________________________________________________________________________________
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
____________
For the fiscal year ended December 31, 1997
Commission file no. 0-22861
____________
FIRST INTERNATIONAL BANCORP, INC.
(Exact name of registrant as specified in its charter)
Delaware 06-1151731
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
One Commercial Plaza
Hartford, CT 06103
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (860) 727-0700
____________
Securities Registered Pursuant to Section 12(b) of the Act:
(Title of each class)
Common Stock, par value $.10 per share
Securities Registered Pursuant to Section 12(g) of the Act: None
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No__
---
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
or Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. ____
As of March 5, 1998, the aggregate market value of the voting stock held by non-
affiliates of the Registrant, based on the closing price of the common stock as
reported by the Nasdaq Stock Market of $15.375, was approximately $52,828,838.
As of March 5, 1998, the Registrant had 7,876,208 shares of Common Stock
outstanding.
DOCUMENTS INCORPORATED BY REFERENCE:
Part II, items 5, 6, 7, 7A and 8 are incorporated by reference to First
International Bancorp's, Inc. 1997 Annual Report to Shareholders which is
included as an exhibit hereto.
Part III, items 10, 11, 12 and 13 are incorporated by reference to First
International Bancorp, Inc.'s definitive proxy statement to stockholders which
will be filed with the Securities and Exchange Commission no later than 120 days
after December 31, 1997.
________________________________________________________________________________
TABLE OF CONTENTS
PART 1 Page No.
ITEM 1. BUSINESS 1
ITEM 2. PROPERTIES 24
ITEM 3. LEGAL PROCEEDINGS 24
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY
HOLDERS 24
PART II
ITEM 5. MARKET FOR THE COMPANY'S COMMON STOCK AND
RELATED STOCKHOLDER MATTERS 25
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA 25
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 25
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES 25
ABOUT MARKET RISK
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 25
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS
ON ACCOUNTING AND FINANCIAL DISCLOSURE 25
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT 25
ITEM 11. EXECUTIVE COMPENSATION 25
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS
AND MANAGEMENT 25
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS 25
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND
REPORTS ON FORM 8-K 26
PART 1
ITEM 1: BUSINESS
GENERAL
Overview
First International Bancorp, Inc., a Delaware corporation, is a one bank holding
company incorporated in 1985 and regulated by the Board of Governors of the
Federal Reserve System. Its principal asset and subsidiary is First National
Bank of New England, a national banking association established in 1955 and
regulated by the Office of the Comptroller of the Currency (the "OCC").
The Company specializes in providing credit, trade and depository services to
small and medium size manufacturing companies located in the United States and
in international emerging markets. The Company serves its target market by
offering flexible and attractive terms to borrowers and manages its credit risk
through the combined utilization of commercial loan guarantee programs made
available by three U.S. federal agencies: the U.S. Small Business
Administration (the "SBA"), the U.S. Department of Agriculture (the "USDA"), and
the Export-Import Bank of the U.S. ("Ex-Im Bank").
For the federal fiscal year ending September 30, 1997, the Company was the
country's fourteenth largest SBA 7(a) lender, and the largest SBA lender in New
England, measured by dollar volume; the country's largest USDA Business and
Industry lender measured by dollar volume; and the country's largest Ex-Im Bank
lender measured by number of transactions. The Company maintains preferred
status with the federal agencies for several jurisdictions and programs. In
recognition of the Company's efforts in promoting small business exports and its
high volume of loan originations, the Company received Ex-Im Bank's annual
"Small Business Bank of the Year Award" in May 1997.
Loan Originations
Management believes that the specialized market knowledge and experience of the
Company's lending officers, combined with a broad range of commercial and
international financing products, enable the Company to satisfy the needs of its
small and medium size manufacturing clients. Brand recognition for the Company
is maintained by incorporating the servicemark Financing Manufacturers
Worldwide(R) in its logos. The Company's domestic and international lending
relationships generally range from $150,000 to $2.5 million.
The Company's Commercial business units underwrite lines of credit, term loans,
industrial mortgages and trade financing for businesses located primarily in the
Northeast and Midatlantic regions of the United States. Commercial lenders
operate from the Company's Hartford,
1
Connecticut headquarters, as well as from regional representative offices
located in Boston and Springfield, Massachusetts; Providence, Rhode Island;
Morristown, New Jersey; Pittsburgh and Philadelphia, Pennsylvania; Rochester,
New York and Washington D.C. The Company is considering the opening of
additional offices in the Midwest U.S. in 1998. The Company's domestic loan
officers are trained to understand the specific financial needs of small and
medium size manufacturers, and to use government guaranteed and other commercial
loan products to respond to those needs. Domestic loan officers participate in
industrial trade organizations representing the Company's target market and
conduct other marketing activities to reach potential borrowers.
The Company's International business units underwrite Ex-Im Bank guaranteed and
insured loans to small and medium size manufacturers located throughout the
United States and in eleven international emerging markets. In 1998, the
Company's International business units also began offering loans to U.S.
importers of foreign-made goods. See "International Banking Services and
Products." International lending activities support trade flows between the
United States and emerging markets which have grown at a rate of 12% annually
since 1990. The Company's International business units operate from its
Hartford, Connecticut headquarters and are assisted in their efforts by
contractual international marketing representatives, or "master agents", who are
actively involved in providing financial, accounting, consulting and/or
engineering services to manufacturers in their home countries. Contractual
marketing arrangements have been established with professionals in Argentina,
Brazil, Central America, India, Indonesia, Korea, Mexico, Philippines, Poland,
South Africa and Turkey. The Company began lending internationally in 1994 and
has increased its medium term loan originations from $397,000 in 1994 to $1.8
million in 1995, $13.6 million in 1996 and $60.9 million in 1997.
Underwriting
The Company's underwriting activities are initiated from each of its lending
offices and supported and approved at the Hartford, Connecticut headquarters.
Commercial lending officers analyze the creditworthiness of proposed borrowers
and evaluate each borrower's financial statements, credit reports, business
plans and other data to determine if the credit and proposed collateral satisfy
the Company's specific lending standards and policies. All credit memoranda are
reviewed by an independent credit officer and may require additional approval
depending on the particular circumstances of the financing package. Domestic
and international loans undergo a substantially identical approval process.
Loan Sales
The Company seeks to achieve high returns while meeting the growing credit needs
of its target market by selling a portion of its commercial and international
loans on a non-recourse, servicing-retained basis. A separate Capital Markets
business unit was established in 1996 to sell loans, including commercial and
international loans without federal guarantees. The Capital Markets business
unit directs its resources toward identifying non-government guaranteed
secondary loan markets as a further means of mitigating credit risk, leveraging
capital and replenishing liquidity. As of December 31, 1997, $87.7 million, or
20%, of the loan portfolio
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serviced for investors did not have government guarantees or credit enhancements
compared to $48.9 million, or 18%, of such servicing portfolio as of December
31, 1996.
Funding Sources
The Company's lending and investing activities are funded primarily by interest-
bearing deposits from commercial borrowers, their principals and other private
banking clients. The Private Banking business units provide stable, low-cost
funding to the Company by managing the deposit base while offering a full array
of financial products to serve the personal needs of, and facilitate
relationships with, the Company's client base. Private bankers continually seek
to expand the Company's deposit base by soliciting deposits from individuals who
seek highly personalized service and to strengthen existing deposit
relationships by offering new financial products and services to both existing
and prospective clients. In addition to deposits, alternative funding sources
are being developed to support the Company's business strategy.
BUSINESS STRATEGY
The Company's strategy is to serve small and medium size manufacturers through
the following key activities:
Domestic Loan Origination Activities. Commercial business units currently
operate from the Hartford, Connecticut headquarters, as well as from eight
regional loan production or "representative" offices located in Boston and
Springfield, Massachusetts; Providence, Rhode Island; Pittsburgh and
Philadelphia, Pennsylvania; Morristown, New Jersey; Rochester, New York and the
Washington D.C. area. The Company intends to continue to expand in its
established geographic markets by adding additional staff during the next two
years. In addition, the Company will continue to enter new markets by opening
representative offices as marketing diligence is completed, most likely in the
Midwest U.S.
