SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q [X] Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For Six Months Ended June 30, 2001 or [_] Transition Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from ____________to____________ Commission File Number 0-7974 CHITTENDEN CORPORATION (Exact Name of Registrant as Specified in its Charter) VERMONT 03-028404 (State of Incorporation) (IRS Employer Identification No.) TWO BURLINGTON SQUARE BURLINGTON, VERMONT 05401 (Address of Principal Executive Offices) (Zip Code) Registrant's Telephone Number: (802) 658-4000 NOT APPLICABLE Former Name, Former Address and Formal Fiscal Year If Changed Since Last Report Indicate by checkmark 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 At August 8, 2001, there were 25,685,031 shares of the Corporation's $1.00 par value common stock issued and outstanding. 1 PART I. FINANCIAL INFORMATION Item 1. Financial Statements 2 Chittenden Corporation Consolidated Balance Sheets (Unaudited) June 30, December 31, 2001 2000 --------------------------- (in thousands) Assets Cash and cash equivalents $ 228,073 $ 178,621 Securities available for sale 571,025 585,281 FHLB stock 13,613 12,311 Loans held for sale 34,327 44,950 Loans: Commercial 632,768 515,926 Municipal 62,535 83,566 Real Estate: Residential 997,019 1,024,174 Commercial 785,223 723,339 Construction 52,772 57,701 --------------------------- Total Real Estate 1,835,014 1,805,214 Consumer 405,185 451,392 --------------------------- Total Loans 2,935,502 2,856,098 Less: Allowance for loan losses (44,541) (40,255) --------------------------- Net loans 2,890,961 2,815,843 Accrued interest receivable 24,836 25,642 Other real estate owned 625 513 Other assets 44,239 39,020 Premises and equipment, net 55,272 51,959 Intangible assets 35,058 15,721 --------------------------- Total assets $ 3,898,029 $ 3,769,861 =========================== Liabilities: Deposits: Demand $ 567,788 $ 530,975 Savings 2,044,384 1,934,227 Certificates of deposit less than $100,000 and other time deposits 644,701 615,336 Certificates of deposit $100,000 and over 195,832 211,869 --------------------------- Total deposits 3,452,705 3,292,407 Short-term borrowings 45,422 93,757 Accrued expenses and other liabilities 50,969 41,631 --------------------------- Total liabilities 3,549,096 3,427,795 Stockholders' Equity: Preferred stock - $100 par value authorized - 1,000,000 shares; issued and outstanding - none Common stock - $1 par value; authorized - 60,000,000 shares; 28,594 28,589 issued - 28,593,708 in 2001 and 28,589,428 in 2000 Surplus 153,399 153,474 Retained earnings 238,557 222,140 Treasury stock, at cost - 2,944,180 shares in 2001 and 2,492,344 shares in 2000 (79,588) (65,637) Accumulated other comprehensive income 4,549 164 Directors deferred compensation to be settled in stock 3,514 3,414 Unearned portion of employee restricted stock (92) (78) --------------------------- Total stockholders' equity 348,933 342,066 --------------------------- Total liabilities and stockholders' equity $ 3,898,029 $ 3,769,861 =========================== The accompanying notes are an integral part of these consolidated financial statements. 3 Chittenden Corporation Consolidated Statements of Income (Unaudited) For the Three Months For the Six Months Ended June 30, Ended June 30, 2001 2000 2001 2000 ------------------------------------------------- (in thousands) (in thousands) Interest income: Interest on loans $ 57,955 $ 61,555 $ 116,062 $ 121,384 Investment securities: Taxable 9,580 10,104 19,238 20,819 Tax-favored 248 120 387 222 Short-term investments 103 142 337 161 ------------------------------------------------ Total interest income 67,886 71,921 136,024 142,586 ------------------------------------------------ Interest expense: Deposits: Savings 13,479 15,400 29,297 29,493 Time 10,951 10,776 22,103 21,162 ------------------------------------------------ Total interest on deposits 24,430 26,176 51,400 50,655 Short-term borrowings 772 4,307 1,765 7,757 ------------------------------------------------ Total interest expense 25,202 30,483 53,165 58,412 ------------------------------------------------ Net interest income 42,684 41,438 82,859 84,174 Provision for loan losses 2,041 2,175 3,991 4,350 ------------------------------------------------ Net interest income after provision for loan losses 40,643 39,263 78,868 79,824 ------------------------------------------------ Noninterest income: Investment management income 3,849 3,124 7,225 6,617 Service charges on deposit accounts 3,705 3,393 7,053 7,055 Mortgage servicing income 944 1,121 1,922 2,058 Gains on sales of loans, net 1,945 547 6,884 1,120 Credit card income, net 1,114 1,428 2,114 2,545 Insurance commissions, net 834 688 1,728 1,469 Other 3,052 3,256 5,716 6,226 ------------------------------------------------ Total noninterest income 15,443 13,557 32,642 27,090 ------------------------------------------------ Noninterest expense: Salaries 15,350 13,124 29,367 27,911 Employee benefits 3,102 2,800 6,869 4,342 Net occupancy expense 4,260 3,668 8,995 8,502 Amortization of intangibles 741 520 1,253 1,060 Other real estate owned, income and expense, net 8 (23) 47 (67) Special charges - - - 833 Other 10,364 10,640 20,242 20,935 ------------------------------------------------ Total noninterest expense 33,825 30,729 66,773 63,516 ------------------------------------------------ Income before income tax expense 22,261 22,091 44,737 43,398 Income tax expense 7,935 7,620 15,900 14,336 ------------------------------------------------ Net income $ 14,326 $ 14,471 $ 28,837 $ 29,062 ================================================ Basic earnings per share $ 0.56 $ 0.53 $ 1.12 $ 1.05 Diluted earnings per share 0.55 0.53 1.10 1.04 Dividends per share 0.24 0.24 0.48 0.46 The accompanying notes are an integral part of these consolidated financial statements. 