PART I
Item 1. Business.
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Connecticut Bancshares, Inc. (the "Company"), a Delaware corporation, was
organized in October 1999 for the purpose of becoming the holding company for
Savings Bank of Manchester (the "Bank") upon the conversion of the Bank's former
parent holding company, Connecticut Bankshares, M.H.C. ("M.H.C."), from a mutual
to stock form of organization (the "Conversion"). The Conversion was completed
on March 1, 2000. In connection with the Conversion, the Company sold
10,400,000 shares of its common stock, par value $0.01 per share ("Common
Stock") at a purchase price of $10 per share, to depositors of the Bank in a
subscription offering. In addition, the Company issued an additional 832,000
shares, representing 8% of the shares sold in the subscription offering, to SBM
Charitable Foundation, Inc., a charitable foundation established by the Bank.
The Company has not engaged in any significant activity other than holding all
the issued and outstanding stock of the Bank. Accordingly, the information set
forth in this report, including financial statements and related data, relates
primarily to the Bank.
The Bank was founded in 1905 as a Connecticut-chartered mutual savings
bank. In 1996, the Bank converted to stock form as part of the M.H.C.'s mutual
holding company formation. The Bank is regulated by the Connecticut Department
of Banking and the Federal Deposit Insurance Corporation. The Bank's deposits
are insured to the maximum allowable amount by the Bank Insurance Fund of the
Federal Deposit Insurance Corporation. The Bank has been a member of the Federal
Home Loan Bank System since 1977.
The Bank is a traditional savings association that accepts retail deposits
from the general public in the areas surrounding its 23 full-service banking
offices and uses those funds, together with funds generated from operations and
borrowings, to originate residential mortgage loans, commercial loans and
consumer loans, primarily home equity loans and lines of credit. The Bank
primarily holds the loans that it originates for investment. However, the Bank
also sells loans, primarily fixed-rate mortgage loans, in the secondary market,
while generally retaining the servicing rights. The Bank also invests in
mortgage-backed securities, debt and equity securities and other permissible
investments. The Bank's revenues are derived principally from the generation of
interest and fees on loans originated and, to a lesser extent, interest and
dividends on investment and mortgage-backed securities. The Bank's primary
sources of funds are deposits, principal and interest payments on loans and
investments and mortgage-backed securities and advances from the Federal Home
Loan Bank of Boston.
Market Area
The Bank is headquartered in Manchester, Connecticut in Hartford County.
The Bank's primary deposit gathering and lending areas are concentrated in the
communities surrounding its 23 banking offices located in Hartford, Tolland and
Windham Counties.
Hartford County is located in central Connecticut approximately two hours
from both Boston and New York City and contains the City of Hartford. The
region serves as the governmental and as a financial center of Connecticut.
Hartford County has a diversified mix of industry groups, including insurance
and financial services, manufacturing, service, government and retail. The
major employers in the area include several prominent international and national
insurance and manufacturing companies, such as Aetna, Inc., The Hartford
Financial Services Group, Inc., Travelers Property Casualty Corp., United
Technologies Corp., Stanley Works, as well as many regional banks and the
Connecticut State Government.
Competition
The Bank faces intense competition in attracting deposits and loans in its
primary market area. Historically, the Bank's most direct competition for
deposits came from the several commercial and savings banks operating in its
primary market area and, to a lesser extent, from other financial institutions,
such as brokerage firms, credit unions and insurance companies. Although these
entities continue to provide a source of competition for deposits, the Bank
1
faces increasingly significant competition for deposits from the mutual fund
industry as customers seek alternative sources of investment for their funds.
The Bank also must compete for investors' funds which may be used to purchase
short-term money market securities and other corporate and government
securities. While the Bank faces competition for loans from the significant
number of traditional financial institutions, primarily savings banks and
commercial banks in its market area, its most significant competition comes from
other financial service providers, such as the mortgage companies and mortgage
brokers operating in its primary market area. Additionally, the Bank expects
competition to increase as a result of recent regulatory actions and legislative
changes, most notably the recent enactment of the Financial Services
Modernization Act of 1999. These changes have eased and likely will continue to
ease restrictions on interstate banking and entry into the financial services
market by non-depository and non-traditional financial services providers,
including insurance companies, securities brokerage and underwriting firms, and
specialty financial services companies such as internet-based providers.
Lending Activities
General. The types of loans that the Bank may originate are limited by
federal and state laws and regulations. Interest rates charged by the Bank on
loans are affected principally by the Bank's current asset/liability strategy,
the demand for such loans, the supply of money available for lending purposes
and the rates offered by competitors. These factors are, in turn, affected by
general and economic conditions, monetary policies of the federal government,
including the Federal Reserve Board, legislative tax policies and governmental
budgetary matters.
2
Loan Portfolio Analysis. The following table sets forth the composition of
the Bank's loan portfolio in dollar amounts and as a percentage of the portfolio
at the dates indicated.
At December 31,
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1999 1998 1997 1996 1995
--------------------- ------------------ ----------------- ----------------- -----------------
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
of of of of of
Total Total Total Total Total
----------------------------------------- ------------------------------------------------------------
(Dollars in thousands)
Real estate loans:
One- to four-family..... $540,124 56.92% $464,623 56.85% $489,105 60.53% $457,168 61.66% $431,208 61.23%
Construction (1)........ 40,727 4.29 35,860 4.39 23,524 2.90 16,900 2.27 15,804 2.25
Commercial and multi-
family............... 159,984 16.86 131,717 16.11 117,622 14.55 104,364 14.07 105,050 14.92
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total real estate
loans............... 740,835 78.07 632,200 77.35 630,251 77.98 578,432 78.00 552,062 78.39
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Commercial loans........... 134,550 14.18 114,650 14.03 106,874 13.22 97,117 13.10 86,975 12.35
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Consumer loans:
Home equity loans and
lines of credit........ 23,019 2.42 21,605 2.64 20,559 2.54 18,959 2.56 16,796 2.38
Other................... 50,553 5.33 48,917 5.98 50,553 6.26 47,071 6.34 48,448 6.88
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total consumer loans. 73,572 7.75 70,522 8.62 71,112 8.80 66,030 8.90 65,244 9.26
-------- ------ -------- ------ -------- ------ -------- ------ -------- ------
Total loans.......... 948,957 100.00% 817,372 100.00% 808,237 100.00% 741,579 100.00% 704,281 100.00%
====== ====== ====== ====== ======
Allowance for loan
losses................. (10,617) (10,585) (9,945) (9,131) (8,484)
-------- -------- -------- -------- --------
Total loans, net..... $938,340 $806,787 $798,292 $732,448 $695,797
======== ======== ======== ======== ========
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(1) Includes residential and commercial real estate loans.
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One- to Four-Family Real Estate Loans. The Bank's primary lending activity
is to originate loans secured by one- to four-family residences located in its
primary market area. At December 31, 1999, $540.1 million, or 56.9%, of the
Bank's total loans consisted of one- to four-family mortgage loans. Of the one-
to four-family loans outstanding at that date, 51.9% were fixed-rate mortgage
loans and 48.1% were adjustable-rate loans.
The Bank originates fixed-rate fully amortizing loans with maturities
ranging between ten and 30 years. Management establishes the loan interest rates
based on market conditions. The Bank offers mortgage loans that conform to
Fannie Mae and Freddie Mac guidelines, as well as jumbo loans, which are
presently loans in amounts over $240,000. Fixed-rate conforming loans are
generally originated for portfolio. However, the Bank may sell such loans from
time to time. Management periodically determines whether or not to sell loans
based on changes in prevailing market interest rates. Loans that are sold are
generally sold to Freddie Mac, with the servicing rights retained.
Currently, the Bank also offers adjustable-rate mortgage loans, with an
interest rate based on the one year Constant Maturity Treasury index, which is
adjusted annually at the outset of the loan or which is adjusted annually after
a three or five year initial fixed period and with terms of up to 30 years.
Interest rate adjustments on such loans are limited to no more than 2% during
any adjustment period and 6% over the life of the loan. Adjustable-rate loans
may possess a conversion option, whereby the borrower may opt to convert the
loan to a fixed interest rate after a predetermined period of time, generally
within the first 60 months of the loan term. Included in the Bank's adjustable-
rate mortgage loan portfolio are adjustable-rate loans which are originated at
an interest rate below the fully indexed rate. During 1999, the Bank originated
$43.5 million of these discounted adjustable-rate mortgage loans, or 4.6% of the
total loan portfolio, with an average yield of 5.8%. The time period in which
such loans will reprice to their fully indexed rate may be longer than the
Bank's other fully indexed adjustable-rate loans. However, the Bank's
experience, which cannot be guaranteed in future periods, is that these
discounted adjustable-rate loans tend to be more stable and less susceptible to
prepayment activity in a falling interest rate environment and less subject to
default in a rising interest environment.
Adjustable-rate mortgage loans help reduce the Bank's exposure to changes
in interest rates. There are, however, unquantifiable credit risks resulting
from the potential of increased costs due to changed rates to be paid by
borrowers. It is possible that during periods of rising interest rates the risk
of default on adjustable-rate mortgage loans may increase as a result of
repricing and the increased payments required to be paid by borrowers. In
addition, although adjustable-rate mortgage loans allow the Bank to adjust the
sensitivity of its asset base to changes in interest rates, the extent of this
interest sensitivity is limited by the annual and lifetime interest rate
adjustment limits. Because of these considerations, the Bank has no assurance
that yields on adjustable-rate mortgage loans will be sufficient to offset
increases in the Bank's cost of funds during periods of rising interest rates.
The Bank believes these risks, which have not had a material adverse effect on
the Bank to date, are generally less than the risks associated with holding
fixed-rate loans in its portfolio in a rising interest rate environment.
The Bank underwrites fixed- and variable-rate one- to four-family
residential mortgage loans with loan-to-value ratios of up to 97% and 95%,
respectively, provided that a borrower obtains private mortgage insurance on
loans that exceed 80% of the appraised value or sales price, whichever is less,
of the secured property. The Bank also requires fire, casualty, title, hazard
insurance and, if appropriate, flood insurance be maintained on all properties
securing real estate loans made by the Bank. An independent licensed appraiser
generally appraises all properties.
In an effort to provide financing for moderate income and first-time home
buyers, the Bank offers FHA and CHFA (Connecticut Housing Finance Authority)
loans and has its own First-Time Home Buyer loan program. These programs offer
residential mortgage loans to qualified individuals. These loans are offered
with adjustable-and fixed-rates of interest and terms of up to 30 years. Such
loans may be secured by one- to four-family residential property, in the case of
FHA and CHFA loans, and must be secured by a single family owner-occupied unit
in the case of First-Time Home Buyer loans. All of these loans are originated
using modified underwriting guidelines. FHA loans are closed in the name of the
Bank and immediately sold on the secondary market to Countrywide Mortgage
Company with the loan servicing released. CHFA loans are immediately assigned
4
after closing to the Connecticut Housing Finance Authority with servicing rights
retained by the Bank. Countrywide Mortgage and CHFA establish their respective
rates and terms upon which such loans are offered. First-Time Home Buyer loans
are offered with a discounted interest rate (approximately 50 basis points) and
usually with no application or loan origination fees. All such loans are
originated in amounts of up to 97% of the lower of the property's appraised
value or the sale price. Private mortgage insurance is required on all such
loans.
The Bank also offers to its full-time employees who satisfy certain
criteria and the general underwriting standards of the Bank fixed and
adjustable-rate mortgage loans with reduced interest rates, which are currently
50 to 100 basis points below the rates offered to the Bank's other customers.
The Employee Mortgage Rate is limited to the purchase, construction or
refinancing of an employee's owner-occupied primary residence. The Employee
Mortgage Rate normally ceases upon termination of employment or if the property
no longer is the employee's primary residence. Upon termination of the Employee
Mortgage Rate, the interest rate reverts to the contract rate in effect at the
time that the loan was extended. All other terms and conditions contained in
the original mortgage and note continue to remain in effect. As of December 31,
1999, the Bank had $8.0 million of Employee Mortgage Rate loans, or 0.85% of
total loans.
Construction Loans. The Bank originates construction loans to individuals
for the construction and acquisition of personal residences. At December 31,
1999, residential construction loans amounted to $ 9.8 million, or 1.0% of the
Bank's total loans. At December 31, 1999, the unadvanced portion of
construction loans totalled $ 5.1 million.
The Bank's residential construction loans generally provide for the payment
of interest only during the construction phase, which is usually twelve months.
At the end of the construction phase, the loan converts to a permanent mortgage
loan. Loans can be made with a maximum loan-to-value ratio of 90%, provided that
the borrower obtains private mortgage insurance on the loan if the loan balance
exceeds 80% of the appraised value or sales price, whichever is less, of the
secured property. At December 31, 1999, the largest outstanding residential
construction loan commitment was for $400,000, $399,000 of which was
outstanding. This loan was performing according to its terms at December 31,
1999. Construction loans to individuals are generally made on the same terms as
the Bank's one- to four-family mortgage loans.
Before making a commitment to fund a residential construction loan, the
Bank requires an appraisal of the property by an independent licensed appraiser.
The Bank also reviews and inspects each property before disbursing any funds
during the term of the construction loan. Loan proceeds are disbursed after
each inspection based on the percentage of completion method.
The Bank also originates residential development loans primarily to finance
the construction of single-family homes and subdivisions. At December 31, 1999,
residential development loans totalled $24.1 million, or 2.5% of the Bank's
total loans. These loans are generally offered to experienced builders with
whom the Bank has an established relationship. Residential development loans
are typically offered with terms of up to 24 months. The maximum loan-to-value
limit applicable to these loans is 80% for contract sales and 70% for
speculative properties. Construction loan proceeds are disbursed periodically in
increments as construction progresses and as inspection by an approved appraiser
of the Bank warrants. At December 31, 1999, the Bank's largest residential
development loan was a nonperforming loan for $4.1 million secured by a
retirement facility located in Central New England. That facility is part of a
larger development, that also had a loan which matured on June 30, 1999 in the
amount of $563,000 secured by eight residential units. Interest payments were
kept current on the latter loan, and such loan was repaid in 2000. Proceeds
from the sale of units were used to reduce the amount outstanding on the overall
lending relationship by an additional $463,000 in 2000.
The Bank also makes construction loans for commercial development projects.
The projects include multi-family, apartment, industrial, retail and office
buildings. These loans generally have an interest-only phase during
construction and then convert to permanent financing. Disbursement of funds are
at the sole discretion of the Bank and are based on the progress of
construction. The maximum loan-to-value limit applicable to these loans is 75%.
At December 31, 1999, commercial construction loans totalled $6.8 million, or
0.7%, of total loans.
5
The Bank also originates land loans to local contractors and developers for
the purpose of improving the property, or for the purpose of holding or
developing the land for sale. Such loans are secured by a lien on the property,
are limited to 70% of the lower of the acquisition price or the appraised value
of the land and have a term of up to two years with a floating interest rate
based on the Bank's internal base rate. The Bank's land loans are generally
secured by property in its primary market area. The Bank requires title
insurance and, if applicable, a hazardous waste survey reporting that the land
is free of hazardous or toxic waste.
Construction and development financing is generally considered to involve a
higher degree of credit risk than long-term financing on improved, owner-
occupied real estate. Risk of loss on a construction loan depends largely upon
the accuracy of the initial estimate of the property's value at completion of
construction compared to the estimated cost (including interest) of construction
and other assumptions. If the estimate of construction cost proves to be
inaccurate, the Bank may be required to advance funds beyond the amount
originally committed in order to protect the value of the property.
Additionally, if the estimate of value proves to be inaccurate, the Bank may be
confronted with a project, when completed, having a value which is insufficient
to assure full repayment.
Commercial and Multi-Family Real Estate Loans. The Bank originates multi-
family and commercial real estate loans that are generally secured by five or
more unit apartment buildings and properties used for business purposes such as
small office buildings, industrial facilities or retail facilities primarily
located in the Bank's primary market area. At December 31, 1999, the Bank had
$160.0 million in commercial and multi-family real estate loans which amounted
to 16.9% of total loans. The Bank's multi-family and commercial real estate
underwriting policies provide that such real estate loans may be made in amounts
of up to 75% of the appraised value of the property provided such loan complies
with the Bank's current loans-to-one-borrower limit, which at December 31, 1999
was $18.4 million. The Bank's multi-family and commercial real estate loans may
be made with terms of up to 25 years and are offered with interest rates that
adjust periodically and are generally indexed to the one, three or five year
Constant Maturity Treasury index. In reaching its decision on whether to make a
multi-family or commercial real estate loan, the Bank considers the net
operating income of the property, the borrower's expertise, credit history and
profitability and the value of the underlying property. In addition, with
respect to commercial real estate rental properties, the Bank will also consider
the term of the lease and the quality of the tenants. The Bank has generally
required that the properties securing these real estate loans have debt service
coverage ratios (the ratio of earnings before debt service to debt service) of
at least 1.20x. Environmental surveys are generally required for commercial
real estate loans. Generally, multi-family and commercial real estate loans
made to corporations, partnerships and other business entities require personal
guarantees by the principals. The largest multi-family or commercial real
estate loan in the Bank's portfolio at December 31, 1999 was a performing $4.6
million real estate loan secured by two separate multi-tenant retail buildings
located in Middletown and Newington, Connecticut.
Loans secured by multi-family and commercial real estate properties
generally involve larger principal amounts and a greater degree of risk than
one- to four-family residential mortgage loans. Because payments on loans
secured by multi-family and commercial real estate properties often depend on
the successful operation or management of the properties, repayment of such
loans may be affected by adverse conditions in the real estate market or the
economy. The Bank tries to minimize these risks through its underwriting
standards.
Commercial Loans. At December 31, 1999, the Bank had $134.6 million in
commercial loans which amounted to 14.2% of total loans. In addition, at such
date, the Bank had $57.2 million of unadvanced commercial lines of credit. The
Bank makes commercial business loans primarily in its market area to a variety
of professionals, sole proprietorships and small businesses. The Bank offers a
variety of commercial lending products, including term loans for fixed assets
and working capital, revolving lines of credit, letters of credit, and Small
Business Administration guaranteed loans. The maximum amount of a commercial
business loan is limited by the Bank's loans-to-one-borrower limit which at
December 31, 1999, was $18.4 million. Term loans are generally offered with
initial fixed rates of interest for the first five years and with terms of up to
ten years. Business lines of credit have adjustable rates of interest and are
payable on demand, subject to annual review and renewal. Business loans with
variable rates of interest adjust on a daily basis and are indexed to the Bank's
internal base rate.
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When making commercial business loans, the Bank considers the financial
statements of the borrower, the Bank's lending history with the borrower, the
debt service capabilities of the borrower, the projected cash flows of the
business and the value of the collateral. Commercial business loans are
generally secured by a variety of collateral, primarily accounts receivable,
inventory and equipment, and are supported by personal guarantees. Depending on
the collateral used to secure the loans, commercial loans are made in amounts of
up to 90% of the value of the collateral securing the loan. The Bank generally
does not make unsecured commercial loans.
Unlike residential mortgage loans, which generally are made on the basis of
the borrower's ability to make repayment from his or her employment or other
income, and which are secured by real property whose value tends to be more
easily ascertainable, commercial loans are of higher risk and typically are made
on the basis of the borrower's ability to make repayment from the cash flow of
the borrower's business. As a result, the availability of funds for the
repayment of commercial loans may depend substantially on the success of the
business itself. Further, any collateral securing such loans may depreciate over
time, may be difficult to appraise and may fluctuate in value. At December 31,
1999, the Bank's largest commercial loan was a $3.2 million loan secured by
commercial real estate located in Windham, Connecticut and operating as a mobile
home park. This loan was performing according to its original terms at December
31, 1999.
Consumer Loans. The Bank offers a variety of consumer loans, including
second mortgage loans and home equity lines of credit, both of which are secured
by owner-occupied one- to four-family residences. At December 31, 1999, second
mortgage loans and equity lines of credit totalled $ 48.2 million, or 5.1% of
the Bank's total loans and 65.5% of consumer loans. Additionally, at December
31, 1999, the unadvanced amounts of home equity lines of credit totalled $24.7
million. The underwriting standards employed by the Bank for second mortgage
loans and equity lines of credit include a determination of the applicant's
credit history, an assessment of the applicant's ability to meet existing
obligations and payments on the proposed loan and the value of the collateral
securing the loan. Home equity lines of credit have adjustable rates of
interest which are indexed to the prime rate as reported in The Wall Street
Journal. Interest rate adjustments on home equity lines of credit are limited
to no more than a maximum of 18%. Generally, the maximum loan-to-value ratio on
home equity lines of credit is 90%. A home equity line of credit may be drawn
down by the borrower for a period of 10 years from the date of the loan
agreement. During this period, the borrower has the option of paying, on a
monthly basis, either principal and interest or only the interest. The borrower
has to pay back the amount outstanding under the line of credit at the end of a
20 year period. The Bank offers fixed- and adjustable-rate second mortgage
loans with terms up to 20 years. The loan-to-value ratios of both fixed-rate and
adjustable-rate home equity loans are generally limited to 90%.
The Bank offers fixed-rate automobile loans for new or used vehicles with
terms of up to 72 months and loan-to-value ratios of the lesser of the purchase
price or the retail value shown in the NADA Used Car Guide. At December 31,
1999, automobile loans totalled $10.3 million, or 1.1% of the Bank's total loans
and 14.0% of consumer loans. For the year ended December 31, 1999, the Bank
originated $5.4 million of automobile loans.
Other consumer loans at December 31, 1999 amounted to $ 15.1 million, or
1.6% of the Bank's total loans and 20.5% of consumer loans. These loans
include unsecured personal loans, collateral loans, credit card loans and
education loans. Unsecured personal loans generally have a fixed-rate, a
maximum borrowing limitation of $25,000 and a maximum term of five years.
Collateral loans are generally secured by a passbook account, a certificate of
deposit or marketable securities.
Consumer loans entail greater risk than do residential mortgage loans,
particularly in the case of loans that are unsecured or secured by rapidly
depreciating assets such as automobiles. In these cases, any repossessed
collateral for a defaulted consumer loan may not provide an adequate source of
repayment of the outstanding loan balance as a result of the greater likelihood
of damage, loss or depreciation. The remaining deficiency often does not warrant
further substantial collection efforts against the borrower beyond obtaining a
deficiency judgment. In addition, consumer loan collections depend on the
borrower's continuing financial stability, and thus are more likely to be
adversely affected by job loss, divorce, illness or personal bankruptcy.
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Loans to One Borrower. The maximum amount that the Bank may lend to one
borrower is limited by statute. At December 31, 1999, the Bank's statutory limit
on loans to one borrower was $18.4 million. At that date, the Bank's largest
amount of loans to one borrower, including the borrower's related interests, was
approximately $7.6 million and consisted of ten loans secured by various
residential and commercial properties. These loans were performing according to
their original terms at December 31, 1999.
Maturity of Loan Portfolio. The following table shows the remaining
contractual maturity of the Bank's total loans at December 31, 1999, excluding
the effect of future principal prepayments.
At December 31, 1999
-------------------------------------------------------------------------------
Commercial
and Multi-
One- to Family
four-family (1) Construction (2) Real Estate Commercial Consumer Total
--------------- ---------------- ----------- ---------- -------- --------
(In thousands)
Amounts due in:
One year or less............................... $ 1,798 $16,482 $ 6,428 $ 29,572 $ 931 $ 55,211
After one year:
More than one year to three years........... 2,579 7,928 2,269 22,295 10,428 45,499
More than three years to five years......... 3,489 -- 7,435 29,251 16,633 56,808
More than five years to 10 years............ 25,856 1,723 25,260 26,125 16,255 95,219
More than 10 years to 15 years.............. 77,634 1,349 44,784 7,955 9,999 141,721
More than 15 years.......................... 428,768 13,244 73,807 19,352 19,325 554,496
-------- ------- -------- -------- ------- --------
Total amount due......................... $540,124 $40,727 $159,984 $134,550 $73,572 $948,957
======== ======= ======== ======== ======= ========
- --------------------------
(1) Includes home equity loans and lines of credit and second mortgages on
one- to four-family residences.
(2) Includes residential and commercial real estate loans.
The following table sets forth, at December 31, 1999, the dollar amount of
loans contractually due after December 31, 2000, and whether such loans have
fixed interest rates or adjustable interest rates.
Due After December 31, 2000
------------------------------
Fixed Adjustable Total
-------- ---------- --------
(In thousands)
Real estate loans:
One- to four-family (1)....... $278,765 $259,561 $538,326
Construction (2).............. 6,657 17,588 24,245
Commercial and multi-family... 16,575 136,981 153,556
-------- -------- --------
Total real estate loans.... 301,997 414,130 716,127
Commercial loans................. 39,150 65,828 104,978
Consumer loans................... 47,289 25,352 72,641
-------- -------- --------
Total loans.............. $388,436 $505,310 $893,746
======== ======== ========
- --------------------------
(1) Includes home equity loans and lines of credit and second mortgages on
one- to four-family residences.
(2) Includes residential and commercial real estate loans.
Scheduled contractual principal repayments of loans do not reflect the
actual life of the loans. The average life of a loan is substantially less than
its contractual term because of prepayments. In addition, due-on-sale clauses on
loans generally give the Bank the right to declare loans immediately due and
payable if, among other things, the borrower sells the real property with the
mortgage and the loan is not repaid. The average life of a mortgage loan tends
to increase, however, when current mortgage loan market rates are substantially
8
higher than rates on existing mortgage loans and, conversely, tends to decrease
when rates on existing mortgage loans are substantially higher than current
mortgage loan market rates.
Loan Approval Procedures and Authority. The Bank's lending activities
follow written, non-discriminatory, underwriting standards and loan origination
procedures established by the Bank's Board of Directors and management. The
Bank's policies and loan approval limits are established by management and are
approved by the Board of Directors. The Board of Directors has designated
certain individuals of the Bank and certain branch managers to consider and
approve loans within their designated authority.
All one- to four-family mortgage loans secured by the borrower's primary
residence in amounts of up to $400,000 and all residential construction and
second mortgage loans and home equity lines of credit in amounts of up to
$250,000 may be approved by any two designated individuals. All residential
construction and second mortgage loans and home equity lines of credit in excess
of $250,000 and up to $400,000 require the approval of the Bank's loan
committee. All residential loans in excess of $400,000 and up to $1.0 million
require the approval of the Bank's loan committee. All residential loans in
excess of $1.0 million require the approval of the Executive Committee of the
Board of Directors.
All commercial loans, including commercial real estate loans, multifamily
loans, commercial construction and development loans and commercial business
loans in amounts of up to $350,000 may be approved by any two of the designated
individuals. All commercial loans in excess of $350,000 and up to $1.0 million
require the approval of the Bank's loan committee; and all commercial loans in
excess of $1.0 million require the approval of the Executive Committee of the
Board of Directors.
With regard to consumer loans, automobile loans in amounts of up to $50,000
and unsecured personal loans in amounts of up to $25,000 may be approved by
either one or two of the designated individuals depending on the credit score;
automobile loans in excess of $50,000 and unsecured personal loans in excess of
$25,000 must be approved by the Bank's loan committee. Collateral loans of up
to $25,000 may be approved by any branch manager.
Loan Originations, Purchases and Sales. The Bank's lending activities are
conducted by its salaried and commissioned loan personnel and through non-bank
third-party correspondents. Currently, the Bank uses 17 loan originators who
solicit and originate mortgage loans on behalf of the Bank. These loan
originators accounted for approximately three quarters of the adjustable-rate
and fixed-rate mortgage loans originated by the Bank in 1999. Loan originators
are compensated by a commission that is based on product, mortgage type, and new
or existing customer relationship. The commission currently ranges from 30 to
60 basis points of the loan amount. All loans originated by the loan
originators are underwritten in conformity with the Bank's loan underwriting
policies and procedures. At December 31, 1999, the Bank serviced $210.2 million
of loans for others.
From time to time, the Bank will purchase loans or participation interests
in loans, primarily secured by one- to four-family residential properties
located outside of the Bank's primary market area, usually in Fairfield County,
Connecticut or in Massachusetts. Purchased loans are underwritten according to
the Bank's own underwriting criteria and procedures and are generally purchased
without the accompanying servicing rights. Amounts outstanding related to loan
purchases and participation interests totalled $73.3 million and $51.0 million
at December 31, 1999 and 1998, respectively.
Substantially all of the Bank's adjustable-rate mortgage loans are
originated for inclusion in the Bank's loan portfolio. Historically, the Bank
originated fixed-rate mortgage loans for sale in the secondary market. However,
since 1998 and due to the low demand for adjustable-rate mortgage loans, the
Bank has begun to retain for its portfolio a significant portion of fixed-rate
mortgage loans in order to maintain its targeted loan to asset ratio of 80%.
Sales are generally to Freddie Mac, with servicing rights retained. Loan sale
decisions are made by the Bank's management and are generally based on
prevailing market interest rates and the Bank's loan-to-asset ratio.
9
The following table presents total loans originated, sold, purchased and
repaid during the periods indicated.
For the Year Ended
December 31,
----------------------------
1999 1998 1997
-------- -------- --------
(In thousands)
Loans at beginning of year....................... $817,372 $808,237 $741,579
-------- -------- --------
Originations:
Real estate:
One-to four-family...................... 128,630 160,974 97,764
Construction (1)........................ 60,500 55,492 45,768
Commercial and multi-family............. 31,571 24,948 23,921
-------- -------- --------
Total real estate loans........... 220,701 241,414 167,453
Commercial................................. 97,246 88,170 85,483
Consumer................................... 33,926 30,684 30,634
-------- -------- --------
Total loans originated.................. 351,873 360,268 283,570
Loans purchased............................... 36,911 17,281 8,284
-------- -------- --------
Total loans originated and purchased.... 388,784 377,549 291,854
-------- -------- --------
Deduct:
Principal loan repayments and prepayments.. 236,869 274,246 208,643
Loan sales................................. 18,646 91,917 11,729
Charge-offs................................ 1,360 1,087 946
Transfers to other real estate owned....... 324 1,164 3,878
-------- -------- --------
Total deductions..................... 257,199 368,414 225,196
-------- -------- --------
Net increase in loans............................ 131,585 9,135 66,658
-------- -------- --------
Loans at end of year............................. $948,957 $817,372 $808,237
======== ======== ========
- ----------------------
(1) Includes residential and commercial real estate loans.
Loan Commitments. The Bank issues loan commitments to prospective
borrowers on the condition that certain events occur. Commitments are made in
writing on specified terms and conditions and are generally honored for up to 60
days from approval. At December 31, 1999, the Bank had loan commitments and
unadvanced loans and lines of credit totalling $155.2 million.
Loan Fees. In addition to interest earned on loans, the Bank receives
income from fees derived from loan originations, loan modifications, late
payments and for miscellaneous services related to its loans. Income from these
activities varies from period to period depending upon the volume and type of
loans made and competitive conditions. On loans originated by third-party
originators, the Bank may pay a premium to compensate an originator for loans
where the borrower is paying a higher rate on the loan.
The Bank charges loan origination fees which are calculated as a percentage
of the amount borrowed. As required by applicable accounting principles, loan
origination fees, discount points and certain loan origination costs are
deferred and recognized over the contractual remaining lives of the related
loans on a level yield basis. At December 31, 1999, the Bank had approximately
$1.5 million of net deferred loan fees. The Bank amortized approximately
$800,000 of net deferred loan fees during the year ended December 31, 1999.