Financing Trade with International Emerging Markets. The International business
units operating from the Hartford, Connecticut headquarters are assisted in
their efforts abroad by its contractual relationships with international master
agents in Argentina, Brazil, Central America, India, Indonesia, Korea, Mexico,
Philippines, Poland, South Africa and Turkey. The master agents are actively
involved in providing professional financial services to small and medium size
manufacturers in their home countries. The Company also provides working
capital to U.S. manufacturers who export to, and in 1998 the Company began
financing U.S. imports from, international emerging markets.
Loan Sales Activities. The Capital Markets business unit was established in
July 1996 to sell the non-recourse, servicing-retained portions of government
guaranteed and non-government guaranteed loans. Sales of the unguaranteed
portions of SBA and USDA loans and unguaranteed commercial loans have increased
as the Capital Markets business unit has developed a network of purchasers. The
Company plans to continue developing this network of
3
purchasers as loan origination activities increase and secondary markets, evolve
for all categories of loans.
LENDING ACTIVITIES AND POLICIES
The Company's distribution of domestic and international commercial loan
originations are detailed below:
FOR THE YEARS ENDED
-----------------------------------------------------------------------
DECEMBER 31, 1997 DECEMBER 31, 1996
------------------------------- ---------------------------------
LOAN ORIGINATIONS BY DEPARTMENT PRINCIPAL PERCENTAGE PRINCIPAL PERCENTAGE
--------------- -------------- --------------- --------------
(Dollars in thousands)
Domestic:
SBA loans....................................... $100,382 33% 85,303 50%
USDA loans...................................... 30,404 10% 12,700 7%
Other commercial loans.......................... 84,975 28% 37,824 22%
-------------- ------------ ----------- ----------
Total domestic banking........................ 215,761 71% 135,827 79%
International:
Ex-Im working capital lines..................... 30,347 10% 23,300 13%
Ex-Im medium term loans......................... 59,852 19% 13,617 8%
Inventory buyer credit.......................... 1,000 - - -
-------------- ------------ ----------- ----------
Total international banking.................... 91,199 29% 36,917 21%
-------------- ------------ ----------- ----------
Total commercial loan originations............. $306,960 100.00% $172,744 100.00%
============== ============ =========== ==========
MARKETING
Domestic Banking
The Company originates domestic loans through its network of 31 commercial loan
officers in nine offices who seek to establish long-term relationships with
their clients. The Company believes it is uniquely positioned to serve its
domestic market through an ability to provide clients with a flexible
combination of lines of credit, term loans and mortgages for industrial property
and trade financing. The Company generally utilizes the SBA, USDA and/or Ex-Im
Bank loan guarantee and insurance programs as a part of a financing package in
light of an applicant's particular situation. The Company's participation in
three government guaranteed loan programs enables it to provide clients with
longer loan terms than are typically available to small and medium size
manufacturers.
Commercial loan officers are responsible for marketing, underwriting, servicing,
monitoring and collecting their portfolio of loans. The Company believes that
this broad range of responsibilities enables the commercial loan officers to
establish strong working relationships with both existing and prospective
clients and promotes strong client service and prudent loan portfolio
management. Commercial loan officers are encouraged to keep apprised of market
conditions
4
through frequent contact with clients and potential borrowers, to develop
specific knowledge of their clients' businesses, and to offer flexible
structuring of loan products. In consultation with the borrower, a commercial
loan officer will evaluate the financing needs of the business and then
recommend the best way to structure the lending transaction to fit the client's
unique needs.
The marketing efforts by commercial loan officers include participation in trade
associations serving the needs of small and medium size manufacturers;
contacting accountants, attorneys and other professionals known by the Company
to have contact with businesses in need of financing; personal visits; direct
mail solicitations; and referrals from existing clients. Since the target
client of both domestic and international loan officers is often the same, there
is an active cross-selling effort between these two functions.
International Banking
The Company has four international loan officers who target U.S. exporters
eligible for trade financing programs, including those supported by Ex-Im Bank.
These loan officers market pre-export working capital lines of credit. As with
the domestic banking relationships, the Trade Finance business unit is
responsible for marketing, underwriting, servicing, monitoring and collecting
its portfolio of loans. If a borrower has both domestic and international
banking loan facilities, the relationship is evaluated and monitored on an
aggregate basis and each loan officer is responsible for his loan and further
responsible for close coordination with his lending counterpart to ensure proper
maintenance of the entire relationship.
Internationally, the Company has established contractual marketing relationships
with professional firms in eleven emerging markets who, in the course of
conducting their primary business, have frequent contact with local
manufacturers who require financing to purchase U.S. goods. Prior to entering
into relationships with these "Master Agents," the Company conducts due
diligence, including visiting the prospective representative and conducting
local diligence concerning their business reputation and legal status. The
Company also requires that each Master Agent be trained on the Company's
products and services at the Hartford, Connecticut headquarters. Each Master
Agent markets, on behalf of the Company, medium terms loans guaranteed by Ex-Im
Bank in its respective foreign market. Once the Master Agent develops a lead
with a potential borrower, it directs the prospect to a U.S.-based loan officer
who completes the application process. The Master Agent receives a negotiated
fee when a loan referral made to the Company has been underwritten and closed.
The Master Agent assists the loan officer in obtaining certain information from
the applicant and in responding to inquiries of the applicant, but does not have
any direct underwriting responsibilities. All decisions with respect to
referrals of Master Agents are made by the Company, which retains full control
over international loan originations.
Although the Company has contractual marketing relationships with firms in
eleven markets, 90% of the $60.8 in million medium term loan originations during
1997 were loans to borrowers in Brazil, Turkey and Mexico. This concentration
of originations reflects the length of time which the Company has been marketing
in these countries. Loan origination activity does not begin until some months
after the date a Master Agent is established, the Company's in-country
5
representatives are trained, marketing plans have been developed and initial
calling efforts are undertaken.
Marketing efforts include visits to and direct mail solicitation of, U.S.-based
exporters of capital goods, direct mail solicitation of foreign-based
manufacturers and industrial trade organizations and in-country marketing by the
Company's network of Master Agents.
DOMESTIC BANKING SERVICES AND PRODUCTS
Loan Products and the Origination Process
The commercial loans originated by the Company include industrial mortgage loans
(i.e., loans to businesses collateralized by industrial real property),
equipment term loans and revolving lines of credit to manufacturers, wholesalers
and distributors, many of which are exporters. The typical commercial borrower
is a privately owned and operated company with annual sales of $2 million to $25
million, employing 10-175 workers, which has been in business for at least three
years. A number of the Company's borrowers have a proprietary product line,
export their products and/or have a geographically diverse client base. The
Company is typically the borrower's primary lender and provides loans which are
collateralized by assets of the borrower. The Company's Private Banking
business units also provide a variety of business and personal financial
services to borrowers and their principals. The Company believes it has a
competitive advantage in the marketplace because it is able to provide a wide
range of lending options, deposit accounts and related services.
The Company originates loans to a variety of industries; however, based upon its
loss experience and economic forecasts, the Company may decide to de-emphasize
industries from time to time.
The interest rates accruing on the Company's commercial loans are typically
Prime-based, changing monthly or quarterly when the Prime Rate changes. The
Company also makes fixed rate loans from time to time. The Company originates
certain loans for sale through loan purchase programs pre-established with
investors. The term of a loan depends upon whether the loan is guaranteed or is
underwritten for a loan purchase program. Government guarantee programs give
clients access to longer term financing and slower amortization than otherwise
available. A government guaranteed mortgage loan has a maximum term and
amortization of up to 30 years, while the term and amortization of an
unguaranteed mortgage loan typically does not exceed 15 years. Equipment loans
are underwritten to correspond to the useful life of the equipment and generally
range from 5-15 years. SBA guaranteed working capital term loans range from 7-
10 years, while unguaranteed working capital revolving lines of credit have one-
year terms. Medium term loans are generally fully amortizing.