4 Chittenden Corporation Consolidated Statements of Cash Flows (Unaudited) For the Six Months Ended June 30, 2001 2000 ----------------------- (in thousands) Cash flows from operating activities: Net income $ 28,837 $ 29,062 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 3,991 4,350 Depreciation and amortization 2,943 2,596 Amortization of intangible assets 1,253 1,060 Amortization of premiums, fees, and discounts, net 944 253 Recovery of goodwill related to sale of branch - 702 Investment securities (gains) losses 407 688 Deferred income taxes (1,544) 10,417 Loans originated for sale (167,272) (82,858) Proceeds from sales of loans 184,779 78,056 Gains on sales of loans (6,884) (1,120) Changes in assets and liabilities, net of effect from purchase of acquired companies: Accrued interest receivable 1,674 (718) Other assets (1,956) 3,177 Accrued expenses and other liabilities 8,817 (32,253) ----------------------- Net cash provided by operating activities 55,989 13,412 ----------------------- Cash flows from investing activities: Cash acquired, net of cash paid in acquisition of Maine Bank & Trust 8,001 - Purchases of Federal Home Loan Bank stock (616) (1,494) Proceeds from sales of securities available for sale 189,159 186,464 Proceeds from maturing securities and principal payments on securities available for sale 191,994 51,203 Purchases of securities available for sale (355,614) (196,998) Loans originated, net of principal repayments 88,052 (31,758) Purchases of premises and equipment (458) (7,883) ----------------------- Net cash provided by (used in) investing activities 120,518 (466) ----------------------- Cash flows from financing activities: Net increase (decrease) in deposits (52,127) (39,193) Net increase (decrease) in short-term borrowings (48,335) 88,942 Tax benefit of stock plans - 856 Proceeds from issuance of treasury and common stock 823 1,707 Dividends on common stock (12,421) (12,807) Repurchase of common stock (14,995) (47,081) ----------------------- Net cash provided by (used in) financing activities (127,055) (7,576) ----------------------- Net increase (decrease) in cash and cash equivalents 49,452 5,370 Cash and cash equivalents at beginning of period 178,621 150,415 ----------------------- Cash and cash equivalents at end of period $ 228,073 $ 155,785 ======================= Supplemental disclosure of cash flow information: Cash paid during the period for: Interest $ 26,047 $ 59,886 Income taxes 19,978 6,875 Non-cash investing and financing activities: Loans transferred to other real estate owned 821 1,480 Issuance of treasury and restricted stock 143 70 Assets acquired and liabilities assumed through acquisitions: Fair value of assets acquired $ 239 $ - Liabilities assumed 212 - Cash paid 47 - ----------------------- Goodwill $ 20 $ - ======================= The accompanying notes are an integral part of these consolidated financial statements. 5 Chittenden Corporation Notes to Consolidated Financial Statements NOTE 1 - ACCOUNTING POLICIES The financial information included herein is unaudited; however, such information reflects all adjustments (consisting of normal recurring adjustments) which are, in the opinion of management, necessary for a fair statement of results for the interim periods. Results for interim periods are not necessarily indicative of the results of operations for the full year or any other interim period. The Company's significant accounting policies are described in Note 1 of the Notes to Consolidated Financial Statements included in its 2000 Annual Report on Form 10-K filed with the Securities and Exchange Commission. For interim reporting purposes, the Company follows the same basic accounting policies and considers each interim period as an integral part of an annual period. Certain amounts for 2000 have been reclassified to conform to 2001 classifications. Effective January 1, 2001, the Company adopted SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities ("SFAS 133"). This statement establishes the 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 a liability measured at its fair value. The Statement requires that changes in the derivative's fair value be recognized currently in income 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 a company must formally document, designate and assess the effectiveness of transactions that receive hedge accounting. If a derivative qualifies as a hedge, depending on the nature of the hedge, changes in the fair value of the derivative are either offset against the change in the fair value of assets, liabilities, or firm commitments through earnings or are recognized