10
Nonperforming Assets, Delinquencies and Impaired Loans. All loan payments
are due on the first day of each month. When a borrower fails to make a required
loan payment, the Bank attempts to cure the deficiency by contacting the
borrower and seeking the payment. A late notice is mailed on the 16/th/ day of
the month. In most cases, deficiencies are cured promptly. If a delinquency
continues beyond the 30/th/ day of the month, the account is referred to an in-
house collector. The Bank generally prefers to work with borrowers to resolve
problems, but the Bank will institute foreclosure or other proceedings, as
necessary, to minimize any potential loss.
On a monthly basis, management informs the Board of Directors of the amount
of loans delinquent for more than 30 days, all loans in foreclosure, and all
foreclosed and repossessed property that the Bank owns. The Bank ceases
accruing interest on mortgage loans when principal or interest payments are
delinquent 90 days or more unless management determines that the loan principal
and interest is fully secured and in the process of collection. Once the
accrual of interest on a loan is discontinued, all interest previously accrued
is reversed against current period interest income once management determines
that interest is uncollectible.
On January 1, 1995, the Bank adopted SFAS No. 114, "Accounting by Creditors
for Impairment of a Loan," as amended by SFAS No. 118 "Accounting by Creditors
for Impairment of a Loan--an amendment to SFAS No. 114." At December 31, 1999,
1998 and 1997, the Bank had a $11.5 million, $1.5 million and $2.8 million,
respectively, recorded investment in impaired loans all of which had no specific
allowances.
At December 31, 1999, the Bank's largest residential development loan was a
nonperforming loan for $4.1 million secured by a retirement facility located in
Central New England. That facility is part of a larger development, that also
had a loan which matured on June 30, 1999 in the amount of $563,000 secured by
eight residential units. Interest payments were kept current on the latter
loan, and such loan was repaid in 2000. Proceeds from the sale of units were
used to reduce the amount outstanding on the overall lending relationship by an
additional $463,000 in 2000. At December 31, 1999, the second largest loan in
the Bank's loan portfolio was also nonperforming. In 1988, the Bank made a $4.8
million first mortgage for the construction of a 45,000 square foot office
building in the Bank's primary market area. In 1993, the $4.7 million balance
of the loan was converted to an amortizing loan with a balloon payment maturing
in November 1998. The loan is additionally secured by a first mortgage on
another commercial property and a second mortgage on a multi-family property.
The loan matured in November 1998. At that time, the loan was current as to
principal and interest payments. However, the borrower requested a discounted
payoff which the Bank refused. The Bank has since instituted foreclosure
proceedings. In April 1999, the loan was placed on nonaccrual status. At
December 31, 1999, the loan had an outstanding carrying balance of $4.3 million.
Based on a January 2000 appraisal, the properties securing the loan had an
appraised value of $5.13 million. The Bank has negotiated a settlement with the
borrower requiring full repayment of the loan principal by May 2000.
11
The following table sets forth information regarding nonperforming loans,
troubled debt restructurings and other real estate owned at the dates indicated.
At December 31,
---------------------------------------------
1999 1998 1997 1996 1995
-------- ------- ------- -------- -------
(Dollars in thousands)
Nonperforming loans:
One- to four-family real estate........... $ 501 $ 456 $1,732 $ 5,181 $ 5,478
Commercial and multi-family real estate... 10,513 388 408 1,076 1,093
Commercial................................ 454 665 680 992 605
Consumer.................................. 17 15 15 29 81
------- ------ ------ ------- -------
Total nonperforming loans.................... 11,485 1,524 2,835 7,278 7,257
Other real estate owned...................... 604 1,759 4,708 5,482 4,749
------- ------ ------ ------- -------
Total nonperforming assets................ 12,089 3,283 7,543 12,760 12,006
Troubled debt restructurings................. -- -- -- -- 1,192
------- ------ ------ ------- -------
Total nonperforming assets and troubled
debt restructurings....................... $12,089 $3,283 $7,543 $12,760 $13,198
======= ====== ====== ======= =======
Total nonperforming loans and troubled
debt restructurings as a percentage
of total loans............................ 1.27% 0.19% 0.35% 0.98% 1.20%
Total nonperforming assets and troubled
debt restructurings as a percentage
of total assets........................... 0.98% 0.30% 0.73% 1.32% 1.41%
Interest income that would have been recorded for the years ended December
31, 1999, 1998 and 1997 had nonaccruing loans been current according to their
original terms amounted to approximately $635,000, $136,000 and $337,000,
respectively. No interest related to these loans was included in interest income
in either year.
12
The following tables set forth the delinquencies in the Bank's loan
portfolio as of the dates indicated.
At December 31, 1999 At December 31, 1998
-------------------------------------------- ----------------------------------------------
60-89 Days 90 Days or More 60-89 Days 90 Days or More
------------------- ----------------------- --------------------- -----------------------
Number Principal Number Principal Number Principal Number Principal
of Balance of of Balance of of Balance of of Balance of
Loans Loans Loans Loans Loans Loans Loans Loans
------ ----------- ------ --------------- ------ ----------- ---------- -------------
(Dollars in thousands)
Real estate loans:
One- to four-family......... 1 $ 32 3 $ 227 1 $ 1 4 $ 151
Commercial and multi-
family................... -- -- -- -- -- -- 1 279
-- ----- -- ----- -- ----- -- -----
Total real estate
loans................... 1 32 3 227 1 1 5 430
-- ----- -- ----- -- ----- -- -----
Commercial loans............... 5 223 3 124 7 137 6 294
-- ----- -- ----- -- ----- -- -----
Consumer loans:
Home equity loans and
lines of credit.......... -- -- -- -- 1 15 -- --
Other....................... 3 5 4 4 5 7 3 16
-- ----- -- ----- -- ----- -- -----
Total consumer loans..... 3 5 4 4 6 22 3 16
-- ----- -- ----- -- ----- -- -----
Total.................... 9 $ 260 10 $ 355 14 $ 160 14 $ 740
== ===== == ===== == ===== == =====
Delinquent loans to
total loans................. 0.03% 0.04% 0.02% 0.09%
===== ===== ===== =====
At December 31, 1997
--------------------------------------------------
60-89 Days 90 Days or More
---------------------- --------------------------
Principal Principal
Number Balance of Number Balance of
of Loans Loans of Loans Loans
---------------------- --------------------------
(Dollars in thousands)
Real estate loans:
One- to four-family......... 1 $ 87 6 $ 473
Commercial and multi-
family................... -- -- -- --
-- ----- -- -----
Total real estate loans.. 1 87 6 473
-- ----- -- -----
Commercial loans............... 3 116 2 140
-- ----- -- -----
Consumer loans:
Home equity loans and
lines of credit.......... 3 95 3 130
Other....................... 5 29 4 15
-- ----- -- -----
Total consumer loans..... 8 124 7 145
-- ----- -- -----
Total.................... 12 $ 327 15 $ 758
== ===== == =====
Delinquent loans to
total loans................. 0.04% 0.09%
===== =====
Real Estate Owned. Real estate acquired by the Bank as a result of
foreclosure or by deed in lieu of foreclosure is classified as real estate owned
until sold. When property is acquired, it is recorded at fair market value at
the date of foreclosure, establishing a new cost basis. Holding costs and
declines in fair value result in changes to expense after acquisition are
expensed. At December 31, 1999, the Bank had $604,000 of real estate owned, net,
consisting of a one- to four-family residence and one commercial property.
Asset Classification. Banking regulators have adopted various regulations
and practices regarding problem assets of savings institutions. Under such
regulations, federal and state examiners have authority to identify problem
assets during examinations and, if appropriate, require their classification.
13
There are three classifications for problem assets: substandard, doubtful
and loss. Substandard assets have one or more defined weaknesses and are
characterized by the distinct possibility that the insured institution will
sustain some loss if the deficiencies are not corrected. Doubtful assets have
the weaknesses of substandard assets with the additional characteristic that the
weaknesses make collection or liquidation in full on the basis of currently
existing facts, conditions and values questionable, and there is a high
possibility of loss. An asset classified as loss is considered uncollectible and
of such little value that its continued status as an asset of the institution is
not warranted. If an asset or portion thereof is classified as loss, the insured
institution establishes specific allowances for loan losses for the full amount
of the portion of the asset classified as loss. All or a portion of general loan
loss allowances established to cover probable losses related to assets
classified substandard or doubtful can be included in determining an
institution's regulatory capital, while specific valuation allowances for loan
losses generally do not qualify as regulatory capital. Assets that do not
currently expose the insured institution to sufficient risk to warrant
classification in one of the aforementioned categories but possess weaknesses
are designated "special mention." The Bank performs an internal analysis of its
loan portfolio and assets to classify such loans and assets similar to the
manner in which such loans and assets are classified by the federal banking
regulators. In addition, the Bank regularly analyzes the losses inherent in its
loan portfolio and its nonperforming loans in determining the appropriate level
of the allowance for loan losses.
Allowance for Loan Losses. In originating loans, the Bank recognizes that
losses will be experienced on loans and that the risk of loss will vary with,
among other things, the type of loan being made, the creditworthiness of the
borrower over the term of the loan, general economic conditions and, in the case
of a secured loan, the quality of the security for the loan. The Bank maintains
an allowance for loan losses to absorb losses inherent in the loan portfolio.
The allowance for loan losses represents management's estimate of probable
losses based on information available as of the date of the financial
statements. The allowance for loan losses is based on management's evaluation
of the collectibility of the loan portfolio, including past loan loss
experience, known and inherent risks in the nature and volume of the portfolio,
information about specific borrower situations and estimated collateral values,
and economic conditions.
The loan portfolio and other credit exposures are regularly reviewed by
management to evaluate the adequacy of the allowance for loan losses. The
methodology for assessing the appropriateness of the allowance includes
comparison to actual losses, peer group comparisons, industry data and economic
conditions. In addition, the regulatory agencies, as an integral part of their
examination process, periodically review the Bank's allowance for loan losses
and may require the Bank to make additional provisions for estimated losses
based upon judgments different from those of management.
In assessing the allowance for loan losses, loss factors are applied to
various pools of outstanding loans and certain unused commitments. The Bank
segregates the loan portfolio according to risk characteristics (i.e., mortgage
loans, home equity, consumer). Loss factors are derived using the Bank's
historical loss experience and may be adjusted for significant factors that, in
management's judgment, affect the collectibility of the portfolio as of the
evaluation date.
In addition, management assesses the allowance using factors that cannot be
associated with specific credit or loan categories. These factors include
management's subjective evaluation of local and national economic and business
conditions, portfolio concentration and changes in the character and size of the
loan portfolio. The allowance methodology reflects management's objective that
the overall allowance appropriately reflects a margin for the imprecision
necessarily inherent in estimates of expected credit losses.
At December 31, 1999, the Bank had an allowance for loan losses of $10.6
million which represented 1.12% of total loans and 92.4% of nonperforming loans
and troubled debt restructurings at that date. Although management believes
that it uses the best information available to establish the allowance for loan
losses, future adjustments to the allowance for loan losses may be necessary and
results of operations could be adversely affected if circumstances differ
substantially from the assumptions used in making the determinations.
Furthermore, while the Bank believes it has established its existing allowance
for loan losses consistent with generally accepted accounting principles, there
can be no assurance that regulators, in reviewing the Bank's loan portfolio,
will not request the Bank to increase its allowance for loan losses. In
addition, because future events affecting borrowers and collateral cannot be
14
predicted with certainty, there can be no assurance that the existing allowance
for loan losses is adequate or that increases will not be necessary should the
quality of any loans deteriorate as a result of the factors discussed above.
Any material increase in the allowance for loan losses may adversely affect the
Bank's financial condition and results of operations.
The following table presents an analysis of the Bank's allowance for loan
losses at and for the periods indicated.
At or For the Year Ended December 31,
-----------------------------------------------
1999 1998 1997 1996 1995
-------- -------- -------- -------- -------
(Dollars in thousands)
Allowance for loan losses,
beginning of year................. $10,585 $ 9,945 $ 9,131 $ 8,484 $ 7,691
------- ------- ------- ------- -------
Charged-off loans:
One- to four-family real estate... 110 340 299 695 474
Commercial and multi-family
real estate.................... 790 112 133 326 395
Commercial........................ 337 483 311 366 287
Consumer.......................... 123 152 203 375 325
------- ------- ------- ------- -------
Total charged-offs loans....... 1,360 1,087 946 1,762 1,481
------- ------- ------- ------- -------
Recoveries on loans previously
charged off:
One- to four-family real estate... 55 146 215 38 3
Commercial and multi-family
real estate.................... 98 12 10 18 --
Commercial........................ 96 283 229 939 533
Consumer.......................... 43 86 106 214 188
------- ------- ------- ------- -------
Total recoveries............... 292 527 560 1,209 724
------- ------- ------- ------- -------
Net loans charged-off................ 1,068 560 386 553 757
------- ------- ------- ------- -------
Provision for loan losses............ 1,100 1,200 1,200 1,200 1,550
------- ------- ------- ------- -------
Allowance for loan losses, end
of year........................... $10,617 $10,585 $ 9,945 $ 9,131 $ 8,484
======= ======= ======= ======= =======
Net loans charged-off to average
interest-earning loans............ 0.12% 0.07% 0.05% 0.08% 0.11%
Allowance for loan losses
to total loans.................... 1.12 1.30 1.23 1.23 1.20
Allowance for loan losses to
nonperforming loans and
troubled debt restructurings...... 92.44 694.55 350.79 125.46 100.41
Net loans charged-off to allowance
for loan losses................... 10.06 5.29 3.88 6.06 8.92
Recoveries to charge-offs............ 21.47 48.48 59.20 68.62 48.89
15
The following table presents the approximate allocation of the allowance
for loan losses by loan categories at the dates indicated and the percentage of
such amounts to the total allowance and to total loans. Management believes that
the allowance can be allocated by category only on an approximate basis. The
allocation of the allowance to each category is not indicative of future losses
and does not restrict the use of any of the allowance to absorb losses in any
category.
At December 31,
--------------------------------------------------------------------------------------------------
1999 1998 1997
-------------------------------- -------------------------------- --------------------------------
Percent Percent Percent
of of of
Allowance Percent Allowance Percent Allowance Percent
in Each of Loans in Each of Loans in Each of Loans
Category in Each Category in Each Category in Each
to Total Category to to Total Category to to Total Category to
Amount Allowance Total Loans Amount Allowance Total Loans Amount Allowance Total Loans
-------- --------- ----------- -------- --------- ----------- -------- --------- -----------
(Dollars in thousands)
Real estate................. $ 5,198 49% 78% $ 4,995 47% 77% $4,310 43% 78%
Commercial.................. 4,473 42 14 4,714 45 14 4,913 50 13
Consumer.................... 946 9 8 876 8 9 722 7 9
------- --- --- ------- --- --- ------ --- ---
Total allowance
for loan losses.... $10,617 100% 100% $10,585 100% 100% $9,945 100% 100%
======= === === ======= === === ====== === ===
At December 31,
-----------------------------------------------------------------
1996 1995
-------------------------------- --------------------------------
Percent Percent
of of
Allowance Percent Allowance Percent
in Each of Loans in Each of Loans
Category in Each Category in Each
to Total Category to to Total Category to
Amount Allowance Total Loans Amount Allowance Total Loans
-------- --------- ----------- -------- --------- -----------
Real estate................. $3,531 39% 78% $3,485 41% 79%
Commercial.................. 4,958 54 13 4,349 51 12
Consumer.................... 642 7 9 650 8 9
------ --- --- ------ --- ---
Total allowance
for loan losses.... $9,131 100% 100% $8,484 100% 100%
====== === === ====== === ===
16
Investment Activities
General. Under Connecticut law, the Bank has authority to purchase a wide
range of investment securities. As a result of recent changes in federal banking
laws, however, financial institutions such as the Bank may not engage as
principals in any activities that are not permissible for a national bank,
unless the Federal Deposit Insurance Corporation has determined that the
investments would pose no significant risk to the Bank Insurance Fund and that
the Bank is in compliance with applicable capital standards. In 1993, the
Regional Director of the Federal Deposit Insurance Corporation approved a
request by the Bank to invest in certain listed stocks and/or registered stocks
subject to certain conditions.
The Bank's Board of Directors has the overall responsibility for the Bank's
investment portfolio, including approval of the Bank's investment policy,
appointment of the Bank's investment adviser and approval of the Bank's
investment transactions. All investment transactions are reviewed by the Board
on a monthly basis. The Bank's President and/or Chief Financial Officer, or
their designees, are authorized to make investment decisions consistent with the
Bank's investment policy and the recommendations of the Bank's investment
adviser and the Board's Investment Committee. The Investment Committee meets
quarterly with the President and Chief Financial Officer in order to review and
determine investment strategies.
The Bank's investment policy is designed to complement the Bank's lending
activities, provide an alternative source of income through interest, dividends
and capital gains, diversify the Bank's assets and improve liquidity while
minimizing the Bank's tax liability. Investment decisions are made in
accordance with the Bank's investment policy and are based upon the quality of a
particular investment, its inherent risks, the composition of the balance sheet,
market expectations, the Bank's liquidity, income and collateral needs and how
the investment fits within the Bank's interest rate risk strategy. Although the
Bank utilizes the investment advisory services of a Boston-based investment
firm, management is ultimately and completely responsible for all investment
decisions.
The Bank's investment policy divides investments into two categories, fixed
income and equity portfolios. The primary objective of the fixed income
portfolio is to maintain an adequate source of liquidity sufficient to meet
regulatory and operating requirements, and to safeguard against deposit
outflows, reduced loan amortization and increased loan demand. The fixed income
portfolio primarily includes debt issues, including mortgage-backed and asset-
backed securities. Substantially all of the Bank's mortgage-backed securities
are issued or guaranteed by agencies of the U.S. Government. Accordingly, they
carry lower credit risk than mortgage-backed securities of a private issuer.
Asset-backed securities are typically collateralized by the cash flow from a
pool of auto loans, credit card receivables, consumer loans and other similar
obligations.
The Bank's investment policy permits the Bank to be a party to financial
instruments with off-balance sheet risk in the normal course of business in
order to manage interest rate risk. The Bank's derivative position is reviewed
by the Investment Committee on a quarterly basis. The investment policy
authorizes the Bank to be involved in and purchase various types of derivative
transactions and products including interest rate swap, cap and floor agreements
investment conduits. At December 31, 1999, the Bank was a party to one interest
rate cap agreement with a notional principal amount of $25 million. Under the
terms of the cap agreement, the Bank paid a premium totalling $123,000 which is
included in other assets and being amortized over three years which is the term
of the agreement. Amortization for the year ended December 31, 1999 totalled
$38,000 and is recorded as an interest expense on advances. The agreement
provides that, if the London Interbank Offered Rate exceeds 7%, the Bank will
receive cash payments on a quarterly basis. There were no cash payments due at
December 31, 1999. The Bank was not a party to any interest rate swap, cap or
floor arrangements during the years ended December 31, 1998 and 1997.
The marketable equity securities portfolio has the objective of producing
capital appreciation through long-term investment. Safety of principal and
prudent risk taking are of paramount importance. The total market value of the
marketable equity securities portfolio, excluding Federal Home Loan Bank stock,
is limited by the investment policy to 50% of the Bank's Tier 1 capital. At
December 31, 1999, the marketable equity securities portfolio totalled $50.5
million or 46.1% of the Bank's Tier 1 capital . At December 31, 1999, the net
17
unrealized gains associated with the marketable equity securities portfolio were
$18.3 million. In future periods and subject to market conditions and other
factors, the Bank intends to increase its marketable equity securities portfolio
through periodic purchases of high quality equity investments. Emphasis will be
placed on companies with established records of growth and financial strength.
SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities" requires that investments be categorized as "held to maturity,"
"trading securities" or "available for sale," based on management's intent as to
the ultimate disposition of each security. SFAS No. 115 allows debt securities
to be classified as "held to maturity" and reported in financial statements at
amortized cost only if the reporting entity has the positive intent and ability
to hold those securities to maturity. Securities that might be sold in response
to changes in market interest rates, changes in the security's prepayment risk,
increases in loan demand, or other similar factors cannot be classified as "held
to maturity." Debt and equity securities held for current resale are classified
as "trading securities." These securities are reported at fair value, and
unrealized gains and losses on the securities would be included in earnings.
The Bank does not currently use or maintain a trading account. Debt and equity
securities not classified as either "held to maturity" or "trading securities"
are classified as "available for sale." These securities are reported at fair
value, and unrealized gains and losses on the securities are excluded from
earnings and reported, net of deferred taxes, as a separate component of
capital. As permitted by SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities," the Company adopted the provisions of SFAS No. 133 on
January 1, 2000, earlier than required, and reclassified all held to maturity
investments to available for sale.
All of the Bank's debt securities and mortgage-backed and asset-backed
securities carry market risk insofar as increases in market rates of interest
may cause a decrease in their market value. They also carry prepayment risk
insofar as they may be called or repaid before maturity in times of low market
interest rates, so that the Bank may have to invest the funds at a lower
interest rate. The marketable equity securities portfolio also carries equity
price risk in that, if equity prices decline due to unfavorable market
conditions or other factors, the Bank's capital would decrease.
18
The following table presents the amortized cost and fair value of the
Bank's securities, by type of security, at the dates indicated.
At December 31,
---------------------------------------------------------------
1999 1998 1997
--------------------- ------------------- -------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
----------- -------- --------- -------- --------- --------
(In thousands)
Debt securities held to maturity:
Asset-backed securities................. $ 17,481 $ 17,418 $ 23,204 $ 23,386 $ 25,674 $ 25,752
U.S. Government and agency
obligations.......................... -- -- 3,506 3,524 7,055 7,071
Other debt securities................... 3,105 2,950 3,145 3,246 3,145 3,224
-------- -------- -------- -------- -------- --------
Total............................. 20,586 20,368 29,855 30,156 35,874 36,047
-------- -------- -------- -------- -------- --------
Debt securities available for sale:
U.S. Government and agency
obligations.......................... 82,486 81,328 70,563 71,703 48,534 48,767
Corporate securities.................... 33,870 33,345 40,128 40,420 23,771 24,010
-------- -------- -------- -------- -------- --------
Total............................. 116,356 114,673 110,691 112,123 72,305 72,777
-------- -------- -------- -------- -------- --------
Equity securities available for sale:
Marketable equity securities............ 32,273 50,545 29,427 42,773 29,389 40,635
Other equity securities................. 432 432 396 396 192 192
-------- -------- -------- -------- -------- --------
Total............................. 32,705 50,977 29,823 43,169 29,581 40,827
-------- -------- -------- -------- -------- --------
Total debt and equity securities.. 169,647 186,018 170,369 185,448 137,760 149,651
-------- -------- -------- -------- -------- --------
Mortgage-backed securities:
Mortgage-backed securities held to
maturity:
FHLMC................................ 7,182 6,960 8,615 8,719 10,238 10,259
FNMA................................. 6,077 5,807 7,376 7,464 1,508 1,548
GNMA................................. 12,215 11,863 6,751 6,715 2,663 2,682
-------- -------- -------- -------- -------- --------
Total mortgage-backed securities
held to maturity............... 25,474 24,630 22,742 22,898 14,409 14,489
-------- -------- -------- -------- -------- --------
Mortgage-backed securities available
for sale:
FHLMC................................ 2,099 2,080 3,086 3,130 4,595 4,649
FNMA................................. 7,425 7,115 4,782 4,878 5,847 5,929
GNMA................................. 7,217 7,009 4,964 4,851 7,434 7,407
-------- -------- -------- -------- -------- --------
Total mortgage-backed securities
available for sale............. 16,741 16,204 12,832 12,859 17,876 17,985
-------- -------- -------- -------- -------- --------
Total mortgage-backed securities.. 42,215 40,834 35,574 35,757 32,285 32,474
-------- -------- -------- -------- -------- --------
Total investment securities....... $211,862 $226,852 $205,943 $221,205 $170,045 $182,125
======== ======== ======== ======== ======== ========
19
At December 31, 1999, the Bank did not own any investment or mortgage-
backed securities of a single issuer, other than U.S. Government and agency
securities, which had an aggregate book value in excess of 10% of the Bank's
capital at that date.
The following presents the activity in the investment securities and
mortgage-backed securities portfolios for the periods indicated.
Year Ended December 31,
------------------------------
1999 1998 1997
--------- --------- --------
(In thousands)
Mortgage-backed and asset-backed securities (1):
Mortgage-backed and asset-backed securities, beginning of year... $ 58,805 $ 58,068 $ 57,477
Purchases:
Asset-backed securities - held to maturity.................... -- 5,069 6,336
Mortgage-backed securities - held to maturity................. 6,876 12,235 4,929
Mortgage-backed securities - available for sale............... 7,278 -- 2,990
Sales:
Mortgage-backed securities - available for sale............... -- -- (1,297)
Repayments and prepayments.................................... (13,249) (16,510) (12,643)
Increase in net premium.......................................... 13 25 114
Change in unrealized net gain on securities
available for sale............................................ (564) (82) 162
-------- -------- --------
Net increase in mortgage-backed and
asset-backed securities................................. 354 737 591
-------- -------- --------
Mortgage-backed and asset-backed securities, end of year......... 59,159 58,805 58,068
-------- -------- --------
Investment securities (1):
Investment securities, beginning of year......................... 161,943 123,804 121,350
Purchases:
Investment securities - held to maturity...................... -- -- 775
Investment securities - available for sale.................... 49,875 61,694 86,593
Sales:
Investment securities - available for sale.................... (18,530) (18,132) (60,815)
Maturities:
Investment securities - held to maturity...................... (3,535) (3,500) (9,375)
Investment securities - available for sale.................... (21,778) (5,000) (18,815)
(Decrease) increase in net premium............................... (31) 17 159
Change in unrealized net gain on securities available for sale... 1,811 3,060 3,932
-------- -------- --------
Net increase in investment securities......................... 6,812 38,139 2,454
-------- -------- --------
Investment securities, end of year............................... 168,755 161,943 123,804
-------- -------- --------
Total mortgage-backed, asset-backed and investment securities,
end of period.................................................... $227,914 $220,748 $181,872
======== ======== ========
- -------------------------
(1) Available for sale securities are presented at market value and held to
maturity securities are presented at amortized cost.
20
The following table presents certain information regarding the carrying
value, weighted average yields and maturities or periods to repricing of the
Bank's debt securities at December 31, 1999.
At December 31, 1999
--------------------------------------------------------------------
More than One Year More than Five Years
One Year or Less to Five Years to Ten Years
---------------------- --------------------- ---------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
----------- --------- ---------- --------- -------- -----------
(Dollars in thousands)
Held to maturity
securities:
Mortgage-backed
securities................ $ 144 7.50% $ 95 7.50% $ 1,205 7.09%
Asset-backed securities.... -- -- 7,571 6.23 655 6.34
Other securities........... 10 5.50 135 7.75 -- --
------- ---- ------- ---- ------- ----
Total debt
securities at
amortized cost...... $ 154 7.37% $ 7,801 6.27% $ 1,860 6.83%
======= ======= =======
Available for sale
securities:
U.S. Government and
agency obligations........ $14,005 6.20% $38,418 6.11% $28,905 6.03%
Corporate securities....... 11,982 6.81 21,363 6.79 -- --
Mortgage-backed
securities................ -- -- 667 6.50 2,250 6.84
------- ---- ------- ---- ------- ----
Total debt
securities at
fair value.......... $25,987 6.48% $60,448 6.35% $31,155 6.01%
======= ======= =======
At December 31, 1999
--------------------------------------------
More than Ten Years Total
---------------------- --------------------
Weighted Weighted
Carrying Average Carrying Average
Value Yield Value Yield
---------- ---------- --------- --------
(Dollars in thousands)
Held to maturity
securities:
Mortgage-backed
securities................ $24,030 6.93% $ 25,474 6.94%
Asset-backed securities.... 9,255 7.19 17,481 6.74
Other securities........... 2,960 8.60 3,105 8.55
------- ---- -------- ----
Total debt
securities at
amortized cost...... $36,245 7.13% $ 46,060 6.97%
======= ========
Available for sale
securities:
U.S. Government and
agency obligations........ $ -- --% $ 81,328 6.09%
Corporate securities....... -- -- 33,345 6.80
Mortgage-backed
securities................ 13,287 7.26 16,204 7.17
------- ---- -------- ----
Total debt
securities at
fair value.......... $13,287 7.26% $130,877 6.40%
======= ========
21
Deposit Activities and Other Sources of Funds
General. Deposits are the major external source of funds for the Bank's
lending and other investment activities. In addition, the Bank also generates
funds internally from loan principal repayments and prepayments and maturing
investment securities. Scheduled loan repayments are a relatively stable source
of funds, while deposit inflows and outflows and loan prepayments are influenced
significantly by general interest rates and money market conditions. the Bank
may use borrowings from the Federal Home Loan Bank of Boston to compensate for
reductions in the availability of funds from other sources.
Deposit Accounts. Substantially all of the Bank's depositors reside in
Connecticut. The Bank offers a wide variety of deposit accounts with a range of
interest rates and terms. The Bank's deposit accounts consist of interest-
bearing checking, noninterest-bearing checking, regular savings, money market
savings and certificates of deposit. The maturities of the Bank's certificate of
deposit accounts range from seven days to five years. In addition, the Bank
offers retirement accounts, including IRAs and Keogh accounts and simplified
employee pension plan accounts. The Bank also offers commercial business
products to small businesses operating within its primary market area. Deposit
account terms vary with the principal differences being the minimum balance
deposit, early withdrawal penalties, limits on the number of transactions and
the interest rate. The Bank reviews its deposit mix and pricing on a weekly
basis.
The Bank believes it offers competitive interest rates on its deposit
products. The Bank determines the rates paid based on a number of factors,
including rates paid by competitors, the Bank's need for funds and cost of
funds, borrowing costs and movements of market interest rates. While
certificate accounts in excess of $100,000 are accepted by the Bank, and may
receive preferential rates, the Bank does not actively seek such deposits as
they are more difficult to retain than core deposits. The Bank does not utilize
brokers to obtain deposits and at December 31, 1999, had no brokered deposits.
In the unlikely event the Bank is liquidated after the Conversion,
depositors will be entitled to full payment of their deposit accounts before any
payment is made to the Company as the sole stockholder of the Bank.
The following table presents the deposit activity of the Bank for the
periods indicated.
For the Year Ended December 31,
-------------------------------
1999 1998 1997
---------- --------- --------
(In thousands)
Beginning balance................................ $855,117 $827,667 $792,833
Increase (decrease) before interest credited..... 20,565 (4,969) 1,870
Interest credited................................ 30,909 32,419 32,964
-------- -------- --------
Net increase..................................... 51,474 27,450 34,834
-------- -------- --------
Ending balance................................... $906,591 $855,117 $827,667
======== ======== ========
At December 31, 1999, the Bank had $60.5 million in certificate of deposit
accounts in amounts of $100,000 or more maturing as follows:
Weighted
Average
Maturity Period Amount Rate
- --------------- -------------- --------
(In thousands)
Three months or less............. $19,446 5.22%
Over 3 months through 6 months... 20,505 5.31
Over 6 months through 12 months.. 10,758 5.55
Over 12 months................... 9,780 5.77
-------
Total...................... $60,489
=======
22
The following table presents information concerning average balances and
weighted average interest rates for the periods indicated.
