods if the lower interest rate environment
results in the acceleration of prepayment activity in excess of current
expectations.
Professional fees declined $53,000 or 15.2% during 1998. This decrease
was attributable to nonrecurring legal fees incurred in 1997 in connection with
a severance settlement with the former president of an acquired savings
institution and its holding company.
Foreclosed properties expense declined $32,000 or 17.7% during 1998,
which was attributable to the decline in foreclosed properties from $1.5 million
at December 31, 1997 to $571,000 at December 31, 1998.
The significant components of the increase in other miscellaneous
noninterest expense for the years ended December 31, 1998 and 1997 are presented
below and reflect the impact of the increase in the Company's loan origination
and servicing volumes and deposit levels on general operating expenses:
Change
1998 1997 Amount Percent
---- ---- ------ -------
Loan expense....................... $ 211,092 $ 150,457 $ 60,635 40.3
Telephone.......................... 249,770 175,474 74,296 42.3
Postage and courier................ 185,819 153,349 32,470 21.2
Stationery and supplies............ 115,111 99,545 15,566 15.6
Advertising and marketing.......... 198,399 155,654 42,745 27.5
Corporate insurance................ 100,630 116,882 (16,252) (13.9)
Officers life insurance............ 30,692 (41,082) 71,774 100.0+
Travel............................. 62,060 47,453 14,607 30.8
Year 2000 readiness................ 48,270 510 47,760 93.7
Other.............................. 262,630 229,120 33,510 14.6
---------- ---------- --------
$1,464,473 $1,087,362 $377,111 34.7
========= ========= =======
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. In addition to the $7.6 million impact of the sale of the
Branches on the decline in noninterest expense during 1997, there were further
decreases in (i) salaries and employee benefits resulting from the impact of the
Company's downsizing efforts, (ii) net occupancy and equipment expense resulting
from the relocation of the Company's headquarters to a smaller more economical
facility and (iii) deposit insurance premiums resulting from the improvement in
the Bank's risk classification for insurance assessment purposes. The only
category of noninterest expense to increase during 1997 was foreclosed
properties expense, 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.
15
The significant components of the decrease in other miscellaneous
noninterest expense for the years ended December 31, 1997 and 1996 are presented
below and reflect the impact of the sale of the Branches during 1996 on general
operating expenses in 1997:
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)
========= ========= ========
Provision For Income Taxes. As a result of historical losses prior to
1998, the Company accumulated net deferred tax assets of $7.7 million as of
December 31, 1997, the largest component of which was the deferred tax benefit
of net operating loss carryforwards. The Company had established a valuation
allowance for the net deferred tax assets in their entirety because the ultimate
realization of the tax benefit within the carryforward periods available under
the tax law could not be assured. This resulted in the recognition of no income
tax provision or benefit during the years ended December 31, 1997 and 1996. In
December 1998, however, the Company partially reduced the deferred tax valuation
allowance, thus recognizing a deferred tax asset of $550,000. This reduction was
predicated upon the Company's favorable trends in actual and projected core
profitability. Continuation of these favorable trends in core profitability
would support further reductions in the deferred tax valuation allowance in
future periods. However, there can be no assurance that these trends will
continue or that the net deferred tax assets will be realized. For additional
information, refer to 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, such as 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 an Asset and Liability Management Committee ("ALCO") 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
16
of changes in interest rates. The ALCO implements and maintains 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 may
undertake 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 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, 1998. 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, 1998 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 $27,662 $45,104 $ 7,148 $ 13,445 $ - $ 93,359 43.7%
Fixed-rate 6,544 5,944 19,015 14,438 35,873 81,814 38.3
Second mortgage 3,462 511 1,562 992 809 7,336 3.4
All other 5,792 855 3,860 3,254 422 14,183 6.7
Investments 16,116 - - 750 - 16,866 7.9
------ ------ ------- ------- ------- -------- ------
Total 59,576 52,414 31,585 32,879 37,104 $213,558 100.0%
======= =====
Interest-bearing liabilities:
Deposits 58,429 65,731 37,407 13,500 9,262 $184,329 88.0%
Fixed-rate borrowings 9,530 5,300 7,850 - - 22,680 10.8
Variable-rate borrowings 2,500 - - - - 2,500 1.2
------ ------ ------- ------- ------- -------- ------
Total 70,459 71,031 45,257 13,500 9,262 $209,509 100.0%
======= =====
Effect of off-balance sheet
items (1) (11,579) 664 3,244 1,497 6,176
------ ------ ------- ------- -------
Maturity gap $(22,462) $(17,953) $(10,428) $ 20,876 $34,018
======= ======= ======= ====== ======
Cumulative gap $(22,462) $(40,415) $(50,843) $(29,967) $ 4,051
======= ======= ======= ======= =======
Cumulative gap as a percent
of total assets (9.9)% (17.9)% (22.5)% (13.3)% 1.8%
==== ===== ===== ===== ===
Cumulative ratio of interest-
earning assets to interest-
bearing liabilities 84.6% 79.2% 76.9% 88.1% 101.9%
==== ==== ==== ==== =====
(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 17.9% at December 31, 1998, 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 FHLB advances. The Company will
benefit from the lower cost of funds as these FHLB advances mature and will
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 loans, customer demand for such loans has
decreased as borrowers' demand for fixed-rate loans has increased. Within the
spectrum of loan products offered by the Bank, balloon payment and
adjustable-rate loans with longer initial adjustment terms predominate.
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 tables
present the Bank's NPV at December 31, 1998 and 1997.
18
As of December 31, 1998
Net Portfolio Value NPV as % of PV of Assets
Change in ------------------------------------------- ------------------------
Interest Rates $ Amount $ Change % Change NPV Ratio Change
-------------- -------- -------- -------- --------- ------
+400bp $ 9,282 $(9,444) (50.43)% 4.20% (378)bp
+300bp 12,577 (6,149) (32.84) 5.59 (239)bp
+200bp 15,392 (3,334) (17.80) 6.72 (126)bp
+100bp 17,510 (1,216) (6.49) 7.54 (44)bp
Base Scenario 18,726 7.98
-100bp 19,198 472 2.52 8.12 14bp
-200bp 19,645 919 4.91 8.25 27bp
-300bp 20,570 1,844 9.85 8.55 57bp
-400bp 21,268 2,542 13.58 8.76 78bp
As of December 31, 1997
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 ALCO has established limits for the impact of changes in interest
rates on NPV. As of December 31, 1998, 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, 1998, the
Bank's sensitivity of NPV was within internal policy limits, which reflects an
improvement over December 31, 1997 when the Bank was outside its 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 changes 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 not 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, 1998, had a liquidity ratio of 12.74%.
19
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. If the Bank requires funds which cannot be
generated internally, borrowings from the FHLB may provide an additional source
of funds. At December 31, 1998, the Bank had $24.9 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, 1998, the Bank had
outstanding commitments (including unused lines of credit) to originate and/or
purchase mortgage and non-mortgage loans of $4.7 million. The undisbursed
portions of construction builder loans and construction/permanent loans in
process totaled $6.2 million and $10.1 million, respectively, as of December 31,
1998. Certificates of deposit which are scheduled to mature within one year
totaled $94.1 million at December 31, 1998, and borrowings from the FHLB that
are scheduled to mature within the same period amounted to $17.3 million.
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 or leverage 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, 1998,
the Bank's tangible and core capital amounted to 6.97% of adjusted total assets
and the Bank's total capital amounted to 13.09% 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 or leverage
capital, Tier I risk-based capital, and total risk-based capital. At December
31, 1998, the Bank's Tier I, Tier I risk-based, and total risk-based capital
ratios were 6.97%, 12.12%, and 13.09%, 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, Tier I risk-based, and risk-based
regulatory capital under FDICIA totaled $4.5 million, $8.1 million, and $4.1
million, respectively, at December 31, 1998.