in other comprehensive income until the hedged item is recognized in earnings. The ineffective portion of a derivative's change in fair value is to be immediately recognized in earnings. The Company's derivatives include certain commitments to fund mortgage loans, which are intended for sale and the related forward sale agreements with investors. The Company's adoption of SFAS 133 did not have a material impact on its financial position or results of operations. The Financial Accounting Standards Board (FASB) has issued Statement of Financial Accounting Standards (SFAS) No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities. This Statement replaces SFAS No. 125, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, and rescinds FASB Statement No. 127, Deferral of the Effective Date of Certain Provisions of FASB Statement No. 125. SFAS No. 140 provides accounting and reporting standards for transfers and servicing of financial assets and extinguishments of liabilities. This Statement provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings. This Statement is effective for transfers and servicing of financial assets and extinguishments of liabilities occurring after March 31, 2001 and is effective for recognition and reclassification of collateral and for disclosures relating to securitization transactions and collateral for fiscal years ending after December 15, 2000. The Company has quantified the impact of provisions effective for 2000 and 2001 and the adoption did not have a material impact on its financial position or results of operations. NOTE 2 - ACQUISITIONS AND SALES On April 30, 2001, the Company acquired Maine Bank Corp., headquartered in Portland, Maine and its subsidiary, Maine Bank & Trust for $49.25 million in cash. The acquisition has been accounted for as a purchase and, accordingly, the operations of Maine Bank & Trust (MBT) are included in these financial statements from the date of acquisition. 6 The purchase price has been allocated to assets acquired and liabilities assumed based on estimates of fair value at the date of acquisition. The excess of purchase price over the fair value of assets acquired has been recorded as goodwill. The fair value of these assets and liabilities is summarized as follows (in thousands): Cash and cash equivalents ...................................................... $ 54,519 FHLB Stock ..................................................................... 686 Securities available for sale .................................................. 5,968 Net loans ...................................................................... 168,860 Premises and equipment ......................................................... 5,798 Goodwill ....................................................................... 20,590 Prepaid expenses and other assets .............................................. 3,422 Deposits ....................................................................... (212,425) Accrued expenses and other liabilities ......................................... 34 ------------------ Total acquisition cost ......................................................... $ 47,452 ================== Included in the total acquisition cost is approximately $636,000 of capitalized cost incurred in connection with the acquisition. Following is supplemental information reflecting selected pro forma results as if this acquisition had been consummated as of January 1, 2000 (in thousands, except EPS): For the three months For the six months ended June 30, ended June 30, 2001 2000 2001 2000 -------------------------------------------------------------- Total revenue $59,657 $59,731 $121,568 $119,400 Income before income taxes 22,534 23,174 45,708 45,312 Net income 14,463 15,048 29,303 30,055 Earnings per share (EPS) 0.56 0.55 1.12 1.07 Total revenue includes net interest income and noninterest income. During the first quarter of 2001, the Company sold its retail credit card portfolio, totaling approximately $39 million, at a gain of $4.3 million. An additional gain of $330,000 was recognized in the second quarter of 2001 after the expiration of certain contingent obligations accrued in the first quarter. NOTE 3 - SPECIAL CHARGES Special charges of $833,000 (pre-tax) were recorded during the first quarter of 2000 which included the loss on branch fixed assets and recovery of goodwill (net of deposit premiums) of $145,000 and losses of $688,000 on securities sold to fund the final branch divestiture required as a condition of regulatory approval of the VFSC merger. Total loans and deposits sold in the final branch divestiture were $3.6 million and $27.0 million, respectively. Upon consummation of the VFSC acquisition in the second quarter of 1999, the Company recorded special charges, which included an accrual for merger related expenses that would occur in future periods. Included in accrued expenses and other liabilities at June 30, 2001, are merger-related expenses totaling $627,000, which will be paid in future periods. The change in accrued merger related expenses at June 30, 2001 is summarized below (amounts in thousands): Accrual Balance as Less: Accrual Balance as of December 31, 2000 Cash Transactions of June 30, 2001 ================================================================================= Compensation and Benefits $1,218 $591 $627 --------------------------------------------------------------------------------- Total $1,218 $591 $627 ================================================================================= 7 NOTE 4 - RECENT ACCOUNTING PRONOUNCEMENTS In July 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, Business Combinations ("SFAS 141"), and No. 142, Goodwill and Other Intangible Assets ("SFAS 142"). Statement No. 141 requires that the purchase accounting method be used for all business combinations initiated after June 30, 2001. SFAS 142 addresses the method of identifying and measuring goodwill and other intangible assets acquired in a business combination, eliminates further amortization of goodwill, and requires periodic evaluations of impairment of goodwill balances. SFAS 142 is effective for fiscal years beginning after December 15, 2001. The Company is currently assessing the impact of adopting SFAS 141 and SFAS 142. In relation to SFAS 142, the Company expects that its annualized goodwill amortization of $2.6 million will be eliminated beginning in 2002. NOTE 5 - COMPREHENSIVE INCOME The Company's comprehensive income for the three-month and six-month periods ended June 30, 2001 and 2000 is presented below (amounts in thousands): For the Three Months For the Six Months Ended June 30, Ended June 30, 2001 2000 2001 2000 -------------------------------------------- Net Income $14,326 $14,471 $28,837 $29,062 Unrealized gains/losses on investment securities: Unrealized holding gains (losses) on securities available for sale, net of tax (1,452) (216) 4,120 (1,035) Reclassification adjustments for (gains) losses arising during period, net of tax (14) 475 265 475 -------------------------------------------- Total Comprehensive income $12,860 $14,730 $33,222 $28,502 ============================================ NOTE 6 - BUSINESS SEGMENTS The Company has identified Commercial Banking as its reportable operating business segment based on the fact that the chief operating decision-maker views the results of operations as a single strategic unit. The Commercial Banking segment is comprised of Chittenden Bank, The Bank of Western Massachusetts, Flagship Bank and Trust, Maine Bank & Trust, and Chittenden Connecticut Corporation, which provide similar products and services, have similar distribution methods, types of customers and regulatory responsibilities. The Commercial Banking segment derives its revenue from a wide range of banking services, including lending activities, acceptance of demand, savings and time deposits, safe deposit facilities, merchant credit card services, trust and investment management, data processing, brokerage services, mortgage banking, and loan servicing for investor portfolios. Immaterial operating segments of the Company's operations, which do not have similar characteristics to the commercial banking operations and do not meet the quantitative thresholds requiring disclosure, are included in the Other category in the disclosure of business segments below. The accounting policies used in the disclosure of business segments are the same as those described in the summary of significant accounting policies included in Note 1 of the Company's 2000 Annual Report on Form 10-K. The consolidation adjustments reflect certain eliminations of inter-segment revenue, cash and parent company investments in subsidiaries. 8 For the Three Months Ended June 30, 2001 Commercial Consolidation (in thousands) Banking Other (2) Adjustments Consolidated ------------------------------------------------------------ Net interest revenue (1) $ 42,684 $ 66 $ (66) $ 42,684 Noninterest income 14,607 836 - 15,443 Provision for loan losses 2,041 - - 2,041 Noninterest expense 32,826 999 - 33,825 ------------------------------------------------------------ Net income (loss) before income tax 22,424 (97) (66) 22,261 Income tax expense/(benefit) 7,948 (13) - 7,935 ------------------------------------------------------------ Net income (loss) $ 14,476 $ (84) $ (66) $ 14,326 ============================================================ End of Period Assets $3,896,909 $355,355 $(354,235) $3,898,029 For the Three Months Ended June 30, 2000 Commercial Consolidation (in thousands) Banking Other (2) Adjustments Consolidated ------------------------------------------------------------ Net interest revenue (1) $ 41,430 $ 122 $ (114) $ 41,438 Noninterest income 12,864 681 12 13,557 Provision for loan losses 2,175 - - 2,175 Noninterest expense 29,960 757 12 30,729 ------------------------------------------------------------ Net income (loss) before income tax 22,159 46 (114) 22,091 Income tax expense/(benefit) 7,599 21 - 7,620 ------------------------------------------------------------ Net income (loss) $ 14,560 $ 25 $ (114) $ 14,471 ============================================================ End of Period Assets $3,814,718 $342,606 $(341,233) $3,816,091 For the Six Months Ended June 30, 2001 Commercial Consolidation (in thousands) Banking Other (2) Adjustments Consolidated ------------------------------------------------------------ Net interest revenue (1) $ 82,852 $ 169 $ (162) $ 82,859 Noninterest income 30,905 1,758 (21) 32,642 Provision for loan losses 3,991 - - 3,991 Noninterest expense 64,796 1,998 (21) 66,773 ------------------------------------------------------------ Net income (loss) before income tax 44,970 (71) (162) 44,737 Income tax expense/(benefit) 15,883 17 - 15,900 ------------------------------------------------------------ Net income (loss) $ 29,087 $ (88) $ (162) $ 28,837 ============================================================ End of Period Assets $3,896,909 $355,355 $(354,235) $3,898,029 For the Six Months Ended June 30, 2000 Commercial Consolidation (in thousands) Banking Other (2) Adjustments Consolidated ------------------------------------------------------------ Net interest revenue (1) $ 84,148 $ 198 $ (172) $ 84,174 Noninterest income 25,614 1,473 3 27,090 Provision for loan losses 4,350 - - 4,350 Noninterest expense 61,820 1,693 3 63,516 ------------------------------------------------------------ Net income (loss) before income tax 43,592 (22) (172) 43,398 Income tax expense/(benefit) 14,324 12 - 14,336 ------------------------------------------------------------ Net income (loss) $ 29,268 $ (34) $ (172) $ 29,062 ============================================================ End of Period Assets $3,814,718 $342,606 $(341,233) $3,816,091 (1) The Commercial Banking segment derives a majority of its revenue from interest. In addition, management primarily relies on net interest revenue, not the gross revenue and expense amounts, in managing the segment. Therefore, only the net amount has been disclosed. (2) Revenue derived from these non-reportable segments includes insurance commissions from various insurance related products and services. 9 NOTE 7 - SUBSEQUENT EVENT On July 18, 2001, the Company declared regular dividends of $0.24 per share or approximately $6.2 million, to be paid on August 17, 2001 to shareholders of record on August 3, 2001. In addition, Chittenden announced a five-for-four stock split. The stock split will be distributed on September 14, 2001, to shareholders of record on August 31, 2001. The accompanying consolidated financial statements do not give effect to the stock split. Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations Results of Operations On April 30, 2001, the Company acquired Maine Bank Corp., headquartered in Portland, Maine and its subsidiary, Maine Bank & Trust for $49.25 million in cash. The acquisition has been accounted for as a purchase and, accordingly, the operations of Maine Bank & Trust (MBT) are included in these financial statements from the date of acquisition. On May 28, 1999, Chittenden Corporation ("Chittenden" or "the Company") completed the acquisition of Vermont Financial Services Corp. (VFSC) in a stock- for-stock transaction accounted for as a pooling of interests. The Company recognized $792,000 of after-tax special charges in the first quarter of 2000 related to the final branch sale required as a condition of the regulatory approval of the acquisition. Results excluding these special charges are referred to in the following discussion as operating. A reconciliation of the Company's net income to its operating earnings for the periods ended June 30, 2001 and 2000 is presented below (amounts in thousands): For the Three Months For the Six Months Ended June 30, Ended June 30, ------------------------------------------ 2001 2000 2001 2000 Net income, as reported $14,326 $14,471 $28,837 $29,062 Add: Loss on branch sale - - - 833 Tax effect of adjustment for loss on branch sale - - - (41) ------------------------------------------ Operating net income $14,326 $14,471 $28,837 $29,854 ========================================== Diluted Operating EPS $ 0.55 $ 0.53 $ 1.10 $ 1.07 During the first quarter of 2000, special charges of $833,000 (pre-tax) were recorded which included the loss on branch fixed assets and recovery of goodwill (net of deposit premiums) of $145,000 and losses of $688,000 on securities sold to fund the final branch divestiture. Chittenden Corporation posted second quarter 2001 net income of $0.55 per diluted share, compared to the net income of $0.53 per diluted share posted in the second quarter of last year. Net income for the second quarter of 2001 was $14.3 million, compared to net income of $14.5 million recorded in the same quarter a year ago. Return on average equity was 16.63% for the quarter ended June 30, 2001 compared with operating return on average equity of 17.32% for the same period in 2000. Return on average assets was 1.51% for the second quarter of 2001, compared with the return on average assets of 1.52% for the second quarter of last year. For the first six months of 2001, diluted earnings per share were $1.10, compare to the $1.07 diluted operating earnings per share recorded for the same time period in 2000. Year to date net income for 2001 was $28.8 million, compared to operating net income of $29.9 million for the same period a year ago. Return on average equity for the first six months of 2001 was 16.89%, down from operating return on average equity of 17.24% a year ago. Return on average assets for the first six months of 2001 was 1.56%, flat to a year ago. The decline in return on average equity for the quarter and the year to date in 2001 has been a result of higher