Year Ended December 31,
-----------------------------------------------------------------------------------------------
1999 1998 1997
-------------------------------- ------------------------------ -----------------------------
Percent Percent Percent
of Total Weighted of Total Weighted of Total Weighted
Average Average Average Average Average Average Average Average Average
Balance Deposits Rate Balance Deposits Rate Balance Deposits Rate
---------- --------- --------- -------- --------- --------- -------- --------- --------
(Dollars in thousands)
Savings accounts.......... $225,767 25.8% 3.35% $215,769 25.8% 2.36% $207,423 25.4% 2.27%
Money market accounts..... 51,204 5.9 3.19 33,146 4.0 2.87 30,709 3.8 2.56
NOW accounts.............. 109,095 12.5 1.38 94,394 11.2 1.38 80,445 9.9 1.37
Certificates of deposit... 445,474 50.9 4.53 463,226 55.3 5.45 471,865 57.8 5.58
Demand deposits........... 43,523 5.0 -- 30,985 3.7 -- 25,123 3.1 --
-------- ----- -------- ----- -------- -----
Total.................. $875,063 100.0% 3.53% $837,520 100.0% 3.90% $815,565 100.0% 4.03%
======== ===== ======== ===== ======== =====
Certificates of Deposit by Rates and Maturities. The following table
presents by various rate categories, the amount of certificate accounts
outstanding at the dates indicated and the periods to maturity of the
certificate accounts outstanding at December 31, 1999.
Period to Maturity from December
31, 1999 Total at December 31,
-------------------------------------- ------------------------------
One to Two to Over
Less than Two Three Three
One Year Years Years Years 1999 1998 1997
----------- ------- ------- ------- -------- -------- --------
(Dollars in thousands)
0.00 - 2.00%... $ 18 $ -- $ -- $ -- $ 18 $ 21 $ 30
2.01 - 4.00%... 2,094 -- 11 224 2,329 2,598 2,743
4.01 - 5.00%... 179,892 15,936 1,102 10,733 207,163 222,709 74,900
5.01 - 6.00%... 125,424 22,033 22,089 25,857 195,403 178,662 335,908
6.01 - 7.00%... 27,208 814 7,722 3,385 39,129 32,907 52,072
7.01 - 8.00%... 6,306 -- -- -- 6,306 9,227 10,100
8.01 - 9.00%... -- -- -- -- -- 15 13
-------- ------- ------- ------- -------- -------- --------
Total....... $340,942 $38,283 $30,924 $40,198 $450,347 $446,139 $475,766
======== ======= ======= ======= ======== ======== ========
Borrowings. The Bank may use advances from the Federal Home Loan Bank of
Boston to supplement its supply of lendable funds and to meet deposit withdrawal
requirements. The Federal Home Loan Bank of Boston functions as a central
reserve bank providing credit for savings banks and certain other member
financial institutions. As a member of the Federal Home Loan Bank of Boston, the
Bank is required to own capital stock in the Federal Home Loan Bank of Boston
and is authorized to apply for advances on the security of the capital stock and
certain of its mortgage loans and other assets, principally securities that are
obligations of, or guaranteed by, the U.S. Government or its agencies, provided
certain creditworthiness standards have been met. Advances are made under
several different credit programs. Each credit program has its own interest rate
and range of maturities. Depending on the program, limitations on the amount of
advances are based on the financial condition of the member institution and the
adequacy of collateral pledged to secure the credit. At December 31, 1999, the
Bank had the ability to borrow a total of approximately $34 million from the
Federal Home Loan Bank of Boston. At that date, the Bank had no outstanding
advances. At December 31, 1999, the Bank also maintained an unused $15 million
line of credit with a third party financial institution.
Federal banking laws and regulations prohibit a bank from paying interest
on commercial checking accounts. However, the Bank offers to its commercial
23
customers a transactional repurchase agreement, a form of non-deposit borrowing
by the Bank, that is designed as a mechanism to offer business customers the
functional equivalent of a commercial checking account that pays interest. This
account, overseen by an outside agent, is not an FDIC-insured deposit account,
but is backed by a security interest in U.S. Government and agency securities at
a ratio of approximately 1.10 to 1.00. At December 31, 1999, the Bank had 1,524
of such accounts with balances aggregating $94.6 million.
The following tables presents certain information regarding the Bank's
Federal Home Loan Bank advances and short-term borrowed funds at the dates or
for the periods indicated.
At or For the Year Ended December
31,
-------------------------------------
1999 1998 1997
-------------------------------------
(Dollars in thousands)
Average balance outstanding:
Federal Home Loan Bank advances..... $ 60,589 $36,534 $14,144
Short-term borrowed funds........... 90,158 76,523 61,677
Maximum amount outstanding at any
month-end during the period:
Federal Home Loan Bank advances..... 95,962 45,000 17,987
Short-term borrowed funds........... 104,575 87,790 72,780
Balance outstanding at end of period:
Federal Home Loan Bank advances..... 84,000 45,000 17,987
Short-term borrowed funds........... 95,814 79,545 71,179
Weighted average interest rate
during the period:
Federal Home Loan Bank advances..... 5.97% 6.31% 6.90%
Short-term borrowed funds........... 2.99 3.00 2.83
Weighted average interest rate
at end of period:
Federal Home Loan Bank advances..... 6.03 6.21 6.54
Short-term borrowed funds........... 3.12 2.84 3.21
Subsidiary Activities
The following are descriptions of the Bank's wholly owned subsidiaries,
which are indirectly owned by the Company.
SBM, Ltd. SBM, Ltd. was organized in February 1983 for the purpose of
acquiring and holding real estate acquired by the Bank. In 1990, the purpose
changed to acquire, hold and dispose of real estate acquired through
foreclosure. At December 31, 1999, SBM held property consisting of one
residential subdivision with a book value of $0.
923 Main, Inc. 923 Main was incorporated in December, 1994 for the purpose
of maintaining an ownership interest in a third party registered broker-dealer,
Infinex Financial Group. Infinex maintains an office at the Bank and offers to
customers a complete range of nondeposit investment products, including mutual
funds, debt, equity and government securities, retirement accounts, insurance
products and fixed and variable annuities. The Bank receives a portion of the
commissions generated by Infinex from sales to customers. For each of the years
ended December 31, 1999 and 1998, the Bank received fees of $1.2 million through
its relationship with Infinex.
Savings Bank of Manchester Mortgage Company, Inc. SBM Mortgage was
established in January 1999 to service and hold loans secured by real property.
SBM Mortgage was established and is managed to qualify as a "passive investment
company" for Connecticut income tax purposes. Income earned by a qualifying
passive investment company is exempt from Connecticut income tax. Accordingly,
no state income taxes were provided in 1999.
24
Savings Bank of Manchester Foundation, Inc.
In 1998, the Bank established a private charitable foundation, Savings Bank
of Manchester Foundation, Inc. This foundation, which is not a subsidiary of
the Bank, provides grants to individuals and not-for-profit organizations within
the communities that the Bank serves. In 1998, the Bank contributed marketable
equity securities with a cost basis and fair market value of $700,000 and $3.0
million, respectively, at the date of contribution and transfer. At December
31, 1999, the foundation had assets of approximately $3.2 million. The
foundation's five member Board of Trustees consists of current directors,
officers and employees of the Bank. The Bank intends to maintain the
foundation, but does not expect to make any further contributions to the
foundation in the future.
REGULATION AND SUPERVISION
General
As a savings bank chartered by the State of Connecticut, the Bank is
extensively regulated under state law by the Connecticut Banking Commissioner
with respect to many aspects of its banking activities. In addition, as a bank
whose deposits are insured by the Federal Deposit Insurance Corporation through
the Bank Insurance Fund, the Bank must pay deposit insurance assessments and is
examined and supervised by the Federal Deposit Insurance Corporation. These
laws and regulations have been established primarily for the protection of
depositors, customers and borrowers of the Bank, not its stockholders.
The Company is also required to file reports with, and otherwise comply
with the rules and regulations of, the Office of Thrift Supervision, the
Connecticut Banking Commissioner, and the Securities and Exchange Commission
under the federal securities laws. The following discussion of the laws and
regulations material to the operations of the Company and the Bank is a summary
and is qualified in its entirety by reference to such laws and regulations.
The Bank and the Company, as a savings and loan holding company, are
extensively regulated and supervised. Regulations, which affect the Bank on a
daily basis, may be changed at any time, and the interpretation of the relevant
law and regulations may also change because of new interpretations by the
authorities who interpret those laws and regulations. Any change in the
regulatory structure or the applicable statutes or regulations, whether by the
Connecticut Banking Commissioner, the State of Connecticut, the Office of Thrift
Supervision, the Federal Deposit Insurance Corporation or the U.S. Congress,
could have a material impact on the Company and the Bank.
Connecticut Banking Laws and Supervision
The Connecticut Banking Commissioner regulates the Bank's internal
organization as well as its deposit, lending and investment activities. The
approval of the Connecticut Banking Commissioner is required for, among other
things, the establishment of branch offices and business combination
transactions. The Connecticut Banking Commissioner conducts periodic
examinations of the Bank. The Federal Deposit Insurance Corporation also
regulates many of the areas regulated by the Connecticut Banking Commissioner
and federal law may limit some of the authority provided to the Bank by
Connecticut law.
Lending Activities. Connecticut banking laws grant banks broad lending
authority. With certain limited exceptions, however, total secured and
unsecured loans made to any one obligor under this statutory authority may not
exceed 25% of the Bank's equity capital and reserves for loan and lease losses.
A savings bank may pay cash dividends out of its net profits. For purposes
of this restriction, "net profits" means the remainder of all earnings from
current operations. Further, the total amount of all dividends declared by a
savings bank in any calendar year may not exceed the sum of the bank's net
profits for the year in question combined with its retained net profits from the
preceding two calendar years. Additionally, earnings appropriated to reserves
25
for loan losses and deducted for federal income tax purposes are not available
for cash dividends without the payment of taxes at then current income tax rates
on the amount used. Federal law also prevents an institution from paying
dividends or making other capital distributions if doing so would cause it to
become "undercapitalized." The Federal Deposit Insurance Corporation may limit a
savings bank's ability to pay dividends. No dividends may be paid to the Bank's
stockholders if such dividends would reduce stockholders' equity below the
amount of the liquidation account required by the Connecticut conversion
regulations.
Branching Activities. Any Connecticut-chartered bank meeting certain
statutory requirements may, with the Connecticut Banking Commissioner's
approval, establish and operate branches in any town or towns within the state.
In 1996, legislation was enacted which permits banks to establish mobile
branches with the Connecticut Banking Commissioner's approval.
Investment Activities. In 1996, legislation was enacted which requires the
board of directors of each Connecticut bank to adopt annually and to
periodically review an investment policy governing investments by such bank,
which policy must establish standards for the making of prudent investments. In
addition, Connecticut law now permits Connecticut banks to sell fixed and
variable rate annuities if licensed to do so by the Connecticut Insurance
Commissioner.
Further, legislation was enacted in 1996 which expands the ability of
Connecticut banks to invest in debt securities and debt mutual funds. Before the
legislation, Connecticut banks could invest in debt securities and debt mutual
funds without regard to any other liability to the Connecticut bank of the maker
or issuer of the debt securities and debt mutual funds, if the debt securities
and debt mutual funds were rated in the three highest rating categories or
otherwise deemed to be a prudent investment, and so long as the total amount of
debt securities and debt mutual funds of any one issuer did not exceed 15% of
the Bank's total equity capital and reserves for loan and lease losses and the
total amount of all its investments in debt securities and debt mutual funds did
not exceed 15% of its assets. In 1996, these percentages each were increased to
25%. In addition, before 1996, the percentage limitation described above also
applied to certain government and agency obligations. As a result of the 1996
legislation, this limitation was deleted for such obligations.
The 1996 legislation also expanded the ability of Connecticut banks to
invest in equity securities and equity mutual funds. Connecticut banks now may
invest in equity securities and equity mutual funds without regard to any other
liability to the Connecticut bank of the issuer of equity securities and equity
mutual funds, so long as the total amount of equity securities and equity mutual
funds of any one issuer does not exceed 25% of the bank's total equity capital
and reserves for loan and lease losses and the total amount of the bank's
investment in all equity securities and equity mutual funds does not exceed 25%
of its assets. Before the enactment of this legislation, Connecticut banks could
invest up to 15% of their assets in the equity securities and equity mutual
funds of corporations incorporated and doing a major portion of their business
in the United States.
Recent Legislation. Connecticut legislation enacted in 1999 authorizes a
new form of Connecticut bank to be known as an uninsured bank. An uninsured
bank does not accept retail deposits and is not required to insure deposits with
the Federal Deposit Insurance Corporation. The 1999 legislation also authorizes
Connecticut banks with the prior approval of the Connecticut Banking
Commissioner to engage in a broad range of activities related to the business of
banking, or that are financial in nature or that are permitted under the Bank
Holding Company Act or the Home Owners' Loan Act, both federal statutes, or the
regulations promulgated as a result of these statutes. The legislation also
authorizes a Connecticut bank to engage in any activity permitted for a national
bank or a federal savings association upon filing notice with the Connecticut
Banking Commissioner unless the Connecticut Banking Commissioner disapproves the
activity.
Enforcement. Under Connecticut law, the Connecticut Banking Commissioner
has extensive enforcement authority over Connecticut banks and, under certain
circumstances, affiliated parties, insiders, and agents. The Connecticut
Banking Commissioner's enforcement authority includes: cease and desist orders,
fines, receivership, conservatorship, removal of officers and directors,
emergency closures, dissolution, and liquidation.
26
Federal Regulations
Capital Requirements. Under Federal Deposit Insurance Corporation
regulations, federally insured state-chartered banks that are not members of the
Federal Reserve System ("state non-member banks"), such as the Bank, are
required to comply with minimum leverage capital requirements. For an
institution determined by the Federal Deposit Insurance Corporation to not be
anticipating or experiencing significant growth and to be in general a strong
banking organization, rated composite 1 under the Uniform Financial Institutions
Ranking System (the rating system) established by the Federal Financial
Institutions Examination Council, the minimum capital leverage requirement is a
ratio of Tier 1 capital to total assets of 3%. For all other institutions, the
minimum leverage capital ratio is not less than 4%. Tier 1 capital is the sum of
common stockholders' equity, noncumulative perpetual preferred stock (including
any related surplus) and minority investments in certain subsidiaries, less
intangible assets (except for certain servicing rights and credit card
relationships).
The Bank must also comply with the Federal Deposit Insurance Corporation
regulations. The Federal Deposit Insurance Corporation regulations require state
non-member banks to maintain certain levels of regulatory capital in relation to
regulatory risk-weighted assets. The ratio of regulatory capital to regulatory
risk-weighted assets is referred to as the Bank's "risk-based capital ratio."
Risk-based capital ratios are determined by allocating assets and specified off-
balance sheet items to four risk-weighted categories ranging from 0% to 100%,
with higher levels of capital being required for the categories perceived as
representing greater risk. For example, under the Federal Deposit Insurance
Corporation's risk-weighting system, cash and securities backed by the full
faith and credit of the U.S. government are given a 0% risk weight, loans
secured by one- to four-family residential properties generally have a 50% risk
weight and commercial loans have a risk weighting of 100%.
State non-member banks must maintain a minimum ratio of total capital to
risk-weighted assets of at least 8%, of which at least one-half must be Tier 1
capital. Total capital consists of Tier 1 capital plus Tier 2 or supplementary
capital items, which include allowances for loan losses in an amount of up to
1.25% of risk-weighted assets, cumulative preferred stock, a portion of the net
unrealized gain on equity securities and other capital instruments. The
includable amount of Tier 2 capital cannot exceed the amount of the
institution's Tier 1 capital.
The Federal Deposit Insurance Corporation Improvement Act required each
federal banking agency to revise its risk-based capital standards for insured
institutions to ensure that those standards take adequate account of interest-
rate risk, concentration of credit risk, and the risk of nontraditional
activities, as well as to reflect the actual performance and expected risk of
loss on multi-family residential loans. The Federal Deposit Insurance
Corporation, along with the other federal banking agencies, has adopted a
regulation providing that the agencies will take into account the exposure of a
bank's capital and economic value to changes in interest rate risk in assessing
a bank's capital adequacy.
As a savings and loan holding company regulated by the Office of Thrift
Supervision, the Company is not, under current law, subject to any separate
regulatory capital requirements.
Standards for Safety and Soundness. As required by statute, the federal
banking agencies adopted final regulations and Interagency Guidelines
Establishing Standards for Safety and Soundness to implement safety and
soundness standards. The guidelines set forth the safety and soundness
standards that the federal banking agencies use to identify and address problems
at insured depository institutions before capital becomes impaired. The
guidelines address internal controls and information systems, internal audit
system, credit underwriting, loan documentation, interest rate risk exposure,
asset growth, asset quality, earnings and compensation, and fees and benefits.
Most recently, the agencies have issued guidelines for Year 2000 computer
compliance. If the appropriate federal banking agency determines that an
institution fails to meet any standard prescribed by the guidelines, the agency
may require the institution to submit to the agency an acceptable plan to
achieve compliance with the standard.
27
Investment Activities
Since the enactment of the Federal Deposit Insurance Corporation
Improvement Act, all state-chartered Federal Deposit Insurance Corporation
insured banks, including savings banks, have generally been limited to
activities as principal and equity investments of the type and in the amount
authorized for national banks, notwithstanding state law. The Federal Deposit
Insurance Corporation Improvement Act and the Federal Deposit Insurance
Corporation permit exceptions to these limitations. For example, state
chartered banks, such as the Bank, may, with Federal Deposit Insurance
Corporation approval, continue to exercise state authority to invest in common
or preferred stocks listed on a national securities exchange or the Nasdaq
National Market and in the shares of an investment company registered under the
Investment Company Act of 1940, as amended. In addition, the Federal Deposit
Insurance Corporation is authorized to permit such institutions to engage in
state authorized activities or investments that do not meet this standard (other
than non-subsidiary equity investments) for institutions that meet all
applicable capital requirements if it is determined that such activities or
investments do not pose a significant risk to the Bank Insurance Fund. The
Federal Deposit Insurance Corporation has adopted revisions to its regulations
governing the procedures for institutions seeking approval to engage in such
activities or investments. These revisions, among other things, streamline the
application procedures for healthy banks and impose quantitative and qualitative
restrictions on a bank's dealings with its subsidiaries engaged in activities
not permitted for national bank subsidiaries. All non-subsidiary equity
investments, unless otherwise authorized or approved by the Federal Deposit
Insurance Corporation, must have been divested by December 19, 1996, under a
Federal Deposit Insurance Corporation-approved divestiture plan, unless such
investments were grandfathered by the Federal Deposit Insurance Corporation.
The Bank received grandfathered authority from the Federal Deposit Insurance
Corporation in March 1993 to invest in listed stocks and/or registered shares.
However, the maximum permissible investment is 100% of Tier 1 capital, as
specified by the Federal Deposit Insurance Corporation's regulations, or the
maximum amount permitted by Connecticut law, whichever is less. Such
grandfathered authority may be terminated upon the Federal Deposit Insurance
Corporation's determination that such investments pose a safety and soundness
risk to the Bank or if the Bank converts its charter, other than a mutual to
stock conversion, or undergoes a change in control. As of December 31, 1999, the
Bank had $56.9 million of securities which were held under such grandfathering
authority.
Interstate Branching
Until recently, branching across state lines was generally not available to
a state bank such as the Bank. Out-of-state branches of banking institutions are
authorized under the Connecticut Banking Law, but similar authority does not
exist generally under the laws of most other states. Beginning June 1, 1997,
the Interstate Banking Act permitted the responsible federal banking agencies to
approve merger transactions between banks located in different states,
regardless of whether the merger would be prohibited under the law of the two
states. The Interstate Banking Act also permitted a state to "opt in" to the
provisions of the Interstate Banking Act before June 1, 1997, and permitted a
state to "opt out" of the provisions of the Interstate Banking Act by adopting
appropriate legislation before that date. In 1995, Connecticut affirmatively
"opted-in " to the provisions of the Interstate Banking Act. Accordingly,
beginning June 1, 1997, the Interstate Banking Act permitted a bank, such as the
Bank, to acquire branches in a state other than Connecticut unless the other
state had opted out of the Interstate Banking Act. The Interstate Banking Act
also authorizes de novo branching into another state if the host state enacts a
law expressly permitting out of state banks to establish such branches within
its borders.
Prompt Corrective Regulatory Action
Federal law requires, among other things, that federal bank regulatory
authorities take "prompt corrective action" with respect to banks that do not
meet minimum capital requirements. For these purposes, the law establishes five
capital categories: well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized, and critically undercapitalized.
The Federal Deposit Insurance Corporation has adopted regulations to
implement the prompt corrective action legislation. An institution is deemed to
be "well capitalized" if it has a total risk-based capital ratio of 10% or
28
greater, a Tier 1 risk-based capital ratio of 6% or greater and a leverage ratio
of 5% or greater. An institution is "adequately capitalized" if it has a total
risk-based capital ratio of 8% or greater, a Tier 1 risk-based capital ratio of
4% or greater, and generally a leverage ratio of 4% or greater. An institution
is "undercapitalized" if it has a total risk-based capital ratio of less than
8%, a Tier 1 risk-based capital ratio of less than 4%, or generally a leverage
ratio of less than 4%. An institution is deemed to be "significantly
undercapitalized" if it has a total risk-based capital ratio of less than 6%, a
Tier 1 risk-based capital ratio of less than 3%, or a leverage ratio of less
than 3%. An institution is considered to be "critically undercapitalized" if it
has a ratio of tangible equity (as defined in the regulations) to total assets
that is equal to or less than 2%. As of December 31, 1999, the Bank was a "well
capitalized" institution and remained a "well capitalized" institution upon
completion of the Conversion.
"Undercapitalized" banks must adhere to growth, capital distribution
(including dividend) and other limitations and are required to submit a capital
restoration plan. A bank's compliance with such plan is required to be
guaranteed by any company that controls the undercapitalized institution in an
amount equal to the lesser of 5% of the institution's total assets when deemed
undercapitalized or the amount necessary to achieve the status of adequately
capitalized. If an "undercapitalized" bank fails to submit an acceptable plan,
it is treated as if it is "significantly undercapitalized." "Significantly
undercapitalized" banks must comply with one or more of a number of additional
restrictions, including but not limited to an order by the Federal Deposit
Insurance Corporation to sell sufficient voting stock to become adequately
capitalized, requirements to reduce total assets and cease receipt of deposits
from correspondent banks or dismiss directors or officers, and restrictions on
interest rates paid on deposits, compensation of executive officers and capital
distributions by the parent holding company. "Critically undercapitalized"
institutions must comply with additional sanctions including, subject to a
narrow exception, the appointment of a receiver or conservator within 270 days
after it obtains such status.
Transactions with Affiliates
Under current federal law, transactions between depository institutions and
their affiliates are governed by Sections 23A and 23B of the Federal Reserve
Act. In a holding company context, at a minimum, the parent holding company of
a savings bank and any companies which are controlled by such parent holding
company are affiliates of the savings bank. Generally, Section 23A limits the
extent to which the savings bank or its subsidiaries may engage in "covered
transactions" with any one affiliate to 10% of such savings bank's capital stock
and surplus, and contains an aggregate limit on all such transactions with all
affiliates to 20% of capital stock and surplus. The term "covered transaction"
includes, among other things, the making of loans or other extensions of credit
to an affiliate and the purchase of assets from an affiliate. Section 23A also
establishes specific collateral requirements for loans or extensions of credit
to, or guarantees, acceptances on letters of credit issued on behalf of an
affiliate. Section 23B requires that covered transactions and a broad list of
other specified transactions be on terms substantially the same, or no less
favorable, to the savings bank or its subsidiary as similar transactions with
nonaffiliates.
Further, Section 22(h) of the Federal Reserve Act restricts an institution
with respect to loans to directors, executive officers, and principal
stockholders ("insiders"). Under Section 22(h), loans to insiders and their
related interests may not exceed, together with all other outstanding loans to
such persons and affiliated entities, the institution's total capital and
surplus. Loans to insiders above specified amounts must receive the prior
approval of the board of directors. Further, under Section 22(h), loans to
directors, executive officers and principal shareholders must be made on terms
substantially the same as offered in comparable transactions to other persons,
except that such insiders may receive preferential loans made under a benefit or
compensation program that is widely available to the Bank's employees and does
not give preference to the insider over the employees. Section 22(g) of the
Federal Reserve Act places additional limitations on loans to executive
officers.
Enforcement
The Federal Deposit Insurance Corporation has extensive enforcement
authority over insured savings banks, including the Bank. This enforcement
authority includes, among other things, the ability to assess civil money
penalties, to issue cease and desist orders and to remove directors and
29
officers. In general, these enforcement actions may be initiated in response to
violations of laws and regulations and unsafe or unsound practices.
The Federal Deposit Insurance Corporation has authority under Federal law
to appoint a conservator or receiver for an insured bank under limited
circumstances. The Federal Deposit Insurance Corporation is required, with
certain exceptions, to appoint a receiver or conservator for an insured state
non-member bank if that bank was "critically undercapitalized" on average during
the calendar quarter beginning 270 days after the date on which the institution
became "critically undercapitalized." The Federal Deposit Insurance Corporation
may also appoint itself as conservator or receiver for an insured state non-
member institution under specific circumstances on the basis of the
institution's financial condition or upon the occurrence of other events,
including: (1) insolvency; (2) substantial dissipation of assets or earnings
through violations of law or unsafe or unsound practices; (3) existence of an
unsafe or unsound condition to transact business; and (4) insufficient capital,
or the incurring of losses that will deplete substantially all of the
institution's capital with no reasonable prospect of replenishment without
federal assistance.
Insurance of Deposit Accounts
The Federal Deposit Insurance Corporation has adopted a risk-based
insurance assessment system. The Federal Deposit Insurance Corporation assigns
an institution to one of three capital categories based on the institution's
financial information consisting of (1) well capitalized, (2) adequately
capitalized or (3) undercapitalized, and one of three supervisory subcategories
within each capital group. The supervisory subgroup to which an institution is
assigned is based on a supervisory evaluation provided to the Federal Deposit
Insurance Corporation by the institution's primary federal regulator and
information which the Federal Deposit Insurance Corporation determines to be
relevant to the institution's financial condition and the risk posed to the
deposit insurance funds. An institution's assessment rate depends on the
capital category and supervisory category to which it is assigned. Assessment
rates for insurance fund deposits currently range from 0 basis points for the
strongest institution to 27 basis points for the weakest. Bank Insurance Fund
members are also required to assist in the repayment of bonds issued by the
Financing Corporation in the late 1980's to recapitalize the Federal Savings and
Loan Insurance Corporation. Bank Insurance Fund members are currently assessed
about 1.2 basis points, which is generally 20% of the amount charged Savings
Association Insurance Fund members. Effective January 1, 2000, full pro rata
sharing of the payments between Bank Insurance Fund and Savings Association
Insurance Fund members will occur. The Federal Deposit Insurance Corporation is
authorized to raise the assessment rates. The Federal Deposit Insurance
Corporation has exercised this authority several times in the past and may raise
insurance premiums in the future. If such action is taken by the Federal
Deposit Insurance Corporation, it could have an adverse effect on the earnings
of the Bank.
The Federal Deposit Insurance Corporation may terminate insurance of
deposits if it finds that the institution is in an unsafe or unsound condition
to continue operations, has engaged in unsafe or unsound practices, or has
violated any applicable law, regulation, rule, order or condition imposed by the
Federal Deposit Insurance Corporation. The management of the Bank does not know
of any practice, condition or violation that might lead to termination of
deposit insurance.
Federal Reserve System
The Federal Reserve Board regulations require depository institutions to
maintain non-interest-earning reserves against their transaction accounts
(primarily NOW and regular checking accounts). The Federal Reserve Board
regulations generally require that reserves be maintained against aggregate
transaction accounts as follows: for that portion of transaction accounts
aggregating $44.3 million or less (which may be adjusted by the Federal Reserve
Board) the reserve requirement is 3%; and for accounts greater than $44.3
million, the reserve requirement is $1.33 million plus 10% (which may be
adjusted by the Federal Reserve Board between 8% and 14%) against that portion
of total transaction accounts in excess of $44.3 million. The first $5.0
million of otherwise reservable balances (which may be adjusted by the Federal
Reserve Board) are exempted from the reserve requirements. The Bank is in
compliance with these requirements.
30
Community Reinvestment Act
Under the Community Reinvestment Act, as implemented by Federal Deposit
Insurance Corporation regulations, a state non-member bank has a continuing and
affirmative obligation consistent with its safe and sound operation to help meet
the credit needs of its entire community, including low and moderate income
neighborhoods. The Community Reinvestment Act neither establishes specific
lending requirements or programs for financial institutions nor limits an
institution's discretion to develop the types of products and services that it
believes are best suited to its particular community. The Community
Reinvestment Act requires the Federal Deposit Insurance Corporation, in
connection with its examination of an institution, to assess the institution's
record of meeting the credit needs of its community and to consider such record
when it evaluates applications made by such institution. The Community
Reinvestment Act requires public disclosure of an institution's Community
Reinvestment Act rating. The Bank's latest Community Reinvestment Act rating
from the Federal Deposit Insurance Corporation was "Satisfactory." the Bank's
latest Community Reinvestment Act rating from the Connecticut Banking
Commissioner was "Outstanding."
Federal Home Loan Bank System
The Bank is a member of the Federal Home Loan Bank System, which consists
of 12 regional Federal Home Loan Banks. The Federal Home Loan Bank provides a
central credit facility primarily for member institutions. The Bank, as a
member of the Federal Home Loan Bank of Boston, is required to acquire and hold
shares of capital stock in the Federal Home Loan Bank of Boston in an amount at
least equal to 1% of the aggregate principal amount of its unpaid residential
mortgage loans and similar obligations at the beginning of each year, or 1/20 of
its advances (borrowings) from the Federal Home Loan Bank of Boston, whichever
is greater. The Bank was in compliance with this requirement with an investment
in Federal Home Loan Bank of Boston stock at December 31, 1999 of $5.9 million.
At December 31, 1999, the Bank had $84.0 million in Federal Home Loan Bank of
Boston advances.
The Federal Home Loan Banks are required to provide funds for certain
purposes including contributing funds for affordable housing programs. These
requirements could reduce the amount of dividends that the Federal Home Loan
Banks pay to their members and result in the Federal Home Loan Banks imposing a
higher rate of interest on advances to their members. For the years ended
December 31, 1999 and 1998 and, cash dividends from the Federal Home Loan Bank
of Boston to the Bank amounted to approximately $383,000 and $369,000,
respectively. Further, there can be no assurance that the impact of recent or
future legislation on the Federal Home Loan Banks will not also cause a decrease
in the value of the Federal Home Loan Bank stock held by the Bank.
Holding Company Regulation
Federal law allows a state savings bank that qualifies as a "Qualified
Thrift Lender," discussed below, to elect to be treated as a savings association
for purposes of the savings and loan holding company provisions of the Home
Owners' Loan Act. Such election allows its holding company to be regulated as a
savings and loan holding company by the Office of Thrift Supervision rather than
as a bank holding company by the Federal Reserve Board. The Bank has made such
election and the Company is a nondiversified savings and loan holding company
within the meaning of the Home Loan Owners' Act. The Company is registered with
the Office of Thrift Supervision and has adhered to the Office of Thrift
Supervision's regulations and reporting requirements. In addition, the Office
of Thrift Supervision may examine and supervise the Company and the Office of
Thrift Supervision has enforcement authority over the Company and its non-
savings institution subsidiaries. Among other things, this authority permits
the Office of Thrift Supervision to restrict or prohibit activities that are
determined to be a serious risk to the subsidiary savings institution.
Additionally, the Bank is required to notify the Office of Thrift Supervision at
least 30 days before declaring any dividend to the Company. By regulation, the
Office of Thrift Supervision may restrict or prohibit the Bank from paying
dividends.