The primary collateral sought by the Company for commercial loans consists of
liens which are generally first liens, on owner-occupied industrial real estate,
equipment, inventory and/or accounts receivable, although additional collateral
may include junior liens on residential properties. The Company generally
requests the personal guarantee of the principals of a
6
business because the Company believes this induces the guarantor to facilitate
repayment of the loan.
In striving to meet the credit needs of its clients, the Company utilizes
government guarantee loan programs which allow it to offer longer-term loans
while mitigating the credit risk to the Company through the government
guarantee. The two government guarantee loan programs utilized by the Company's
Commercial business units to provide financing to its niche market are discussed
below.
SBA Guaranteed Loan Originations
The Company utilizes the SBA's 7(a) loan program for eligible borrowers. Eight
of the Company's nine offices have Preferred Lender status. Preferred Lender
status allows the Bank to approve loans on behalf of the SBA, with the national
SBA processing center's concurrence that the applicant meets the SBA eligibility
requirements. The SBA generally completes its eligibility review within 24
hours of submission. Eight of the Company's offices also have Certified Lender
status. Certified Lender status entitles the Bank to 72-hour turnaround from
local SBA district offices for approval of loan applications.
The SBA's 7(a) loan program provides for a guarantee equal to 75% of the
principal balance, up to a maximum guarantee of $750,000 per borrower.
The Company makes SBA loans to businesses which qualify under agency regulations
as a "small business." The primary operative SBA eligibility criterion
privately-owned manufacturers employing fewer than 500 workers. Loans may
generally be used for the acquisition or refinancing of plant and equipment,
working capital and debt consolidation.
In the event of default, the SBA and Company share in any collections or
collateral on a pari passu basis. For example, if a loan carries a 75%
guarantee, the SBA receives 75% of all collections while the Company receives
25% of such amounts, beginning with the initial recovery. The SBA also
reimburses the Company's collection costs on a similar basis.
If the SBA establishes that any resulting loss is attributable to a failure by
the Company to comply with SBA policies and procedures in connection with the
origination, documentation or funding of a loan, the SBA may decline to pay the
guaranteed amount, or if the guaranty has already been paid, may seek recovery
of funds from the Company. With respect to guaranteed SBA loan participations
which have been sold, the SBA will first honor its guarantee and then seek
compensation from the Company in the event that a loss is deemed to be
attributable to such failure to comply with SBA policies and procedures.
USDA Guaranteed Loan Originations
The Company utilizes the Business and Industry Program ("B&I Program") of the
USDA when applicable based on an applicant's geographical location and other
characteristics. The B&I Program provides for 80% guarantees on loans with
principal balances up to $5 million and 70%
7
guarantees on loans with principal balances up to $10 million and, therefore,
enables the Company to provide financing to borrowers with greater needs than
those eligible for SBA loans and non-guaranteed commercial loans from the
Company, due to legal lending limit constraints. The stated purpose of this
program is to support industry, employment and general economic and
environmental conditions in rural communities, which are defined as towns with
fewer than 50,000 inhabitants. Such loans may be utilized for acquisition,
improvement or refinancing of plant, equipment, working capital and debt
consolidation.
Loans to be guaranteed under the B&I Program are submitted to the USDA district
office and, depending on that office's loan authority, may be required to be
forwarded to the national USDA for approval. The USDA approved the Company as a
Certified Lender in six states in 1997, making it one of the first USDA
Certified Lenders nationally. As a Certified Lender, the Company is recognized
as a "Subject Matter Expert" and is able to reserve funds, which facilitates the
processing of USDA loans.
The guarantee of the USDA also provides for pari passu recovery of collection
proceeds, and for recourse to the Company similar to that discussed above for
SBA loans in the event the Company is found to have been negligent in the
origination, documentation or funding of USDA loans.
DOMESTIC UNDERWRITING
For the Company's domestic underwriting process, the Company's staff seeks to:
(i) analyze borrowers' credit profiles; (ii) assess the collateral underlying a
loan; (iii) assure compliance with eligibility requirements for inclusion under
the guarantee programs; and (iv) obtain or provide documentation.
Commercial lending officers receive and assemble initial applications, analyze
the creditworthiness of proposed borrowers, prepare credit memoranda, and aided
by staff prepare any required government guarantee loan application forms and
conduct credit and trade reference checks. In the course of analyzing the
creditworthiness of prospective borrowers, commercial lending officers evaluate
each applicant's and any guarantors' financial statements, credit reports,
appraisals and other information regarding the value of collateral the
experience, strength and continuity of the borrower's management business plans
and other data to determine if the credit and collateral satisfy the Company's
standards and compliance with any applicable government guaranteed loan program
requirements. Such standards may include debt service coverage ratios, or other
financial ratios, reasonableness of the borrower's projections (when submitted),
the experience, strength and continuity of the borrower's management, the
financial condition of individual guarantors, the value of collateral, and
compliance with government guarantee loan program requirements. An originating
officer and, generally, another senior officer perform on-site inspections to
determine the condition of a borrower's facility, the manner in which business
is being conducted, the condition and maintenance of assets, the existence of
environmental issues, and other market conditions.
8
Originating lending officers have no authority to approve a loan on their own.
Subject to compliance with credit policies and program parameters, the business
manager of each commercial business unit has limited lending authority in
accordance with his experience, and loans above his lending authority must be
approved by the Chief Operating Officer ("COO") and the Loan Committee of the
Bank's Board of Directors. All loans to a borrower and its affiliates are
aggregated to determine whether they are within a loan officer's lending
authority.
Upon initial approval by a business manager, the credit memorandum must be
approved by the Credit Policy Officer, who reports to the Chief Credit Officer.
The Credit Policy Officer reviews the memorandum and supporting file for
compliance with internal Company policy as well as applicable government
guarantee requirements. If additional approvals are required, the credit
memorandum is forwarded to the appropriate parties as noted above. If the
financing package includes a government guaranteed loan, the application is
forwarded to the applicable government agency.
The Company performs a credit analysis on all applications, considering the type
and value of the assets collateralizing a loan, the characteristics of the
borrower, the borrower's industry, and the anticipated debt service ratio. The
Company generally requires that a borrower's most recently completed fiscal year
financial statements demonstrate historical debt service coverage ratio of at
least 1.25 to 1. If requested funding is for plant or line of business
expansions, consideration may also be given to projected results and, therefore,
certain loans may be granted when historical debt service coverage is less than
1.25 to 1.
Real property taken as primary collateral for a loan is valued by an independent
appraiser in accordance with federal banking regulations, and the appraisal is
then subject to an internal review in accordance with such regulations.
Equipment serving as primary collateral for a loan is generally valued by an
independent equipment appraiser. The Company will generally obtain a Phase I
environmental report completed in accordance with the standards of the American
Society for Testing and Materials on any commercial real property to be
mortgaged. Additional environmental reporting and remediation are required
prior to closing if environmental issues either exist or are suspected.
INTERNATIONAL BANKING SERVICES AND PRODUCTS
The Company's International Banking business units offer Ex-Im Bank guaranteed
revolving lines of credit to U.S. manufacturers, medium term loans to foreign
buyers of U.S. goods, and letters of credit issued in connection with such
facilities.