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
20
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
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, 1998, 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). In addition, 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 6.1 basis points is added to the regular
SAIF-assessment until December 31, 1999 in order to cover FICO debt service
payments.
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. The merger of the
SAIF and BIF did not occur on such date as there continue to be savings
associations. Such a merger of the SAIF and the BIF may occur in the future if
legislation containing such a provision is enacted. 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.
Year 2000 Readiness
As previously reported, the Company 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 the Company,
including the Company'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;
21
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.
The Company has completed the awareness, assessment and planning phases
of its Year 2000 plan and is now proceeding with the renovation phase.
Substantially all reprogramming and replacement efforts were complete by
December 31, 1998. Because the Company 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. The Company 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, the
Company 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 approximating $280,000) 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. Most of the capitalized costs are associated
with technology changes that will enhance the Company's ability to provide
competitive services. During the year ended December 31, 1998, the Company
recognized $48,000 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 the Company 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. Furthermore, the Year 2000 compliance
status of integral third party suppliers and networks, which could adversely
impact the Company's mission critical applications, cannot be fully known. As a
result, the Company is unable to determine the impact that any system
interruption would have on its results of operations, financial position and
cash flows. However, such impact could be material.
Inability to reach substantial Year 2000 compliance in the Company's
systems and integral third party systems could result in interruption of
telecommunications services, interruption or failure of the Company's ability to
service customers, failure of operating and other information systems and
failure of certain date-sensitive equipment. Such failures could result in loss
of revenue due to service interruption, delays in the Company's ability to
service its customers accurately and timely and increased expenses associated
with stabilization of operations following such failures or execution of
contingency plans.
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.
22
Quarterly Results of Operations
Quarterly unaudited financial data for the years ended December 31,
1998 and 1997 is presented below (in thousands, except per share data). The most
significant factor impacting operating results for the fourth quarter of 1998
was the recognition of a $550,000 income tax benefit for the partial reversal of
the deferred tax valuation allowance based on favorable trends in the Company's
actual and projected core profitability.
Year Ended December 31, 1998
--------------------------------------------------------------
1st 2nd 3rd 4th
Quarter Quarter Quarter Quarter
------- ------- ------- -------
Net interest income $1,385 $1,425 $1,407 $1,435
Provision for loan losses - - - 13
------ ------ ------ ------
Net interest income after
provision for loan losses 1,385 1,425 1,407 1,422
Noninterest income 552 619 765 776
Noninterest expenses 1,839 1,907 2,014 2,097
------ ------ ------ ------
Income before provision for
(benefit from) income taxes 98 137 158 101
Provision for (benefit from)
income taxes - - 29 (547)
------ ------ ------ ------
Net income $ 98 $ 137 $ 129 $ 648
====== ====== ====== ======
Basic and diluted net income
(loss) available to common
stockholders $ (335) $ (304) $ (321) $ 182
====== ====== ====== ======
Net income (loss) per common share:
Basic $ (.32) $ (.29) $ (.30) $ .17
====== ====== ====== ======
Diluted $ (.32) $ (.29) $ (.30) $ .04
====== ====== ====== ======
Weighted average shares
outstanding:
Basic 1,058 1,059 1,059 1,060
===== ===== ===== =====
Diluted 1,058 1,059 1,059 5,030
===== ===== ===== =====
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)
====== ====== ====== ======
Basic and diluted net loss
available to common
stockholders $ (378) $ (14) $ (903) $ (638)
====== ====== ====== ======
Basic and diluted net loss
per common share $ (.36) $ (.01) $ (.85) $ (.60)
====== ====== ====== ======
Basic and diluted weighted
average shares outstanding 1,053 1,055 1,057 1,058
===== ===== ===== =====
23
Report of Independent Accountants
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, 1998
and 1997, and the results of their operations and their cash flows for
each of the three years in the period ended December 31, 1998, 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.
PricewaterhouseCoopers LLP
Virginia Beach, Virginia
February 19, 1999
24
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
December 31, 1998 and 1997
1998 1997
---- ----
ASSETS
Cash..................................................................... $ 5,315,805 $ 2,023,197
Interest-bearing deposits................................................ 11,314,478 6,261,686
Federal funds sold and securities purchased under agreements to resell... 1,314,397 2,748,000
------------- -------------
Cash and cash equivalents....................................... 17,944,680 11,032,883
Federal Home Loan Bank stock............................................. 1,548,800 1,431,000
Securities available for sale - cost approximates market................. 18,406 17,451
Securities held for investment - market value of $2,704,000 in 1998
and $2,217,000 in 1997................................................. 2,750,089 2,299,120
Mortgage-backed securities held for investment - market value of
$1,454,000 in 1998 and $1,886,000 in 1997.............................. 1,455,738 1,904,989
Loans, net of allowance for loan losses of $1,845,000 in 1998 and
$2,382,000 in 1997..................................................... 192,667,763 167,440,733
Loans held for sale...................................................... 4,486,271 2,165,074
Mortgage servicing rights................................................ 831,197 1,169,766
Foreclosed properties, net............................................... 571,294 1,511,629
Accrued interest receivable.............................................. 1,250,349 1,196,980
Excess of cost over net assets acquired, less accumulated
amortization of $2,140,000 in 1998 and $2,078,000 in 1997.............. 97,692 159,754
Advances for taxes, insurance, and other................................. 1,572,225 633,053
Premises and equipment, net.............................................. 3,183,577 1,926,729
Other assets............................................................. 2,661,487 2,198,598
------------- -------------
Total Assets.................................................... $231,039,568 $195,087,759
=========== ===========
(Continued)
25
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (continued)
December 31, 1998 and 1997
1998 1997
---- ----
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Deposits:
Noninterest-bearing.................................................... $ 16,791,063 $ 5,055,545
Interest-bearing....................................................... 170,841,193 148,871,154
----------- -----------
Total deposits.................................................. 187,632,256 153,926,699
Federal Home Loan Bank advances.......................................... 24,908,333 23,546,667
Notes payable............................................................ - 72,102
Capital lease obligations................................................ 268,123 331,970
Other liabilities........................................................ 2,395,768 2,393,814
------------- -------------
Total Liabilities............................................... 215,204,480 180,271,252
COMMITMENTS AND CONTINGENCIES (Notes 8, 10 and 15)
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 1998 and 1997............. 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 1998 and 1997............... 833,750 833,750
Common stock, $.01 par value:
Authorized shares - 20,000,000 in 1998 and 10,000,000 in 1997
Issued and outstanding shares - 1,060,642 in 1998 and 1,058,136
in 1997............................................................. 10,606 10,581
Additional paid-in capital............................................... 8,687,772 8,681,739
Accumulated deficit...................................................... (7,870,790) (8,883,313)
------------ ------------
Total Shareholders' Equity...................................... 15,835,088 14,816,507
------------ ------------
Total Liabilities and Shareholders' Equity...................... $231,039,568 $195,087,759
=========== ===========
See notes to consolidated financial statements.