The Company is a unitary savings and loan holding company under federal law
because the Bank is its only insured subsidiary immediately after the
Conversion. Formerly, a unitary savings and loan holding company was not
31
restricted as to the types of business activities in which it could engage,
provided that its subsidiary savings association continued to be a qualified
thrift lender. The Financial Services Modernization Act of 1999, however,
restricts unitary savings and loan holding companies not existing or applied for
before May 4, 1999 to activities permissible for a financial holding company as
defined under the legislation, including insurance and securities activities,
and those permitted for a multiple savings and loan holding company as described
below. The Company is subject to these activities restrictions. Upon any non-
supervisory acquisition by the Company of another savings association as a
separate subsidiary, the Company would become a multiple savings and loan
holding company. The Home Owners' Loan Act limits the activities of a multiple
savings and loan holding company and its non-insured institution subsidiaries
primarily to activities permissible for bank holding companies under Section
4(c)(8) of the Bank Holding Company Act, provided the prior approval of the
Office of Thrift Supervision is obtained, and to other activities authorized by
Office of Thrift Supervision regulation. Multiple savings and loan holding
companies are generally prohibited from acquiring or retaining more than 5% of a
non-subsidiary company engaged in activities other than those permitted by the
Home Owners' Loan Act.
The Home Owners' Loan Act prohibits a savings and loan holding company
from, directly or indirectly, acquiring more than 5% of the voting stock of
another savings association or savings and loan holding company or from
acquiring such an institution or company by merger, consolidation or purchase of
its assets, without prior written approval of the Office of Thrift Supervision.
In evaluating applications by holding companies to acquire savings associations,
the Office of Thrift Supervision considers the financial and managerial
resources and future prospects of the Company and the institution involved, the
effect of the acquisition on the risk to the insurance funds, the convenience
and needs of the community and competitive factors.
The Office of Thrift Supervision is prohibited from approving any
acquisition that would result in a multiple savings and loan holding company
controlling savings institutions in more than one state, except: (1) interstate
supervisory acquisitions by savings and loan holding companies; and (2) the
acquisition of a savings institution in another state if the laws of the state
of the target savings institution specifically permit such acquisitions.
To be regulated as a savings and loan holding company by the Office of
Thrift Supervision (rather than as a bank holding company by the Federal Reserve
Board), the Bank must qualify as a Qualified Thrift Lender. To qualify as a
Qualified Thrift Lender, the Bank must maintain compliance with the test for a
"domestic building and loan association," as defined in the Internal Revenue
Code, or with a Qualified Thrift Lender Test. Under the Qualified Thrift Lender
Test, a savings institution is required to maintain at least 65% of its
"portfolio assets" (total assets less: (1) specified liquid assets up to 20% of
total assets; (2) intangibles, including goodwill; and (3) the value of property
used to conduct business) in certain "qualified thrift investments" (primarily
residential mortgages and related investments, including certain mortgage-backed
and related securities) in at least 9 months out of each 12 month period. As of
December 31, 1999 the Bank maintained in excess of 75% of its portfolio assets
in qualified thrift investments. The Bank also met the Qualified Thrift Lender
test in each of the last 12 months and, therefore, met the Qualified Thrift
Lender test.
Connecticut Holding Company Regulations. Under Connecticut banking law, no
person may acquire beneficial ownership of more than 10% of any class of voting
securities of a Connecticut-chartered bank, or any bank holding company of such
a bank, without prior notification of, and lack of disapproval by, the
Connecticut Banking Commissioner. The Connecticut Banking Commissioner will
disapprove the acquisition if the bank or holding company to be acquired has
been in existence for less than five years, unless the Connecticut Banking
Commissioner waives this requirement, or if the acquisition would result in the
acquirer controlling 30% or more of the total amount of deposits in insured
depository institutions in Connecticut. Similar restrictions apply to any
person who holds in excess of 10% of any such class and desires to increase its
holdings to 25% or more of such class.
32
Federal Securities Laws
Upon the completion of the Conversion in March, 2000, the Company's common
stock became registered with the Securities and Exchange Commission under the
Exchange Act. The Company now observes the information, proxy solicitation,
insider trading restrictions and other requirements under the Exchange Act.
The registration under the Securities Act of shares of the common stock to
be issued in the Conversion did not cover the resale of such shares. Shares of
the common stock purchased by persons who are not affiliates of the Company may
be resold without registration. The resale restrictions of Rule 144 under the
Securities Act govern shares purchased by an affiliate of the Company. If the
Company meets the current public information requirements of Rule 144 under the
Securities Act, each affiliate of the Company who complies with the other
conditions of Rule 144 (including those that require the affiliate's sale to be
aggregated with those of other persons) would be able to sell in the public
market, without registration, a number of shares not to exceed, in any three-
month period, the greater of (1) 1% of the outstanding shares of the Company or
(2) the average weekly volume of trading in such shares during the preceding
four calendar weeks. Provision may be made in the future by the Company to
permit affiliates to have their shares registered for sale under the Securities
Act under specific circumstances.
FEDERAL AND STATE TAXATION OF INCOME
Federal Income Taxation
General. The Company and the Bank report their income on a calendar year
basis using the accrual method of accounting. The federal income tax laws apply
to the Company and the Bank in the same manner as to other corporations with
some exceptions, including particularly the Bank's reserve for bad debts
discussed below. The following discussion of tax matters is intended only as a
summary and does not purport to be a comprehensive description of the tax rules
applicable to the Bank or the Company. The Bank's federal income tax returns
have been either audited or closed under the statute of limitations through tax
year 1995. For its 1999 tax year, the Bank's maximum federal income tax rate
was 35%.
Bad Debt Reserves. For fiscal years beginning before December 31, 1995,
thrift institutions which qualified under certain definitional tests and other
conditions of the Internal Revenue Code of 1986, as amended, were permitted to
use certain favorable provisions to calculate their deductions from taxable
income for annual additions to their bad debt reserve. A reserve could be
established for bad debts on qualifying real property loans, generally secured
by interests in real property improved or to be improved, under the percentage
of taxable income method or the experience method. The reserve for
nonqualifying loans was computed using the experience method.
Federal legislation enacted in 1996 repealed the reserve method of
accounting for bad debts and the percentage of taxable income method for tax
years beginning after 1995 and require savings institutions to recapture or take
into income certain portions of their accumulated bad debt reserves.
Approximately $12.6 million of the Bank accumulated bad debt reserves would not
be recaptured into taxable income unless the Bank makes a "non-dividend
distribution" to the Company as described below.
Distributions. If the Bank makes "non-dividend distributions" to the
Company, they will be considered to have been made from the Bank's unrecaptured
tax bad debt reserves, including the balance of its reserves as of December 31,
1987, to the extent of the "non-dividend distributions," and then from the
Bank's supplemental reserve for losses on loans, to the extent of those
reserves, and an amount based on the amount distributed, but not more than the
amount of those reserves, will be included in the Bank's taxable income. Non-
dividend distributions include distributions in excess of the Bank's current and
accumulated earnings and profits, as calculated for federal income tax purposes,
distributions in redemption of stock, and distributions in partial or complete
liquidation. Dividends paid out of the Bank's current or accumulated earnings
and profits will not be so included in the Bank's taxable income.
33
The amount of additional taxable income triggered by a non-dividend is an
amount that, when reduced by the tax attributable to the income, is equal to the
amount of the distribution. Therefore, if the Bank makes a non-dividend
distribution to the Company, approximately one and one-half times the amount of
the distribution not in excess of the amount of the reserves would be includable
in income for federal income tax purposes, assuming a 35% federal corporate
income tax rate. The Bank does not intend to pay dividends that would result in
a recapture of any portion of its bad debt reserves.
Connecticut Taxation
The Company and its subsidiaries are subject to the Connecticut corporation
business tax. The Company and its subsidiaries are eligible to file a combined
Connecticut corporation business tax return and will pay the regular corporation
business tax (income tax).
The Connecticut corporation business tax is based on the federal taxable
income before net operating loss and special deductions of the Company and its
subsidiaries and makes certain modifications to federal taxable income to arrive
at Connecticut taxable income. Connecticut taxable income is multiplied by the
state tax rate (8.5% for 1999 and 7.5% for 2000 and thereafter) to arrive at
Connecticut income tax.
In May 1998, the State of Connecticut enacted legislation permitting the
formation of passive investment company subsidiaries by financial institutions.
This legislation exempts qualifying passive investment companies from the
Connecticut corporation business tax and excludes dividends paid from a passive
investment company from the taxable income of the parent financial institution.
The Bank's formation of a passive investment company in January 1999 is expected
to eliminate the state income tax expense of the Company and its subsidiaries.
34
Item 2. Properties.
- --------------------
Properties
The Company and the Bank currently conduct their business through its main
office located in Manchester, Connecticut, and 22 other full-service banking
offices. The Company and the Bank believe that their facilities are adequate to
meet their present and immediately foreseeable needs.
Net Book Value
of Property
or Leasehold
Leased, Original Improvements
Licensed Year Date of Lease/ at December
or Leased License 31,
Location Owned or Acquired Expiration 1999
- -------- -----------------------------------------------------------
(In thousands)
Main Branch and Executive
Office:
923 Main Street
Manchester, CT 06040........... Owned 1932 -- $1,377
Branch Offices:
285 East Center Street
Manchester, CT 06040........... Leased 1956 2011 109
220 North Main Street
Manchester, CT 06040........... Leased 1970 2005 119
241 West Middle Turnpike
Manchester, CT 06040........... /(1)/ 1983 2023 167
955 Sullivan Avenue
South Windsor, CT 06074........ /(1)/ 1965 2010 507
477 Connecticut Boulevard
East Hartford, CT 06108........ Leased 1996 2006 91
236 Spencer Street
Manchester, CT 06040........... Leased 1974 2004 --
1 Main Street
East Hartford, CT 06118........ Leased 1975 2000/(1)/ 9
62 Buckland Street
Manchester, CT 06040........... Leased 1990 2009 100
Eastford Center, County Road
Eastford, CT 06242............. Leased 1985 2004 --
122A Prospect Hill Road
East Windsor, CT 06088......... Leased 1985 2004 --
6 Storrs Road
Mansfield, CT 06250............ Leased 1986 2015 80
200 Merrow Road
Tolland, CT 06084.............. Leased 1989 2004 67
1320 Manchester Road
Glastonbury, CT 06033.......... /(2)/ 1987 2007 269
435 Hartford Turnpike
Vernon, CT 06066............... Leased 1988 2003 66
1078 N. Main Street
Dayville (Killingly), CT 06241. Leased 1990 2000/(3)/ 17
Route 66
Columbia, CT 06237............. Owned 1991 -- 241
35
Net Book Value
of Property
or Leasehold
Leased, Original Improvements
Licensed Year Date of Lease/ at December
or Leased License 31,
Location Owned or Acquired Expiration 1999
- -------- --------------------------------------------------------------
(In thousands)
1671 Boston Turnpike
Coventry, CT 06238......... Leased 1993 2013 $ 80
574 & 596 Middle Turnpike
Storrs, CT 06268........... Owned 1995 -- 779
49 Hazard Avenue
Enfield, CT 06082.......... Leased 1995 2007 106
2133 Poquonock Avenue
Windsor, CT 06095.......... Leased 1996 2006 170
44-48 Wells Road
Wethersfield, CT 06109..... Leased 1996 2008 119
55 South Main Street
West Hartford, CT 06107.... Leased 1997 2016 229
ATM Facilities:
Rt.6
Andover, CT 06232......... Leased 1974 2004 --
Junction 44 & 74
Ashford, CT 06278......... Leased 1976 2001 1
Rt. 44A, 663 Boston Turnpike
Bolton, CT 06043.......... Leased 1968 2000/(4)/ 1
700 Burnside Ave.
East Hartford, CT 06108... Leased 1966 2000/(5)/ --
60 Bidwell Street
Manchester, CT 06040...... Licensed/(6)/ 1990 / (7)/ --
Buckland Hills Mall
Manchester, CT 06040...... Leased 1992 2004 --
31 Union Street
Rockville, CT 06066....... Licensed/(6)/ 1995 /(7)/ --
469 Hartford Rd
Manchester, CT 06040...... Leased 1970 2002 --
71 Haynes Street
Manchester, CT 06040...... Licensed/(6)/ 1989 /(7)/ --
Administrative Offices:
469 Hartford Road
Manchester, CT 06040....... Leased 1970 2002 30
50-56 Cottage Street
Manchester, CT 06040...... Owned 1986 -- 473
881 Main Street
Manchester, CT 06040...... Leased 1984 2001 58
935 Main Street
Manchester, CT 06040...... Owned /(8)/ -- 2,665
935 Main Street
Units B102 & B102A
Manchester, CT 06040...... Leased 1997 2006 88
36
Net Book Value
of Property
or Leasehold
Leased, Original Improvements
Licensed Year Date of Lease/ at December
or Leased License 31,
Location Owned or Acquired Expiration 1999
- --------------------------- ----------------------------------------------------------------
(In thousands)
945 Main Street
Unit 102A
Manchester, CT 06040...... Leased 1999 2001 --
945 Main Street
Unit 305
Manchester, CT 06040...... Owned 1997 -- 136
945 Main Street
Unit 309
Manchester, CT 06040...... Owned 1998 -- 76
35-43 Oak Street
Manchester, CT 06040...... Owned 1995 -- 744
681 Main Street
Plantsville, CT 06479..... Leased 1997 /(9)/ --
------------
$ 8,974
============
(1) The Bank does not have an option to renew the lease. The Bank is currently
negotiating the terms of a new lease.
(2) The Bank owns the building and leases the land and only owns the building
as long as the lease is in effect.
(3) The Bank exercised its option to renew this lease for two additional five-
year periods.
(4) The Bank intends to renew this lease for one additional one-year period.
(5) A new lease was signed for a five-year term.
(6) The Bank maintains a license to possess the property. Generally, the
holder of a license has less property rights than the possessor of a
leasehold interest.
(7) A new license agreement was signed.
(8) The Bank owns sixteen commercial condominiums, which were all acquired at
various times between 1990 and 1999.
(9) The Bank possesses this property on a month-to-month basis.
Item 3. Legal Proceedings.
- --------------------------
Periodically, there have been various claims and lawsuits involving the
Bank, such as claims to enforce liens, condemnation proceedings on properties in
which the Bank holds security interests, claims involving the making and
servicing of real property loans and other issues incident to the Bank's
business. The Company is not a party to any pending legal proceedings that it
believes would have a material adverse effect on the financial condition or
operations of the Company.
37
Item 4. Submission of Matters to a Vote of Security Holders.
- -------------------------------------------------------------
None.
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
- --------------------------------------------------------------------------
Matters.
- --------
The Company's Common Stock has been traded on the Nasdaq National Market
under the symbol "SBMC" since the Company's initial public offering closed on
March 1, 2000 and the Common Stock began trading on March 2, 2000. The initial
offering price was $10.00 per share. Between March 2, 2000 and March 15, 2000,
the Company's Common Stock traded as high as $10.1875 per share and as low as
$9.75 per share. As of March 15, 2000, the Company had approximately 6,670
holders of record.
The Company has not paid any dividends to date. The Board of Directors of
the Company has the authority to declare dividends on the Common Stock, subject
to statutory and regulatory requirements. In the future, the Board of Directors
intends to consider a policy of paying cash or stock dividends on the Common
Stock. However, no decision has been made with respect to the payment of
dividends. Declarations of dividends by the Board of Directors, if any, will
depend upon a number of factors, including the amount of net proceeds retained
by the Company in the Conversion, investment opportunities available to the
Company or the Bank, capital requirements, regulatory limitations, the Company's
and the Bank's financial condition and results of operations, tax considerations
and general economic conditions. No assurances can be given, however, that any
dividends will be paid or, if commenced, will continue to be paid.
The Company is subject to the requirements of Delaware law, which generally
limits dividends to an amount equal to the excess of the net assets of the
Company (the amount by which total assets exceed total liabilities) over its
statutory capital or, if there is no excess, to its net profits for the current
and/or immediately preceding fiscal year.
Use of Proceeds
The following information is provided with respect to the Company's sale of
its common stock as part of the Conversion.
a. The effective date of the Registration Statement on Form S-1 (File No.
333-90865) was January 12, 2000.
b. The offering was consummated on March 1, 2000 with the sale of all
securities registered pursuant to the Registration Statement. Sandler
O'Neill & Partners, L.P. acted as marketing agent for the offering.
c. The class of securities registered was common stock, par value $0.01 per
share. The aggregate amount of such securities registered was 16,425,450
shares which represented an aggregate amount of $164,254,500. The amount
included 10,400,000 shares (or $104 million) sold in the offering and
832,000 shares (or $8.3 million) issued to SBM Charitable Foundation,
Inc.
d. A reasonable estimate of the expenses incurred in connection with the
Conversion and offering was $4.3 million, including expenses paid to and
for underwriter of $1.7 million, and other expenses of $2.6 million. The
net proceeds resulting from the offering after deducting expenses was
$99.7 million.
38
e. The net proceeds are invested in federal funds sold and fixed income
securities. This use of net proceeds is materially consistent with the
use of proceeds described in the prospectus.
39
Item 6. Selected Financial Data.
- ---------------------------------
The Company has derived the following selected consolidated financial and
other data of the Bank in part from the consolidated financial statements and
notes appearing elsewhere in this Form 10-K.
At December 31,
------------------------------------------------------
1999 1998 1997 1996 1995
---------- ---------- ---------- ------- ---------
(In thousands)
Selected Consolidated Financial Data:
Total assets................................ $1,227,798 $1,108,287 $1,033,086 $968,252 $935,833
Cash and cash equivalents................... 26,678 45,048 14,660 22,850 39,972
Loans, net.................................. 938,340 806,787 798,292 732,448 695,797
Securities held to maturity:
Mortgage-backed securities............... 25,474 22,742 14,409 8,047 4,280
Other investment securities.............. 20,586 29,855 35,874 39,518 47,123
---------- ---------- ---------- -------- --------
Total securities held to maturity..... 46,060 52,597 50,283 47,565 51,403
---------- ---------- ---------- -------- --------
Securities available for sale:
Mortgage-backed securities............... 16,204 12,859 17,985 24,570 26,818
U.S. Government and agency obligations... 81,328 71,703 48,767 35,907 14,333
Marketable equity securities............. 50,545 42,773 40,635 37,797 29,038
Other securities......................... 33,777 40,816 24,202 32,987 46,250
---------- ---------- ---------- -------- --------
Total securities available for sale... 181,854 168,151 131,589 131,261 116,439
---------- ---------- ---------- -------- --------
Deposits.................................... 906,591 855,117 827,667 792,833 764,789
Short-term borrowed funds................... 95,814 79,545 71,179 58,747 64,262
Advances from Federal Home Loan Bank........ 84,000 45,000 17,987 15,000 17,593
Capital..................................... 123,223 112,807 101,191 88,535 77,143
Premises and equipment, net................. 14,436 15,621 15,709 11,369 9,849
Nonperforming assets (1).................... 12,089 3,283 7,543 12,760 13,198
For the Year Ended December 31,
--------------------------------------------
1999 1998 1997 1996 1995
-------- ------- ------- ------- -------
Selected Operating Data:
Total interest and dividend income...................... $78,834 $76,858 $73,931 $69,973 $64,840
Total interest and dividend expense..................... 37,374 37,200 35,856 34,714 32,728
------- ------- ------- ------- -------
Net interest income.................................. 41,460 39,658 38,075 35,259 32,112
Provision for loan losses............................... 1,100 1,200 1,200 1,200 1,550
------- ------- ------- ------- -------
Net interest income after provision for loan losses.. 40,360 38,458 36,875 34,059 30,562
------- ------- ------- ------- -------
Noninterest income:
Gains on sales of securities, net.................... 1,372 2,621 4,007 842 2,522
Other................................................ 8,034 9,539 7,460 8,155 5,788
------- ------- ------- ------- -------
Total noninterest income.......................... 9,406 12,160 11,467 8,997 8,310
------- ------- ------- ------- -------
Noninterest expense..................................... 36,586 37,092 31,556 27,772 24,539
------- ------- ------- ------- -------
Income before provision for income taxes............. 13,180 13,526 16,786 15,284 14,333
Provision for income taxes.............................. 4,426 4,208 6,584 5,853 5,927
------- ------- ------- ------- -------
Net income........................................... $ 8,754 $ 9,318 $10,202 $ 9,431 $ 8,406
======= ======= ======= ======= =======
40
At or For the Year Ended December 31,
------------------------------------------
1999 1998 1997 1996 1995
------- ------- ------- ------- ------
Selected Operating Ratios and Other Data (2):
Performance Ratios:
Average yield on interest-earning assets.................. 7.10% 7.54% 7.75% 7.69% 7.85%
Average rate paid on interest-bearing liabilities......... 3.78 4.02 4.11 4.15 4.04
Average interest rate spread (3).......................... 3.32 3.52 3.64 3.54 3.81
Net interest margin (4)................................... 3.74 3.89 3.96 3.85 3.89
Interest-earning assets to interest-bearing liabilities... 112.37 110.29 109.47 108.62 106.58
Net interest income after provision for
loan losses to noninterest expense..................... 110.32 103.68 116.86 122.64 124.54
Noninterest expense as a percentage of average assets..... 3.16 3.46 3.15 2.92 2.75
Return on average assets.................................. 0.76 0.87 1.02 0.99 0.94
Return on average capital................................. 7.48 8.71 10.75 11.38 11.78
Ratio of average capital to average assets................ 10.12 9.99 9.48 8.70 7.99
Regulatory Capital Ratios (2):
Leverage capital ratio.................................... 9.10 9.33 8.98 8.41 7.60
Total risk-based capital ratio............................ 13.96 13.89 13.67 13.09 12.68
Asset Quality Ratios (2):
Nonperforming loans and troubled debt restructurings
as a percentage of total loans (5)..................... 1.21 0.19 0.35 0.98 1.20
Nonperforming assets and troubled debt restructurings
as a percentage of total assets........................ 0.98 0.29 0.73 1.32 1.41
Allowance for loan losses as a percentage of total loans.. 1.12 1.30 1.23 1.23 1.20
Allowance for loan losses as a percentage of nonperforming
loans and troubled debt restructurings................. 92.44 694.55 350.79 125.46 100.41
Net loans charged-off to average interest-earning loans... 0.12 0.07 0.05 0.08 0.11
Full service offices at end of period..................... 23 23 23 22 20
- -----------------------
(1) Nonperforming assets consist of nonperforming loans, troubled debt
restructurings, and other real estate owned.
(2) Asset Quality and Regulatory Capital Ratios are end of period ratios.
Except for end of period ratios, all ratios are based on average monthly
balances during the indicated periods and are annualized for interim
periods.
(3) Average interest rate spread represents the difference between the average
yield on interest-earning assets and the average rate paid on interest-
bearing liabilities.
(4) Net interest margin represents net interest income as a percentage of
average interest-earning assets.
(5) Nonperforming loans consist of nonperforming loans and loans 90 days or more
past due and accruing interest.
41
Item 7. Management's Discussion and Analysis of Financial Condition and Results
- --------------------------------------------------------------------------------
of Operations.
- --------------
The following discussion should be read in conjunction with the "Selected
Consolidated Financial Data" and the Consolidated Financial Statements and
related Notes appearing elsewhere in this Form 10-K.
General
The Company has only recently been formed and had no results of operations
for the year ended December 31, 1999. The Bank's results of operations depend
primarily on net interest income, which is the difference between the interest
income earned on its interest-earning assets, such as loans and securities, and
the interest expense on its interest-bearing liabilities, such as deposits and
borrowings. The Bank also generates non-interest income primarily from fees
charged on customers' accounts and fees earned on activities such as investment
services provided through a third party registered broker-dealer. Gains on the
sales of securities is another source of non-interest income. The Bank's non-
interest expenses primarily consist of employee compensation and benefits,
occupancy expense, advertising and other operating expenses. The Bank's results
of operations are also affected by general economic and competitive conditions,
notably changes in market interest rates, government policies and regulations.
The Bank exceeded all of its regulatory capital requirements at December 31,
1999.
Forward Looking Statements
This Form 10-K contains forward looking statements that are based on
assumptions and describe future plans, strategies, and expectations of the
Company. These forward looking statements are generally identified by use of
the words "believe," "expect," "intend," "anticipate," "estimate," "project," or
similar expressions. The Company' ability to predict results or the actual
effect of future plans or strategies is inherently uncertain. Factors which
could have a material adverse effect on the operations of the Company and the
subsidiaries include, but are not limited to, changes in interest rates, general
economic conditions, legislative/regulatory changes, monetary and fiscal
policies of the U.S. Government, including policies of the U.S. Treasury and the
Federal Reserve Board, the quality and composition of the loan or investment
portfolios, demand for loan products, deposit flows, competition, demand for
financial services in the Company's market area and changes in relevant
accounting principles and guidelines. These risks and uncertainties should be
considered in evaluating forward looking statements and undue reliance should
not be placed on such statements. The Company does not undertake--and
specifically disclaim any obligation--to publicly release the result of any
revisions which may be made to any forward looking statements to reflect events
or circumstances after the date of the statements or to reflect the occurrence
of anticipated or unanticipated events.
Operating Strategy
The Bank is an independent, community-oriented savings bank, delivering
quality customer service and offering a wide range of deposit, loan and
investment products to its customers. In recent years, the Bank's strategy has
been to enhance profitability by emphasizing the origination of commercial real
estate and business loans, increasing sources of noninterest income and by
improving operating efficiencies while managing its capital position and
limiting its credit and interest rate risk exposure. To accomplish these
objectives, the Bank has sought to:
.Operate as a full service community bank.
.Provide superior customer service and innovative products by
expanding delivery systems through the opening of new branch offices,
offering a bank-issued credit card and debit card services,
establishing Internet banking and a call center that provides
interest rate information for deposit and loan products and other
customer services.
42
. Increase fee income by broadening non-depository product offerings
and services, including the establishment of a relationship with a
third party registered broker-dealer to provide a wide array of
investment offerings through financial service specialists and
representatives.
. Increase fee income by providing merchant credit card processing
services.
. Originate high quality commercial real estate and commercial business
loans which increase the yields earned on its overall loan portfolio,
without incurring unacceptable credit risk.
. Control credit risk by focusing on the origination of single-family,
owner-occupied residential mortgage loans and consumer loans,
consisting primarily of home equity loans and lines of credit.
. Monitor and control interest rate risk primarily by selling longer-
term fixed-rate loans as market interest rate conditions dictate, by
investing in shorter-term mortgage-backed securities and by
selectively using off-balance sheet hedging transactions.
. Invest funds in excess of loan demand primarily in mortgage-backed
securities, investment grade debt and equity mutual funds.
. Invest in technological enhancements to increase productivity and
efficiency.
Comparison of Financial Condition at December 31, 1999 and 1998
Total assets increased $119.5 million, or 10.8%, to $1.23 billion at
December 31, 1999 as compared to $1.11 billion at December 31, 1998. The
increase was due primarily to a $131.6 million increase in the loan portfolio, a
$7.2 million increase in securities, partially offset by a $18.4 million
decrease in cash and cash equivalents which reflects reduced liquidity
associated with year-end Y2K cash requirements. The growth in assets was funded
by deposits ($51.5 million), short-term borrowed funds ($16.3 million) and
Federal Home Loan Bank advances ($39.0 million). Loans, net increased due to
strong loan demand in most sectors of the loan portfolio, reflecting the
continued strong state and local economy. The Savings Bank of Manchester
continues to offer an increased array of loan products to an expanded market
area using aggressive marketing efforts. The growth of the loan portfolio was
affected during 1999 by management's decision to reduce the level of sales of
fixed-rate residential mortgages to the secondary market. Sales of fixed-rate
loans were $19.2 million in 1999 compared to $94.3 million in 1998. This
decision reflects management's reevaluation of the Bank's asset/liability
position and desire for fixed-rate products despite slightly rising interest
rate environment.
Deposits totalled $906.6 million at December 31, 1999, an increase of $51.5
million, or 6.0%, compared to $855.1 million at December 31, 1998. The deposit
growth reflects an increase of $30.1 million, or 78.5%, in money market accounts
and a $12.2 million, or 31.3%, increase in demand deposits. Certificates of
deposits, savings accounts and NOW accounts increased $4.2 million, $3.0 million
and $1.9 million, respectively, for a combined increase of $9.1 million, or
1.2%. The substantial increases in money market accounts and demand deposits
reflect aggressive marketing of both retail and commercial deposit accounts. In
addition, the Bank continues to market a short-term commercial transactional
repurchase agreement (repo) account to commercial businesses. These repo
accounts increased $15.9 million, or 20.2% , during 1999. Advances from
Federal Home Loan Bank increased $39.0 million, or 86.7%, from $45.0 million in
1998, to $84.0 million at December 31, 1999.
Nonperforming assets totalled $12.1 million at December 31, 1999 compared
to $3.3 million at December 31, 1998, representing an increase of $8.8 million,
or 268%. The increase is due to the addition of two large commercial real
estate relationships, which were placed on nonaccrual status during 1999. One
commercial real estate loan for $4.3 million, which is in foreclosure, is
scheduled for full repayment of principal in May 2000. The second relationship
includes four commercial real estate loans to one borrower aggregating $5.7
million. Management believes both relationships are adequately secured by
43
collateral. Excluding both of the above commercial real estate relationships,
the Bank's nonperforming assets would have been $2.1 million, a decrease of
36.4% from 1998. Other Real Estate Owned declined $1.2 million, or 65.7%,
during 1999 due to property sales.
Total capital increased $10.4 million, or 9.2%, to $123.2 million at
December 31, 1999 compared to $112.8 million at December 31, 1998. The increase
was due to net income of $8.8 million and an increase of $1.7 million in
accumulated other comprehensive income related to unrealized gains on available
for sale securities at December 31, 1999.
Comparison of Operating Results for the Years Ended December 31, 1999 and 1998
Net Income. Net income decreased by $564,000, or 6.1%, to $8.8 million for
1999 from $9.3 million for 1998. The decrease was primarily attributable to
reduced gains on the sale of mortgages to the secondary market and reduced gains
on the sale of securities. Net interest income after provision for loan losses
increased $1.9 million, or 4.9%, to $40.4 million for 1999 compared to $38.5
million for 1998. Service charges and fees and other noninterest income
increased slightly from $7.1 million to $7.5 million for 1999. Noninterest
expense decreased $506,000, or 1.4%, to $36.6 million for 1999 from $37.1
million for 1998. Noninterest expense for 1998 included a $3.0 million expense
relating to the establishment of Savings Bank of Manchester Foundation, Inc. in
June 1998. Excluding the effect of this charge, noninterest expense would have
increased in 1999 by $2.5 million or 7.3% primarily due to an increase in
salaries expense in 1999.
Net Interest Income. Net interest income increased $1.8 million, or 4.5%,
to $41.5 million for 1999 from $39.7 million for 1998. The increase was
primarily a result of higher interest income from an increase in the level of
interest earning assets, despite declining interest yields on loans and
investments and a decrease in the average cost of funds on interest bearing
liabilities due to a lower interest rate environment, particularly during the
early part of 1999. Interest and dividend income increased $2.0 million, or
2.6%, to $78.8 million for 1999 from $76.9 million for 1998. The average yield
on interest earning assets declined 44 basis points to 7.10% in 1999 from 7.54%
in 1998, primarily due to a decline in market interest rates during the early
part of 1999. Interest income on loans increased $1.9 million, or 3.0%, to
$66.4 million for 1999 compared to $64.5 million for 1998. The increase was due
to a $76.4 million increase in the average balance of loans outstanding,
partially offset by a 48 basis point decrease in the average yield on such loans
primarily due to a lower interest rate environment. Interest and dividend
income from investment securities increased $62,000, or 0.5%, to $12.4 million
for 1999 compared to $12.3 million for 1998. The small increase in interest and
dividend income from investment securities was due to an increase in the average
balance of investment securities of $8.7 $ million, or 4.3% , to $230.6 million
for the year ended December 31, 1999, partially offset by a 27 basis point
decrease in the average yield.