levels of unrealized gains on the investment portfolio. Unrealized gains (after tax) averaged approximately $5.4 million for the second quarter and $4.2 million for the year to date of 2001 versus average unrealized losses of approximately $7.5 million for the quarter and for the first six months of 2000. Net interest income on a tax equivalent basis for the three months ended June 30, 2001 was $43.3 million, up from $41.8 million for the same period a year ago. The yield on earning assets was 4.87% in the second quarter of 2001, compared with 4.66% in the same period of 2000 and 4.78% for the first quarter of 2001. The increase in net interest 10 income from the second quarter of 2000 was attributed primarily to lower cost of funds in 2001 due to a reduction in short-term borrowings, as well as the acquisition of Maine Bank & Trust. Excluding the impact of MBT, the net yield on earning assets in the second quarter of 2001 would have been 4.82%. The following table presents an analysis of average rates and yields on a fully taxable equivalent basis for the three months and six months ended June 30, 2001 and 2000: For the Three Months For the Three Months Ended June 30, Ended June 30, 2001 2000 Interest Average Interest Average Average Income/ Yield/ Average Income/ Yield/ Description Balance Expense(1) Rate(1) Balance Expense(1) Rate(1) - ---------------------------------------------------------------------------------------------------------- ASSETS Interest-Earning Assets: Loans $ 2,934,629 $58,459 7.99% $2,962,165 $61,872 8.40% Investments: Taxable 600,233 9,580 6.40% 624,917 10,136 6.52% Tax-Favored Securities 24,680 347 5.64% 8,309 128 6.21% Interest-Bearing Deposits 225 2 3.55% 239 2 3.86% Federal Funds Sold 7,663 101 5.29% 8,891 140 6.33% ----------------------- -------------------- Total Interest-Earning Assets 3,567,430 68,489 7.70% 3,604,521 72,278 8.06% --------- -------- Noninterest-Earning Assets 271,484 276,538 Allowance for Loan Losses (42,665) (40,906) ------------ ----------- Total Assets $ 3,796,249 $3,840,153 ============ =========== LIABILITIES AND STOCKHOLDERS' EQUITY Interest-Bearing Liabilities: Savings and Interest-Bearing Transactional Accounts $ 1,967,315 $13,479 2.75% $1,848,359 $15,400 3.35% Time Deposits * $100,000 214,184 2,723 5.10% 230,351 3,191 5.57% Other Time Deposits 636,409 8,225 5.18% 620,161 7,585 4.92% ---------------------- -------------------- Total Interest-Bearing Deposits 2,817,908 24,427 3.48% 2,698,871 26,176 3.90% Short-Term Borrowings 53,972 773 5.74% 270,145 4,307 6.41% ---------------------- -------------------- Total Interest-Bearing Liabilities 2,871,880 25,200 3.52% 2,969,016 30,483 4.13% --------- -------- NonInterest-Bearing Liabilities: Demand Deposits 523,392 494,008 Other Liabilities 55,411 41,036 ----------- ----------- Total Liabilities 3,450,683 3,504,060 Stockholders' Equity 345,566 336,093 ----------- ----------- Total Liabilities and Stockholders' Equity $ 3,796,249 $3,840,153 =========== =========== Net Interest Income $43,289 $41,795 ========= ======== Interest Rate Spread (2) 4.18% 3.93% Net Yield on Earning Assets (3) 4.87% 4.66% For the Six Months For the Six Months Ended June 30, Ended June 30, 2001 2000 Interest Average Interest Average Average Income/ Yield/ Average Income/ Yield/ Description Balance Expense(1) Rate(1) Balance Expense(1) Rate(1) - ---------------------------------------------------------------------------------------------------------- ASSETS Interest-Earning Assets: Loans $2,883,286 $117,073 8.19% $2,939,535 $122,075 8.35% Investments: Taxable 596,509 19,238 6.50% 648,330 20,865 6.47% Tax-Favored Securities 18,644 544 5.88% 8,327 258 6.24% Interest-Bearing Deposits 225 4 3.80% 257 5 4.01% Federal Funds Sold 12,179 333 5.51% 5,076 156 6.18% --------------------- -------------------- Total Interest-Earning Assets 3,510,843 137,192 7.88% 3,601,525 143,359 8.00% -------- -------- Noninterest-Earning Assets 258,063 290,063 Allowance for Loan Losses (41,486) (41,273) ---------- ---------- Total Assets $3,727,420 $3,850,315 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Interest-Bearing Liabilities: Savings and Interest-Bearing Transactional Accounts $1,926,026 $ 29,297 3.07% $1,824,724 $ 29,493 3.25% Time Deposits * $100,000 212,119 5,716 5.43% 218,726 5,849 5.38% Other Time Deposits 626,900 16,386 5.27% 630,919 15,313 4.88% --------------------- -------------------- Total Interest-Bearing Deposits 2,765,045 51,399 3.75% 2,674,369 50,655 3.81% Short-Term Borrowings 60,535 1,766 5.88% 258,145 7,757 6.04% --------------------- -------------------- Total Interest-Bearing Liabilities 2,825,580 53,165 3.79% 2,932,514 58,412 4.01% -------- -------- NonInterest-Bearing Liabilities: Demand Deposits 502,891 504,040 Other Liabilities 54,726 65,507 ---------- ---------- Total Liabilities 3,383,197 3,502,061 Stockholders' Equity 344,223 348,254 ---------- ---------- Total Liabilities and Stockholders' Equity $3,727,420 $3,850,315 ========== ========== Net Interest Income $ 84,027 $ 84,947 ======== ======== Interest Rate Spread(2) 4.09% 3.99% Net Yield on Earning Assets (3) 4.83% 4.74% (1) On a fully taxable equivalent basis, calculated using a Federal income tax rate of 35%. Loan income includes fees. (2) Interest