26
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
For the years ended December 31, 1998, 1997 and 1996
1998 1997 1996
---- ---- ----
INTEREST INCOME
Loans, including fees............................ $14,608,478 $13,588,215 $17,881,529
Federal funds sold and securities purchased
under agreements to resell..................... 111,054 150,972 319,298
Investment securities, including dividend
income......................................... 226,042 353,957 615,429
Mortgage-backed securities....................... 121,643 124,515 497,879
Other............................................ 362,943 329,846 558,139
----------- ----------- -----------
Total Interest Income................... 15,430,160 14,547,505 19,872,274
----------- ----------- -----------
INTEREST EXPENSE
Deposits ........................................ 8,491,101 7,679,314 11,945,273
Federal Home Loan Bank advances.................. 1,229,741 1,473,949 1,625,574
Notes payable.................................... 792 9,079 10,750
Subordinated capital notes....................... - - 52,444
Other............................................ 56,858 67,793 130,297
----------- ----------- -----------
Total Interest Expense.................. 9,778,492 9,230,135 13,764,338
----------- ----------- -----------
Net Interest Income..................... 5,651,668 5,317,370 6,107,936
PROVISION FOR LOAN LOSSES............................ 12,699 113,467 1,410,710
----------- ----------- -----------
Net Interest Income After
Provision for Loan Losses............... 5,638,969 5,203,903 4,697,226
NONINTEREST INCOME
Loan servicing fees.............................. 1,222,478 1,312,476 1,665,768
Mortgage banking income, including
gain on sale of loans.......................... 755,450 458,520 577,130
Other service charges and fees................... 466,135 368,671 497,316
Net gain (loss) on sale of:
Securities..................................... - - 153,188
Loans.......................................... - (1,458) (1,018,185)
Deposits....................................... - - 1,940,010
Other............................................ 268,890 324,596 466,519
----------- ----------- -----------
Total Noninterest Income................ 2,712,953 2,462,805 4,281,746
----------- ----------- -----------
(Continued)
27
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (continued)
For the years ended December 31, 1998, 1997 and 1996
1998 1997 1996
---- ---- ----
NONINTEREST EXPENSE
Salaries and employee benefits................... 3,476,785 3,788,695 4,554,540
Net occupancy and equipment...................... 954,804 1,084,593 1,470,284
Deposit insurance premiums....................... 497,081 478,684 674,730
Amortization of intangible assets................ 503,148 530,707 7,011,288
Service bureau fees.............................. 513,826 461,217 599,207
Professional fees................................ 296,295 349,218 507,031
Foreclosed properties, net....................... 150,461 182,880 (175,055)
Other............................................ 1,464,473 1,087,362 1,713,958
----------- ----------- ----------
Total Noninterest Expense............... 7,856,873 7,963,356 16,355,983
----------- ----------- ----------
Income (Loss) Before Income Taxes....... 495,049 (296,648) (7,377,011)
NET BENEFIT FROM INCOME TAXES........................ (517,474) - -
----------- ----------- ----------
Net Income (Loss)....................... $ 1,012,523 $ (296,648) $(7,377,011)
=========== =========== ==========
Net Loss Available to Common
Shareholders (Note 4).......................... $ (777,204) $(1,932,136) $(8,823,879)
=========== ========== ==========
Basic and Diluted Loss Per Common
Share (Note 4)................................. $(.73) $(1.83) $(8.39)
==== ===== =====
See notes to consolidated financial statements.
28
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
For the years ended December 31, 1998, 1997 and 1996
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
--------- ------------ ------------ ------- -------
Balance, January 1, 1996.................. $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 -
Comprehensive loss (Note 3):
Net loss............................... - - - - (7,377,011)
Other comprehensive loss:
Reclassification adjustment for
gains on securities available for
sale included in net loss........ - - - - -
Total comprehensive loss............... - - - - -
------- ----------- -------- ---------- -----------
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 -
Comprehensive net loss.................... - - - - (296,648)
------- ----------- -------- ---------- -----------
Balance, December 31, 1997................ 10,581 14,173,750 833,750 8,681,739 (8,883,313)
Common stock issued under the
Employee Stock Purchase Plan........... 25 - - 6,033 -
Comprehensive net income.................. - - - - 1,012,523
------- ----------- -------- ---------- -----------
Balance, December 31, 1998................ $10,606 $14,173,750 $833,750 $8,687,772 $(7,870,790)
====== ========== ======= ========= ==========
Accumulated
Other
Comprehensive
Income (Loss) Total
------------- -----
Balance, January 1, 1996................. $154,174 $22,629,652
Common stock issued under the
Employee Stock Purchase Plan.......... - 7,235
Comprehensive loss (Note 3):
Net loss.............................. -
Other comprehensive loss:
Reclassification adjustment for
gains on securities available fo
sale included in net loss....... (154,174)
Total comprehensive loss.............. - (7,531,185)
-------- -----------
Balance December 31, 1996................ - 15,105,702
Common stock issued under the
Employee Stock Purchase Plan.......... - 7,453
Comprehensive net loss................... - (296,648)
-------- -----------
Balance, December 31, 1997............... - 14,816,507
Common stock issued under the
Employee Stock Purchase Plan.......... - 6,058
Comprehensive net income................. - 1,012,523
-------- -----------
Balance, December 31, 1998............... $ - $15,835,088
======= ==========
See notes to consolidated financial statements.
29
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the years ended December 31, 1998, 1997 and 1996
1998 1997 1996
---- ---- ----
OPERATING ACTIVITIES
Net income (loss)......................................... $ 1,012,523 $ (296,648) $ (7,377,011)
Adjustments to reconcile net income (loss) to cash
provided by (used in) operating activities:
Provision for:
Losses on loans, foreclosed properties, and
servicing...................................... 163,038 296,808 1,415,365
Depreciation and amortization of premises
and equipment.................................. 368,838 419,829 538,561
Amortization (accretion) of:
Premiums and discounts on loans, investments
and mortgage-backed securities............... 130,161 77,038 211,642
Mortgage servicing rights...................... 441,087 468,647 528,444
Excess of costs over net assets acquired....... 62,062 62,061 6,482,843
Other.......................................... - - (94,399)
Mortgage banking activities:
Proceeds from loan sales........................... 63,636,477 40,717,559 56,311,191
Loan originations and purchases.................... (65,277,646) (39,725,806) (54,961,912)
Realized gains from sale of loans.................. (680,028) (414,902) (548,744)
Realized (gains) and losses from sales of:
Mortgage-backed securities available for sale...... - - (153,188)
Loans.............................................. - 1,458 1,018,185
Deposits........................................... - - (1,940,011)
Other.............................................. (70,377) (185,283) (599,062)
Changes in operating assets and liabilities exclusive
of business acquisitions:
Accrued interest receivable........................ (53,369) (49,047) 1,000,846
Advances for taxes, insurance and other............ (963,172) 133,875 (214,597)
Other assets....................................... (462,889) (647,246) 539,749
Other liabilities.................................. 2,666 453,828 483,325
----------- ------------ ------------
Net cash provided by (used in) operating activities....... (1,690,629) 1,312,171 2,641,227
----------- ------------ ------------
(Continued)
30
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(continued) For the years ended December 31,
1998, 1997 and 1996
1998 1997 1996
---- ---- ----
INVESTING ACTIVITIES
Purchase of certificates of deposit in other
financial institutions................................ (4,000,000) (5,000,000) (17,000,000)
Proceeds from maturities of certificates of deposit
in other financial institutions....................... 4,000,000 5,000,000 17,000,000
Purchase of Federal Home Loan Bank stock.................. (117,800) (95,800) -
Redemption of Federal Home Loan Bank stock................ - 1,204,800 1,062,800
Purchase of securities held to maturity................... (750,023) (298,406) (1,020,625)
Proceeds from maturities of securities held to maturity... 300,000 4,000,000 3,000,000
Purchase of securities available for sale................. (955) (2,508,289) (5,165,516)
Proceeds from sale of securities available for sale....... - 2,500,000 6,650,000
Principal remittances on mortgage-backed securities....... 448,012 - -
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........................................ (35,514,557) (22,224,143) -
Proceeds from sales of loans.............................. - - 117,509,060
Net (increase) decrease in net loans...................... 9,550,071 (1,428,880) 1,834,572
Proceeds from sales of foreclosed properties.............. 1,547,763 2,146,555 5,270,509
Additions to foreclosed properties........................ (69,026) (358,419) (174,753)
Increase in mortgage servicing rights..................... (102,518) (289,253) (243,297)
Purchase of premises and equipment........................ (1,625,686) (388,145) (197,281)
Proceeds from sales of premises and equipment............. 525 601,714 1,414,705
----------- ----------- -----------
Net cash provided by (used in) investing activities....... (26,334,194) (17,138,266) 140,998,428
----------- ----------- -----------
FINANCING ACTIVITIES
Net increase in NOW and savings deposits.................. 15,179,844 13,305,806 4,898,050
Net increase in certificates of deposit................... 18,525,713 9,587,515 10,211,469
Proceeds from Federal Home Loan Bank advances............. 46,000,000 25,500,000 4,000,000
Repayment of Federal Home Loan Bank advances.............. (44,638,334) (27,643,333) (8,143,333)
Payments on notes payable................................. (72,102) (24,040) (24,061)
Payments on capital lease obligation...................... (63,847) (53,281) (39,705)
Repayments of mortgages payable on foreclosed
properties............................................. - (10,391) (25,258)
Redemption of Settlement Preferred Stock.................. (712) (6,002) (103,385)
Common stock issued under the Employee Stock
Purchase Plan.......................................... 6,058 7,453 7,235
Decrease in deposits attributable to branch sales:
NOW and savings deposits............................... - - (18,937,078)
Certificates of deposit................................ - - (144,669,198)
Redemptions of subordinated notes......................... - - (627,858)
----------- ----------- ------------
Net cash provided by (used in) financing activities....... 34,936,620 20,663,727 (153,453,122)
----------- ----------- ------------
Increase (decrease) in cash and cash equivalents....... 6,911,797 4,837,632 (9,813,467)
Cash and cash equivalents at beginning of period....... 11,032,883 6,195,251 16,008,718
----------- ------------- --------------
Cash and cash equivalents at end of period............. $ 17,944,680 $ 11,032,883$ 6,195,251
=========== =========== ==============
(Continued)
31
ESSEX BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(continued) For the years ended December 31,
1998, 1997 and 1996
1998 1997 1996
---- ---- ----
NONCASH INVESTING AND FINANCING ACTIVITIES
Transfer from loans to foreclosed properties.............. $ 594,888 $ 1,294,615 $ 1,865,227
Termination of Essex Mortgage Trust I REMIC............... - - 2,678,222
Increase (decrease) in mortgages payable on
foreclosed properties................................. - - 10,391
SUPPLEMENTAL CASH FLOW INFORMATION
Cash paid (received) during the year for:
Interest.............................................. $ 9,827,556 $ 9,199,677 $ 13,814,733
Income taxes, net of refunds.......................... 29,526 - (109,244)
See notes to consolidated financial statements.