Interest and dividend expense increased $174,000, or 0.5%, to $37.4 million
for 1999 from $37.2 million for 1998. The increase reflects an increase in
expense on short-term borrowed funds and advances from Federal Home Loan Bank of
$1.3 million, offset by a decrease in expense of $1.1 million on core deposits.
Advances from Federal Home Loan Bank increased from $45.0 million as of December
31, 1998 to $84.0 million at the end of 1999. Short-term borrowed funds
represented by commercial transactional repurchase agreements increased to $94.6
million at December 31, 1999 from $78.7 million at December 31, 1998. The
average rate paid on Federal Home Loan Bank advances decreased 34 basis points
to 5.97% in 1999 from 6.31% in 1998 due to a lower interest rate environment and
the repayment of several older long-term advances bearing higher interest rates.
Interest expense on deposits declined $1.1 million or 3.3% to $33.8 million for
1999 from $34.9 million for 1998, reflecting lower interest rates.
Provision for Loan Losses. The provision for loan losses was $1.1 million
for 1999 compared to $1.2 million for 1998. For 1999, management decreased the
provision by 50% for the first half of the year, reflecting improved delinquency
trends during 1998 and early 1999. The addition of two large commercial real
estate relationships to nonaccrual status by September 1999 required an
adjustment to the provision during the last quarter of 1999. The allowance for
loan losses was 1.12% of total loans and 92.44% of nonperforming loans at
December 31, 1999 compared to 1.30% and 694.55%, respectively, at December 31,
1998. The changes reflect the addition of two large commercial real estate
relationships to nonperforming loan status during 1999.
44
The Bank's management assesses the adequacy of the allowance for loan
losses based on known and inherent risks in the loan portfolio and upon
management's continuing analysis of the quality of the loan portfolio. While
management believes that, based on information currently available, the Bank's
allowance for loan losses is sufficient to cover probable losses inherent in its
loan portfolio at this time, no assurances can be given that the Bank's level of
allowance for loan losses will be sufficient to cover loan losses incurred by
the Bank or that future adjustments to the allowance for loan losses will not be
necessary if economic and other conditions differ substantially from the
economic and other conditions used by management to determine the current level
of the allowance for loan losses. Management may increase its level of
allowance for loan losses as a percentage of total loans and nonperforming loans
if the level of commercial, multi-family, construction or consumer lending as a
percentage of total loan portfolio increases. In addition, various regulatory
agencies, as an integral part of their examination process, periodically review
the Bank's allowance for loan losses. Such agencies may require the Bank to
provide additions to the allowance based on judgments different from those of
management.
Noninterest Income. Noninterest income totalled $9.4 million and $12.2
million for 1999 and 1998, respectively. The decline was due to the combined
effect of decreased securities gains and reduced gains from the sale of
mortgages to the secondary market. The decline in securities gains is due to
the gains realized in 1998 relating to the formation of Savings Bank of
Manchester Foundation, Inc. and the contribution of appreciated securities to
the foundation. The decreased gains from the sale of mortgages to the secondary
market reflect management's decision to retain fixed rate mortgages in order to
grow the loan portfolio. During 1999, the Bank sold $19.2 million of loans to
the secondary market, realizing gains of $551,000, compared with sales of $94.3
million in 1998, which generated gains of $2.4 million. Fee income from service
charges and account fees was $5.9 million in 1999 compared with $5.4 million for
1998. Other fee income declined slightly from $1.7 million in 1998 to $1.6
million in 1999 and reflects fees earned from brokerage services and rental
income on properties in Other Real Estate Owned. Other Real Estate Owned
declined from $1.8 million at the end of 1998 to $604,000 at the end of 1999.
Noninterest Expense. Noninterest expense decreased $506,000, or 1.4%, to
$36.6 million for 1999 from $37.1 million for 1998. The decrease is
attributable to the one-time expense in 1998 relating to the charitable
contribution of $3.0 million of appreciated securities to Savings Bank of
Manchester Foundation, Inc. Excluding this charitable contribution, 1998
noninterest expense would be $34.1 million and the increase in 1999 would be
$2.5 million, or 7.3%. Increases in noninterest expense include $1.1 million,
or 7.8%, for salary and wage compensation, $575, 000, or 17.9%, for fees and
services, and $338,000, or 8.5%, for pension and other employee benefits. These
increases reflect an increase in commercial lending staff, continued development
of the Merchant Services Center program, the Year 2000 project, and increased
benefits costs. Marketing expenses increased $120,000, or 7.2%, due to a new
television advertising program.
Provision for Income Taxes. The provision for income taxes increased
$218,000, or 5.2%, to $4.4 million for 1999 from $4.2 million for 1998. The
increase reflects the adjustment in effective tax rates between 1999 and 1998.
During 1998, the Bank created Savings Bank of Manchester Foundation, Inc. and
donated appreciated securities to the foundation, resulting in a lower 1998
effective tax rate. During 1999, the Bank formed the Savings Bank of Manchester
Mortgage Company, Inc. which eliminated the Bank's Connecticut state income tax
liability for 1999. The effective tax rates were 33.58% for 1999 and 31.11% for
1998.
Comparison of Operating Results for the Years Ended December 31, 1998 and
1997
Net Income. Net income decreased by $884,000, or 8.7%, to $9.3 million for
1998 from $10.2 million for 1997. The decrease was primarily attributable to a
$5.5 million increase in noninterest expense and a $1.4 million decrease in
gains on sale of securities partially offset by a $1.6 million increase in net
interest income, a $693,000 increase in noninterest income and $2.4 million
decrease in the provision for income taxes.
Net Interest Income. Net interest income increased by $1.6 million, or
4.2%, to $39.7 million for 1998 from $38.1 million for 1997. This increase was
primarily a result of higher interest income from an increase in the level of
average interest-earning assets and a decrease in the average rate paid on
45
interest-bearing liabilities due to a lower interest rate environment. Interest
and dividend income increased $2.9 million, or 4.0%, to $76.9 million for 1998
from $73.9 million for 1997. The average yield on interest-earning assets
declined 15 basis points to 7.54% in 1998 from 7.75% in 1997 primarily due to a
decline in market interest rates. Interest income on loans increased $1.2
million, or 1.9%, to $64.5 million for 1998, compared to $63.3 million for the
prior year. This increase was due to a $42.5 million increase in the average
balance of loans outstanding, offset by an 18 basis point decrease in the
average yield on such loans primarily due to a decline in market interest rates.
Interest and dividend income from investment securities increased $1.7 million,
or 16.3%, from $10.6 million for 1997 to $12.3 million for 1998. The increase in
interest and dividend income from investment securities was due to an increase
in the average balance of investment securities of $32.1 million, or 18.6%, to
$204.1 million for the year ended December 31, 1998, and a 23 basis point
increase in the average yield.
Interest expense increased $1.3 million, or 3.7%, to $37.2 million for 1998
from $35.9 million for 1997 primarily due to an increase in interest expense on
Federal Home Loan Bank advances. The average balance of such advances was $14.1
million for 1997 and $36.5 million for 1998, an increase of $22.4 million, or
158.87%. These advances were used primarily to fund loan originations. The
average rate paid on Federal Home Loan Bank advances decreased 59 basis points
to 6.31% in 1998 from 6.90% in 1997 due to a lower market interest rate
environment. Interest on deposits remained fairly constant at approximately
$34.9 million for 1998 and 1997 due to a decrease in the average rate paid on
deposits of 16 basis points during 1998 offset by an increase in the average
balance of $31.2 million.
Provision for Loan Losses. The provision for loan losses remained constant
at $1.2 million for 1998 and 1997. The allowance for loan losses was 1.30% of
total loans and 694.55% of nonperforming loans at December 31, 1998 compared to
1.23% and 350.79%, respectively, at December 31, 1997 due to the overall
improvement of the loan portfolio.
Noninterest Income. Noninterest income totalled $12.2 million and $11.5
million for 1998 and 1997, respectively. The $693,000 increase in noninterest
income was attributable to an increase in gains on mortgage sales of $2.0
million, or 489%, to $2.4 million for 1998 from $410,000 for 1997. This
increase was attributable primarily to sales of fixed-rate residential mortgages
to manage interest rate risk in 1998. This increase was partially offset by a
decrease in gains on sale of securities of $1.4 million, or 34.6%, to $2.6
million for the year ended December 31, 1998 from $4.0 million for the year
ended December 31, 1997. The $1.4 million decrease in gains on sales of
securities was primarily due to management's decision to defer the realization
of additional gains for tax purposes.
Noninterest Expense. Noninterest expense increased by $5.5 million, or
17.5%, to $37.1 million for 1998 from $31.6 million for 1997. The increase in
noninterest expense was primarily attributable to an increase in salaries and
employee benefits of $1.5 million, or 12.0%, to $14.1 million for 1998, from
$12.6 million for 1997 resulting from a combination of additional commercial
lending staff, the development of the Merchant Services Center program,
conversion to a new computer system in late 1997, and the Year 2000 project. In
addition, 1998 noninterest expense includes a $3.0 million expense associated
with the contribution of appreciated securities to Savings Bank of Manchester
Foundation, Inc. There was no such contribution in 1997. These increases were
partially offset by a $518,000 decrease in foreclosed real estate expense in
1998 due primarily to reduced holding periods for foreclosed properties in 1998
compared to 1997.
Provision for Income Taxes. The provision for income taxes decreased $2.4
million to $4.2 million for 1998, compared to $6.6 million for 1997. The
effective tax rates were 31.1% and 39.2% for 1998 and 1997, respectively. The
lower effective tax rate for 1998 was primarily the result of the gain on the
securities contributed to the Savings Bank of Manchester Foundation, Inc. not
being subject to income taxes.
46
Average Balances, Interest and Average Yields/Cost
The following table presents certain information for the periods indicated
regarding average balances of assets and liabilities, as well as the total
dollar amounts of interest income from average interest-earning assets and
interest expense on average interest-bearing liabilities and the resulting
average yields and costs. The yields and costs for the periods indicated are
derived by dividing income or expense by the average balances of assets or
liabilities, respectively, for the periods presented. Average balances were
derived from average monthly balances. The yields and rates include fees which
are considered adjustments to yields.
For the Year Ended December 31,
--------------------------------------------------------------------------------------------------
1999 1998 1997
------------------------------- -------------------------------- -------------------------------
Average Average Average
Average Yield/ Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate Balance Interest Rate
----------- -------- -------- ------------ -------- -------- ------------ -------- -------
(Dollars in thousands)
Interest-earning assets:
Loans (1):
Real estate............ $ 683,175 $50,087 7.73% $ 621,751 $48,338 7.77% $ 597,902 $47,713 7.98%
Consumer............... 71,967 5,653 7.85 71,132 5,780 8.13 68,768 5,842 8.50
Commercial............. 124,287 10,686 8.60 110,158 10,393 9.43 104,705 9,759 9.32
---------- ------- ------ ---------- ------- ------ ---------- ------- ------
Total loans.......... 879,429 66,426 7.55 803,041 64,511 8.03 771,375 63,314 8.21
---------- ------- ------ ---------- ------- ------ ---------- ------- ------
Mortgage-backed
securities (2)........... 36,771 2,460 6.69 35,762 2,392 6.69 31,087 2,186 7.03
Investment securities (3):
U.S. Government and
agency obligations.... 72,567 4,168 5.75 65,637 3,813 5.81 50,149 2,892 5.77
Corporate securities... 39,324 2,523 6.42 34,960 2,266 6.48 27,557 1,721 6.25
Marketable equity
securities............ 43,525 999 2.30 42,066 1,373 3.26 37,265 1,375 3.69
Other equity
securities............ 418 -- -- 302 -- -- 192 -- --
Asset-backed
securities............ 20,258 1,265 6.24 25,419 1,650 6.49 25,824 1,683 6.52
Other interest-bearing
assets:
Federal Home Loan
Bank stock............ 5,909 383 6.48 5,831 369 6.33 5,512 350 6.35
Federal funds sold..... 11,800 610 5.17 6,846 484 5.03 5,115 410 5.13
---------- ------- ------ ---------- ------- ------ ---------- ------- ------
Total interest-
earning assets...... 1,110,001 $78,834 7.10% 1,019,864 $76,858 7.54% 954,076 $73,931 7.75%
======= ======= =======
Noninterest-earning
assets................... 46,606 59,199 50,195
---------- ---------- ----------
Total assets......... $1,156,607 $1,079,063 $1,004,271
========== ========== ==========
Interest-bearing liabilities:
Deposits:
NOW accounts........... $ 109,095 $ 1,507 1.38% $ 94,394 $ 1,299 1.38% $ 80,445 $ 1,101 1.37%
Savings and money
market accounts....... 276,971 9,200 3.32 248,915 5,982 2.40 238,132 5,644 2.37
Certificates of
deposit............... 445,474 20,202 4.53 463,226 25,138 5.43 471,865 26,219 5.56
Escrow deposits........ 5,545 158 2.85 5,092 176 3.46 5,290 171 3.23
---------- ------- ------ ---------- ------- ------ ---------- ------- ------
Total interest-
bearing deposits.... 837,085 31,067 3.71 811,627 32,595 4.02 795,732 33,135 4.16
Short-term borrowed
funds.................... 90,158 2,692 2.99 76,523 2,298 3.00 61,677 1,745 2.83
Advances from Federal
Home Loan Bank........... 60,589 3,615 5.97 36,534 2,307 6.31 14,144 976 6.90
---------- ------- ------ ---------- ------- ------ ---------- ------- ------
Total interest-
bearing liabilities. 987,832 $37,374 3.78% 924,684 $37,200 4.02% 871,553 $35,856 4.11%
======= ======= =======
Noninterest-bearing
liabilities.............. 51,729 47,865 37,398
---------- ---------- ----------
Total liabilities.... 1,039,561 972,549 908,951
Capital................... 117,046 106,514 95,320
---------- ---------- ----------
Total liabilities
and capital......... $1,156,607 $1,079,063 $1,004,271
========== ========== ==========
Net interest-earning
assets................... $ 122,169 $ 94,018 $ 89,310
========== ========== ==========
Net interest income....... $41,460 $39,658 $38,075
======= ======= =======
Interest rate spread (4).. 3.32% 3.52% 3.58%
Net interest margin (5)... 3.74% 3.89% 3.96%
Ratio of interest-earning
assets to interest-
bearing liabilities...... 112.37% 110.17% 110.25%
- ------------------------
(1) Balances are net of undisbursed proceeds of construction loans in process
and include nonperforming loans.
(2) Includes mortgage-backed securities available for sale at market value and
held to maturity at amortized cost.
(3) Includes investment securities available for sale at market and held to
maturity at cost.
(4) Interest rate spread represents the difference between the weighted average
yield on interest-earning assets and the weighted average cost of interest-
bearing liabilities.
(5) Net interest margin represents net interest income as a percentage of
average interest-earning assets.
47
Rate/Volume Analysis
The following table presents the effects of changing rates and volumes on
the interest income and interest expense of the Bank. The rate column shows the
effects attributable to changes in rate (changes in rate multiplied by prior
volume). The volume column shows the effects attributable to changes in volume
(changes in volume multiplied by prior rate). The net column represents the sum
of the prior columns. For purposes of this table, changes attributable to
changes in both rate and volume, which cannot be segregated, have been allocated
proportionately based on the absolute value of the change due to rate and the
change due to volume.
1999 1998
Compared to Compared to
1998 1997
---------------------------- ------------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
------------------ -------- ----------------- -----------
Rate Volume Net Rate Volume Net
--------- ------- -------- -------- ------- -----------
(In thousands)
Interest-earning assets:
Loans:
Real estate.............................. $(2,891) $4,639 $ 1,748 $(1,254) $1,879 $ 625
Consumer................................. (194) 67 (127) (258) 196 (62)
Commercial............................... (981) 1,274 293 123 511 634
------- ------ ------- ------- ------ -------
Total loans........................... (4,066) 5,980 1,914 (1,389) 2,586 1,197
Mortgage-backed securities.................. 1 67 68 (115) 322 207
Investment securities....................... (682) 676 (6) (143) 1,666 1,523
------- ------ ------- ------- ------ -------
Total interest-earning assets............ (4,747) 6,723 1,976 (1,647) 4,574 2,927
------- ------ ------- ------- ------ -------
Interest-bearing liabilities:
Deposits:
Demand accounts.......................... 5 203 208 7 191 198
Savings accounts......................... 2,382 818 3,200 219 124 343
Certificates of deposit.................. (4,052) (884) (4,936) (607) (474) (1,081)
Other.................................... (15) 408 393 120 433 553
------- ------ ------- ------- ------ -------
Total deposits....................... (1,680) 545 (1,135) (261) 274 13
Advances from Federal Home Loan Bank........ (167) 1,476 1,309 (148) 1,479 1,331
------- ------ ------- ------- ------ -------
Total interest-bearing liabilities.... (1,847) 2,021 174 (409) 1,753 1,344
------- ------ ------- ------- ------ -------
Increase (decrease) in net interest income.. $(2,900) $4,702 $ 1,802 $(1,238) $2,821 $ 1,583
======= ====== ======= ======= ====== =======
Liquidity and Capital Resources
Liquidity is the ability to meet current and future financial obligations
of a short-term nature. The Bank further defines liquidity as the ability to
respond to the needs of depositors and borrowers as well as maintaining the
flexibility to take advantage of investment opportunities. Primary sources of
funds consist of deposit inflows, loan repayments, maturities, paydowns, and
sales of investment and mortgage-backed securities and borrowings from the
Federal Home Loan Bank of Boston. While maturities and scheduled amortization
of loans and securities are predictable sources of funds, deposit outflows and
mortgage prepayments are greatly influenced by general interest rates, economic
conditions and competition.
The Bank's primary investing activities are (1) originating residential
one-to four-family mortgage loans and, to a lesser extent, commercial business
and real estate loans, multi-family loans, single-family construction loans,
home equity loans and lines of credit and consumer loans and (2) investing in
mortgage-backed securities, U.S. Government and agency obligations and corporate
equity securities and debt obligations. These activities are funded primarily
48
by principal and interest payments on loans, maturities of securities, deposit
growth and Federal Home Loan Bank of Boston advances. During the years ended
December 31, 1999 and 1998 , the Bank's loan originations totalled $388.8
million and $377.6 million, respectively. At December 31, 1999 and 1998, the
Bank's investments in mortgage-backed securities, U.S. Government and agency
obligations and corporate securities and debt obligations totalled $130.9
million and $124.9 million, respectively. The Bank experienced a net increase
in total deposits of $51.5 million, $27.4 million and $34.8 million for the
years ended December 31, 1999, 1998 and 1997, respectively, primarily as a
result of retail and commercial programs designed to attract deposits. Deposit
flows are affected by the overall level of interest rates, the interest rates
and products offered by the Bank and its local competitors and other factors.
The Bank closely monitors its liquidity position on a daily basis. If the Bank
should require funds beyond its ability to generate them internally, additional
sources of funds are available through Federal Home Loan Bank advances and
through repurchase agreement borrowing facilities.
Outstanding commitments for all loans and unadvanced construction loans and
lines of credit totalled $155.2 million at December 31, 1999. Management of the
Bank anticipates that it will have sufficient funds available to meet its
current loan commitments. Certificates of deposit that are scheduled to mature
in one year or less from December 31, 1999 totalled $340.9 million. The Bank
relies primarily on competitive rates, customer service, and long-standing
relationships with customers to retain deposits. Occasionally, the Bank will
also offer special competitive promotions to its customers to increase retention
and promote deposit growth. Based upon the Bank's historical experience with
deposit retention, management believes that, although it is not possible to
predict future terms and conditions upon renewal, a significant portion of such
deposits will remain with the Bank.
The Bank must satisfy to various regulatory capital requirements
administered by the federal banking agencies including a risk-based capital
measure. The risk-based capital guidelines include both a definition of capital
and a framework for calculating risk-weighted assets by assigning balance sheet
assets and off-balance sheet items to broad risk categories. At December 31,
1999, the Bank exceeded all of its regulatory capital requirements with a
leverage capital level of $109.7 million, or 9.1% of average assets, which is
above the required level of $48.2 million, or 4%, and risk-based capital of
$120.3 million, or 14.0% of risk weighted assets, which is above the required
level of $68.9 million, or 8.0%. The Bank is considered "well capitalized"
under regulatory guidelines.
The capital from the Conversion has significantly increased the Company's
liquidity and capital resources. Over time, the initial level of liquidity will
be reduced as net proceeds are used for general corporate purposes, including
the funding of lending activities. The Company's financial condition and
results of operations will be enhanced by the capital from the Conversion,
resulting in increased net interest-earning assets and net income. However, due
to the large increase in equity resulting from the capital injection, return on
equity will be adversely impacted following the Conversion.
Year 2000 Readiness
The Bank accomplished the objectives established in its Year 2000 Action
Plan. All internal software and hardware used in the Bank's business made it
through the transition from 1999 to 2000 without any known abnormalities or
inaccurate results. In addition, the Bank's critical vendors and suppliers have
informed the Bank that they have also made the transition successfully.
Furthermore, the Bank has not been notified by any of its significant borrowers
of any material Year 2000 related problems that would adversely affect the
borrowers' abilities to satisfy their current obligations to the Bank.
Other critical, future dates previously identified as being potentially
vulnerable to the Year 2000 problem were tested as part of the century rollover
testing. All critical applications thought to be impacted by future dates were
evaluated and further testing of various dates conducted as necessary. Any
potential problems identified during this testing have been corrected.
The Bank has budgeted approximately $3.8 million in connection with the
costs associated with achieving Year 2000 compliance. As of December 31, 1999,
the Bank had expended approximately $3.7 million on Year 2000 issues.
49
Impact of Inflation and Changing Prices
The consolidated financial statements and related data presented in this
Form 10-K have been prepared in conformity with generally accepted accounting
principles, which require the measurement of financial position and operating
results in terms of historical dollars, without considering changes in the
relative purchasing power of money over time due to inflation. Unlike many
industrial companies, substantially all of the assets and liabilities of the
Bank are monetary in nature. As a result, interest rates have a more
significant impact on the Bank's performance than the general level of
inflation. Over short periods of time, interest rates may not necessarily move
in the same direction or in the same magnitude as inflation.
Impact of New Accounting Standards
Accounting for Derivative Instruments and Hedging Activities. Effective
January 1, 1999, Connecticut Bankshares, M.H.C. adopted Statement of Financial
Accounting Standards ("SFAS") No. 134, "Accounting for Mortgage-Backed
Securities Retained after the Securitization of Mortgage Loans Held for Sale by
a Mortgage Banking Enterprise, an amendment of SFAS No. 65." This statement
requires that after the securitization of mortgage loans held for sale, an
entity engaged in mortgage banking activities shall classify the resulting
mortgage-backed securities or other retained interests based on its ability and
intent to sell or hold those investments. The adoption has no effect on the
Company's financial condition or results of operations.
In June 1998, the Financial Accounting Standards Board ("FASB")issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities." This
statement establishes accounting and reporting standards requiring that every
derivative instrument (including certain derivative instruments embedded in
other contracts) be recorded in the balance sheet as either an asset or
liability measured at its fair value. The statement requires that changes in
the derivative's fair value be recognized currently in earnings unless specific
hedge accounting criteria are met. Special accounting for qualifying hedges
allows a derivative's gains and losses to offset related results on the hedged
item in the statement of operations and requires that an entity formally
document, designate and assess the effectiveness of transactions that receive
hedge accounting. This statement was amended by SFAS No. 137, "Accounting for
Derivatives and Hedging Activities - Deferral of the Effective Date of FASB
Statement No. 133." As a result, SFAS No. 133 will be effective in 2001 for the
Company. The Company adopted this statement on January 1, 2000. Management
does not expect that the adoption of this statement will have a material impact
on the Company' financial position or results of operations.
Revenue Recognition in Financial Statements. On December 3, 1999, the SEC
released Staff Accounting Bulletin ("SAB") No. 101, "Revenue Recognition in
Financial Statements." The guidelines set forth in SAB No. 101 stipulate that
revenue should not be recognized until it is realized or realizable and earned.
The Company adopted SAB No. 101 on January 1, 2000 without effect on the
Company's consolidated financial condition or results of operations.
50
Item 7A. Quantitative and Qualitative Disclosure About Market Risk.
- --------------------------------------------------------------------
Qualitative Aspects of Market Risk
The Bank's most significant form of market risk is interest rate risk. The
principal objectives of the Bank's interest rate risk management are to evaluate
the interest rate risk inherent in certain balance sheet accounts, determine the
level of risk appropriate given its business strategy, operating environment,
capital and liquidity requirements and performance objectives, and manage the
risk consistent with its established policies. The Bank has an Asset/Liability
Committee, responsible for reviewing its asset/liability policies and interest
rate risk position, which meets quarterly and reports trends and interest rate
risk position to the Executive Committee of the Board of Directors and the Board
of Directors. The extent of the movement of interest rates is an uncertainty
that could have a negative impact on the earnings of the Bank. In recent years,
the Bank has managed interest rate risk by:
(1) emphasizing the origination of adjustable-rate loans and generally
selling longer term fixed-rate loans as market interest rate
conditions dictate;
(2) originating variable rate commercial real estate loans and prime rate
commercial business loans;
(3) emphasizing shorter-term consumer loans including home equity lines of
credit indexed to the prime rate, as reported in The Wall Street
Journal;
(4) maintaining a high quality securities portfolio that provides adequate
liquidity and flexibility to take advantage of opportunities that may
arise from fluctuations in market interest rates, the overall maturity
and duration of which is monitored in relation to the repricing of its
loan portfolio;
(5) promoting lower cost liability accounts such as demand deposits and
business repurchase accounts;
(6) using Federal Home Loan Bank advances to better structure maturities
of its interest rate sensitive liabilities; and
(7) selectively utilizing off-balance sheet hedging transactions, such as
interest rate swaps and caps.
The Bank's market risk also includes equity price risk. The Bank's
marketable equity securities portfolio had gross unrealized gains of $19.4
million and gross unrealized losses of $1.2 million at December 31, 1999 which
are included, net of taxes, in accumulated other comprehensive income, a
separate component of the Bank's capital. If equity security prices decline due
to unfavorable market conditions or other factors, the Bank's capital would
decrease.
The Bank's investment policy authorizes it to be a party to financial
instruments with off-balance sheet risk in the normal course of business to
reduce its exposure to fluctuations in interest rates. These financial
instruments include interest rate cap agreements. Interest rate cap agreements
generally involve the payment of a premium in return for cash receipts if
interest rates rise above or fall below a specified interest rate level.
Payments are based on a notional principal amount. Caps generally are not
readily available for time periods longer than five years. The Bank's objective
in using interest rate caps is to reduce risk associated with adverse rate
volatility while enabling the Bank to benefit from favorable interest rate
movements. All counter-parties to cap arrangements must be pre-approved by the
Bank's Executive Committee and reported to its Investment Committee. At
December 31, 1999, the notional principal amount of the Bank's outstanding
interest rate cap agreement was $25 million. Under the terms of the cap
agreement, the Bank paid a premium totalling $123,000 which is included in other
assets and being amortized over three years which is the term of the agreement.
Amortization for the year ended December 31, 1999 totalled $38,000 and is
recorded as an interest expense on advances. The agreement provides that, if
the London Interbank Offered Rate exceeds 7%, the Bank receives cash payments on
51
a quarterly basis. There were no cash payments due at December 31, 1999. The
Bank was not a party to any interest rate cap arrangements during the years
ended December 31, 1998 and 1997.
Quantitative Aspects of Market Risk
The matching of assets and liabilities may be analyzed by examining the
extent to which such assets and liabilities are "interest rate sensitive" and by
monitoring a bank's interest rate sensitivity "gap." An asset or liability is
said to be interest rate sensitive within a specific time period if it will
mature or reprice within that time period. The interest rate sensitivity gap is
defined as the difference between the amount of interest-earning assets maturing
or repricing within a specific time period and the amount of interest-bearing
liabilities maturing or repricing within that same time period. At December 31,
1999, the Bank's one-year gap position, the difference between the amount of
interest-earning assets maturing or repricing within one year and interest-
bearing liabilities maturing or repricing within one year, was (2.72)%. 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 the amount of
interest rate sensitive assets. Accordingly, during a period of rising interest
rates, an institution with a negative gap position would be in a worse position
to invest in higher yielding assets which, consequently, may result in the cost
of its interest-bearing liabilities increasing at a rate faster than its yield
on interest-earning assets than if it had a positive gap. Conversely, during a
period of falling interest rates, an institution with a negative gap would tend
to have its interest-bearing liabilities repricing downward at a faster rate
than its interest-earning assets as compared to an institution with a positive
gap which, consequently, may tend to positively affect the growth of its net
interest income.
The following table sets forth the amount of interest-earning assets and
interest-bearing liabilities outstanding at December 31, 1999, which are
anticipated by the Bank, based upon certain assumptions, to reprice or mature in
each of the future time periods shown. Except as stated below, the amount of
assets and liabilities shown which reprice or mature during a particular period
were determined in accordance with the earlier of term to repricing or the
contractual maturity of the asset or liability. The table sets forth an
approximation of the projected repricing of assets and liabilities at December
31, 1999, on the basis of contractual maturities, anticipated prepayments, and
scheduled rate adjustments within a series of time intervals. For loans on
residential mortgages, adjustable-rate loans, and fixed-rate loans, prepayment
rates were assumed to range from 1% to 50% annually. Mortgage-related securities
were assumed to prepay at rates between 4% and 14% annually. Investment
securities, which include callable federal agency obligations, are presented
based on stated maturities. NOW accounts were assumed to decay at 15%, 15%,
15%, 15%, 15% and 25%, respectively, for each of the following periods: one
year, one to two years, two to three years, three to four years, four to five
years and over five years. Money market accounts were assumed to decay at 40%,
30%, 20%, 10%, 0% and 0%, respectively, for each of the following periods: one
year, one to two years, two to three years, three to four years, four to five
years, and over five years. Prepayment of deposit rates can have a significant
impact on the Bank's estimated gap. While the Bank believes such assumptions to
be reasonable, there can be no assurance that assumed prepayment rates and decay
rates will approximate actual future loan repayment and deposit withdrawal
activity.