rate spread is the average rate earned on total interest-earning assets less the average rate paid on interest-bearing liabilities. (3) Net yield on earning assets is net interest income divided by total interest-earning assets. * Denotes greater than sign. Noninterest income amounted to $15.4 million for the second quarter of 2001 and $32.6 million for the first half of 2001, up from $13.6 million and $27.1 million for the respective periods last year. Gains on sales of loans increased $1.4 million for the second quarter to $1.9 million. For the year, gains on sales of loans consisted of $2.3 million from 11 mortgage banking activities and $4.6 million gain on the sale of the Company's retail credit card portfolio. Increases in investment management, insurance, and service charges on deposits income were offset by declines in credit card income (due to the sale of the retail credit card portfolio) and other income. Noninterest expenses increased to $33.8 million for the second quarter of 2001 from $30.7 million for same period last year. Salaries and employee benefits increased $2.5 million from the second quarter of 2000. Approximately half of this increase was attributable to the inclusion of Maine Bank & Trust in the 2001 amounts. In addition, accruals for incentive compensation were $1.3 million higher in 2001 than in 2000. Net occupancy expenses for the second quarter of 2001 were $4.3 million compared with $3.7 million a year ago. The majority of this increase was also due to the inclusion of MBT. Amortization of intangibles also increased due to the MBT acquisition as a result of recording goodwill of approximately $20.6 million in the transaction. For the first six months, total noninterest expenses were $66.8 million in 2001, compared with $63.5 million the year before. Salaries and employee benefits increased $4.0 million from the 2000 level. Approximately $2.5 million of the variance in salaries and benefits related to the second quarter (see previous paragraph). In addition, a $1.3 million pension curtailment gain taken in the first quarter of 2000 upon the merger of the Vermont National and Chittenden Bank pension plans reduced expenses for the previous year. Net occupancy and amortization expenses increased $493,000 and $193,000, respectively, for the first six months primarily as a result of the inclusion of MBT in the 2001 amounts. Income Taxes The Company and its subsidiaries are taxed on income by the IRS at the Federal level and by various states in which they do business. The majority of the Company's income is generated in the State of Vermont, which levies franchise taxes on banks based upon average deposit levels in lieu of taxing income. Franchise taxes are included in income tax expense in the consolidated statements of income. For the six months ended June 30, 2001 and 2000, Federal and state income tax provisions amounted to $15.9 million and $14.3 million, respectively. The effective income tax rates for the respective periods were 35.5% and 32.5%, after adjusting for the tax effect of the branch sale. In addition, the 2000 provision was reduced by approximately $750,000 for the effect of the exercise of non-qualified stock options. Excluding this amount, the 2000 effective tax rate would have been 34.2%. The increase from this amount to the 35.5% for the second quarter of 2001 is primarily attributable to increases in taxable income at the Massachusetts banks, relative to the Vermont bank. During all periods, the Company's statutory Federal corporate tax rate was 35%. Financial Position The Company invests the majority of its assets in loans and securities. Total loans were flat from a year ago, at $2.9 billion as of June 30, 2001. The June 30, 2001 balance included approximately $174 million in total loans at MBT. Residential real estate loans declined $68.8 million due to higher levels of prepayments caused by declining market interest rates. During the quarter, the Company originated primarily fixed rate residential loans, which were sold on the secondary market rather than variable rate residential real estate loans, which it keeps in portfolio. For the quarter, residential real estate loans were up $10 million from March 31, 2001. This was due to the addition of approximately $36 million of variable rate home equity loans in the MBT portfolio. Consumer loans declined $107 million from June 30, 2000. Of that amount, approximately $39 million was due to the sale of the retail credit card portfolio, which occurred in the first quarter of 2001. In addition, paydowns on the automotive finance portfolio, driven by lower market interest rates, outpaced originations. The Company's decision effective January 1, 2001, to concentrate its lease origination efforts in Vermont, while scaling back in Massachusetts, also affected automotive finance originations in the first two quarters of 2001. Overall commercial balances increased approximately $205 million from a year ago. Approximately $126 million was attributed to the purchase of MBT. Excluding the effect of MBT, the commercial portfolio at June 30, 2001 was $79 million higher than a year ago, with growth primarily in the commercial category while commercial real estate loans were flat. Total deposits at June 30, 