32
ESSEX BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 1998, 1997 and 1996
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, 1998 operates
(i) four retail banking branches located in North Carolina and Virginia and (ii)
Essex First, a division of the Bank ("Essex First"), that engages principally in
the origination and sale of residential mortgage loans. EBI's other principal
operating subsidiary is Essex Home Mortgage Servicing Corporation ("Essex
Home"), a majority-owned subsidiary of the Bank that is engaged primarily in the
servicing of mortgage loans owned by the Bank, governmental agencies, and third
party investors. Essex Mortgage Corporation ("EMC") is also a subsidiary of EBI
that was formerly engaged in mortgage banking activities and, at December 31,
1998, held loans and other assets as a result of its past activities.
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
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 other comprehensive
income within 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.
33
Derivatives: On June 15, 1998, the Financial Accounting Standards Board ("FASB")
issued Statement of Financial Accounting Standards ("SFAS") No. 133 - Accounting
for Derivative Instruments and Hedging Activities ("SFAS 133"). SFAS 133 is
effective for all fiscal quarters of all fiscal years beginning after June 15,
1999 (January 1, 2000 for the Company). SFAS 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. The Company's
management anticipates that, due to its limited use of derivative instruments,
the adoption of SFAS 133 will not have a significant effect on its results of
operations or its financial position.
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.
SFAS No. 114 - Accounting by Creditors for Impairment of a Loan, as amended by
SFAS 118 - Accounting by Creditors for Impairment of a Loan-Income Recognition
and Disclosures, 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 provided 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.
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
34
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. Cash
receipts from an impaired loan, whether designated as principal or interest, are
applied to reduce the carrying value of the loan. When future collection of the
loan balance is expected, interest income may be recognized on a cash basis.
Mortgage Banking Activities: Loans held for sale are carried 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. If the carrying
value of the MSRs exceeds the estimated fair value, a valuation allowance is
established. Changes to the valuation allowance are charged against or credited
to amortization of MSRs.
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 SFAS 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. The Company applies the provisions of SFAS No. 109 -
Accounting for Income Taxes ("SFAS 109"), which requires an asset and liability
approach for determining income taxes. Under SFAS 109, deferred income taxes are
recognized for the estimated tax effects of differences between the basis of
assets and liabilities for financial reporting and income tax purposes. Deferred
tax assets are only recognized when, in the judgment of management, it is more
likely than not that they will be realized.
35
Stock-Based Compensation Plans: Effective January 1, 1997, the Company adopted
SFAS 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 1998 and 1997.
NOTE 3 - COMPREHENSIVE INCOME
In June 1997, the FASB issued SFAS No. 130 - Reporting Comprehensive Income
("SFAS 130"), which establishes standards for reporting and displaying
comprehensive income and its components. Comprehensive income is the total of
all components of comprehensive income, including net income and other
comprehensive income. Other comprehensive income represents revenues, expenses,
gains and losses that are included in comprehensive income but excluded from net
income under generally accepted accounted principles. SFAS 130 became effective
in 1998 and requires that comparative financial statements for earlier periods
be reclassified to reflect application of the provisions of SFAS 130.
Accordingly, the Company adopted SFAS 130 in 1998. Because there were no items
of other comprehensive income for the years ended December 31, 1998 and 1997,
the Company is not providing a report of comprehensive income for those periods.
Comprehensive income for the year ended December 31, 1996 consisted of a net
loss of $7.4 million and a $154,000 reclassification adjustment for gains on
securities available for sale included in the net loss for 1996.
NOTE 4 - EARNINGS PER SHARE
The Company calculates its basic and diluted earnings per share ("EPS") in
accordance with SFAS 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:
1998 1997 1996
---- ---- ----
Net income (loss) $ 1,012,523 $ (296,648) $(7,377,011)
Preferred stock dividends (Note 18) (1,789,727) (1,635,488) (1,446,868)
---------- ---------- ----------
Net loss available to common shareholders $ (777,204) $(1,932,136) $(8,823,879)
=========== ========== ==========
Weighted average common shares
outstanding 1,059,138 1,055,776 1,051,180
========= ========= =========
The Company's outstanding options and warrants (Note 19) are antidilutive with
respect to loss available to common shareholders for each of the years
presented; therefore, basic and diluted EPS are the same.
NOTE 5 - SALES OF BRANCHES
In January 1996, the Company formed a Strategic Evaluation 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.
36
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 the sales are summarized
below.
In the aggregate, the Bank sold deposits and related accrued interest totaling
$167.5 million, along with loans and related accrued interest totaling $204,000,
premises and equipment totaling $1.2 million, and other assets totaling $69,000.
The sale of the Branches required cash of $162.0 million, which was funded by
the sale of fixed-rate and adjustable-rate first mortgage loans totaling $118.3
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 net loss of $1.0 million and a gain of $153,000 from the sale of
loans and mortgage-backed securities, respectively. In the aggregate, the Bank
recognized net gains of $1.9 million and $216,000 on the sale of deposits and
premises and equipment, respectively, during 1996. 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 certain of the Branches. The Company
recognized a $5.9 million write-down in the net asset value of these branches
prior to the consummation of their sale.
NOTE 6 - INVESTMENT SECURITIES
The amortized cost and fair value of securities held for investment at December
31 were as follows (in thousands):
1998 1997
------------------------------------------ ------------------------------------------
Amortized Gross Unrealized Fair Amortized Gross Unrealized Fair
Cost Gains Losses Value Cost Gains Losses Value
Securities of U.S. govern-
ment agencies other than
the U.S. Treasury $2,750 $ - $ 46 $2,704 $2,299 $ - $ 82 $2,217
===== ======== ======= ===== ===== ======== ======= =====
The $2.8 million of U.S. government agency securities held for investment at
December 31, 1998 consisted of a $2.0 million note issued by the Federal Home
Loan Bank ("FHLB") which matures in the year 2000 and a $750,000 note issued by
the FHLB which matures in the year 2002 provided a one-time call option is not
exercised in October 1999. The U.S. government agency security with a book value
of $750,000 and a fair value of $743,000 is pledged as collateral for public
depository accounts over $100,000 at December 31, 1998. The U.S. government
agency security with a book value of $2.0 million and a fair value of $1.96
million at December 31, 1998 is pledged as collateral for FHLB advances. No
securities held for investment were sold in 1998, 1997, and 1996.