52
At December 31, 1999
-----------------------------------------------------------------------------------------------
More
More than than
More than Two Years Three More than
One Year to Years to Four Years
One Year to Three Four to More Than Total Fair
or Less Two Years Years Years Five Years Five Years Amount Value
--------- --------- --------- -------- ----------- ------------- ----------- -----------
(Dollars in thousands)
Interest-earning assets:
Securities (1):
Investment
securities (2)........... $ 32,035 $ 33,321 $ 17,297 $10,036 $10,035 $ 35,535 $ 138,259 $ 138,041
Mortgage-related
securities............. 5,660 5,266 3,945 3,375 3,376 20,056 41,678 40,833
Equity securities (3)..... 8,206 1,700 1,700 150 150 44,980 56,886 56,886
-------- -------- -------- ------- ------- -------- ---------- ----------
Total securities....... 45,901 40,287 22,942 13,561 13,561 100,571 236,823 235,760
-------- -------- -------- ------- ------- -------- ---------- ----------
Loans........................ 431,586 109,465 76,686 75,058 75,059 181,103 948,957 941,989
-------- -------- -------- ------- ------- -------- ---------- ----------
Total interest-
earning assets........... $477,487 $149,752 $ 99,628 $88,619 $88,620 $281,674 $1,185,780 $1,177,749
======== ======== ======== ======= ======= ======== ========== ==========
Interest-bearing liabilities:
Money market accounts........ $ 27,413 $ 20,560 $ 13,706 $ 6,853 $ -- $ -- $ 68,532 $ 68,532
Savings accounts............. 22,366 22,366 22,366 22,365 22,365 111,828 223,656 223,656
Mortgagors' escrow
accounts................. 8,674 -- -- -- -- -- 8,674 8,674
NOW accounts................. 16,911 16,911 16,911 16,911 16,911 28,186 112,741 112,741
Certificates of deposit...... 343,157 36,359 31,012 19,826 19,827 166 450,347 451,238
Advances from Federal
Home Loan Bank............ 54,000 -- -- -- -- 30,000 84,000 82,054
Short-term borrowed
funds..................... 38,326 28,744 19,163 9,581 -- -- 95,814 95,814
-------- -------- -------- ------- ------- -------- ---------- ----------
Total interest-
bearing liabilities...... $510,847 $124,940 $103,158 $75,536 $59,103 $170,180 $1,043,764 $1,042,709
======== ======== ======== ======= ======= ======== ========== ==========
Interest-earning assets
less interest-bearing
liabilities................. $(33,360) $ 24,812 $ (3,530) $ 13,083 $ 29,517 $ 111,494 $142,016
Cumulative interest-rate
sensitivity gap........... (33,360) (8,548) (12,078) 1,005 30,522 142,016
Cumulative interest-rate
gap as a percentage
of total assets........... (2.72)% (0.70)% (0.98)% 0.08% 2.49% 11.57%
Cumulative interest-rate
gap as a percentage of
total interest-earning
assets.................... (2.81)% (0.72)% (1.02)% 0.08% 2.57% 11.98%
Cumulative interest-earning
assets as a percentage
of cumulative interest-
bearing liabilities....... 93.47 % 98.66 % 98.37 % 100.12% 103.49% 113.61%
Cumulative interest-
earning assets............ $477,487 $627,239 $726,867 $815,486 $904,106 $1,185,780
Cumulative interest-
bearing liabilities....... $510,847 $635,787 $738,945 $814,481 $873,584 $1,043,764
- --------------------------
(1) Includes available for sale at market value and held to maturity at
amortized cost.
(2) Includes Federal funds sold.
(3) Includes Federal Home Loan Bank stock.
53
Item 8. Financial Statements and Supplementary Data
- ---------------------------------------------------
54
Item 9. Changes in and Disagreements with Accountants on Accounting and
- ------------------------------------------------------------------------
Financial Disclosure.
- ---------------------
None.
PART III
Item 10. Directors and Executive Officers of the Registrant.
- -------------------------------------------------------------
The following table presents information with respect to the directors and
executive officers of the Company and Bank.
Directors
Director Term
Name Age (1) Position(s) Held (2) Since(3) Expires(4)
- --------------------------- ------- ------------------------------------------------------- ---------- ---------
Thomas A. Bailey 69 Director and Chairman of the Board 1974 2001
Richard P. Meduski 54 Director, President and Chief 1983 2001
Executive Officer of the Company
and Director, President and Treasurer of the Bank
A. Paul Berte 58 Director 1993 2000
Timothy J. Devanney 47 Director 1999 2002
M. Adler Dobkin 68 Director 1976 2002
Sheila B. Flanagan 59 Director 1987 2002
John D. LaBelle, Jr. 50 Director 1991 2000
Michael B. Lynch (5) 60 Director 1986 2001
Eric A. Marziali 41 Director 1999 2002
Jon L. Norris 58 Director 1996 2000
William D. O'Neill 61 Director 1998 2002
Laurence P. Rubinow 55 Director 1996 2000
John G. Sommers 44 Director 1993 2001
Thomas E. Toomey 66 Director 1981 2001
Gregory S. Wolff 48 Director 1997 2000
Executive Officers Who Are Not Directors
Name Age (1) Position(s) Held (2)
- --------------------------- ------- -------------------------------------------------------
Charles L. Pike 56 First Executive Vice President
Douglas K. Anderson 49 Executive Vice President
Nicholas B. Mason 55 Senior Vice President and Chief Financial Officer
Roger A. Somerville 55 Senior Vice President of the Bank
- ---------------------------------
(1) As of December 31, 1999.
(2) Positions listed are for the Company and the Bank unless otherwise noted.
(3) Lists the date when the individual became a director for the Bank. All
directors of the Company were appointed in 1999, the year of the Company's
incorporation.
(4) Expiration date is the same for the Company and the Bank.
(5) Mr. Lynch passed away on February 15, 2000.
55
Biographical Information
Below is certain information regarding the directors and executive officers
of the Company and the Bank. Unless otherwise stated, each director and
executive officer has held his or her current occupation for the last five
years. There are no family relationships among or between the directors or
executive officers except as set forth below.
Thomas A. Bailey has served as the Chairman of the Board of the Bank since
1990. He is a retired attorney and formerly a partner in the law firm of Gilman
& Marks, Hartford, Connecticut.
Richard P. Meduski has served as the President and Treasurer of the Bank
since 1988. He has served as the President and Chief Executive Officer of the
Company since its formation.
A. Paul Berte is a self-employed attorney in Manchester, Connecticut.
Timothy J. Devanney is the President of Highland Park Market of Manchester
and Highland Park Market of Glastonbury, and a Member of Highland Park Market of
Farmington L.L.C., all three of which are retail grocery businesses. Mr.
Devanney is related to Mr. Toomey by marriage to Mr. Toomey's niece.
M. Adler Dobkin is Vice President of Rayco, Inc., a metal finishing
facility. He was previously the President of the company.
Sheila B. Flanagan is a retired attorney and acted as a consultant between
1996 and 1999. Before 1996, she served as in-house counsel to the Massachusetts
Mutual Life Insurance Company.
John D. LaBelle, Jr. is a principal with the law firm of LaBelle, LaBelle,
Naab & Horvath P.C., Manchester, Connecticut.
Eric A. Marziali has served as the President of United Abrasives, Inc. and
SAIT Overseas Trading and Technical Corp., and Vice President of United
Abrasives Canada, Inc., all related entities, which manufacture abrasive
products, since 1982.
Jon L. Norris is the co-owner and operator of Independent Insurance Center,
Inc., a full-service insurance agency in which he is also a principal financial
partner.
William D. O'Neill is a consultant to and was the President of Fuss &
O'Neill Inc. until June 1999. Fuss & O'Neill is a civil and environmental
engineering firm with headquarters in Manchester, Connecticut and offices in the
states of Massachusetts, Rhode Island and Vermont.
Laurence P. Rubinow is the President and Chief Executive Officer of the law
firm of Woodhouse, Rubinow & Macht, P.C., located in Manchester, Connecticut.
Mr. Rubinow is the son of Eleanor S. Rubinow, a Director Emeritus.
John G. Sommers is the President of Allied Printing Services Inc., a
commercial printing company, located in Manchester, Connecticut.
Thomas E. Toomey is the Executive Vice President of Marketing Specialists,
Inc., a marketing firm. Until 1997, he was the President of Toomey DeLong Food
Brokers, a wholesale grocer, which no longer operates. Mr. Toomey is related to
Mr. Devanney by marriage of his niece to Mr. Devanney.
Gregory S. Wolff is the Chairman of Wolff-Zackin & Associates Inc., an
insurance agency located in Vernon, Connecticut.
56
Executive Officers Who Are Not Directors
Charles L. Pike joined the Bank in 1983 and serves as the First Executive
Vice President and Senior Loan Officer. Mr. Pike is also First Vice President
of the Company.
Douglas K. Anderson joined the Bank in 1987 and served full-time as
Executive Vice President until 1995, at which time he changed his employment
status to part-time in order to become President and Chief Executive Officer of
Open Solutions, Inc., a computer software provider, located in Glastonbury,
Connecticut and the Bank's primary computer software provider. In August 1999,
Mr. Anderson resigned as President and Chief Executive Officer of Open Solutions
and returned to full-time employment with the Bank. Mr. Anderson is now
Executive Vice President of the Bank and the Company and a director of Open
Solutions.
Nicholas B. Mason joined the Bank in 1988 as Chief Financial Officer and
Senior Vice President. In addition, he serves as a Secretary to the Hartford
Mutual Investment Fund and a Director on the Board of Directors of Bankers' Bank
Northeast.
Roger A. Somerville joined the Bank in 1984 as a commercial loan officer.
He has been Senior Vice President of Commercial Lending since 1988. In
addition, Mr. Somerville is a director of The Greater Manchester Chamber of
Commerce, Genesis Center, Inc., Community Health Resources, Inc., Hartford
Economic Development Co., Greater Hartford Business Development Corp., and the
Greater Manchester United Way.
Item 11. Executive Compensation.
- ---------------------------------
Directors' Compensation
Fees. Effective upon consummation of the Conversion, non-employee
directors of the Bank each receive an annual retainer of $15,000, $750 for each
board meeting attended and $200 for each committee meeting attended. Non-
employee directors of the Company will receive an annual retainer of $15,000.
Directors' Consultation Plan. The Bank has adopted a post-retirement
consultation program for incumbent non-employee directors to ensure the
continued availability of its retired directors as consultants to management
because of their significant knowledge of and involvement in the Bank's
operations. A director who retires at age 70 with at least 10 years of service
will receive an annual benefit equal to 50% of the average cash board
compensation (retainers and meeting fees) received by the director over the
three years preceding retirement. The benefit increases by 5% for each
additional year of service with a benefit equal to 100% of final average board
compensation payable after 20 years of service. The benefit will be payable
until the earlier to occur of the tenth anniversary of the director's retirement
or the director's death. A director with at least 10 years of service may elect
to retire before age 70 but after age 65 with a corresponding reduction in the
benefit equal to 5% for each year the director's age is less than age 70. The
plan provides that each married retired director is guaranteed at least five
annual payments. If a retired director dies before the receipt of at least five
annual payments, any remaining payments will be made to the retired director's
surviving spouse to ensure that a minimum of five payments are made. The plan
also provides that the surviving spouse of an active director with at least 10
years of service who dies before age 65 will receive a benefit payable for five
years equal to 50% of the benefit the director would have been eligible to
receive had the director attained age 70 before his death, and that the
surviving spouse of an active director with at least 10 years of service who
dies after attaining age 65 will receive a benefit payable for five years equal
to 100% of what that director would have received. In the event of a change in
control (as defined in the plan), each incumbent director will be deemed retired
for purposes of the plan and will be eligible to receive a lump sum benefit
equal to the present value of the normal retirement benefit with each director
assumed to have at least 10 years of service. The Bank expects to accrue an
additional $239,000 in 2000 with respect to its anticipated liability under the
program.
57
Executive Compensation
Compensation Committee Report on Executive Compensation. Under rules
established by the Securities and Exchange Commission, the Company is required
to provide certain data and information in regard to the compensation and
benefits provided to the Company's Chief Executive Officer and the other
executive officers of the Company. The disclosure requirements for these
executive officers include the use of a report explaining the rationale and
considerations that led to fundamental compensation decisions affecting those
individuals. In fulfillment of this requirement, the Compensation Committee has
prepared the following report for inclusion in this Annual Report. Since the
Company has no employees other than Bank employees who perform services to the
Company without additional compensation, the Company's Compensation Committee
evaluates the performance of each named executive officer , including the Chief
Executive Officer, and makes recommendations to the Board of Directors which
reviews the recommendations and determines the compensation based on their
report.
Compensation Practices. The Company's executive compensation practices are
intended to attract and retain qualified executives, to recognize and reward
individual contributions and achievement and to offer a compensation package
that is competitive in the financial industry and motivational to each
individual executive. In furtherance of these objectives, the Company and the
Bank maintain a compensation program for executive officers which consists of a
base salary and a bonus. The salary levels are intended to be consistent and
competitive with the practices of other comparable financial institutions and
each executive's level of responsibility. In making its determinations, the
Compensation Committee utilizes surveys of compensation paid to executive
officers performing similar duties for depository institutions and their holding
companies with particular focus on the level of compensation paid by
institutions of comparable size and characteristics primarily in Connecticut.
Salary increases are aimed at reflecting the overall performance of the Company
and the performance of the individual executive officer.
A Board awarded discretionary bonus is also provided to executive officers.
Such bonuses are subject to limitations as a percentage of salary and budget
constraints. In addition, the named executive officers participate in other
benefit plans available to all employees including the 401(k) Plan.
Compensation of the Chief Executive Officer. During the fiscal year ended
December 31, 1999, Mr. Meduski's base salary was $294,000. In addition, he
received a performance bonus of $110,000 and other compensation totalling
$41,135 as set forth in the Summary Compensation Table appearing later in this
Annual Report. This resulted in total compensation of $445,135. The Board of
Directors believes that Mr. Meduski's compensation is appropriate based upon Mr.
Meduski's performance in managing the Bank and the Bank's financial performance
during the 1999 fiscal year.
Compensation Committee
John G. Sommers
A. Paul Berte
M. Adler Dobkin
Sheila B. Flanagan
Gregory S. Wolff
Thomas A. Bailey (ex-officio member)
58
Compensation Committee Interlocks and Insider Participation. No executive
officer of the Company or the Bank serves or has served as a member of the
Compensation Committee of another entity, one of whose executive officers serves
on the Compensation Committee of the Company or the Bank. No executive officer
of the Company or the Bank serves or has served as a director of another entity,
one of whose executive officers serves on the Compensation Committee of the
Company or the Bank.
Summary Compensation Table. The following information sets forth cash
compensation paid by the Bank as well as other compensation paid or accrued for
services rendered in all capacities during the year ended December 31, 1999 to
the Chief Executive Officer and to other officers of the Bank who received a
salary and bonus of at least $100,000 ("Named Executives").
Annual Compensation (1)
----------------------------------
All Other
Name and Position Year (2) Salary Bonus (3) Compensation (4)
- -------------------------------- -------- -------- -------------- ---------------
Richard P. Meduski, 1999 $294,000 $110,000 $41,135
President and Treasurer
Charles L. Pike, 1999 195,848 37,300 4,800
First Executive Vice President
Douglas K. Anderson 1999 160,000 15,200 2,199
Executive Vice President
Roger A. Somerville, 1999 124,833 27,500 4,339
Senior Vice President
Nicholas B. Mason, 1999 122,911 16,000 4,455
Senior Vice President and
Chief Financial Officer
- ---------------------------------
(1) Does not include the aggregate amount of perquisites and other personal
benefits, which was less than $50,000 or 10% of the total annual salary and
bonus reported.
(2) Compensation information for the years ended December 31, 1998 and 1997 has
been omitted because the Company was neither a public company nor a
subsidiary of a public company at that time.
(3) Represents board awarded discretionary cash bonus.
(4) Represents matching contributions under the Bank's 401(k) Plan in the
amounts of $4,800, $4,800, $2,199, $4,339 and $4,455 for Messrs. Meduski,
Pike, Anderson, Somerville and Mason, respectively. Also includes $36,335
paid to Mr. Meduski for premiums on an insurance policy.
Employment Agreements. The Bank and the Company each have entered into
employment agreements with Messrs. Meduski, Pike, Anderson, Mason and
Somerville. The employment agreements are intended to ensure that the Bank and
the Company will be able to maintain a stable and competent management base
after the Conversion. The continued success of the Bank and the Company depends
to a significant degree on the skills and competence of officers.
The employment agreements provide for a three-year term. The term of the
employment agreements may be extended on an annual basis unless written notice
of non-renewal is given by the Board of Directors of the Company or the Bank.
The employment agreements provide that each executive's base salary will be
reviewed annually. In addition to the base salary, the employment agreements
provide for, among other things, participation in stock benefits plans and other
fringe benefits applicable to executive personnel. The employment agreements
provide for termination by the Bank or the Company for cause, as defined in the
employment agreements, at any time. If the Bank or the Company chooses to
terminate an executive's employment for reasons other than for cause, or if an
executive resigns from the Bank or the Company after a: (1) failure to re-elect
the executive to his/her current offices; (2) material change in the executive's
functions, duties or responsibilities; (3) relocation of the executive's
59
principal place of employment by more than 35 miles; (4) reduction in the
benefits and perquisites being provided to the executive in the employment
agreement; (5) liquidation or dissolution of the Bank or the Company; or (6)
breach of the employment agreement by the Bank or the Company, the executive or,
if the executive dies, his/her beneficiary, would be entitled to receive an
amount equal to the remaining base salary payments due to the executive for the
remaining term of the employment agreement and the contributions that would have
been made on the executive's behalf to any employee benefit plans of the Bank
and the Company during the remaining term of the employment agreement. The Bank
and the Company would also continue and/or pay for the executive's life, health,
dental and disability coverage for the remaining term of the employment
agreement. Upon termination of the executive for reasons other than a change in
control, the executive must adhere to a one year non-competition restriction.
Under the employment agreements, if voluntary or involuntary termination
follows a change in control of the Bank or the Company, the executive or, if the
executive dies, his/her beneficiary, would be entitled to a severance payment
equal to the greater of: (1) the payments due for the remaining terms of the
agreement; or (2) three times the average of the five preceding taxable years'
annual compensation. The Bank and the Company would also continue the
executive's life, health, dental and disability coverage for thirty-six months.
Even though both the Bank and the Company employment agreements provide for a
severance payment if a change in control occurs, the executive would only be
entitled to receive a severance payment under one agreement. The executive
would also be entitled to receive an additional tax indemnification payment if
payments under the employment agreements or any other payments triggered
liability under the Internal Revenue Code as an excise tax constituting "excess
parachute payments." Under applicable law, the excise tax is triggered by
change in control-related payments which equal or exceed three times the
executive's average annual compensation over the five years preceding the change
in control. The excise tax equals 20% of the amount of the payment in excess of
one times the executive's average compensation over the preceding five-year
period.
Payments to the executive under the Bank's employment agreement will be
guaranteed by the Company if payments or benefits are not paid by the Bank.
Payment under the Company' employment agreement would be made by the Company.
The employment agreements also provide that the Bank and the Company will
indemnify the executive to the fullest extent legally allowable.
In addition to the foregoing employment agreements, the Bank has entered
into an employment agreement with Mr. Bailey in his capacity as Chairman of the
Board of Directors of the Bank. The Chairman's employment agreement is in
effect through 2000. The Chairman's base salary under the agreement is $90,000.
In addition to those terms and conditions generally contained in the employment
agreements as described above, Mr. Bailey's employment agreement also provides
that upon the Chairman's retirement as an employee of the Bank, the Chairman
will be retained as a consultant for a ten year period at his then current base
salary.
Benefits
Pension Plan. The Bank maintains a non-contributory pension plan for its
employees. Generally, employees of the Bank begin participation in the pension
plan once they reach age 21 and complete 1,000 hours of service in a consecutive
12-month period. A participant in the pension plan becomes vested in his or her
accrued benefit under the pension plan upon the earlier of the: (i) attainment
of the "normal retirement age" (as described in the pension plan) while employed
at the Bank; or (ii) completion of five vesting years with the Bank.
Participants are credited with vesting years for each plan year in which they
complete at least 1,000 hours of service.
A participant's accrued benefit under the pension plan is determined by
multiplying 2% of the participant's annual compensation (defined as average
annual compensation for the three consecutive calendar years that produce the
highest average) by the number of years of service the participant has with the
Bank up to thirty (30). However, pension benefits are reduced 1/15th for each
of the first five years and 1/30th for each of the next five years, by which
benefit commencement precedes normal retirement. Pension benefits are payable in
equal monthly installments for life, or for married persons as a joint survivor
annuity over the lives of the participant and spouse. If a participant dies
while employed by the Bank, a death benefit will be payable to either his or her
60
spouse or estate, or named beneficiary, equal to the entire amount of the
participant's accrued benefit in the plan. If a participant is terminated from
employment with a vested benefit and dies before starting to receive payments,
the benefit will be payable on his or her behalf. Married participants in the
pension plan may elect, with spousal consent where required by law, to receive
their pension benefits in the form of a 50%, 75% or 100% joint and survivor
annuity or a life only payment option.
The following table indicates the annual retirement benefits that would be
payable under the pension plan and the related supplemental executive retirement
plan (see below) upon retirement at age 65 to a participant electing to receive
his or her pension benefit in the standard form of benefit, assuming various
specified levels of plan compensation and various specified years of credited
service. Under the Internal Revenue Code, maximum annual benefits under the
pension plan are limited to $130,000 per year and annual compensation for
calculation purposes is limited to $160,000 per year for the 1999 calendar year.
Years of Service
Average Annual --------------------------------------------------------
Compensation 5 10 15 20 25 30+
- -------------- --------------------------------------------------------
$ 25,000 $ 2,500 $ 5,000 $ 7,500 $ 10,000 $ 12,500 $ 15,000
50,000 5,000 10,000 15,000 20,000 25,000 30,000
75,000 7,500 15,000 22,500 30,000 37,500 45,000
100,000 10,000 20,000 30,000 40,000 50,000 60,000
125,000 12,500 25,000 37,500 50,000 62,500 75,000
150,000 15,000 30,000 45,000 60,000 75,000 90,000
175,000 17,500 35,000 52,500 70,000 87,500 105,000
200,000 20,000 40,000 60,000 80,000 100,000 120,000
250,000 25,000 50,000 75,000 100,000 125,000 150,000
300,000 30,000 60,000 90,000 120,000 150,000 180,000
350,000 35,000 70,000 105,000 140,000 175,000 210,000
At December 31, 1999, which is the date of the most recent pension plan
statement, the pension plan's assets exceeded the benefit obligation by
approximately $1.7 million. The pension plan benefits listed on the table above
are not subject to a deduction for Social Security benefits or any other offset
amount. As of January 1, 2000, Messrs. Meduski, Pike, Anderson, Somerville and
Mason had 16, 16, 13, 15 and 11 years of service with the Bank, respectively,
for purposes of the pension plan.
Supplemental Executive Retirement Programs. The Bank maintains a non-tax-
qualified supplemental executive retirement plan to provide key personnel with
pension benefits that cannot be provided directly through the Bank's pension
plan as result of Internal Revenue Code limitations on the benefits available
through a tax-qualified plan. Benefits under the supplemental executive
retirement plan are based on the same formula as the employee pension plan, but
without regard to the limitations on the amount of salary that may be taken into
account for benefits purposes under the pension plan or the level of benefits
permitted under the pension plan. The benefits available under the supplemental
executive retirement plan are reduced by the benefits actually payable under the
pension plan. Supplemental executive retirement plan benefits are payable at the
same times and in the same forms as benefits payable under the pension plan. At
present, the only participants in the plan are Messrs. Meduski and Pike. At
December 31, 1999, the plan's benefit liability was approximately $384,000.
In addition to this supplemental executive retirement plan, the Bank also
provides Mr. Meduski with an annual supplemental payment of $36,335 to cover the
premiums on a life insurance policy in which Mr. Meduski is the sole owner. The
cash value of the policy is intended to provide Mr. Meduski with an additional
source of retirement income.
61
The Bank has amended and restated the supplemental executive retirement
plan to provide for similar supplemental benefits with respect to the 401(k)
plan and the employee stock ownership plan, as well as benefits otherwise
limited by other provisions of the Internal Revenue Code or the terms of the
employee stock ownership plan loan (see below). Specifically, the amended and
restated plan will provide benefits to eligible individuals (designated by the
Board of Directors of the Bank or its affiliates) that cannot be provided under
the 401(k) Plan and/or the employee stock ownership plan as a result of the
limitations imposed by the Internal Revenue Code, but that would have been
provided under the 401(k) Plan and/or the employee stock ownership plan but for
such limitations. In addition to providing for benefits lost under tax-
qualified plans as a result of limitations imposed by the Internal Revenue Code,
the amended and restated plan will also provide supplemental benefits to
designated individuals who retire, who are participants at the time of a change
in control, or whose participation in the employee stock ownership plan ends due
to termination of the employee stock ownership plan (regardless of whether the
individual terminates employment) before the complete scheduled repayment of the
employee stock ownership plan loan. Generally, if an eligible individual
retires or a change in control of the Bank or the Company occurs before complete
repayment of the employee stock ownership plan loan, the supplemental executive
retirement plan will provide the individual with a benefit equal to what the
individual would have received under the employee stock ownership plan had he
remained employed throughout the term of the employee stock ownership plan or
had the employee stock ownership plan not been terminated before the scheduled
repayment of the employee stock ownership plan loan less the benefits actually
provided under the employee stock ownership plan on behalf of such individual.
An individual's benefits under the supplemental executive retirement plan will
generally become payable upon the participant's retirement (in accordance with
the standard retirement policies of the Bank), upon the change in control of the
Bank or the Company or as determined under the applicable tax-qualified
retirement plans sponsored by the Bank. The Board of Directors intends to
designate Messrs. Meduski, Pike, Anderson and Bailey as participants in the
supplemental executive retirement plan.
The amended and restated supplemental executive retirement plan will also
provide the Board of Directors with the opportunity to provide a retention
incentive for key personnel in the form of enhanced early retirement benefits.
Upon selection by the Board, a designated officer would be eligible to retire at
age 60 with a retirement benefit equal to 60 percent of his final average
compensation (base salary and cash bonus) less benefits payable under the Bank
pension plan and the pension provisions of the supplemental executive retirement
plan. However, no benefit would be payable under this provision in the event of
the officer's termination of employment before age 60, other than in the event
of the officer's death, disability or upon a change in control of the Bank or
the Company. The plan further provides that a designated officer's spouse would
receive a survivor's benefit equal to 50 percent of the benefit provided to the
officer during his lifetime. It is anticipated that the Board will designate
Mr. Meduski as a participant under this provision in order to ensure that his
overall compensation reflects his significant role at the Bank and to provide an
incentive for his continued employment. In connection with Mr. Meduski's
designation, it is anticipated that the Bank will accrue compensation expense of
approximately $297,000 over the next five years.
The Bank currently maintains a grantor trust in connection with the
supplemental executive retirement plan. The Bank has amended this trust
agreement to include the amended and restated supplemental executive retirement
plan. The assets of the grantor trust are subject to the claims of the Bank's
general creditors in the event of the Bank's insolvency until paid to the
individual according to the terms of the supplemental executive retirement
plans.
62
Item 12. Security Ownership of Certain Beneficial Owners and Management.
- -------------------------------------------------------------------------
The following table sets forth information as to those persons believed by
management to be beneficial owners of more than 5% of the Company's outstanding
shares of Common Stock or as disclosed in certain reports received to date
regarding such ownership filed by such persons with the Company and the
Securities and Exchange Commission, in accordance with Section 13(d) and 13(g)
of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Other
than those persons listed below, the Company is not aware of any person, as such
term is defined in the Exchange Act, who owns more than 5% of the Company's
Common Stock as of the Record Date.
Name and Address Number Percent
Title of Class of Beneficial Owner of Shares of Class
- ---------------- ------------------------------- ------------------ ----------
Common Stock..... The Savings Bank of Manchester 898,560(1) 8.0%
Employee Stock Ownership Plan
(the "ESOP")
923 Main Street
Manchester, CT 06040
Common Stock..... SBM Charitable Foundation, Inc. 832,000 (2) 7.4%
(the "Foundation")
923 Main Street
Manchester, CT 06040
_____________________________
(1) Shares of Common Stock were acquired by the ESOP in the Bank's Conversion.
The ESOP Committee administers the ESOP. An independent trust company has
been appointed as the corporate trustee for the ESOP ("ESOP Trustee"). The
ESOP Trustee, subject to its fiduciary duty, must vote all allocated shares
held in the ESOP in accordance with the instructions of the participants.
As of March 15, 2000, no shares had been allocated under the ESOP. Under
the ESOP, unallocated shares and allocated shares as to which voting
instructions are not given by participants are to be voted by the ESOP
Trustee in a manner calculated to most accurately reflect the instructions
received from participants regarding the allocated stock so long as such
vote is in accordance with the provisions of the Employee Retirement Income
Security Act of 1974, as amended ("ERISA").
(2) The Foundation was established and funded by the Company in connection with
the Conversion with an amount of the Company's Common Stock equal to 8.0%
of the total amount of Common Stock sold in the Conversion. The Foundation
is a Delaware non-stock corporation and is dedicated to the promotion of
charitable purposes within the communities in which the Bank operates. The
Foundation is governed by a board of directors with 15 members, all of whom
are directors or officers of the Company or the Bank. Pursuant to the terms
of the contribution of Common Stock, as mandated by the Federal Deposit
Insurance Corporation, all shares of Common Stock held by the Foundation
must be voted in the same ratio as all other shares of the Company's Common
Stock on all proposals considered by shareholders of the Company.
63
Security Ownership of Management
The following table sets forth as of March 15, 2000, the number of shares
of Common Stock that the directors and Named Executive Officers own and that all
directors and executive officers own as group.
Number of Percent of
Name Title of Class Shares (1) Class
- ------------------------------------- ----------------------------------------
Thomas A. Bailey Common Stock 10,000 *
Richard P. Meduski Common Stock 25,000 *
A. Paul Berte Common Stock 591 *
Timothy J. Devanney Common Stock 7,650(2) *
M. Adler Dobkin Common Stock 10,000 *
Sheila B. Flanagan Common Stock 25,000 *
John D. LaBelle, Jr. Common Stock 6,000 *
Eric A. Marziali Common Stock 25,000 *
Jon L. Norris Common Stock 2,500 *
William D. O'Neill Common Stock 29,000(2) *
Laurence P. Rubinow Common Stock 25,000 *
John G. Sommers Common Stock 25,000 *
Thomas E. Toomey Common Stock 1,000 *
Gregory S. Wolff Common Stock 20,000 *
Charles L. Pike Common Stock 25,000 *
Douglas K. Anderson Common Stock 26,640 *
Nicholas B. Mason Common Stock 11,997 *
Roger A. Somerville Common Stock 10,510 *
All Directors and Executive Officers Common Stock 281,888(2) 2.51%
as a Group (18 persons)
_____________________________
*Does not exceed 1.0% of the Company's voting securities.
(1) Each person effectively exercisable sole (or shares with spouse or other
immediate family members) voting or dispositive powers as to shares
reported.
(2) Includes 4,000 shares owned by the St. James School Foundation, Inc.
Messrs. Devanney and O'Neill serve as trustees of the foundation and share
voting control with others with respect to the shares owned by the
foundation.
64
Item 13. Certain Relationships and Related Transactions.
- ---------------------------------------------------------
Loans and Extensions of Credit. Federal regulations require that all loans
or extensions of credit to executive officers and directors must generally be
made on substantially the same terms, including interest rates and collateral,
as those prevailing at the time for comparable transactions with other persons,
unless the loan or extension of credit is made under a benefit program generally
available to all other employees and does not give preference to any insider
over any other employee, and must not involve more than the normal risk of
repayment or present other unfavorable features. In addition, loans made to a
director or executive officer in an amount that, when aggregated with the amount
of all other loans to the person and his or her related interests, are in excess
of the greater of $25,000 or 5% of the Bank's capital and surplus, up to a
maximum of $500,000, must be approved in advance by a majority of the
disinterested members of the Board of Directors.
Except for loans made to employees under the terms of Savings Bank of
Manchester's Employee Mortgage Rate, the Bank currently makes loans to its
executive officers and directors on the same terms and conditions offered to the
general public. The Bank's policy provides that all loans made by the Bank to
its executive officers and directors be made in the ordinary course of business,
on substantially the same terms, including interest rates and collateral, as
those prevailing at the time for comparable transactions with other persons and
do not involve more than the normal risk of collectibility or present other
unfavorable features. The aggregate amount of loans by the Bank to its
executive officers and directors was approximately $15.8 million at December 31,
1999, all of which were performing according to their original terms at December
31, 1999.