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The International banking business units include the following:
TERRITORY EX-IM PRODUCT USED DESCRIPTION
--------- ------------------ -----------
United States (principally Working capital line of credit; One year revolving line of
the Northeast and 90% guaranteed; indexed to U.S. credit to U.S. manufacturers
Mid-atlantic) Prime, variable daily; U.S. collateralized by export
dollar denomination accounts receivable and
inventory
Americas (principally Medium term loan; 100% guaranteed 1- to 5-year term loans to
Argentina, Brazil, Central or insured; indexed to 6-month foreign purchasers of
America, Mexico) and LIBOR, variable semi-annually; qualified U.S. made inventory
Asia/Africa/Europe U.S. dollar denominated and equipment
(principally India,
Indonesia, Korea,
Philippines, Poland, South
Africa and Turkey)
Ex-Im Bank is an independent agency of the U.S. whose mission is to facilitate
export financing of U.S. goods and services by neutralizing the effect of export
credit subsidies from other governments and absorbing credit risks that the
private sector will not accept. The Company utilizes the Ex-Im Bank's loan
guarantee and insurance programs designed to support small and medium size U.S.
exporters. In 1997 the Company received Ex-Im Bank's annual "Small Business
Bank of the Year" award.
International Banking - United States
Working Capital Loan Products and the Origination Process
The typical U.S. client for the Company's international products is a U.S.-based
manufacturer with sales of $2 million to $25 million and export financing
needs. The Trade Finance business unit handles these clients, which comprise
the same target profile as for the Company's domestic loan officers.
The one-year revolving Ex-Im Bank working capital lines of credit are indexed to
WSJ Prime and adjust daily. The primary collateral for these loans includes
export-related accounts receivable and inventory. The accounts receivable are
generally insured under an Ex-Im Bank insurance policy, private export credit
insurance or an acceptable letter of credit. Open accounts receivable may
qualify as collateral if approved in advance by the Company and Ex-Im Bank.
Borrowers must submit borrowing base certificates to the Company to evidence the
availability of acceptable collateral when an advance is requested, and monthly
thereafter.
The Company is one of ten lenders in the U.S. with "AA Level Delegated
Authority" status with respect to Ex-Im Bank's working capital loan guarantee
program and, therefore, has authority to
10
approve working capital lines up to $5 million per borrower, up to an aggregate
portfolio of $75 million without prior Ex-Im Bank approval.
In the event of a loan default, the Company and Ex-Im Bank share in all loan
recovery proceeds on a pari passu basis in accordance with the 90%
guaranteed/10% unguaranteed ratio. The Company also has the responsibility to
ensure that loans are underwritten, documented and funded in accordance with Ex-
Im Bank polices and procedures in order to avoid loss of the guarantee.
International Banking - Emerging Markets
Short and Medium Term Loan Products and Origination Process
Emerging market-based clients of the Company's Americas and Asia/Africa/Europe
business units are typically small and medium size manufacturers requiring
financing to purchase equipment, components and raw materials from the U.S.
Medium term loans are 100% Ex-Im Bank guaranteed or insured, typically 3-5 years
in term, and finance the acquisition of qualified U.S.-made capital goods. Ex-
Im Bank program allows the financing of up to the lower of 85% of purchase price
or 100% of U.S. content. Certain other U.S. content and product requirements
must also be met. The loans range in size from $150,000 to $10 million and are
U.S. dollar-denominated. Although the purchase of the equipment is being
financed, the loans are unsecured; the Company relies on the borrower's cash
flow and the 100% Ex-Im Bank guarantee or insurance.
International lending officers are responsible for marketing, underwriting,
servicing, monitoring and collecting their portfolios of loans. Because the
loans are medium term and fully amortizing with semi-annual payments, there is
less post-closing analysis required for performing loans than for other types of
loans made by the Company.
In the event of default, Ex-Im Bank handles the liquidation of medium term loans
and pays the Company 100% of the principal balance, plus accrued interest. See
"Delinquency and Collection Activities."
INTERNATIONAL BANKING UNDERWRITING
International lending officers receive and assemble initial applications,
analyze the creditworthiness of proposed borrowers, prepare memoranda, and aided
by staff prepare the required Ex-Im Bank loan application forms and conduct
credit and trade reference checks. For medium term loans, in-country Master
Agents, where applicable, aid in the transaction by obtaining required financial
or operational data from borrowers and generally assist in the loan origination
and closing process.
The Company's international lending officers will often visit the prospective
U.S. borrower's place of business and perform on-site inspections. The Company
will generally instruct its in-
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country Master Agents to make such inspections of foreign borrowers. Although
inventory serves as collateral for working capital lines of credit to U.S.
exporters, other tangible assets are generally not taken as collateral under the
Ex-Im Bank loan programs. However, site inspections in most cases are conducted
because such information is helpful in assessing a borrower's operations.
The approval process is substantially similar to that followed by the commercial
lending officers. The Credit Policy Officer reviews the memorandum and
supporting file for compliance with internal Company policies as well as
applicable Ex-Im Bank guarantee program parameters. As with the domestic
lending, exceptions to the Company's and Ex-Im Bank's loan policies are
entertained on a case-by-case basis by the approving loan officers, and
acceptance of exceptions depends upon the overall creditworthiness of the
applicant.
Working capital lines of credit are collateralized by export-related inventory
and accounts receivable less than 90 days old; such collateral has maximum
prescribed collateral values of 75% and 90%, respectively. As is the case with
respect to domestic loans, the collateral value required to support a loan is
based on the borrower's individual circumstances, and applications exceeding the
Company's general standards may receive special consideration.
Medium term loans are unsecured, although debt service coverage and operating
history are reviewed in the underwriting process. The lending officer also
considers the availability to the borrower of U.S. dollars and other "hard"
currency revenue sources from sales to the U.S. and other stable currency
markets.
While most working capital lines of credit are within the Company's "AA
Delegated Authority", applications which do not comply with and/or are above the
Company's authority, and all medium term loans, require Ex-Im Bank approval.
CAPITAL MARKETS AND LOAN SERVICING
Capital Markets Activities
The Capital Markets business unit was established in July 1996 to assume
responsibility for the non-recourse, servicing-retained sale of SBA, USDA and
Ex-Im Bank government guaranteed loans and to identify markets for the sale of
non-guaranteed mortgage, term and revolving loans on a non-recourse, servicing-
retained basis. Capital Markets activities allow the Company to leverage
capital, replenish liquidity, mitigate the risk of balance sheet exposure to any
single borrower, and reduce reliance on government guaranteed loan programs for
revenue.
The guaranteed portions of SBA and USDA loans are generally sold during the
quarter of origination on a single loan basis to established brokers. Brokers
generally pool the SBA guaranteed portions. USDA loans are individually sold.
The guaranteed portions of the Ex-Im Bank loans and lines of credit are sold to
various parties, including Private Funding Export Funding Corporation ("PEFCO").
PEFCO is a private corporation established with the support
12
of the United States Treasury and Ex-Im Bank to assist in financing exports of
U.S. goods and services by making direct loans to foreign importers of U.S. made
goods, and to provide liquidity support for private sector lending utilizing Ex-
Im Bank programs. The Company is a 1% shareholder and one of among approximately
50 PEFCO shareholders, with a common stock investment of $599,000 at December
31, 1997.
SBA and USDA regulations permit the Company to sell a portion of the
unguaranteed amount of loans originated under their respective programs. SBA
regulations require a bank lender to retain an unguaranteed interest equal to
10% of each SBA loan, although in 1997 the Company received permission to reduce
its retained interest in its SBA loans to 5%. The SBA has proposed regulations
which would allow banks to securitize or sell the unguaranteed portions of SBA
loans subject to certain criteria designed to ensure that originators retain a
continuing economic interest in the loans. The regulations would also reduce
the required unguaranteed retention to 5% of the total SBA loan. USDA
regulations permit the Company to sell unguaranteed portions equal to all but 5%
of the total USDA loan. Upon the sale of such unguaranteed portions, the Company
shares in the payment stream and collateral on a pari passu basis with all
(guaranteed and unguaranteed) investors, beginning with the initial recovery.