Securities available for sale at December 31, 1998 and 1997 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. There
were no sales of securities available for sale in 1998. Proceeds from the sale
of securities available for sale totaled $2,500,000 and $6,650,000 in 1997 and
1996, respectively. No gains or losses were realized on these sales.
37
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):
1998 1997
------------------------------------------ ------------------------------------------
Amortized Gross Unrealized Fair Amortized Gross Unrealized Fair
Cost Gains Losses Value Cost Gains Losses Value
U.S. government agencies:
Floating-rate REMIC $1,456 $ - $ 2 $1,454 $1,905 $ - $ 19 $1,886
===== ======== ======= ===== ===== ======== ======= =====
The REMIC is pledged as collateral for FHLB advances at December 31, 1998. There
were no sales of MBS held for investment in 1998, 1997 and 1996.
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. No
MBS were classified as available for sale at December 31, 1998 and 1997.
NOTE 8 - LOANS
Net loans at December 31 include (in thousands):
1998 1997
---- ----
Real estate:
First mortgages $152,891 $130,486
Second mortgages 7,525 8,699
Construction and development 19,430 16,583
Commercial 6,470 5,970
Consumer 5,984 5,426
Commercial - other 1,601 1,883
Secured by deposits 621 805
---------- ---------
Total Loans 194,522 169,852
Less:
Unearned loan fees and discounts 9 29
Allowance for loan losses 1,845 2,382
--------- ---------
Net Loans $192,668 $167,441
======= =======
Included in total loans at December 31, 1998 and 1997 are unamortized premiums
of $951,000 and $668,000, respectively.
At December 31, net loans included the following collateral-dependent real
estate loans (in thousands):
1998 1997
---- ----
First mortgages $298 $611
Second mortgages - 79
----- ----
Total collateral-dependent real estate loans 298 690
Less:
Allowance for loan losses 37 130
---- ---
Net collateral-dependent real estate loans $261 $560
=== ===
38
As of December 31, 1998, the Bank had outstanding commitments (including
unfunded portions of lines of credit and construction loan commitments) to fund
approximately $20.5 million in mortgage loans and $435,000 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, 1998, such commitments aggregated $1.3 million
of fixed rate mortgage loans and $20.3 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 44%
and 42% of total loans at December 31, 1998 and 1997, 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, 1998 and 1997, the Company had $1.2 million and $1.6 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 $115,000, $171,000 and $291,000 for the years ended December
31, 1998, 1997 and 1996, respectively.
Changes in the allowance for loan losses for the years ended December 31 are as
follows:
1998 1997 1996
---- ---- ----
Balance at beginning of period $2,381,639 $2,555,688 $ 5,251,295
Provision for loan losses 12,699 113,467 1,410,710
----------- ---------- ----------
2,394,338 2,669,155 6,662,005
Loans charged-off, net of recoveries (549,043) (287,516) (4,106,317)
---------- ---------- ----------
Balance at end of period $1,845,295 $2,381,639 $ 2,555,688
========= ========= ==========
Loans held for sale at December 31, 1998 and 1997 consisted of first mortgage
loans originated by Essex First. As of December 31, 1998, Essex First had
outstanding commitments to fund mortgage loans totaling approximately $1.7
million, which were committed for sale to unaffiliated third parties.
Essex First sells substantially all conventional loans without recourse so that
losses incurred as a result of nonperformance with respect to the loans sold
become the responsibility of the purchaser of the loan as of the date of the
closing. On occasion, however, Essex First will sell conventional loans in the
secondary market with recourse. As of December 31, 1998, there were $969,000 of
loans outstanding which were previously originated and sold by Essex First in
the secondary market with recourse.
39
NOTE 9 - FORECLOSED PROPERTIES
Foreclosed properties at December 31 consist of the following:
1998 1997
---- ----
Properties acquired through foreclosure $684,900 $1,666,381
Less allowance for losses 113,606 154,752
------- ----------
$571,294 $1,511,629
======= =========
Changes in the allowance for losses on foreclosed properties for the year ended
December 31 are as follows:
1998 1997 1996
---- ---- ----
Balance at beginning of year $ 154,752 $ 178,937 $199,145
Provision for losses on
foreclosed properties 126,338 159,341 (21,345)
------- -------- --------
281,090 338,278 177,800
Charge-offs, net of recoveries (167,484) (183,526) 1,137
-------- -------- ---------
Balance at end of year $ 113,606 $ 154,752 $178,937
======== ======== =======
NOTE 10 - PREMISES AND EQUIPMENT
Premises and equipment at December 31 include:
1998 1997
---- ----
Land $ 842,190 $ 573,675
Buildings 2,051,194 1,046,570
Furniture and equipment 3,027,647 2,681,370
Leasehold improvements 194,254 192,556
Property under capitalized lease 537,737 537,737
---------- ----------
6,653,022 5,031,908
Less accumulated depreciation
and amortization 3,469,445 3,105,179
--------- ---------
$3,183,577 $1,926,729
========= =========
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.
40
Future minimum lease commitments with terms in excess of one year at December
31, 1998, including cost escalation provisions, are as follows:
Capital Noncancelable
Lease Operating Leases
1999 $119,201 $251,546
2000 119,201 249,381
2001 119,201 219,279
2002 - 16,848
2003 - -
Later years - -
----------- ------------
Total minimum lease payments 357,603 $737,054
=======
Amount representing interest 89,480
-------
Present value of net minimum capitalized
payments $268,123
=======
Rent expense for the years ended December 31, 1998, 1997 and 1996 amounted to
$342,496, $435,147 and $602,190, respectively.
NOTE 11 - DEPOSITS
Deposits at December 31 include (dollars in thousands):
1998 1997
------------------------ -----------------------
Amount Percent Amount Percent
------ ------- ------ -------
NOW accounts -
noninterest-bearing $ 16,791 8.95% $ 5,056 3.28%
Passbook and Christmas
Club 4,385 2.34 3,948 2.57
NOW accounts 4,792 2.55 3,965 2.58
Money market 27,878 14.86 25,698 16.69
Certificate accounts -
4.01% to 6.00% 113,403 60.44 87,378 56.77
6.01% to 8.00% 20,377 10.86 27,844 18.09
8.01% to 10.00% 6 .00 38 .02
------- ------ ------- ------
$187,632 100.00% $153,927 100.00%
======= ====== ======= ======
A summary of certificate accounts by scheduled maturity at December 31, 1998 is
as follows (in thousands):
1999 $ 94,139
2000 23,436
2001 6,476
2002 5,518
2003 and thereafter 4,217
--------
$133,786
========
Certificate accounts of $100,000 or more at December 31, 1998 and 1997 amounted
to $22.7 million and $18.5 million, respectively.