Other Transactions. Mr. Anderson, the Bank's Executive Vice President, is
a director of the Board and a significant shareholder of Open Solutions, Inc.,
the Bank's computer software provider. For the years ended December 31, 1999
and 1998, the Bank paid fees to Open Solutions of $333,000 and $156,000,
respectively.
In addition, the Bank uses the services of the law firms of LaBelle,
LaBelle, Naab & Horvath, P.C. and Woodhouse, Rubinow & Macht, P.C. Messrs.
LaBelle and Rubinow, directors of the Company and the Bank, are partners of each
of their respective firms. Both law firms are used for a variety of legal work
in the ordinary course of the Bank's business. Total payments by the Bank to
Mr. LaBelle's law firm totalled $230 for the year ended December 31, 1999 and
there were no fees paid to Mr. LaBelle's law firm for the year ended December
31, 1998. Total payments by the Bank to Mr. Rubinow's law firm totalled $38,000
and $39,000 for the years ended December 31, 1999 and 1998, respectively.
65
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
CONNECTICUT BANKSHARES, M.H.C. AND SUBSIDIARY
---------------------------------------------
Page
----
Report of Independent Public Accountants.......................................................... F-2
Consolidated Statements of Condition as of December 31, 1999 and 1998............................. F-3
Consolidated Statements of Operations for the Years Ended December 31, 1999, 1998 and 1997........ F-4
Consolidated Statements of Changes in Capital for the Years Ended December 31, 1999,
1998 and 1997................................................................................... F-5
Consolidated Statements of Cash Flows for the Years Ended December 31, 1999, 1998 and 1997........ F-6
Notes to Consolidated Financial Statements........................................................ F-7
All schedules, except those set forth above, are
omitted as the required information either
is not applicable or is included in the
Consolidated Financial Statements or related Notes.
F-1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
----------------------------------------
To the Board of Directors of
Connecticut Bankshares, M.H.C.:
We have audited the accompanying consolidated statements of condition of
Connecticut Bankshares, M.H.C. (a Connecticut mutual holding company) and its
subsidiary, The Savings Bank of Manchester (collectively, the Bank), as of
December 31, 1999 and 1998, and the related consolidated statements of
operations, changes in capital and cash flows for each of the three years in the
period ended December 31, 1999. These consolidated financial statements are the
responsibility of the Bank's management. Our responsibility is to express an
opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Connecticut
Bankshares, M.H.C. and subsidiary as of December 31, 1999 and 1998, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 1999 in conformity with accounting principles
generally accepted in the United States.
Hartford, Connecticut
January 21, 2000, except for
Note 14 as to which the date
is March 1, 2000
F-2
CONNECTICUT BANKSHARES, M.H.C. AND SUBSIDIARY
---------------------------------------------
CONSOLIDATED STATEMENTS OF CONDITION
------------------------------------
AS OF DECEMBER 31, 1999 AND 1998
--------------------------------
(In Thousands)
ASSETS 1999 1998
-------- ------- -------
Cash and cash equivalents........................... $ 26,678 $ 45,048
Securities available for sale (cost of
$165,802 at December 31, 1999 and
$153,346 at December 31, 1998).................... 181,854 168,151
Securities held to maturity (market value of
$44,998 at December 31, 1999 and $53,054 at
December 31, 1998)................................ 46,060 52,597
Loans held for sale................................. 38 121
Loans, net.......................................... 938,340 806,787
Federal Home Loan Bank stock, at cost............... 5,909 5,909
Premises and equipment, net......................... 14,436 15,621
Accrued interest receivable......................... 6,900 6,435
Other real estate owned............................. 604 1,759
Excess of purchase price over fair value on
branch acquisitions............................... 2,398 2,830
Other assets........................................ 4,581 3,029
---------- ----------
Total assets................... $1,227,798 $1,108,287
========== ==========
LIABILITIES AND CAPITAL
---------------------------
Deposits............................................ $ 906,591 $ 855,117
Short-term borrowed funds........................... 95,814 79,545
Mortgagors' escrow accounts......................... 8,674 7,627
Advances from Federal Home Loan Bank................ 84,000 45,000
Current and deferred income taxes................... 509 1,019
Other liabilities................................... 8,987 7,172
---------- ----------
Total liabilities.............. 1,104,575 995,480
---------- ----------
Commitments and contingencies (Notes 8, 11
and 14)
Capital:
Surplus........................................... 14,957 14,957
Undivided profits................................. 97,351 88,597
Accumulated other comprehensive income............ 10,915 9,253
---------- ----------
Total capital.................. 123,223 112,807
---------- ----------
Total liabilities and capital.. $1,227,798 $1,108,287
========== ==========
The accompanying notes are an integral part of
these consolidated financial statements.
F-3
CONNECTICUT BANKSHARES, M.H.C. AND SUBSIDIARY
---------------------------------------------
CONSOLIDATED STATEMENTS OF OPERATIONS
-------------------------------------
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
----------------------------------------------------
(In Thousands)
1999 1998 1997
-------- -------- -------
Interest income on loans......................... $66,425 $64,511 $63,314
Interest and dividends on investment securities.. 12,409 12,347 10,617
------- ------- -------
Total interest and dividend income............ 78,834 76,858 73,931
------- ------- -------
Interest and dividend expense:
Dividends on deposits........................... 33,758 34,893 34,880
Interest on borrowings.......................... 3,616 2,307 976
------- ------- -------
Total interest and dividend expense........... 37,374 37,200 35,856
------- ------- -------
Net interest income.............................. 41,460 39,658 38,075
Provision for loan losses........................ 1,100 1,200 1,200
------- ------- -------
Net interest income after provision for loan
losses.......................................... 40,360 38,458 36,875
------- ------- -------
Noninterest income:
Service charges and fees........................ 5,866 5,448 5,120
Gains on sales of securities, net............... 1,372 2,621 4,007
Gains on mortgage loan sales.................... 551 2,415 410
Other........................................... 1,617 1,676 1,930
------- ------- -------
Total noninterest income...................... 9,406 12,160 11,467
------- ------- -------
Noninterest expense:
Salaries........................................ 15,195 14,091 12,582
Pension and other employee benefits............. 4,297 3,959 3,293
Occupancy, net.................................. 3,232 3,162 2,929
Fees and services............................... 3,790 3,215 2,922
Furniture and equipment......................... 2,962 2,852 2,271
Marketing....................................... 1,784 1,664 1,400
Foreclosed real estate expense.................. 277 385 903
Net (gains) losses on sales of other real
estate owned................................... (64) (324) 404
Securities contributed to Savings Bank of
Manchester Foundation, Inc..................... - 3,000 -
Other operating expenses........................ 5,113 5,088 4,852
------- ------- -------
Total noninterest expense..................... 36,586 37,092 31,556
------- ------- -------
Income before provision for income taxes........ 13,180 13,526 16,786
Provision for income taxes...................... 4,426 4,208 6,584
------- ------- -------
Net income...................................... $ 8,754 $ 9,318 $10,202
======= ======= =======
The accompanying notes are an integral part of
these consolidated financial statements.
F-4
CONNECTICUT BANKSHARES, M.H.C. AND SUBSIDIARY
---------------------------------------------
CONSOLIDATED STATEMENTS OF CHANGES IN CAPITAL
---------------------------------------------
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
----------------------------------------------------
(In Thousands)
Accumulated
Other
Undivided Comprehensive
Surplus Profits Income Total
-------- --------- ------------- --------
BALANCE, December 31, 1996..... $15,061 $68,973 $ 4,501 $ 88,535
------- ------- ------------- --------
Comprehensive income:
Net income................. - 10,202 - 10,202
Change in unrealized
gain on securities
available for sale,
net of taxes............. - - 2,454 2,454
------- ------- ------------- --------
Total comprehensive income... - 10,202 2,454 12,656
------- ------- ------------- --------
Transfers, net............... (104) 104 - -
------- ------- ------------- --------
BALANCE, December 31, 1997..... 14,957 79,279 6,955 101,191
------- ------- ------------- --------
Comprehensive income:
Net income................. - 9,318 - 9,318
Change in unrealized
gain on securities
available for sale,
net of taxes............. - - 2,298 2,298
------- ------- ------------- --------
Total comprehensive income... - 9,318 2,298 11,616
------- ------- ------------- --------
BALANCE, December 31, 1998..... 14,957 88,597 9,253 112,807
------- ------- ------------- --------
Comprehensive income:
Net income................. - 8,754 - 8,754
Change in unrealized
gain on securities
available for sale,
net of taxes............. - - 1,662 1,662
------- ------- ------------- --------
Total comprehensive income... - 8,754 1,662 10,416
------- ------- ------------- --------
Transfers, net............... - - - -
------- ------- ------------- --------
BALANCE, December 31, 1999..... $14,957 $97,351 $10,915 $123,223
======= ======= ============= ========
The accompanying notes are an integral part of
these consolidated financial statements.
F-5
CONNECTICUT BANKSHARES, M.H.C. AND SUBSIDIARY
---------------------------------------------
CONSOLIDATED STATEMENTS OF CASH FLOWS
-------------------------------------
FOR THE YEARS ENDED DECEMBER 31, 1999, 1998 AND 1997
----------------------------------------------------
(In Thousands)
1999 1998 1997
---------- ---------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income...................................................... $ 8,754 $ 9,318 $ 10,202
Adjustments:
Provision for loan losses..................................... 1,100 1,200 1,200
Depreciation.................................................. 2,658 2,295 1,645
Provision for loss on other real estate owned................. 214 385 903
Deferred income tax provision (benefit)....................... 61 495 (199)
Amortization/accretion -
Premium on deposits......................................... 432 407 407
Premium on loans and bonds.................................. 654 538 725
Net (gains) losses on sales of other real
estate owned................................................ (64) (324) 404
Gains on sale of securities, net.............................. (1,372) (2,621) (4,007)
Net gains on mortgage loan sales.............................. (551) (2,415) (410)
Changes in operating assets and liabilities -
Accrued interest receivable................................. (465) 289 (442)
Other assets................................................ (1,552) (1,007) (1,663)
Other liabilities........................................... 1,815 807 914
-------- -------- -------
Net cash provided by operating
activities....................................... 11,684 9,367 9,679
-------- -------- -------
CASH FLOWS FROM INVESTING ACTIVITIES:
Loan originations and purchases, net of
repayments.................................................... (151,915) (103,303) (83,211)
Proceeds from sales of loans.................................... 19,197 94,332 12,139
Proceeds from maturities of held to maturity
securities.................................................... 3,535 3,500 9,375
Proceeds from maturities of available for
sale securities............................................... 21,778 5,000 18,815
Proceeds from sales of available for sale
securities.................................................... 19,081 20,753 66,119
Purchases of held to maturity securities........................ (6,876) (17,304) (12,040)
Purchases of available for sale securities...................... (57,153) (61,694) (89,583)
Proceeds from principal payments of
mortgage-backed securities.................................... 13,249 16,510 12,643
Proceeds from sales of other real estate owned.................. 1,481 3,503 3,530
Purchases of premises and equipment............................. (1,372) (3,192) (5,263)
-------- -------- -------
Net cash used in investing activities.............. (138,995) (41,895) (67,476)
-------- -------- -------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in savings, money market, NOW and
demand deposits............................................... 47,266 57,077 16,033
Net increase (decrease) in certificates of
deposit....................................................... 4,208 (29,627) 18,801
Net increase in short-term borrowed funds....................... 16,269 379 19,918
Increase (decrease) in mortgagors' escrow
accounts...................................................... 2,198 87 (145)
Increase (decrease) in advances from Federal
Home Loan Bank................................................ 39,000 35,000 (5,000)
-------- -------- -------
Net cash provided by financing
activities....................................... 108,941 62,916 49,607
-------- -------- -------
Net (decrease) increase in cash and
cash equivalents................................. (18,370) 30,388 (8,190)
CASH AND CASH EQUIVALENTS, beginning of year...................... 45,048 14,660 22,850
-------- -------- --------
CASH AND CASH EQUIVALENTS, end of year............................ $ 26,678 $ 45,048 $ 14,660
======== ======== ========
SUPPLEMENTAL INFORMATION:
Cash paid for -
Interest and dividends........................................ $ 37,312 $ 37,214 $ 33,101
Income taxes.................................................. 4,522 5,025 6,550
Non-cash transactions -
Transfers from loans to other real estate..................... 324 1,164 3,878
owned
The accompanying notes are an integral part of
these consolidated financial statements.
F-6
CONNECTICUT BANKSHARES, M.H.C. AND SUBSIDIARY
---------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
------------------------------------------
DECEMBER 31, 1999, 1998 AND 1997
--------------------------------
1. Organization and Significant Accounting Policies:
------------------------------------------------
Organization -
------------
The accompanying consolidated financial statements include the accounts of
Connecticut Bankshares, M.H.C. (Connecticut Bankshares or the MHC) and its
wholly-owned subsidiary, The Savings Bank of Manchester (SBM), and its
wholly-owned subsidiaries, SBM, Ltd. and 923 Main, Inc. (collectively, the
Bank). Savings Bank of Manchester Mortgage Company, Inc. (SBM Mortgage), a
passive investment company for Connecticut income tax purposes, was
established in January 1999 to service and hold loans secured by real
property. SBM Mortgage is included in the consolidated financial statements
as of December 31, 1999 and for the year then ended. All material
intercompany balances and transactions have been eliminated in
consolidation.
The Bank with its main office located in Manchester, Connecticut operates
through twenty-three branches located primarily in eastern Connecticut. The
Bank's primary source of income is interest received on loans to customers,
which include small and middle market businesses and individuals residing
within the Bank's service area. As discussed in Note 14, the Bank adopted a
Plan of Conversion pursuant to which in March 2000 Connecticut Bankshares
merged into the Bank, with the Bank being the surviving corporation, and
the Bank continuing as a state-chartered stock bank.
In 1998, the Bank contributed securities with a fair market value of
approximately $3 million to the newly formed Savings Bank of Manchester
Foundation, Inc. (the Foundation), a not-for-profit organization. The
Foundation was formed to provide charitable contributions for the
surrounding community. In connection with the contribution, the Bank
realized a gain of approximately $2.3 million on the transfer of
securities.
Use of estimates in the preparation of financial statements -
-----------------------------------------------------------
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities as of the date of the
financial statements and the reported amounts of income and expenses during
the reporting periods. Operating results in the future could vary from the
amounts derived from management's estimates and assumptions. A material
estimate that is particularly susceptible to changes in the near term
relates to the determination of the allowance for loan losses (see Note 4).
Cash flows -
----------
For purposes of reporting cash flows, cash and cash equivalents include
cash and due from banks.
F-7
Investment and mortgage-backed securities -
-----------------------------------------
Investments are classified into one of three categories and accounted for
as follows:
Category Accounting Treatment
-------- --------------------
Trading, representing debt, Reported at fair value, with
equity and mortgage-backed unrealized gains and losses
securities which are held for included in noninterest income
resale in the near term
Held to maturity, representing Reported at amortized cost
debt and mortgage-backed
securities for which the Bank
has the positive intent and
ability to hold to maturity
Available for sale, Reported at fair value, with
representing debt, equity and unrealized gains and losses, net
mortgage-backed securities of tax, reported as a separate
not classified as trading component of accumulated other
or held to maturity comprehensive income
Any security that experiences a decline in value that management believes
is other than temporary is reduced to its net realizable value by a charge
to noninterest income. Realized gains and losses from the sale of
investments are recorded on the trade date by specific identification of
the security sold.
Loans held for sale -
-------------------
Loans held for sale are valued at the lower of acquisition cost (less
principal payments received) or estimated market value. Market is
determined by reference to outstanding commitments from investors
calculated on an individual loan basis. Net unrealized losses are
recognized in a valuation allowance established by charges to noninterest
income.
Loans -
-----
Loans are stated at their principal amounts outstanding net of unearned
income. Interest on loans is recorded as income based on rates applied to
principal amounts outstanding. Some installment and commercial loans are
made on a discounted basis, and the unearned discount is recorded in income
by use of a method that approximates the effective interest method. In
determining income recognition on loans, generally no interest is
recognized with respect to loans on which a default of interest or
principal has occurred for a period of ninety days or more and collection
of any portion of the loan is considered to be doubtful, or for a lesser
period if circumstances indicate collection of any portion of the loan is
doubtful.
Loan origination fees and certain direct loan origination costs are
capitalized, and the net fee or cost is recognized in interest income using
the effective interest method over the contractual life of the loans. When
loans are prepaid, sold or participated out, the unamortized portion of
deferred fees and related origination costs are recognized as income at
that time. As of December 31, 1999 and 1998, net deferred loan fees were
approximately $1,519,000 and $1,021,000, respectively.
F-8
The allowance for loan losses is established through a provision charged to
expense. Loans are charged against the allowance for loan losses when
management believes the collectibility of principal is unlikely. The
allowance represents an amount which, in management's judgment, will be
adequate to absorb losses on existing loans that may become uncollectible.
Management's judgment in determining the adequacy of the allowance is based
on the evaluation of individual performing and impaired loans, risk
characteristics of the loan portfolios, assessment of current economic and
real estate market conditions, estimates of the current value of underlying
collateral, past and current loan loss experience and other relevant
factors.
The Bank has identified certain loans as impaired based upon management's
belief it is probable that the borrower will be unable to pay all principal
and interest amounts in accordance with the loan agreement's contractual
terms. The Bank is required to account for the time value of money when
determining the adequacy of the Bank's allowance for loan losses for
certain impaired loans.
Certain impaired loans are required to be measured based on the present
value of expected future cash flows discounted at the loan's original
effective interest rate. As a practical expedient, impairment also may be
measured based on the loan's observable market price or the fair value of
the collateral if the loan is collateral dependent. When the measure of the
impaired loan is less than the recorded investment in the loan, the
impairment is recorded through a valuation allowance. Interest payments
received on impaired loans are recorded as interest income unless
collection of the remaining recorded investment is doubtful, at which time
payments received are recorded as reductions of principal.
Premises and equipment -
----------------------
Depreciation of premises and equipment and amortization of leasehold
improvements are computed using the straight-line basis over the estimated
useful lives of the assets (5-39 years) or in the case of leasehold
improvements, the lease term if shorter.
Excess of purchase price over fair value on branch acquisitions -
---------------------------------------------------------------
In 1997, the Bank acquired certain assets of a branch in West Hartford,
Connecticut. The premium of $250,000, for lease rights acquired, is being
amortized over the remaining term of the lease (10 years) using the
straight-line method.
In 1995, the Bank acquired certain fixed assets and assumed certain deposit
liabilities of two branches in Storrs and Enfield, Connecticut. In
consideration of the assumption of approximately $47,408,000 of deposit
liabilities, the Bank received approximately $42,392,000 in cash and
$1,553,000 in other assets. The resultant core deposit premium intangible
of approximately $4,062,000 is being amortized over 10 years using the
straight-line method.
Other real estate owned -
-----------------------
Other real estate owned, comprised of real estate acquired through
foreclosure or acceptance of a deed in lieu of foreclosure, is carried at
the lower of cost or fair market value, net of estimated costs to sell.
Property is transferred to other real estate owned at the lower of cost or
fair market value, with any excess over cost charged to the allowance for
loan losses. Any further decline in value based on subsequent changes to
estimated fair market value or any loss upon ultimate disposition of the
property is charged to other real estate owned expenses.
F-9
Mortgage servicing rights -
-------------------------
The Bank applies the provisions of Statement of Financial Accounting
Standards (SFAS) No. 122, "Accounting for Mortgage Servicing Rights," which
requires that the cost of mortgage servicing rights to be amortized in
proportion to, and over the period of, estimated net servicing revenues.
Impairment of mortgage servicing rights is assessed based on the fair value
of those rights. Fair values are estimated using discounted cash flows
based on a current market interest rate. The amount of impairment
recognized is the amount by which the capitalized mortgage servicing rights
for a stratum exceed their fair value.
Effective January 1, 1997, the Bank adopted SFAS No. 125, "Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities," (as amended by SFAS No. 127, "Deferral of the Effective Date
of Certain Provisions of FASB Statement No. 125 (an amendment of FASB
Statement No. 125)"), which supersedes SFAS No. 122 and establishes
standards to account for transfers and servicing of financial assets and
extinguishment of liabilities. The standards are based on consistent
application of a financial-components approach that focuses on control.
Under that approach, after a transfer of financial assets, an entity
recognizes the financial and servicing assets it controls and the
liabilities it has incurred, derecognizes financial assets when control has
been surrendered, and derecognizes liabilities when extinguished. The
adoption of this statement had no effect on the Bank's consolidated
financial condition or results of operations.
When participating interests in loans sold have an average contractual
interest rate, adjusted for normal servicing fees, that differs from the
agreed yield to the purchaser, gains or losses are recognized equal to the
present value of such differential over the estimated remaining life of
such loans. The resulting "excess servicing receivable" or "deferred
servicing revenue" is amortized over the estimated life using a method
approximating the effective interest method.
Quoted market prices are not available for the excess servicing
receivables. Thus, the excess servicing receivables and the amortization
thereon periodically are evaluated in relation to estimated future
servicing revenues, taking into consideration changes in interest rates,
current prepayment rates and expected future cash flows. The Bank evaluates
the carrying value of the excess servicing receivables by estimating the
future servicing income of the excess servicing receivables based on
management's best estimate of remaining loan lives and discounted at the
original discount rate.
Short-term borrowed funds -
-------------------------
Short-term borrowings are comprised of uninsured accounts which are secured
by investment securities.
Income taxes -
------------
Items of income and expense recognized in different time periods for
financial reporting purposes and for purposes of computing income taxes
currently payable (temporary differences) give rise to deferred income
taxes which are reflected in the financial statements. A deferred tax
liability or asset is recognized for the estimated future tax effects,
based upon enacted law, attributed to temporary differences. If applicable,
the deferred tax asset is reduced by the amount of any tax benefits that,
based on available evidence, are not likely to be realized.
F-10
Related party transactions -
--------------------------
Directors and officers of the Bank and their associates have been customers
of, and have had transactions with the Bank, and management expects that
such persons will continue to have such transactions in the future. All
deposit accounts, loans, services and commitments comprising such
transactions were made in the ordinary course of business, on substantially
the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with other customers who
are not directors or officers and, in the opinion of management, the
transactions did not involve more than normal risks of collectibility,
favored treatment or terms, or present other unfavorable features (see Note
4 for further details regarding related party transactions).
Comprehensive income -
--------------------
SFAS No. 130, "Reporting Comprehensive Income" establishes standards for
separately reporting comprehensive income and its components. Components of
comprehensive income represent changes in equity resulting from
transactions and other events and circumstances from non-owner sources.
Comprehensive income for the years ended December 31, 1999, 1998 and 1997
is as follows (in thousands):
1999 1998 1997
-------- -------- --------
Net income............................. $ 8,754 $ 9,318 $10,202
Unrealized gains on securities:
Change in unrealized holding gains
arising during the period........... 3,034 4,919 6,461
Less: reclassification adjustment
for gains included in net
income............................. (1,372) (2,621) (4,007)
------- ------- -------
Comprehensive income................. $10,416 $11,616 $12,656
======= ======= =======
Segment information -
-------------------
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information" requires public companies to report certain financial
information about significant revenue-producing segments of the business
for which such information is available and utilized by the chief operating
decision-maker. Specific information to be reported for individual
operating segments includes a measure of profit and loss, certain revenue
and expense items and total assets. As a community-oriented financial
institution, substantially all of the Bank's operations involve the
delivery of loan and deposit products to customers. Management makes
operating decisions and assesses performance based on an ongoing review of
these community-banking operations, which constitutes that Bank's only
operating segment for financial reporting purposes under SFAS No. 131.
New accounting standards -
------------------------
Effective January 1, 1999 the Bank adopted SFAS No. 134, "Accounting for
Mortgage-Backed Securities Retained after the Securitization of Mortgage
Loans Held for Sale by a Mortgage Banking Enterprise, an amendment of SFAS
No. 65." This statement requires that after the securitization of mortgage
loans held for sale, an entity engaged in mortgage banking activities shall
classify the resulting mortgage-backed securities or other retained
interests based on its ability and intent to sell or hold those
investments. The adoption did not have any effect on the Bank's
consolidated financial condition or results of operations.
F-11
In June 1998, the Financial Accounting Standards Board (FASB) issued SFAS
No. 133, "Accounting for Derivative Instruments and Hedging Activities."
This statement establishes accounting and reporting standards requiring
that every derivative instrument (including certain derivative instruments
embedded in other contracts) be recorded in the balance sheet as either an
asset or liability measured at its fair value. The statement requires that
changes in the derivative's fair value be recognized currently in earnings
unless specific hedge accounting criteria are met. Special accounting for
qualifying hedges allows a derivative's gains and losses to offset related
results on the hedged item in the statement of income and requires that an
entity formally document, designate and assess the effectiveness of
transactions that receive hedge accounting. This statement was amended by
SFAS No. 137, "Accounting for Derivatives and Hedging Activities - Deferral
of the Effective Date of FASB Statement No. 133." As a result, SFAS No. 133
will be effective in 2001 for the Bank. The Bank plans to early adopt this
statement on January 1, 2000. The adoption is not expected to have a
material effect on the Bank's consolidated financial position or results of
operations. In connection with the adoption, the Bank plans to reclassify
all held to maturity investments as available for sale as allowed by SFAS
No. 133.
Reclassifications -
-----------------
Certain prior year amounts have been reclassified to conform to the current
year presentation.
2. Regulatory Matters:
------------------
The Bank is subject to various regulatory capital requirements administered
by the federal banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory, and possibly additional
discretionary, actions by regulators that, if undertaken, could have a
direct material effect on the Bank's consolidated financial statements. The
regulations require the Bank to meet specific capital adequacy guidelines
that involve quantitative measures of assets, liabilities and certain off-
balance sheet items as calculated under regulatory accounting practices.
The Bank's capital amounts and classification are also subject to
qualitative judgments by the banking regulators about components, risk
weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum capital ratios (set forth in the table
below) of Tier I leverage capital (as defined in the regulations) to total
average assets (as defined), and minimum ratios of Tier I and total capital
(as defined) to risk weighted assets (as defined). To be considered
adequately capitalized (as defined) under the regulatory framework from
Prompt Corrective Action, the Bank must maintain minimum Tier I leverage,
Tier I risk-based and total risk-based ratios as set forth in the table.
The Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA)
categorizes banks based on capital levels and triggers certain mandatory
and discretionary supervisory responses for institutions that fall below
certain capital levels. A bank generally is categorized as "well
capitalized" if it maintains a leverage capital ratio of at least 5%, a
Tier I risk-based capital ratio of at least 6% and a total risk-based
capital ratio of at least 10%, and it is not subject to a written
agreement, order or capital directive.
F-12
As of December 31, 1999 and 1998, management believes that the Bank met all
capital adequacy requirements to which it is subject. As of the most recent
notification from the Federal Deposit Insurance Corporation, the Bank was
categorized as well capitalized under the regulatory framework for Prompt
Corrective Action, and the highest capital category, as defined in the
FDICIA regulations. Management believes that there are no events or
conditions which have occurred subsequent to the notification that would
change its category.
Actual capital amounts and ratios for the Bank, which are substantially the
same as the amounts and ratios for SBM, were (dollars in thousands):
To Be Well Capitalized Under
Capital Adequacy Prompt Corrective Action
------------------------------------ --------------------------
Required Actual Required
Amount (Ratio) Amount (Ratio) Amount (Ratio)
----------------- ----------------- --------------------------
December 31, 1999:
Tier I Capital
(to Total
Average Assets)........ $48,189 (4.0%) $109,652 (9.1%) $60,236 (5.0%)
Tier I Capital
(to Risk
Weighted Assets)....... 34,463 (4.0%) 109,652 (12.7%) 51,694 (6.0%)
Total Capital (to
Risk Weighted
Assets)................ 68,925 (8.0%) 120,269 (14.0%) 86,157 (10.0%)
December 31, 1998:
Tier I Capital
(to Total
Average Assets)........ $43,320 (4.0%) $100,719 (9.3%) $54,150 (5.0%)
Tier I Capital
(to Risk
Weighted Assets)....... 31,974 (4.0%) 100,719 (12.6%) 47,961 (6.0%)
Total Capital (to
Risk Weighted
Assets)................ 57,951 (8.0%) 110,689 (13.9%) 72,438 (10.0%)
3. Investment Securities:
---------------------
As of December 31, 1999 and 1998, the amortized cost and market value of
investment securities were (in thousands):
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ----------- --------
December 31, 1999
-----------------
Available for Sale:
U.S. Government and
agency obligations........ $ 82,486 $ 13 $(1,171) $ 81,328
Corporate securities........ 33,870 6 (531) 33,345
Marketable equity
securities................ 32,273 19,428 (1,156) 50,545
Mortgage-backed
securities................ 16,741 128 (665) 16,204
Other equity securities..... 432 - - 432
-------- ------- ------- --------
Total.................. $165,802 $19,575 $(3,523) $181,854
======== ======= ======= ========
F-13
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ----------- --------
Held to Maturity:
U.S. Government and
agency obligations........ $ - $ - $ - $ -
Other securities............ 3,105 - (155) 2,950
Asset-backed securities..... 17,481 191 (254) 17,418
Mortgage-backed
securities................ 25,474 20 (864) 24,630
-------- ------- ------- --------
Total.................. $ 46,060 $ 211 $(1,273) $ 44,998
======== ======= ======= ========
December 31, 1998
------------------
Available for Sale:
U.S. Government and
agency obligations........ $ 70,563 $ 1,164 $ (24) $ 71,703
Corporate securities........ 40,128 348 (56) 40,420
Marketable equity
securities................ 29,427 13,625 (279) 42,773
Mortgage-backed
securities................ 12,832 279 (252) 12,859
Other equity securities..... 396 - - 396
-------- ------- ------- --------
Total.................. $153,346 $15,416 $ (611) $168,151
======== ======= ======= ========
Held to Maturity:
U.S. Government and
agency obligations........ $ 3,506 $ 18 $ - $ 3,524
Other securities............ 3,145 102 (1) 3,246
Asset-backed securities..... 23,204 339 (157) 23,386
Mortgage-backed
securities................ 22,742 226 (70) 22,898
-------- ------- ------- --------
Total.................. $ 52,597 $ 685 $ (228) $ 53,054
======== ======= ======= ========
As of December 31, 1999, the amortized cost and market values of debt
securities, by contractual maturity, are shown below (in thousands).
Expected maturities may differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without
call or prepayment penalties.
F-14
Held to Maturity Available for Sale
------------------ ----------------------------
Amortized Market Amortized Market
Cost Value Cost Value
--------- ------- --------- -----------
December 31, 1999
- -----------------
Due in one year or less.... $ 10 $ 10 $ 26,069 $ 25,987
Due after one year
through five years....... 7,706 7,807 60,901 59,781
Due after five years
through ten years........ 655 619 29,386 28,905
Due after ten years........ 12,215 11,932 - -
------- ------- -------- --------
Mortgage-backed
securities............... 25,474 24,630 16,741 16,204
------- ------- -------- --------
Total................. $46,060 $44,998 $133,097 $130,877
======= ======= ======== ========
For the years ended December 31, 1999 and 1998, proceeds from the sales of
available for sale securities were approximately $19,081,000 and
$20,753,000, respectively. Gross gains of approximately $1,922,000 and
$3,980,000, respectively, and gross losses of approximately $550,000 and
$1,359,000, respectively, were realized on those sales for the years ended
December 31, 1999 and 1998.