Sales of unguaranteed portions of SBA Loans and USDA loans totaled approximately
$29.2 million and $33.1 million for the years ended December 31, 1997 and 1996,
respectively. Approximately $7.8 million of the 1997 sales represented the
additional 5% unguaranteed SBA portions held in the Company's portfolio for
which the Company received permission to sell. A significant portion of the
1996 loans sold had been originated in 1994 and 1995. Due to these unique
circumstances, there can be no assurance that this volume of unguaranteed
portion loan sales will be representative of future sales activity.
The Capital Markets business unit has developed a list of potential buyers of
non-guaranteed mortgage loans, term loans and revolving lines of credit and
devotes substantial resources to the identification of such buyers. A primary
objective in the negotiation and sale of such loans is the Company's retention
of sole responsibility for borrower contact. Investors meet with borrowers only
in rare circumstances, and generally rely on the Company to prudently service
and monitor lending relationships. The Company believes that this is important
to maintain client relationships and also reflects investor confidence in its
servicing ability and reputation.
13
Loan Servicing Activities
At December 31, 1997, the total loan portfolio serviced by the Company was
comprised of the following:
SERVICED FOR COMPANY TOTAL BALANCE
OTHERS BALANCE SERVICED
------------------- --------------------- -------------------
(dollars in thousands)
Commercial banking portfolio:
SBA loans....................................... $247,127 $ 29,913 $277,040
USDA loans...................................... 51,132 6,541 57,673
Business loans.................................. 5,059 28,791 33,850
Revolving lines of credit....................... 2,550 30,414 32,964
Commercial mortgages............................ 19,033 19,918 38,951
Investor property mortgages..................... 593 5,497 6,090
Private loans................................... - 1,353 1,353
------------------- --------------------- ---------------------
Total commercial banking.................. 325,494 122,427 447,921
International banking portfolio:
Ex-Im medium term loans......................... 69,631 723 70,354
Ex-Im working capital lines..................... 12,183 3,858 16,041
Inventory buyer credit loans.................... 980 20 1,000
------------------- --------------------- ---------------------
Total international banking............... 82,794 4,601 87,395
Private banking portfolio:
Residential mortgages........................... 17,305 6,515 23,820
Other consumer loans............................ 3,484 1,855 5,339
------------------- --------------------- ---------------------
Total private banking..................... 20,789 8,370 29,159
Loans held for sale................................ - - 9,070
------------------- --------------------- ---------------------
Totals......................................... $429,077 $135,398 $573,545
=================== ===================== =====================
The Company services substantially all of the loans it originates, whether sold
to investors or held in portfolio. Servicing includes collecting payments from
borrowers and remitting applicable payments and required reports to any
investors; accounting for principal, interest and any real estate taxes or
other escrow receipts and payments; contacting delinquent borrowers; supervising
foreclosures; and liquidating collateral when required. Other than tasks
performed by the assigned lending officers, loan servicing functions are
centralized in the Hartford, Connecticut headquarters.
The Company receives servicing fees on loans serviced for others in varying
amounts, as determined under the particular terms of the sale. Management
believes that servicing most loans originated enhances the Company's
relationship with borrowers. This contact allows the Company to continue to
offer its loan and deposit products to clients who may need additional financing
or retail services. Further, such arrangements provide an additional and
profitable revenue stream that is less cyclical than the business of originating
and selling loans.
14
DELINQUENCY AND COLLECTION ACTIVITIES
The assigned lending officer retains responsibility for routine collection of
his portfolio. The Company attempts to collect all loans on a 30-day basis,
leaving very few loans past due 30 days or more at any month end. An officer's
initial collection efforts generally begin when an account is 15 days past due.
At 20 days past due, a reminder notice is sent to the borrower and the officer
again attempts to contact the borrower to determine the reason for the
delinquency and if the account will be brought current.
If a borrower is unable to make a payment within 30 days of the due date as of
month-end, and has not made acceptable alternative arrangements with the
Company, the account is transferred to the Company's Loan Workout business unit
for consideration of additional collection procedures, including issuance of a
demand letter and possible liquidation of collateral.
The Loan Workout business unit is responsible for contacting the borrower and
analyzing its current and projected financial condition, the reasons leading to
the delinquency and the value of the collateral available to the Company. The
Loan Workout Officer then proposes a workout plan to the Chief Credit Officer
and other involved members of Senior Management. The Loan Workout business unit
will also provide any required notices and generally seek to comply with
applicable government guarantee program or investor requirements.
If a modification of loan terms or other acceptable workout cannot be achieved
within a reasonable time frame, the Company will liquidate the collateral
securing the loan.. The Company prefers not to take title to real property or
equipment unless required to facilitate the collection process. The Company
solicits assistance from the principals of the delinquent borrower to effect the
liquidation of any property, with title remaining in the borrower's name,
thereby avoiding a lengthy foreclosure or repossession process and exposure to
the Company regarding environmental or other liability issues. The Company has
generally found principals of borrowers to be cooperative in assisting the
Company to liquidate collateral efficiently. The Company follows the same
general workout procedures for substantially all of the loans serviced.
If a loan carries an SBA guarantee, the responsible SBA District Office will be
notified of the delinquency and will be presented with a liquidation plan within
60-90 days of such delinquency. Unless the SBA objects, the Company will carry
out the terms of the liquidation plan. As a Preferred Lender, the Bank has
responsibility and authority over liquidation procedures on all SBA guaranteed
loans serviced. Any loss after liquidation of collateral is allocated pro rata
between the guaranteed and unguaranteed portions of an SBA Loan. After an SBA
loan becomes 60-90 days past due, the SBA at the Company's request will
repurchase the guaranteed portion of the principal balance of the loan at par
from the secondary market investor, together with accrued interest covering a
period of up to 120 days.
USDA procedures require that the Company file a liquidation plan when it is
believed action should be taken on a delinquent loan, which is generally when
the loan is 60-90 days delinquent. The USDA has 30 days to review the plan.
The Company will then execute the approved plan or work with the USDA to arrive
at a mutually acceptable plan. Any loss after liquidation of
15
collateral is allocated pro rata between the guaranteed and unguaranteed
portions of the USDA loan. The holder of the guaranteed portion may request
that the USDA repurchase the guaranteed portion at any time, or the Company will
request repayment on such holder's behalf when liquidation is complete. The
USDA does not impose any restrictions on the number of days for which interest
will be paid on the guaranteed portions.
The liquidation of delinquent working capital and medium term Ex-Im Bank loans
is handled by Ex-Im Bank. The Company may submit a claim for repurchase at any
time between 30 and 120 days after a delinquency occurs, but at no time may such
claim be made more than 150 days after the delinquency. Ex-Im Bank will make
payment under its guarantee 30 days after acceptance of the Company's request.
The Company retains responsibility for the proper documentation and servicing of
all loans serviced for others, and may incur losses related to such loans if it
is found to be negligent by a guaranteeing agency or investor in carrying out
these duties.
Unguaranteed loans or unguaranteed portions of loans held by investors are
subject to negotiated servicing agreements, which generally provide investors
with the option of assuming responsibility for all collection efforts after a
loan becomes 60-90 days delinquent. If the Company is contractually responsible
for collection efforts, the servicing agreements generally require that the
investor pre-approve liquidation actions.
CREDIT RISK MANAGEMENT
The Chief Credit Officer has primary responsibility for credit risk management,
ensuring the appropriateness of underwriting criteria and application thereof,
the implementation of RISCOPE/sm/, (the Company's proprietary commercial risk
assessment model), and the independent analyses of loans by the Loan Review
business unit.