41
Interest and weighted average rates on interest-bearing deposits for the years
ended December 31 are as follows:
1998 1997 1996
---------------------- ---------------------- ----------------------
Interest Rate Interest Rate Interest Rate
-------- ---- -------- ---- -------- ----
Passbook and
Christmas Club $ 147,405 3.49% $ 133,737 3.48% $ 225,525 3.33%
NOW accounts 122,330 2.81 122,773 2.83 149,324 2.80
Money Market
accounts 1,317,156 4.91 1,041,566 4.87 949,835 4.50
Certificate accounts 6,904,210 5.67 6,381,238 5.73 10,620,589 5.78
--------- --------- ----------
$8,491,101 5.40% $7,679,314 5.45% $11,945,273 5.51%
========= ========= ==========
NOTE 12 - FEDERAL HOME LOAN BANK ADVANCES
Borrowings from the FHLB at December 31 consist of the following (in thousands):
Maturity Interest Rate 1998 1997
- -------- ------------- ----------- ----------
1998 4.01% to 7.00% $ - $21,139
1999 5.01% to 6.00% 17,308 1,808
2000 4.01% to 6.00% 7,600 600
------- --------
$24,908 $23,547
====== ======
Weighted average rate at end of period 5.89% 5.75%
==== ====
With the exception of $2.5 million and $2.0 million of FHLB advances outstanding
at December 31, 1998 and 1997, respectively, all FHLB advances outstanding at
December 31, 1998 and 1997 carried fixed rates of interest. The $2.5 million
adjustable rate FHLB advances outstanding at December 31, 1998 will mature in
1999 and the applicable rate is indexed to the FHLB overnight deposit rate. The
$2.0 million adjustable rate FHLB advance at December 31, 1997 matured in 1998.
Advances from the FHLB at December 31, 1998 are collateralized by (i) mortgage
loans with a total principal balance of approximately $64.2 million, (ii)
investment securities with a book value of $2.0 million and (iii) MBS with a
book value of $1.5 million. The unused lendable collateral value was $31.6
million at December 31, 1998.
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.
42
NOTE 14 - INCOME TAXES
The Company is subject to federal and state 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:
1998 1997 1996
------------------------ ----------------------- ------------------------
Amount % Amount % Amount %
------ - ------ - ------ -
Provision for (benefit from) income taxes
at statutory federal tax rate $ 168,317 34.0% $(100,860) (34.0)% $(2,508,184) (34.0)%
Increase (decrease) resulting from:
Unrecognized (recognized) tax benefits (192,437) (38.8) 91,443 30.8 991,196 13.4
Future benefit of net deferred tax assets
not previously recognized (550,000) (111.1) - - - -
State income taxes 21,467 4.3 - - - -
Amortization of excess of cost
over net assets acquired 21,101 4.3 21,101 7.1 1,507,950 20.5
Other 14,078 2.8 (11,684) (3.9) 9,038 0.1
--------- ------ --------- ---- ------------ ----
$(517,474) (104.5)% $ - -% $ - -%
======== ====== ========= ==== ========== ====
Significant components of the Company's deferred tax assets and liabilities as
of December 31 were as follows:
1998 1997
---- ----
Deferred tax liabilities
FHLB stock $ 92,297 $ 92,297
Basis in acquired loans 1,776,015 2,114,303
Premises and equipment (4,424) 32,331
Other 31,282 26,362
------------ ------------
Total deferred liabilities 1,895,170 2,265,293
Deferred tax assets
Net operating loss ("NOL") carryforwards7,252,973 7,562,091
Alternative minimum tax ("AMT")
credit carryover 330,000 330,000
MSRs 58,710 78,280
Allowance for losses on loans and
foreclosed properties 449,908 596,417
Core deposit intangible 968,590 1,049,306
Other 364,462 383,524
----------- -----------
Total deferred assets 9,424,643 9,999,618
---------- ----------
Net deferred tax assets before valuation
allowance 7,529,473 7,734,325
Valuation allowance for net deferred tax
assets (6,979,473) (7,734,325)
---------- ----------
Net deferred tax assets $ 550,000 $ -
=========== ==========
The Company applies an asset and liability approach for determining income taxes
as required by SFAS 109. A valuation allowance has been established for a
significant portion of the Company's deferred tax assets and liabilities
because, based on management's assessment, their ultimate realization cannot be
assured. In 1998, the Company recorded net deferred tax assets of $550,000 on
the basis of improvements in profitability and management's expectation that
sufficient taxable income will be generated to utilize a portion of the
Company's NOLs and reversing temporary differences. It is possible that the
43
Company's financial position and management's assessment of its ability to
generate taxable income will change in the near term and result in a material
adjustment to the valuation allowance.
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, 1998) are used for purposes other than
to absorb bad debt losses, they will be subject to federal income tax at the
then applicable rates.
At December 31, 1998, the Company had NOL carryforwards for income tax purposes
of approximately $19.1 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
common stock. In addition, the Company had an AMT credit carryover of $330,000
at December 31, 1998, which can be carried forward indefinitely.
NOTE 15 - MORTGAGE LOAN SERVICING
At December 31, 1998, 1997, and 1996, the Company serviced or subserviced
approximately 15,100, 8,400 and 13,300 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:
1998 1997 1996
------------------------- ------------------------- ------------------------
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 $ 144,602 $ - $128,430 $ - $ 126,373 $ -
Servicing and sub-
servicing rights owned/
participated in by the
Company 1,056,677 1,222,478 354,245 1,312,476 997,279 1,665,768
--------- --------- ------- --------- ---------- ---------
$1,201,279 $1,222,478 $482,675 $1,312,476 $1,123,652 $1,665,768
========= ========= ======= ========= ========= =========
Servicing fee income is net of $1,088,046 in 1998, $858,992 in 1997 and
$1,878,725 in 1996 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, 1998, approximately $10.6 million
of such accounts were on deposit at unaffiliated banks and $15.7 million of such
accounts were on deposit at the Bank.
The fair value of MSRs was $831,000 and $1.2 million at December 31, 1998 and
1997, respectively. As a result of accelerated mortgage loan prepayment activity
44
during 1998, the Company recognized a valuation allowance in order to reduce the
carrying value of its MSRs to the estimated fair value at December 31, 1998.
There were no valuation allowances for MSRs at December 31, 1997. Following is
an analysis of the changes in the Company's MSRs for the years ended December
31:
Carrying Valuation
Value Allowance
----- ---------
Balance at January 1, 1996 $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 -
Purchases 102,518 -
Amortization (387,545) (53,542)
---------- ------
Balance at December 31, 1998 $ 884,739 $(53,542)
========== ======
Advances for taxes, insurance and other disbursements consist of advances on
behalf of investors and advances on behalf of certain investors that have
requested the Company to perform special collection and administrative services.
In addition, certain investors have recourse against the Company in the event of
default on loans which are serviced under a regular servicing option. A
valuation allowance has been established for advances for taxes, insurance and
other disbursements and for the Company's recourse obligations to provide for
future losses related to the Company's servicing portfolio.
NOTE 16 - NOTES PAYABLE
Notes payable at December 31, 1997 consisted solely of a note payable to the
former president of an acquired savings institution and its holding company. The
note accrued interest at 9.50% per annum. Originally, the note was 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. In 1998, the
Company initiated a 25% match for employee contributions of up to 6.00% of
compensation as defined by the plan, which resulted in a $35,829 matching
contribution by the Company for the plan year ended December 31, 1998. The
Company made a "qualified non-elective" contribution of $38,379 for the plan
year ended December 31, 1997 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 $38,808, $37,808 and $38,836 was
recognized in 1998, 1997 and 1996, respectively, in connection with employee
vesting in the SERP. The SERP provides deferred compensation of 5% to 10% of a
covered employee's salary. Deferred compensation in excess of 5% is
discretionary and subject to the approval of EBI's Executive Compensation
Committee. Participants in the SERP as of December 31, 1998 are 100% vested.
45
NOTE 18 - PREFERRED STOCK
On September 15, 1995, EBI merged with Home Bancorp, Inc. ("Home Bancorp") and
its wholly-owned subsidiary Home Savings Bank, F.S.B., a Norfolk, Virginia-based
savings institution (the "Home Acquisition"). 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 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 $4,997,493 and $242,613, respectively, as of December 31, 1998.
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 became exercisable in September 1998 and will 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, 1998 consist of the following: 102,200 exercisable on May 28, 2000
that will expire on May 28, 2007; 6,000 exercisable on February 17, 2001 that
will expire on February 17, 2008; and, 20,000 exercisable on March 31, 2001 that
will expire on March 31, 2008.