As of December 31, 1999 and 1998, investment securities with a book value
of approximately $103,627,000 and $107,358,000 were pledged as security for
short-term borrowed funds, U.S. Treasury tax and loan payments and
municipal deposits held by the Bank, respectively.
4. Loans:
-----
As of December 31, 1999 and 1998, the Bank's residential mortgage loan
portfolio was entirely secured by one- to four-family homes, located
primarily in central and eastern Connecticut. The commercial mortgage loan
portfolio was secured primarily by multi-family, commercial and
manufacturing properties located in Connecticut and surrounding states. A
variety of different assets, including business assets, rental income
properties, and manufacturing and commercial properties, secured a majority
of the commercial loans. The composition of the Bank's loan portfolio as of
December 31, 1999 and 1998 is as follows (in thousands):
1999 1998
--------- ---------
Residential mortgages.............. $549,950 $464,623
Commercial real estate mortgages... 190,885 167,577
Commercial business loans.......... 134,550 114,650
Installment loans.................. 73,572 70,522
-------- --------
Total loans........................ 948,957 817,372
Less - Allowance for loan losses... (10,617) (10,585)
-------- --------
Total loans, net.............. $938,340 $806,787
======== ========
F-15
The Bank services certain loans that it has sold without recourse to third
parties. The aggregate amount of loans serviced for others approximated
$210,158,000, $218,660,000 and $152,768,000 as of December 31, 1999, 1998
and 1997, respectively. Income from servicing loans for others was
approximately $576,000, $503,000 and $402,000 for the years ended December
31, 1999, 1998 and 1997, respectively. Mortgage servicing rights of
approximately $2,550,000, $2,480,000 and $783,000 were capitalized as of
December 31, 1999, 1998 and 1997, respectively. Amortization of mortgage
servicing rights was approximately $425,000, $276,000 and $54,000 for the
years ended December 31, 1999, 1998 and 1997, respectively.
As of December 31, 1999 and 1998, loans to related parties totaled
approximately $15,800,000 and $16,200,000, respectively. Related parties
include directors and officers of the Bank, their respective affiliates in
which they have a controlling interest and their immediate family members.
For the years ended December 31, 1999 and 1998, all loans to related
parties were performing.
Allowance for loan losses -
-------------------------
The allowance for loan losses is maintained at a level determined by
management to be the best estimate of losses incurred in the loan
portfolio. The allowance is increased or decreased by provisions or credits
charged to operations, which represent an estimate of losses that occurred
during the period and a correction of estimates of losses recorded in prior
periods. Confirmed losses, net of recoveries, are charged directly to the
allowance and the loans are written down.
The determination of the adequacy of loan losses by management is based on
an assessment of risk elements in the portfolio, identified factors
affecting specific loans and available information about the current
economic environment in which the Bank and its borrowers operates.
Management reviews overall portfolio quality through an analysis of current
levels and trends in chargeoffs, delinquency and nonaccruing loan data and
the credit risk profile of each component of the portfolio.
The allowance for loan losses consists of a formula allowance for various
loan portfolio classifications and a valuation allowance for loans
identified as impaired, if necessary. The allowance is an estimate, and
ultimate losses may vary from current estimates. Changes in the estimate
are recorded in the results of operations in the period in which they
become known, along with provisions for estimated losses incurred during
that period.
A loan is considered to be impaired when it is probable that a creditor
will be unable to collect all amounts due according to the contractual
terms of the loan agreement. Impaired loans, as defined, may be measured
based on the present value of expected future cash flows, discounted at the
loan's original effective interest rate or on the loan's observable market
price or the fair value of the collateral if the loan is collateral-
dependent. When the measurement of the impaired loan is less than the
recorded investment in the loan, the impairment is recorded through a
valuation allowance.
F-16
For the years ended December 31, 1999, 1998 and 1997, an analysis of the
allowance for loan losses is (in thousands):
1999 1998 1997
-------- -------- -------
Balance, beginning of period... $10,585 $ 9,945 $9,131
Provision for loan losses...... 1,100 1,200 1,200
Loans charged off.............. (1,360) (1,087) (946)
Recoveries..................... 292 527 560
------- ------- ------
Balance, end of period......... $10,617 $10,585 $9,945
======= ======= ======
5. Nonperforming Assets:
--------------------
Nonperforming assets include loans for which the Bank does not accrue
interest ("nonaccrual loans"), loans 90 days past due and still accruing
interest and other real estate owned. Nonaccrual loans and loans 90 days
past due and still accruing interest represent the Bank's impaired loans.
For the years ended December 31, 1999, 1998 and 1997, the average recorded
investment in impaired loans was approximately $6,417,000, $2,200,000 and
$5,000,000, respectively. As of December 31, 1999 and 1998, nonperforming
assets were (in thousands):
1999 1998
------- ------
Nonaccrual loans................. $11,130 $ 784
Loans 90 days past due and
accruing interest.............. 355 740
Other real estate owned.......... 604 1,759
------- ------
Total nonperforming assets.. $12,089 $3,283
======= ======
For the years ended December 31, 1999, 1998 and 1997, had interest income
been accrued on nonaccrual loans at contractual rates, interest income
would have increased by approximately $635,000, $136,000 and $337,000,
respectively. For the years ended December 31, 1999, 1998 and 1997,
interest income on impaired loans of approximately $125,000, $80,000 and
$32,000, respectively, was recognized. As of years ended December 31, 1999,
1998 and 1997, no significant additional funds were committed to customers
whose loans were nonperforming.
As of December 31, 1999 and 1998, the Bank had impaired loans of
approximately $11,485,000 and $1,524,000, respectively, for which no
valuation allowance was required. For the year ended December 31, 1999,
$700,000 was charged off on nonaccrual loans. For the years ended December
31, 1998 and 1997, no chargeoffs occurred on impaired loans.
The increase in the nonperforming asset balance as of December 31, 1999 as
compared to December 31, 1998 relates to two relationships which were
placed on nonaccrual status during 1999. One commercial real estate loan
for $4.3 million and four commercial real estate loans to one borrower
aggregating $6.0 million went on nonaccrual status in April 1999 and
September 1999, respectively.
F-17
6. Deposits:
--------
As of December 31, 1999 and 1998, deposits consisted of (in thousands):
1999 1998
-------- --------
Certificates of Deposit:
One to twelve-month certificates.... $210,597 $127,195
One to five year certificates....... 179,261 261,973
Time certificates in denominations
of $100,000 or more................ 60,489 56,971
-------- --------
450,347 446,139
-------- --------
Savings accounts...................... 223,656 220,653
Money market accounts................. 68,532 38,387
NOW accounts.......................... 112,741 110,841
Demand deposits....................... 51,315 39,097
-------- --------
Total deposits..................... $906,591 $855,117
======== ========
For the years ended December 31, 1999, 1998 and 1997, interest expense on
time deposits in denominations greater than $100,000 was approximately
$2,587,000, $2,921,000 and $3,022,000, respectively.
7. Advances from Federal Home Loan Bank and Short-Term Borrowed Funds:
------------------------------------------------------------------
As of December 31, 1999 and 1998, the Bank had the following borrowings from
Federal Home Loan Bank of Boston (FHLB) (in thousands):
Interest
Rate Maturity Date 1999 1998
-------- ------------- ---- ----
8.96% August 23, 1999 $ - $ 2,000
8.91% September 7, 1999 - 1,000
8.76% September 20, 1999 - 2,000
5.83% March 23, 2000 44,000 -
5.76% April 5, 2000 10,000 -
6.05% May 2, 2005 30,000 30,000
4.99% January 8, 2008 (1) - 10,000
------- ------
Total advances from Federal
Home Loan Bank $84,000 $45,000
======= =======
(1) Advance was callable quarterly and was called during 1999.
The Bank's FHLB stock collateralizes these advances. In addition, mortgage
loans and otherwise unencumbered investment securities qualified as
collateral available to the FHLB were pledged to secure these advances,
unused credit lines and letters of credit issued by the FHLB.
F-18
The Bank maintains a line of credit of $34,000,000 with the FHLB which
accrues interest at variable rates determined by the FHLB on a daily basis.
Amounts drawn against the line of credit are due within one day of
withdrawal, however, such amounts are automatically renewed provided that
the Bank has sufficient cash balances deposited with the FHLB. Borrowings
under the line of credit are secured by U.S. Government treasury and/or
agency bonds. There were no outstanding borrowings on the FHLB line of
credit at December 31, 1999 or 1998. The Bank also maintains a $15,000,000
line of credit with a correspondent bank. No amounts were outstanding on the
correspondent line as of December 31, 1999 or 1998.
Short-term borrowed funds represents commercial transactional repurchase
accounts (business checking accounts which are not Federal Deposit Insurance
Corporation insured).
8. Pension Plans:
-------------
The Bank has a non-contributory defined benefit pension plan (the Plan)
covering substantially all employees. The benefits are based on years of
service and average compensation, as defined in the Plan. The Bank's funding
policy is to contribute annually the maximum amount allowed by federal tax
regulations.
The following table sets forth change in benefit obligation, change in plan
assets and the funded status of the Bank's pension plan for the years ended
December 31, 1999 and 1998. The table also provides a reconciliation of the
plan's funded status and the amounts recognized in the Bank's consolidated
statements of condition (in thousands):
1999 1998
-------- --------
Change in benefit obligation:
Benefit obligation, beginning of
year................................... $18,082 $13,275
Service cost............................. 1,416 989
Interest cost............................ 1,161 980
Actuarial (gain) loss.................... (2,376) 3,251
Benefits paid............................ (448) (413)
------- -------
Benefit obligation, end of year............ 17,835 18,082
------- -------
Change in plan assets:
Fair value of plan assets,
beginning of year...................... 17,163 16,747
Actual return on plan assets............. 2,811 715
Employer contribution.................... - 114
Benefits paid............................ (448) (413)
------- -------
Fair value of plan assets, end of year... 19,526 17,163
------- -------
Funded status.............................. 1,691 (919)
Unrecognized transition asset.............. (271) (348)
Unrecognized prior service cost............ 107 115
Unrecognized contributions................. 97 -
Unrecognized net actuarial gain............ (5,538) (1,648)
------- -------
Net prepaid recognized............. $(3,914) $(2,800)
======= =======
F-19
The components of net periodic pension cost for the years ended December 31,
1999, 1998 and 1997 were as follows (in thousands):
1999 1998 1997
----------- ------------ ------------
Service cost........................ $ 1,416 $ 989 $ 785
Interest cost....................... 1,161 980 844
Expected return on
plan assets....................... (1,297) (1,119) (1,001)
Amortization and
deferral.......................... (69) (69) (69)
------- ------- -------
Net periodic pension
cost.............................. $ 1,211 $ 781 $ 559
======= ======= =======
Significant actuarial assumptions used in determining the actuarial present
value of the projected benefit obligation and the net periodic pension cost
were as follows:
1999 1998 1997
----- ----- -----
Discount rate....................... 7.5% 6.5% 7.5%
Rate of increase in compensation
levels............................ 4.5 4.5 4.5
Long-term rate of return on assets.. 8.5 8.0 8.0
The Bank has entered into deferred compensation agreements with certain
officers providing for benefits after retirement. The liabilities under
these agreements are being accrued over the officers' remaining periods of
employment so that, on the date of retirement, the then-present value of the
benefits will have been accrued. As of December 31, 1999 and 1998,
approximately $384,000 and $276,000, respectively, had been accrued under
these agreements.
In addition to providing pension benefits, the Bank provides certain health
care benefits for retired employees (the Health Care Plan). Only employees
retiring before January 1, 1989 are eligible for these benefits, provided
they attain age 55 while working for the Bank. In addition, all employees
who have attained age 55 and have ten years of vested service are covered
under the Health Care Plan until age 65. Effective January 1, 1993, the Bank
began to accrue for the estimated costs of these benefits through charges to
expense during the years that the employees earn these benefits.
The following table reconciles the Health Care Plan's funded status to the
accrued postretirement cost as of December 31, 1999 and 1998 (in thousands):
1999 1998
------- -------
Accumulated postretirement benefit
obligation:
Retirees............................ $ 454 $ 490
Other fully eligible participants... 137 94
Other active participants........... 403 384
------ ------
994 968
Unrecognized actuarial gain............. 576 588
Unrecognized prior service cost......... (168) (181)
------ ------
Prepaid postretirement cost............. $1,402 $1,375
====== ======
F-20
For the years ended December 31, 1999, 1998 and 1997, net postretirement
health care cost included the following components (in thousands):
1999 1998 1997
------ ------ ------
Service cost............... $ 64 $ 39 $ 34
Interest cost.............. 61 75 71
Amortization and deferral.. (17) (9) (15)
----- ----- -----
$ 108 $ 105 $ 90
===== ===== =====
Significant actuarial assumptions used in determining the actuarial present
value of the projected benefit obligation and the net postretirement health
care cost are as follows:
1999 1998 1997
----- ----- -----
Discount rate.............. 7.5% 6.5% 7.5%
Rate of increase in
compensation levels...... 4.0 4.0 4.0
The health care cost trend rate used to measure the accumulated
postretirement benefit obligation is 7% as of December 31, 1999. Increasing
the health care cost trend rate by 1% would increase the accumulated
postretirement benefit cost by approximately $70,000, and the net
postretirement benefit cost by approximately $11,000, (pretax) annually as
of December 31, 1999.
9. Income Taxes:
------------
For the years ended December 31, 1999, 1998 and 1997, the provision
(benefit) for income taxes consisted of the following (in thousands):
1999 1998 1997
------ ------ -------
Current tax provision:
Federal................................ $4,365 $3,156 $5,766
State.................................. - 557 1,017
------ ------ ------
Total current............... 4,365 3,713 6,783
------ ------ ------
Deferred tax provision (benefit):
Federal................................ 61 421 (169)
State.................................. - 74 (30)
------ ------ ------
Total deferred.............. 61 495 (199)
------ ------ ------
Total provision for income
taxes..................... $4,426 $4,208 $6,584
====== ====== ======
F-21
As of December 31, 1999 and 1998, the components of the net deferred income
tax liability included in current and deferred income taxes in the
accompanying consolidated statements of condition were (in thousands):
1999 1998
-------- --------
Total deferred tax assets......... $ 6,688 $ 7,541
Total deferred tax liabilities.... (7,852) (7,949)
Total state valuation allowance... - (704)
------- -------
Net deferred tax liability.... $(1,164) $(1,112)
======= =======
The deferred tax assets are primarily the result of financial accruals not
currently deductible for tax return purposes and the allowance for loan
losses reflected as a current expense for financial reporting purposes and a
future charge-off for tax return purposes. The deferred tax liabilities are
primarily attributed to accelerated depreciation on premises and equipment
for tax return purposes and unrealized gains in the securities available for
sale portfolio.
Effective for taxable years commencing after December 31, 1998, financial
service companies are permitted to establish in the State of Connecticut a
passive investment company (PIC) to hold and manage loans secured by real
property. Income earned by the PIC is exempt from Connecticut corporation
business tax and dividends received by the financial service company from
the PIC are not taxable. In 1999, the Bank established a PIC, as a wholly-
owned subsidiary, and transferred a portion of its real estate mortgage
portfolio from the Bank to the PIC. During 1999, the deferred state tax
assets that the valuation allowance was established for were written off
upon the transfer to the PIC and the valuation allowance was eliminated.
Prior to 1999, all state deferred tax assets were reserved for due to
uncertainty of realization.
For the years ended December 31, 1999, 1998 and 1997, the provision for
income taxes differed from the amount computed by applying the statutory
federal income tax rate (35%) to income before provision for income taxes
for the following reasons (in thousands):
1999 1998 1997
------- ------- -------
Tax provision at statutory rate...... $4,613 $4,734 $5,875
Increase (decrease) in tax
resulting from:
State income taxes, net of
federal tax benefit............ - 817 1,037
Gain on contribution of
securities to Savings Bank of
Manchester Foundation, Inc..... - (921) -
Dividends received deduction..... (245) (409) (409)
Reduction in state tax rate...... - - 65
Change in valuation allowance.... - (420) (63)
Other, net....................... 58 407 79
------ ------ ------
$4,426 $4,208 $6,584
====== ====== ======
F-22
As of December 31, 1999, the Bank's allowance for loan losses for federal
income tax return purposes was approximately $10,350,000. If any portion of
this allowance is used for purposes other than to absorb loan losses and
write-downs of other real estate owned, such amounts will become subject to
income tax at the then current tax rate. Management does not anticipate that
capital will be used in such a way so as to require the payment of taxes on
taxable income resulting from the recapture of the tax allowance. As a
result, in accordance with SFAS No. 109, no provision for such tax has been
recorded in the accompanying consolidated financial statements.
10. Selected Quarterly Consolidated Financial Information (unaudited):
-----------------------------------------------------------------
The following table presents quarterly consolidated financial information
for the Bank for 1999 and 1998 (in thousands):
1999 1998
---------------------------------- ---------------------------------
Fourth Third Second First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
------- ------- ------- ------- ------- ------- ------- -------
Interest and dividend
income................. $20,720 $19,931 $19,153 $19,030 $19,140 $18,699 $19,771 $19,248
Interest and dividend
expense................ 10,216 9,465 8,972 8,721 9,373 9,379 9,362 9,086
------- ------- ------- ------- ------- ------- ------- -------
Net interest income...... 10,504 10,466 10,181 10,309 9,767 9,320 10,409 10,162
Provision for loan
losses................. 150 650 150 150 300 300 300 300
------- ------- ------- ------- ------- ------- ------- -------
Net interest income
after provision for
loan losses............ 10,354 9,816 10,031 10,159 9,467 9,020 10,109 9,862
Noninterest income....... 3,536 1,350 2,088 2,432 1,752 2,972 4,936 2,500
Noninterest expense...... 10,072 9,377 9,386 7,751 9,020 8,329 11,725 8,018
------- ------- ------- ------- ------- ------- ------- -------
Income before provision
for income taxes....... 3,818 1,789 2,733 4,840 2,199 3,663 3,320 4,344
Provision for income
taxes.................. 1,430 573 874 1,549 697 1,135 1,025 1,351
------- ------- ------- ------- ------- ------- ------- -------
Net income............... $ 2,388 $ 1,216 $ 1,859 $ 3,291 $ 1,502 $ 2,528 $ 2,295 $ 2,993
======= ======= ======= ======= ======= ======= ======= =======
11. Commitments and Contingencies:
-----------------------------
Cash and due from banks withdrawal and usage reserve requirements -
-----------------------------------------------------------------
The Bank is required to maintain reserves against its transaction accounts
and non-personal time deposits. As of December 31, 1999 and 1998, cash and
due from banks withdrawal/usage reserve requirements of approximately
$11,060,000 and $5,600,000, respectively, existed as a result of Federal
Reserve requirements to maintain certain average balances.
F-23
Lease commitments -
-----------------
The Bank leases certain of its premises and equipment under lease agreements
which expire at various dates through June 2010. The Bank has the option to
renew certain of the leases at fair rental values. Rental expense was
approximately $1,132,000, $1,120,000 and $1,136,000 for the years ended
December 31, 1999, 1998 and 1997, respectively.
As of December 31, 1999, minimum rental commitments under noncancellable
operating leases were (in thousands):
Year
------
2000................................ $ 883
2001................................ 768
2002................................ 767
2003................................ 735
2004................................ 664
Thereafter.......................... 3,307
------
$7,124
======
Loan commitments and letters of credit -
--------------------------------------
The Bank is a party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments included commitments to extend credit of
approximately $155,180,000 and $153,725,000 as of December 31, 1999 and
1998, respectively, and standby letters of credit of approximately
$6,216,000 and $6,556,000 as of December 31, 1999 and 1998, respectively.
These consolidated financial instruments involve, to varying degrees,
elements of credit and interest rate risk. The Bank's exposure to credit
loss in the event of non-performance by the other party to the financial
instrument is represented by the contractual amount of those instruments.
The Bank uses the same credit policies in making commitments as it does for
existing loans. Management believes that the Bank controls the credit risk
of these financial instruments through credit approvals, lending limits,
monitoring procedures and the receipt of collateral when deemed necessary.
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. Since many of the commitments
could expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. Bank management evaluates
each customer's credit worthiness on a case-by-case basis. The amount of
collateral obtained, if deemed necessary by the Bank, upon extension of
credit is based on management's credit evaluation of the customer.
Collateral held varies but may include income producing commercial
properties, accounts receivable, inventory and property, plant and
equipment.
F-24
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. The credit risk
involved in issuing letters of credit is essentially the same as that
involved in existing loan facilities to customers. The Bank holds real
estate and marketable securities as collateral supporting those commitments
for which collateral is deemed necessary.
Interest Rate Cap Agreement -
---------------------------
At December 31, 1999, Savings Bank of Manchester was a party to one interest
rate cap agreement with a notional principal amount of $25 million. Under
the terms of the cap agreement, Savings Bank of Manchester paid a premium
totalling $123,000 which is included in other assets and being amortized
over three years which is the term of the agreement. Amortization for the
year ended December 31, 1999 totalled $38,000 and is recorded as an interest
expense on advances. The agreement provides that, if the London Interbank
Offered Rate exceeds 7%, Savings Bank of Manchester receives cash payments
on a quarterly basis. There were no cash payments due at December 31, 1999.
12. Parent Company Financial Information:
------------------------------------
Connecticut Bankshares, M.H.C. has conducted no activities other than board
of director meetings for the period from inception to December 31, 1999.
Summarized information relative to the statements of condition as of
December 31, 1999 and 1998 and statements of operations and cash flows for
the years ended December 31, 1999, 1998 and 1997 of Connecticut Bankshares,
M.H.C. (parent company only) are presented as follows (in thousands):
1999 1998
------ --------
Statements of Condition
Assets:
Cash................................................. $ 50 $ 50
Investment in banking subsidiaries................... 123,173 112,757
-------- --------
Total assets.................................. $123,223 $112,807
======== ========
Liabilities and stockholder's investment:
Stockholder's investment............................. $123,223 $112,807
-------- --------
Total liabilities and
stockholder's investment.................... $123,223 $112,807
======== ========
Statements of Operations 1999 1998 1997
-------- ------ --------
Undistributed equity in earnings
of subsidiary........................................ $ 8,754 $9,318 $ 10,202
-------- ------ --------
Net income................................... $ 8,754 $9,318 $ 10,202
======== ====== ========
F-25
Statements of Cash Flows 1999 1998 1997
-------- -------- ---------
Cash Flows from Operating Activities:
Net income............................. $ 8,754 $ 9,318 $ 10,202
Adjustments:
Undistributed equity in earnings of
subsidiary......................... (8,754) (9,318) (10,202)
------- ------- --------
Net cash provided by operating
activities.................... - - -
------- ------- --------
Net increase in cash..................... - - -
Cash, beginning of year.................. 50 50 50
------- ------- --------
Cash, end of year........................ $ 50 $ 50 $ 50
======= ======= ========
The Bank has paid no dividends to the parent company for the years ended
December 31, 1999, 1998 and 1997.
13. Disclosures about Fair Values of Financial Instruments:
------------------------------------------------------
SFAS No. 107, "Disclosures About Fair Value of Financial Instruments,"
requires entities to disclose the estimated fair value of financial
instruments, both assets and liabilities recognized and not recognized in
the consolidated statements of condition, for which it is practicable to
estimate fair value.
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to
estimate that value.
Cash and due from banks and accrued interest receivable -
-------------------------------------------------------
The carrying amount is a reasonable estimate of fair value.
Securities -
----------
For marketable equity securities and other securities held for investment
purposes, fair values are based on quoted market prices or dealer quotes, if
available. If a quoted market price is not available, fair value is
estimated using quoted market prices for similar securities.
Loans held for sale -
-------------------
The fair value of residential mortgage loans held for sale is estimated
using quoted market prices provided by government agencies.
Loans -
-----
The fair value of the net loan portfolio is estimated by discounting the
loans' future cash flows using the prevailing interest rates as of yearend
at which similar loans would be made to borrowers with similar credit
ratings and for the same remaining maturities.
The book and fair values of unrecognized commitments to extend credit and
standby letters of credit were not significant as of December 31, 1999 and
1998.
F-26
Deposits -
--------
The fair value of savings, NOW, demand and certain money market deposits is
the amount payable on demand as of yearend. The fair value of certificates
of deposit is estimated by discounting the future cash flows using the rates
offered for deposits of similar remaining maturities as of yearend.
Advances from Federal Home Loan Bank -
------------------------------------
The fair value of the advances is based on the estimated costs to prepay the
debt (prior to maturity) as of yearend.
Values not determined -
---------------------
SFAS No. 107 excludes certain financial, as well as non-financial,
instruments from its disclosure requirements, including premises and
equipment, the intangible value of the Bank's portfolio of loans serviced
(both for itself and for others) and related servicing network, and the
intangible value inherent in the Bank's deposit relationships (i.e., core
deposits), among other assets and liabilities. Accordingly, the aggregate
fair value amounts presented do not represent the underlying value of the
Bank.
As of December 31, 1999 and 1998, the estimated fair values and recorded
book balances of the Bank's financial instruments were (in thousands):
1999 1998
----------------- ------------------
Recorded Recorded
Book Fair Book Fair
Balance Value Balance Value
-------- -------- -------- --------
Assets:
Cash and cash equivalents...... $ 26,678 $ 26,678 $ 45,048 $ 45,048
Securities available for sale.. 181,854 181,854 168,151 168,151
Securities held to maturity.... 46,060 44,998 52,597 53,054
Loans held for sale............ 38 38 121 122
Loans, net..................... 938,340 931,372 806,787 822,418
Federal Home Loan Bank stock... 5,909 5,909 5,909 5,909
Accrued interest receivable.... 6,900 6,900 6,435 6,435
Liabilities:
Deposits -
Savings...................... 223,656 223,656 220,653 220,653
Money market................. 68,532 68,532 38,387 38,387
Certificates of deposit...... 450,347 451,238 446,139 449,360
NOW.......................... 112,741 112,741 110,841 110,841
Demand....................... 51,315 51,315 39,097 39,097
Short-term borrowed funds...... 95,814 95,814 79,545 79,545
Mortgagors' escrow accounts.... 8,674 8,674 7,627 7,637
Advances from Federal Home
Loan Bank.................... 84,000 82,054 45,000 44,504
At December 31, 1999, the Bank had an interest rate cap with a notional
value of $25,000,000 and a book asset value of $85,000 representing the
unamortized portion of the premium paid for the caps, which is included in
other assets in the accompanying consolidated statements of condition. The
interest rate cap had an estimated market value of $143,000 at December 31,
1999.
F-27
14. Conversion of MHC to Stock Form of Ownership:
--------------------------------------------
On August 30, 1999, the Boards of Directors of the MHC and the Bank adopted
a Plan of Conversion and, on October 6, 1999 and October 26, 1999,
unanimously amended the Plan of Conversion (as amended, the Plan), pursuant
to which on March 1, 2000 the Bank reorganized from the mutual holding
company form to the stock holding company form, and formed Connecticut
Bancshares, Inc. (the Company). All of the outstanding common stock of the
Bank was sold to the Company which issued and sold its stock pursuant to the
Plan. The net proceeds were $99.7 million, after expenses of approximately
$4.3 million. The Bank had approximately $884,000 of deferred conversion
costs as of December 31, 1999 which are included in other assets in the
accompanying consolidated statement of condition as of December 31, 1999.
All of the stock of the Company sold in the conversion was offered to
eligible account holders, employee benefit plans of the Bank and certain
other eligible subscribers in subscription and direct community offerings
pursuant to subscription rights in order of priority as set forth in the
Plan. Additionally, the Bank established an Employee Stock Ownership Plan
("ESOP") for the benefit of eligible employees, which became effective upon
the conversion. The ESOP borrowed $9,305,202 from the Company to fund the
purchase in the open market of 898,560 shares, or 8%, of the common stock
issued. The Bank expects to make annual contributions adequate to fund the
repayment of any indebtedness of the ESOP.
The Plan provided for the establishment of an additional charitable
foundation (the "New Foundation") in connection with the conversion. The New
Foundation was funded with a contribution of 832,000 common shares, or 8%,
of common stock sold in the conversion. This contribution will result in the
recognition of an expense of $8,320,000 in March 2000, related to the fair
value of the shares contributed. The New Foundation will be dedicated to
charitable purposes within the Bank's local community, including community
development activities.
Effective upon the conversion, the Company entered into employment and
change in control agreements with certain executives. The agreements
include, among other things, provisions for minimum annual compensation and
certain lump-sum severance payments in the event of a "change in control."
The deposit accounts of the Bank's depositors will continue to be insured by
the FDIC and were not affected by the conversion. In accordance with the
Plan, upon the completion of the conversion, the Bank established a special
"liquidation account" for the benefit of eligible account holders and in an
amount equal to the equity capital of the Bank less any subordinated debt
approved as bona fide capital of the Bank, as of the date of its latest
statement of condition contained in the final prospectus used in connection
with the conversion. Eligible account holders continuing to maintain deposit
accounts at the Bank are entitled, on a complete liquidation of the Bank
after the conversion, to an interest in the liquidation account prior to any
payment to the stockholders of the Bank. The Bank's surplus is substantially
restricted with respect to payment of dividends to stockholders due to the
liquidation account. The liquidation account will terminate on the tenth
anniversary of the consummation date of the conversion.
Subsequent to the offering, the Company and the Bank may not declare or pay
dividends on, nor repurchase any of its shares of common stock, if the
effect thereof would cause stockholders' equity to be reduced below either
the balance required for the liquidation account or applicable regulatory
capital maintenance requirements, or if such declaration, payment or
repurchase would otherwise violate regulatory requirements.
F-28
CONFORMED
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Connecticut Bancshares, Inc.
By: /s/ Richard P. Meduski
--------------------------- March 30, 2000
Richard P. Meduski
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Name Title Date
---- ----- ----
/s/ Richard P. Meduski President, Chief Executive March 30, 2000
- ---------------------- Officer and Director
Richard P. Meduski (principal executive officer)
/s/ Nicholas B. Mason Senior Vice President and
- ----------------------- Chief Financial Officer March 30, 2000
Nicholas B. Mason (principal accounting and
financial officer)
/s/ Thomas A. Bailey Director and Chairman March 30, 2000
- ----------------------- of the Board
Thomas A. Bailey
/s/ A. Paul Berte Director March 30, 2000
- -----------------------
A. Paul Berte
/s/ Timothy J. Devanney Director March 30, 2000
- -----------------------
Timothy J. Devanney
/s/ M. Adler Dobkin Director March 30, 2000
- -------------------------
M. Adler Dobkin
/s/ Sheila B. Flanagan Director March 30, 2000
- -------------------------
Sheila B. Flanagan
/s/ John D. LaBelle, Jr. Director March 30, 2000
- -------------------------
John D. LaBelle, Jr.
/s/ Eric A. Marziali Director March 30, 2000
- -------------------------
Eric A. Marziali
1
/s/ Jon L. Norris Director March 30, 2000
- -------------------------
Jon L. Norris
/s/ William D. O'Neill Director March 30, 2000
- -------------------------
William D. O'Neill
/s/ Laurence P. Rubinow Director March 30, 2000
- ------------------------
Laurence P. Rubinow
/s/ John G. Sommers Director March 30, 2000
- ------------------------
John G. Sommers
/s/ Thomas E. Toomey Director March 30, 2000
- ------------------------
Thomas E. Toomey
/s/ Gregory S. Wolff Director March 30, 2000
- ------------------------
Gregory S. Wolff
2