The Credit Policy Officer, who reports to the Chief Credit Officer, reviews all
credit memoranda for compliance with the requirements of government guarantee
programs and Company credit policies. If, based on particular facts and
circumstances, policy exceptions are proposed by lending officers, the Credit
Policy Officer will ensure that all appropriate policy exceptions are documented
and approved by the authorized party. The Chief Credit Officer periodically
evaluates the nature and trends of such exceptions, reporting them quarterly to
the Board of Directors' Audit Committee.
As a nationally-chartered bank, the Bank is required to "risk rate" its loan
portfolio by monitoring changes in the financial condition of borrowers,
assessing overall economic trends, and assigning numerical ratings to individual
loans. The Company applies regulatory risk rating definitions and has developed
additional ratings for the "Pass" or uncriticized loan category. Such a rating
system, in conjunction with other available quantitative and qualitative data,
is
16
utilized to assist management in its quarterly evaluation of the Adequacy of the
Allowance for Loan Losses.
The assigned lending officer has primary responsibility for risk ratings, and
such officer's decisions are periodically reviewed by the Loan Review business
unit. Risk ratings are based on the borrower's operating cash flow, industry,
product line, earnings, assets, liability, management experience, debt capacity,
and prior credit history with the Company.
The Company has developed a proprietary risk analysis model, RISCOPE/sm/, used
in the initial underwriting, post-closing loan monitoring and rating process by
lending officers and the Loan Review business unit. RISCOPE/sm/ assists the
Company in quantifying the credit risk of commercial clients. The model takes
into account quantitative and qualitative factors and was designed to analyze
the Company's primary client base: small and medium size manufacturers.
RISCOPE/sm/ is intended to quantify credit risk with respect to the probability
of default and, therefore, assists management in risk rating loans and providing
an Appropriate Allowance for Loan Losses. Additionally, the model helps
management identify weaknessess in credits earlier than might otherwise be done
if payment default were their only manifestation.
The Loan Review business unit reviews the loan portfolio to evaluate the
appropriateness of officer risk ratings and overall trends in the portfolio.
Loan Review results are reported to the Audit Committee of the Board quarterly.
PRIVATE BANKING
The Private Banking business unit seeks to provide stable, low-cost funding for
the Company by managing its deposit base, which consists of demand deposits,
money market savings accounts and time certificates of deposits. The Company
completed its transition from a retail to wholesale financial institution by
selling its last suburban retail branch facility and deposits totaling $24
million in September 1996. The Company operates one depository branch located
on the first floor of its Hartford, Connecticut headquarters. Many of the
Company's commercial clients transact business through electronic funds
transfer, telephone and the mail.
The Private Banking business units target the commercial depository accounts of
small and medium size manufacturers, as well as the personal accounts of their
principals, by offering a full array of financial products. These products
include automatic sweep accounts, merchant and corporate credit cards, payroll
processing, business and individual retirement accounts, international funds
transfer and foreign exchange conversion.
The Private Banking business units seek to expand the Company's deposit base by
strengthening existing relationships and soliciting new ones. Private bankers
are trained to focus on, and respond to, the needs of commercial borrowers which
management believes are often not served effectively by other depository
institutions. Private bankers based in Hartford, Connecticut market the
Company's services through direct mail and telephone in order to reach
businesses,
17
institutions and individuals in the areas where the Company has domestic offices
and international Master Agents. The Company maintains an interactive voice
response and personal computer-based system, First Access/SM/, which enable
clients to obtain information about their loan or deposit accounts. Business
lock box and expanded its foreign exchange services have recently been
introduced to clients as well.
The following table sets forth the Company's deposit structure as noted:
December 31,
---------------------------------------------------------------------
1997 1996 1995
------------------- ------------------- -------------------
(dollars in thousands)
BUSINESS ACCOUNTS:
Non-interest bearing checking..................... $ 37,718 $ 27,485 $ 19,337
Interest bearing checking......................... 4,670 4,567 5,897
Savings........................................... 58,800 46,660 31,453
------------------- ------------------- -------------------
Total business................................ 101,188 78,712 56,687
CONSUMER ACCOUNTS:
Non-interest bearing checking..................... 518 403 3,284
Interest bearing checking......................... 3,197 3,681 4,835
Savings........................................... 33,203 22,618 39,573
------------------- ------------------- -------------------
Total consumer................................ 36,918 26,702 47,692
TIME DEPOSITS ACCOUNTS:
Non-IRA time deposits............................. 25,110 32,372 17,904
IRA time deposits................................. 9,105 6,530 6,078
------------------- ------------------- -------------------
Total time deposits............................ 34,215 38,902 23,982
------------------- ------------------- -------------------
Total deposits........................... $172,321 $144,316 $128,361
=================== =================== ===================
Externally indexed savings accounts
included above...................................... $ 88,539 $ 65,779 $ 57,310
=================== =================== ===================
The average balances held in checking and savings accounts are higher than
industry norms, which the Company believes is attributable to the Company's
focus of attracting primarily commercial business deposits. Management believes
that such deposits are at least as stable as those obtained from consumers. The
Company does not generally compete with retail branches of other depository
institutions, but rather with mutual and money market funds, yet it retains the
advantage of FDIC insurance. The Company's basic business cash management and
private banking savings accounts are variable rate money market accounts tied to
an external index published daily in The Wall Street Journal and are designed to
-----------------------
compete with non-insured alternatives.
Additional funding for the Company's operations is also available from the on-
going sale of guaranteed and non-guaranteed loans, advances from the Federal
Home Loan Bank of Boston and other sources.
COMPETITION
The Company competes for clients with other commercial and savings banks,
savings and loan associations, credit unions, finance companies, mutual funds,
insurance companies, brokerage and investment banking firms and certain other
nonfinancial institutions, many of whom are able
18
to devote far greater resources than the Company to market, underwrite and
service loans to the same client base. The Company competes by emphasizing its
expertise and knowledge of its clients' businesses, commitment to service,
flexibility in structuring financial transactions, and strong relationships.
Through the combined utilization of government guaranteed loan programs, the
Company is able to provide flexible longer-term financing than would otherwise
be available to borrowers, and through its Private Banking business units it is
able to offer depository and related products.
REGULATION AND SUPERVISION
Holding Company Regulation
The Company is registered as a bank holding company and regulated and subject to
periodic examination by the Federal Reserve Bank ("FRB") under the Bank Holding
Company Act ("BHCA").
Pursuant to FRB regulations, the Company is limited to the business of owning,
managing or controlling banks and engaging in certain other bank-related
activities, including those activities that the FRB determines from time to time
to be closely related to banking. The BHCA requires, among other things, the
prior approval of the FRB if a bank holding company proposes to (i) acquire all
or substantially all of the assets of a bank, (ii) acquire direct or indirect
ownership or control of more than 5% of the outstanding voting stock of any bank
(unless it already owns a majority of such bank's voting shares) or (iii) merge
or consolidate with any other bank holding company.
As a bank holding company, the Company is required by the FRB to act as a source
of financial strength and to take measures to preserve and protect the Bank. As
a result, the Company may be required to inject capital in the Bank if such a
need arises. The FRB may charge a bank holding company such as the Company with
unsafe and unsound practices for failure to commit resources to a subsidiary
bank when required. The Company expects to downstream approximately $11 million
of capital to the Bank in the first quarter of 1998 in support of the Bank's
ongoing activities. Such amount represents the balance of the Company's
available funds.
To be considered regulatory capital, loans from the Company to the Bank must be
on terms subordinate in right of payment to deposits and to most other
indebtedness of the Bank.
The FRB, OCC and Federal Deposit Insurance Corporation (the "FDIC") collectively
have extensive enforcement authority over bank holding companies and national
banks in the United States. This enforcement authority, initiated generally for
violations of law and unsafe and unsound practices, includes, among other
things, the ability to assess civil money penalties, to initiate injunctive
actions and to terminate deposit insurance in extreme cases.