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.
46
The following table summarizes activity under the option plans for years ended
December 31, 1998, 1997 and 1996 and the status at December 31, 1998.
Option Plan Directors Option Plan
----------- ---------------------
Number of Option Number of Option
Options Price Options Price
------- ----- ------- -----
Options outstanding, January 1, 1996 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
Granted 6,000 5.8750 1,350 2.2500
Granted 20,000 4.8750 - -
--------- ----------
Options outstanding as of December 31, 1998 128,200 1.3750-5.8750 5,950 0.9375-5.6250
======== =====
Options exercisable as of December 31, 1998 - 4,600
======== =====
Options available for future grant
as of December 31, 1998 406,553 13,050
======= ======
The Company recognized compensation expense of $498,051 and $412,743 during the
years ended December 31, 1997 and 1996, 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, 1998, the Company
continued to recognize 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 income (loss) and loss per share would have been
$969,000 and $.77 for the year ended December 31, 1998 and $(312,000) and $1.84
for the year ended December 31, 1997. The weighted average fair value of the
options granted during 1998 and 1997 would have been $2.58 per share and $0.71
per share, respectively. The fair value of each option granted under the Option
Plan during 1998 and 1997 was estimated on the date of grant using the
Black-Scholes option pricing model with the following assumptions: risk-free
rates of return of 5.61% in 1998 and 6.29% in 1997 and a dividend yield of zero,
expected life of five years and volatility of 50% for 1998 and 1997.
Stock Purchase Plan: In 1995, the Company adopted the Essex Bancorp, Inc.
Employee Stock Purchase Plan (the "Stock Purchase Plan"), which was submitted to
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, 1998, 1997 and 1996 employees acquired
approximately 2,506, 4,757 and 3,694, respectively, newly-issued shares of the
Company's common stock under the Stock Purchase Plan. Effective October 1998,
the Company suspended purchases of the Company's common stock under the Stock
Purchase Plan.
47
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
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, 1998 and 1997 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, 1998 and 1997. 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 and FHLB advances 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.
48
December 31, 1998 December 31, 1997
---------------------------- ---------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Value Value Value Value
----- ----- ----- -----
(in thousands)
Financial Assets
Cash and cash equivalents..................... $ 17,945 $ 17,945 $ 11,033 $ 11,033
FHLB stock.................................... 1,549 1,549 1,431 1,431
Securities available for sale................. 18 18 17 17
Securities held for investment................ 2,750 2,704 2,299 2,217
Mortgage-backed securities held for
investment................................. 1,456 1,454 1,905 1,886
Loans held for sale........................... 4,486 4,486 2,165 2,165
Loans held for investment, net................ 192,668 197,288 167,441 169,843
Financial Liabilities
Deposits with no stated maturity.............. $ 53,846 $ 53,846 $ 38,667 $ 38,667
Time deposits................................. 133,786 134,895 115,260 115,624
FHLB advances................................. 24,908 25,030 23,547 23,558
Notes payable................................. - - 72 72
Capital lease obligations..................... 268 269 332 332
Off-balance sheet commitments
and recourse obligations................... - 71 - 62
NOTE 21 - REGULATORY MATTERS
The Bank is required pursuant to the Financial Institutions Reform, Recovery and
Enforcement Act of 1989 ("FIRREA") and the Office of Thrift Supervision ("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 or leverage capital requirement, and a risk-based capital
requirement. At December 31, 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 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 or leverage capital, Tier I risk-based
capital, and total risk-based capital. As of December 31, 1998 and 1997, the
Bank was "well capitalized" for PCA purposes.
49
The Bank's capital amounts and ratios as of December 31, 1998 and 1997 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, 1998
Total risk-based capital $17,364 13.09% $10,609 8.0% $13,261 =>10.0%
Tier I risk-based capital 16,071 12.12% 5,304 4.0% 7,957 =>6.0%
Tier I (core) capital 16,071 6.97% 9,223 4.0% 11,529 =>5.0%
Tangible equity 16,071 6.97% 3,459 1.5% - -
As of December 31, 1997
Total risk-based capital $16,762 14.33% $9,354 8.0% $11,692 =>10.0%
Tier I risk-based capital 15,298 13.08% 4,677 4.0% 7,015 =>6.0%
Tier I (core) capital 15,298 7.86% 7,790 4.0% 9,738 =>5.0%
Tangible equity 15,298 7.86% 2,921 1.5% - -
NOTE 22 - PARENT COMPANY ONLY Financial Information
Condensed financial information of EBI is presented below. While EBI and the
Bank are not 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, 1998 and 1997
(in thousands)
1998 1997
---- ----
ASSETS
Cash $ 92 $ 190
Investment in subsidiaries 16,646 15,638
Other 260 257
-------- --------
$16,998 $16,085
====== ======
LIABILITIES AND SHAREHOLDERS' EQUITY
LIABILITIES
Notes payable $ - $ 72
Redeemable Preferred Stock redemption proceeds payable 84 85
Other 1,079 1,111
------- -------
Total Liabilities 1,163 1,268
SHAREHOLDERS' EQUITY 15,835 14,817
------ ------
$16,998 $16,085
====== ======
50
Statements of Operations
For the years ended December 31, 1998, 1997 and 1996
(in thousands)
1998 1997 1996
---- ---- ----
Interest expense on notes payable $ (1) $ (9) $ (11)
Stock option compensation - (601) -
Net operating income 5 25 60
------- ----- -------
Net income (loss) before undistributed
income (loss) of subsidiaries 4 (585) 49
Undistributed income (loss) of subsidiaries 1,009 288 (7,426)
----- ---- ------
Net income (loss) $1,013 $(297) $(7,377)
===== ==== ======
Statements of Cash Flows
For the years ended December 31, 1998, 1997 and 1996
(in thousands)
1998 1997 1996
---- ---- ----
OPERATING ACTIVITIES
Net income (loss) $ 1,013 $(297) $(7,377)
Adjustments to reconcile net income (loss)
to cash (used in) provided by operating
activities:
Equity in (income) loss of subsidiaries (1,009) (288) 7,426
Dividends from subsidiaries - 108 -
Decrease (increase) in other assets (3) (256) 1
Increase (decrease) in other liabilities (32) 827 (7)
-------- ---- -------
NET CASH (USED IN) PROVIDED BY
OPERATING ACTIVITIES (31) 94 43
-------- ----- ------
FINANCING ACTIVITIES
Payments on notes payable (72) (24) (24)
Redemption of Settlement Preferred Stock (1) (5) (104)
Common stock issued under the Employee Stock
Purchase Plan 6 8 7
-------- ------ -------
NET CASH USED IN FINANCING
ACTIVITIES (67) (21) (121)
------- ----- -----
NET INCREASE (DECREASE) IN CASH (98) 73 (78)
Cash at beginning of period 190 117 195
------- ---- -----
CASH AT END OF PERIOD $ 92 $ 190 $ 117
======= ==== =====
SUPPLEMENTAL CASH FLOW INFORMATION
Cash interest paid $ 13 $ - $ 11
As of December 31, 1998 and 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.
51
NOTE 23 - SEGMENT INFORMATION
The Company adopted SFAS No. 131 - Disclosures about Segments of an Enterprise
and Related Information ("SFAS 131"), as required for this Annual Report. SFAS
131 requires companies to report information about the revenues derived from the
enterprise's segments, about the geographical divisions in which the enterprise
earns revenues and holds assets and about major customers.
The Company operates through three primary business segments: retail community
banking, mortgage banking and mortgage loan servicing. These segments are
evaluated based primarily on revenues from customers and pre-tax profit
contribution to the total Company. Segment revenues from customers consist of
(i) net interest income, which represents the difference between interest earned
on loans and investments and interest paid on deposits and other borrowings and
(ii) noninterest income, which consists primarily of mortgage loan servicing
fees, mortgage banking income (primarily gains on the sale of loans) and service
charges and fees (primarily on deposits and the loan servicing portfolio). All
inter-segment transactions are eliminated to arrive at the total Company revenue
and pre-tax income (loss). In addition, the impact of the sales of the Branches
recognized by the Company in 1996 are not allocated to the segments and are
presented separately. Segment revenues and pre-tax income (loss) are determined
using accounting policies consistent with those applied in the preparation of
the consolidated financial statements.
Retail Mortgage
Community Mortgage Loan Corporate/ Sales of
Banking Banking Servicing Eliminations Branches Total
------- ------- --------- ------------ -------- -----
(in thousands)
1998 Segment Information
Customer revenues $ 4,047 $ 2,672 $ 1,565 $ 81 $ - $ 8,365
Affiliate revenues - 497 443 (940) - -
Depreciation and amortizaion 99 63 81 126 - 369
Pre-tax income (loss) 1,008 1,552 158 (2,223) - 495
Total assets 207,189 23,710 9,063 (8,922) - 231,040
1997 Segment Information
Customer revenues 3,666 2,158 1,511 445 - 7,780
Affiliate revenues - 385 536 (921) - -
Depreciation and amortizaion 70 87 94 169 - 420
Pre-tax income (loss) 422 1,037 543 (2,299) - (297)
Total assets 181,072 18,865 6,683 (11,532) - 195,088
1996 Segment Information
Customer revenues 5,394 2,051 1,567 87 1,291 10,390
Affiliate revenues - 456 711 (1,167) - -
Depreciation and amortizaion 134 101 121 183 - 539
Pre-tax income (loss) (421) 573 700 (3,640) (4,589) (7,377)
Total assets 159,622 19,096 6,732 (11,183) - 174,267
Retail Community Banking. The Company provides retail community banking services
through the Bank, which operates four retail banking branches located in North
Carolina and Virginia. The Bank is a savings association that attracts deposits
from the general public in its primary market area, which, together with
borrowings from the FHLB, fund the Bank's investment predominately in real
estate mortgage loans.
Mortgage Banking. The Company engages in mortgage banking activities through
Essex First, which conducts its operations out of four offices located in North
Carolina and Virginia. Essex First was established primarily to originate loans
for sale to private investors in the secondary market in order to generate fee
income while avoiding the interest rate and credit risk associated with holding
long-term fixed-rate mortgage loans in its portfolio. In addition, the majority
52
of the Bank's loan product is currently originated by Essex First. A majority of
all residential mortgage loans originated by Essex First for sale in the
secondary market are sold with servicing released to third party investors in
order to enhance fee income. Substantially all of the loans originated by Essex
First and not sold with servicing released to third party investors are sold to
the Bank on a whole loan basis. In addition to its secondary marketing
activities, Essex First derives interest revenue from its residential
construction loan programs for individuals and builders. Construction lending
activities generally are limited to Essex First's primary market, with
particular emphasis in the greater Richmond, Virginia market, the Tidewater,
Virginia area and counties in northeastern North Carolina. More recently, Essex
First has expanded its construction lending into the Raleigh, North Carolina,
Northern Virginia and Maryland markets. Revenues and pre-tax income for the
mortgage banking segment are presented before cost of funds allocation.
Mortgage Loan Servicing. The Company provides mortgage loan servicing through
Essex Home, which conducts its operations out of a leased operations facility in
Virginia Beach, Virginia. Revenues generated by Essex Home consist primarily of
loan servicing fees, late charges and other ancillary fees. In addition to
servicing loans for the Bank and Essex First and being licensed by Fannie Mae,
Freddie Mac and Ginnie Mae, Essex Home services and subservices loans for
approximately eight private investors and 47 subservicing clients. While Essex
Home services mortgage loans secured by residential real estate throughout the
United States, approximately 83% of its mortgage loan servicing portfolio is
concentrated among New York, California, Virginia, North Carolina, New Jersey,
Maryland, Florida, South Carolina and the District of Columbia. As of December
31, 1998, Essex Home serviced for affiliates and nonaffiliates in the aggregate
approximately 15,100 loans totaling $1.2 billion.
[intentionally blank]
53
ESSEX
BANCORP, INC.
INVESTOR INFORMATION
Annual Meeting of Stockholders Annual Report on Form 10-K and
Additional Information
The Annual Meeting of Stockholders of Essex
Bancorp, Inc. will be held at The Koger Center, A copy of Form 10-K as filed with the
Building #5, First Floor Conference Room, Norfolk, Securities and Exchange Commission is available
Virginia on May 27, 1999 at 1:00 p.m. without charge to stockholders upon written
request. Requests for this or other financial
Stock Price Information information about Essex Bancorp, Inc. should be
directed to:
Essex Bancorp, Inc.'s common stock is listed
on the American Stock Exchange ("AMEX") under the Jennifer L. DeAngelo, Corporate Secretary
symbol "ESX." The table below sets forth the high Essex Bancorp, Inc.
and low sales prices of the common stock, as The Koger Center, Building #9, Suite 200
reported by the AMEX during 1998 and 1997. Norfolk, Virginia 23502
Telephone (757) 893-1326
1998 1997
---------------- ------------------ Independent Accountants
Quarter High Low High Low
- ------- ---- --- ---- --- PricewaterhouseCoopers LLP
First $6.7500 $3.9375 $ 2.1875 $1.0000 One Columbus Center, Suite 400
Second 5.1250 3.0000 1.8750 1.0000 Virginia Beach, Virginia 23462
Third 3.2500 1.9375 10.0000 1.0000 Telephone (757) 493-7700
Fourth 2.3750 1.3125 7.3750 3.5000
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:
Continental Stock Transfer and Trust Co.
2 Broadway
New York, NY 10004
Telephone (212) 509-4000
54
ESSEX
BANCORP, INC.
DIRECTORS AND OFFICERS
EXECUTIVE OFFICERS DIRECTORS
Gene D. Ross Gene D. Ross
Chairman, President and Chief Executive Chairman, President and Chief Executive
Officer Officer
Essex Bancorp, Inc., Essex Bancorp, Inc.
Essex Savings Bank, F.S.B. and
Essex Home Mortgage Servicing Roscoe D. Lacy, Jr.
Corporation Vice President and General Manager
Miles Jennings, Inc.
Roy H. Rechkemmer, Jr. Elizabeth City, North Carolina
Senior Vice President-Finance/Treasurer (industrial supply company)
Essex Bancorp, Inc. and
Essex Savings Bank, F.S.B. Robert G. Hecht
Chief Executive Officer
Mary-Jo Rawson Trumbull Corporation
Vice President/Chief Accounting Officer Pittsburgh, Pennsylvania
Essex Bancorp, Inc. and (highway construction company)
Essex Savings Bank, F.S.B.
Harry F. Radcliffe
Earl C. McPherson President and Chief Executive Officer
President Fort Pitt Capital Management
Essex First Mortgage, a Division of Pittsburgh, Pennsylvania
Essex Savings Bank, F.S.B. (investment management company)
55
ESSEX
BANCORP, INC.
CORPORATE INFORMATION
Executive Offices Essex Savings Bank, F.S.B.
Retail Banking Offices
The Koger Center
Building #9, Suite 200 Virginia
Norfolk, Virginia 23502 520 South Main Street
Telephone (757) 893-1300 Emporia, Virginia 23847
Subsidiaries of Essex Bancorp, Inc. 1401 Gaskins Road
Richmond, Virginia 23233
Essex Savings Bank, F.S.B.
The Koger Center 2825 Godwin Boulevard
Building #9, Suite 200 Suffolk, Virginia 23434
Norfolk, Virginia 23502
Telephone (757) 893-1300 North Carolina
400 W. Ehringhaus Street
Essex Home Mortgage Servicing Elizabeth City, North Carolina 27909
Corporation
2420 Virginia Beach Boulevard, Suite 109 Essex First Mortgage, a Division of Essex
Virginia Beach, Virginia 23454 Savings Bank, F.S.B.
Telephone (757) 631-4240 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
56