19
The bank regulatory agencies' enforcement authority was substantially enhanced
by the Financial Institutions Reform, Recovery and Enforcement Act of 1989
("FIRREA") and the Federal Deposit Insurance Corporation Improvement Act of 1991
("FDICIA"). FIRREA significantly increased the amount of civil money penalties
and expanded the grounds for imposing such penalties. Also, under FIRREA,
should a Bank failure result in a loss to the FDIC, any other FDIC-insured
subsidiaries of the Company could be required to compensate the FDIC for the
estimated amount of the loss. Additionally, pursuant to FDICIA, the Company in
the future could have the potential obligation to guarantee the capital
restoration plans of any undercapitalized FDIC-insured subsidiaries it may
control.
INTERSTATE BANKING
As of September 29, 1995, the Riegle-Neal Interstate Banking and Branching
Efficiency Act of 1994 (the "RNA") permitted adequately capitalized and managed
bank holding companies to acquire control of banks in any state. Additionally,
beginning on June 1, 1997, the RNA enabled banks to branch across state lines,
although individual states are authorized to permit interstate branches earlier
or to elect to opt out entirely.
REGULATION OF THE BANK
General
The Bank, as an FDIC-insured national bank, is subject to regulation primarily
by the OCC, and secondarily by the FDIC. As a national bank, the Bank is a
member of the Federal Reserve System and its operations are subject to certain
FRB regulations. Various other federal and state consumer laws and regulations
also affect the operations of the Bank.
As a national bank, the Bank may be able to engage in certain activities
approved by the OCC which the FRB would not necessarily approve for the Company.
The OCC has been particularly aggressive in recent years in allowing national
banks to undertake an ever-increasing range of securities and insurance
activities. Along these lines, pursuant to certain revisions of the OCC's
regulations pertaining to banking activities effective on December 31, 1996,
national banks are permitted on a case-by-case basis to operate subsidiaries
engaging in activities not permissible for the Bank itself. Although the
revised regulations do not authorize any specific new activities, it is expected
that national banks, if eligible and if they obtain the approval of the OCC,
will use these regulations to expand further into the insurance and securities
businesses.
The revised OCC regulations contain "fire walls" intended to protect a national
bank from the risks taken by a subsidiary, including imposing a 10% cap on the
amount of bank capital that may be invested in a new subsidiary, as well as
requirements that extensions of credit to an operating subsidiary be fully-
collateralized and that transactions between the bank and subsidiary be
conducted at arm's-length. The parent national bank's exposure to any losses
the
20
subsidiary may incur are limited to the bank's equity investment in the
subsidiary. Parent national banks are required to be well-capitalized both
before and after an investment is made.
Since OCC approval is required on a case-by-case basis for an eligible bank to
engage in activities not permissible for the bank to conduct directly, the
effect of these revised regulations on the operations of national banks is
unclear. Further, it is expected that Congress will consider new banking
legislation in the near future addressing these revisions.
As a national bank, the Bank may ordinarily lend up to 15% of its capital on an
unsecured basis to any one borrower, and may lend up to an additional 10% of its
capital to that same borrower on a fully secured basis involving readily liquid
collateral having an established market value as determined by reliable and
continuously available price quotations, and equal at least to the amount
borrowed. In addition, there are various other circumstances in which the Bank
may lend in excess of such limits, including authority to lend up to 35% of
capital and surplus when the loan is secured by documents of title to readily
marketable staples, unlimited authority if loans are guaranteed by a U.S.
government agency, and certain other exceptions relevant to international trade
finance.
Federal law also imposes additional restrictions on the Bank with respect to
loans and credit to certain related parties and transactions with the Company's
principal stockholders, officers, directors and affiliates. Extensions of
credit to such persons (i) must be made on substantially the same terms
(including interest rates and collateral) as, and follow credit underwriting
procedures not less stringent than, those prevailing for comparable transactions
with members of the general public, and (ii) must not involve more than the
normal risk of repayment or present other unfavorable features.
Capital Adequacy
The federal bank regulatory authorities have adopted risk-based capital
guidelines to which the Bank is subject. The guidelines establish a systematic
framework that makes regulatory capital requirements more sensitive to
differences in risk profile among banking organizations, takes off-balance sheet
exposures into explicit account in assessing capital adequacy, and minimizes
disincentives to holding liquid, low-risk assets. These risk-based capital
ratios are determined by allocating assets and specified off-balance sheet
financial instruments into four weighting categories, with higher levels of
capital required for the categories perceived as representing greater risk.
Under these guidelines, a banking organization's capital is divided into two
tiers. The first tier ("Tier 1") includes common equity, perpetual preferred
stock (excluding auction rate, money market or remarketable issues) and minority
interests held by others in a consolidated subsidiary, less goodwill and any
disallowed intangibles. Supplementary ("Tier 2") capital includes, among other
items, cumulative and limited-life preferred stock, mandatory convertible
securities, subordinated debt and the allowance for loan and lease losses,
subject to certain limitations and less required deductions as provided by
regulation.
21
Banking organizations are required to maintain a risk-based capital ratio of
total capital (Tier 1 plus Tier 2) to risk-weighted assets of 8%, of which at
least 4% must be Tier 1 capital. Federal bank regulatory authorities may,
however, set higher capital requirements when a banking organization's
particular circumstances warrant. As a general matter, banking organizations
are expected to maintain capital ratios well above the regulatory minimums.
In addition, federal bank regulatory authorities have established guidelines for
a minimum leverage ratio (Tier 1 capital to average total assets). These
guidelines provide for a minimum leverage ratio of 3% for banking organizations
that meet certain specified criteria, including excellent asset quality, high
liquidity, low interest rate exposure and the highest regulatory rating.
Banking organizations not meeting these criteria or which are experiencing or
anticipating significant growth are required to maintain a leverage ratio which
exceeds the 3% minimum by a least 100 to 200 basis points. The risk based
capital and leverage ratios of the Bank as of December 31, 1997 and December 31,
1996 are set forth in Note 7 to the Company's Consolidated Financial Statements.
Failure to meet applicable capital guidelines could subject a bank or bank
holding company to a variety of enforcement remedies available to the federal
bank regulatory authorities, including limitation on the ability to pay
dividends, the issuance of a capital directive to increase capital and, in the
case of a bank, the termination of deposit insurance by the FDIC or (in severe
cases) the appointment of a conservator or receiver.
Dividends
The Bank is subject to legal limitations on the frequency and amount of
dividends that can be paid to the Company. The OCC, in general, also has the
power to prohibit the payment of dividends by the Bank which would otherwise be
permitted under applicable regulations if the OCC determines that such dividends
would constitute an unsafe or unsound practice.
OCC approval is required for the payment of dividends by the Bank in any
calendar year if the total of all dividends declared by the Bank in that year
exceeds the current year's net income combined with the retained net income of
the two preceding years. "Retained net income" means the net income of a
specified period less any common or preferred stock dividends declared for that
period. Moreover, no dividends may be paid by a national bank in excess of its
undivided profits account. In addition, the FRB and the FDIC have issued policy
statements which provide that, as a general matter, insured banks and bank
holding companies may pay dividends only out of current operating earnings.
There are also statutory limits on other transfers of funds to the Company and
any other future non-banking subsidiaries of the Company by the Bank, whether in
the form of loans or other extensions of credit, investments or asset purchases.
Such transfers by the Bank generally are limited in amount to 10% of the Bank's
capital and surplus to the Company and any such future subsidiary of the
Company, or 20% in the aggregate to the Company and all such subsidiaries.
Furthermore, such loans and extensions of credit are required to be fully
collateralized in specified amounts depending on the nature of the collateral
involved.
22
FDICIA
FDICIA was enacted on December 19, 1991. It substantially revised the bank
regulatory and funding provisions of the Federal Deposit Insurance Act and made
significant revisions to other federal banking statutes.
A central feature of FDICIA is the requirement that the federal banking agencies
take "prompt corrective action" with respect to depository institutions that do
not meet minimum capital requirements. Pursuant to FDICIA, the federal bank
regulatory authorities have adopted regulations setting forth a five-tiered
system for measuring the capital adequacy of the depository institutions they
supervise. Under these regulations, a depository institution is classified in
one of the following capital categories: "well capitalized," "adequately
capitalized," "undercapitalized," "significantly undercapitalized" and
"critically undercapitalized." Based on the Bank's current regulatory capital
position, management believes that the Bank is "well capitalized."
FDICIA generally prohibits the Bank from making any capital distribution
(including payment of a cash dividend) or paying any management fees to the
Company if the Bank would thereafter be undercapitalized. Undercapitalized
depository institutions are subject to growth limitations and are required to
submit a capital restoration plan acceptable to federal banking agencies. If a
depository institution fails to submit an acceptable plan, it is treated as if
it is "significantly undercapitalized."
Significantly undercapitalized depository institutions may be subject to a
number of other requirements and restrictions, including orders to sell
sufficient voting stock to become adequately capitalized, reduce total assets,
and stop accepting deposits from correspondent banks. Critically
undercapitalized institutions are subject to the appointment of a receiver or
conservator, generally within 90 days of the date of such institution is
determined to be critically undercapitalized.
COMMUNITY REINVESTMENT ACT
The Federal Community Reinvestment Act (the "CRA") requires the OCC to evaluate
the Bank's performance in helping to meet the credit needs of the community.
The Bank defines its CRA marketplace as Hartford County. This definition is not
intended to restrict the availability of credit services throughout the Bank's
general service area, but represents a special commitment the Bank has made to
provide lending and depository services to the community. As a part of the CRA
program, the Bank is subject to periodic examinations by the OCC and maintains
comprehensive records of its CRA activities for this purpose. Following its
most recent examination in November 1995, the Bank received a rating of
"Outstanding."
The Bank is specifically interested in making financing available to small and
medium size manufacturers in its defined lending area. The Bank evaluates
credit applications without regard to race, color, religion, national origin,
gender, marital status or age, and does not discriminate
23
against any loan applicant whose income may come entirely or in part from any
public assistance program, or against any applicant who has exercised in good
faith any right under the Consumer Protection Act. The Company maintains
preferred status with the SBA, USDA and Ex-Im Bank which enables it to provide
access to credit products that might otherwise be unavailable.
ITEM 2. PROPERTIES
The Company leases approximately 38,000 square feet in Hartford, Connecticut to
house its headquarters, lending and support staff, and its only full-service
branch. The Company maintains leased space for representative offices in Boston
and Springfield, Massachusetts; Providence, Rhode Island; Morristown, New
Jersey; Rochester, New York; Philadelphia and Pittsburgh, Pennsylvania; and
Washington, D.C. The Company's leases generally provide for two five-year
renewal options and options on additional space. Management believes that its
existing facilities are adequate for their present and proposed uses and that
suitable facilities will be available on reasonable terms for any additional
space required.
ITEM 3. LEGAL PROCEEDINGS
Neither the Company nor the Bank is involved in any legal proceedings except for
routine litigation incidental to the business of banking, none of which is
expected to have a material adverse effect on the Company's financial position,
results of operations or cash flows.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted during the fourth quarter of 1997 to a vote of
security holders through solicitation of proxies or otherwise.
24
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED
STOCKHOLDER MATTERS
Information required by this item may be found on the inside back cover of the
Company's 1997 Annual Report to Shareholders, which is incorporated by reference
and is filed as Exhibit 13.1 hereto.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
Information required by this item may be found on page 4 of the Company's 1997
Annual Report to Shareholders, which is incorporated by reference and is filed
as Exhibit 13.1 hereto.
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS
Information required by this item may be found on pages 5 through 16 of the
Company's 1997 Annual Report to Shareholders, which is incorporated by reference
and is filed as Exhibit 13.1 hereto.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information required by this item may be found on pages 14 and 15 of the
Company's 1997 Annual Report to Shareholders, which is incorporated by reference
and is filed as Exhibit 13.1 hereto.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Information required by this item may be found on pages 17 through 35 of the
Company's 1997 Annual Report to Shareholders, which is incorporated by reference
and is filed as Exhibit 13.1 hereto.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON
ACCOUNTING AND FINANCIAL DISCLOSURE
None.
PART III
ITEMS 10 - 13
Information required by these items may be found in the Company's Proxy
Statement which is incorporated by reference.
25
PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENTS, SCHEDULES AND REPORTS ON
FORM 8-K
A. The following documents are filed as a part of this report:
1. Financial Statements set forth on pages 17 through 35 of the 1997
Annual Report to Shareholders which is filed herewith as Exhibit 13.1.
(i) Report of Independent Accountants
(ii) Consolidated Balance Sheets as of December 31, 1997 and 1996
(iii) Consolidated Statements of Income for the Years Ended December
31, 1997, 1996 and 1995
(iv) Consolidated Statements of Changes in Stockholders' Equity for
the Years Ended December 31, 1997, 1996 and 1995
(v) Consolidated Statements of Cash Flows for the Years Ended
December 31, 1997, 1996 and 1995
2. Financial Schedules:
None required.
3. Exhibits:
Exhibit
Number Description
------ -----------
3.1 Amended and Restated Certificate of Incorporation of
the Registrant.*
3.2 Amended and Restated By-laws of the Registrant.*
10.1 Employment Agreement among Registrant, First National
Bank of New England (the "Bank") and Brett N. Silvers
as amended by Letter Agreement, dated July 3, 1997.*
10.2 Promissory Note of Brett N. Silvers, payable to the
Registrant, dated June 30, 1994, as amended.*
10.3 Stock Pledge Agreement, dated June 30, 1994, between
the Registrant and Brett N. Silvers, as amended.*
10.4 Amended and Restated 1996 Stock Option Plan.*
10.5 1994 Incentive Stock Option Plan, as amended.*
10.6 401(k) Plan.*
10.7 Lease between Cambridge One Commercial Plaza, LLC and
the Bank.*
10.8 Employment Agreement between the Bank and Brian J.
Charlebois dated August 25, 1997.*
10.9 Employment Agreement between the Bank and Leslie A.
Galbraith dated August 25, 1997.*
13.1 1997 Annual Report to Shareholders.
21.1 Subsidiaries of Registrant.*
23.1 Consent of Coopers & Lybrand L.L.P.
26
27.1 Financial Data Schedule for the Year Ended December
31, 1997.
* Denotes an exhibit which has previously been filed as an exhibit to
the Company's Registration Statement on Form S-1, Commission File No. 333-31339.
B. Reports on Form 8-K.
The Company has not filed any Current Reports on Form 8-K since the
filing of its Registration Statement dated September 22, 1997.
27
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.
Date: March 26, 1998
First International Bancorp, Inc.
By: /s/ Brett N. Silvers
------------------------
Brett N. Silvers
Chairman of the Board and
President
Pursuant to the requirements of the Securities 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:
Signature Title Date
--------- ----- ----
/s/ Brett N. Silvers
- ---------------------------
Brett N. Silvers Chairman of the Board March 26, 1998
and President
/s/ Michael R. Carter
- ---------------------------
Michael R. Carter Director March 26, 1998
/s/ Arnold L. Chase
- ---------------------------
Arnold L. Chase Director March 26, 1998
/s/ Cheryl A. Chase
- ---------------------------
Cheryl A. Chase Director March 26, 1998
/s/ Frank P. Longobardi
- ---------------------------
Frank P. Longobardi Director March 26, 1998
/s/ Bernard M. Waldman
- ---------------------------
Bernard M. Waldman Director March 26, 1998
/s/ Leslie A. Galbraith
- ---------------------------
Leslie A. Galbraith Executive Vice President, March 26, 1998
Secretary and Treasurer
28