2001 were $3.5 billion, up $160.3 million from December 31, 2000 and up $287.8 million from June 30, 2000. The increase was primarily in demand and money market/savings accounts. Much of the increase 12 was due to the acquisition of MBT, which contributed $209 million in deposits at June 30, 2001. However, the existing franchise also grew its deposits approximately 2.5% from the level a year ago. Credit Quality Nonperforming assets include nonaccrual loans and foreclosed real estate (Other Real Estate Owned). As of June 30, 2001, nonperforming assets plus loans 90 days past due and still accruing totaled $16.3 million, flat from a quarter ago and a year ago. Net charge-off activity totaled $1.1 million for the second quarter of 2001, compared to $3.8 million for the same period in 2000. Approximately $2.0 million of the charge-offs in the second quarter of 2000 related to a single commercial relationship. The allowance for loan losses was $44.5 million at June 30, 2001, up from $39.6 million a year ago, and $39.5 million at March 31, 2001. The acquisition of MBT accounted for $4.1 million of the increase. The provision for possible loan losses was approximately $4.0 million in 2001 as compared to $4.35 million in 2000. The lower provision in 2001 was due to the sale of the retail credit card portfolio. Net retail credit card charge-offs in 2000 were $1.3 million or approximately $325,000 per quarter. A summary of credit quality follows: 6/30/01 3/31/01 12/31/00 6/30/00 ---------------------------------------------------------------------------------- (in thousands) Nonaccrual loans $ 12,689 $ 11,560 $ 11,376 $ 11,024 Other real estate owned (OREO) 625 328 513 579 ---------------------------------------------------------------------------------- Total nonperforming assets (NPAs) $ 13,314 $ 11,888 $ 11,889 $ 11,603 ================================================================================== Loans past due 90 days or more and still accruing interest $ 3,082 $ 4,318 $ 4,595 $ 4,751 NPAs plus loans past due 90 days or more and still accruing interest 16,396 16,206 16,484 16,354 Allowance for loan losses 44,541 39,546 40,255 39,643 NPAs as % of loans plus OREO 0.45% 0.42% 0.42% 0.40% Allowance as % of loans 1.52% 1.41% 1.41% 1.35% Allowance as % of nonperforming loans 351.02% 342.09% 353.86% 359.61% Allowance as % of NPAs 334.54% 332.65% 338.59% 341.66% Provisions for and activity in the allowance for loan losses are summarized as follows: Three Months Six Months Ended June 30, Ended June 30, 2001 2000 2001 2000 -------------------------------------------------------------------------- (in thousands) Beginning Balance $39,546 $41,228 $40,255 $41,079 Provision for Loan Losses 2,041 2,175 3,991 4,350 Acquisition of Maine Bank & Trust 4,083 - 4,083 - Loans Charged Off (2,294) (4,816) (5,735) (7,649) Loan Recoveries 1,165 1,056 1,947 1,863 -------------------------------------------------------------------------- Ending Balance $44,541 $39,643 $44,541 $39,643 ========================================================================== The allowance for possible loan losses is based on management's estimate of the amount required to reflect the risks in the loan portfolio, based on circumstances and conditions known at each reporting date. Adequacy of the allowance is determined using a consistent, systematic methodology which analyzes the size and risk of the loan portfolio. In addition to evaluating the collectibility of specific loans when determining the adequacy of the allowance for possible loan losses, management also takes into consideration other factors such as changes in the mix and volume of the loan portfolio, historic loss experience, the amount of the delinquencies and loans adversely classified, and economic trends. The adequacy of the allowance for possible loan losses is assessed by an allocation process whereby specific loss allocations are made against certain adversely classified loans, and general loss allocations 13 are made against segments of the loan portfolio which have similar attributes. The Company's historical loss experience, industry trends, and the impact of the local and regional economy on the Company's borrowers, were considered by management in determining the adequacy of the allowance for possible loan losses. Capital On January 19, 2000, the Board of Directors authorized the repurchase of up to two million shares of the Corporation's common stock in negotiated transactions or open market purchases. On July 19, 2000, the Board authorized the repurchase of an additional two million shares, bringing the total authorization to four million shares. As of June 30, 2001, approximately 3.0 million shares had been repurchased. Based on the resolution passed by the Corporation's Board of Directors, the Company has until July 2002 to purchase the remaining 1.0 million shares authorized. Stockholders' equity totaled $348.9 million at June 30, 2001, compared to $342.1 million at year-end 2000. The current level reflects net income of $28.8 million less dividends paid to shareholders totaling $12.4 million, and share repurchases totaling $15.0 million. Accumulated other comprehensive income increased $4.4 million to $4.5 million at June 30, 2001 from $164,000 at December 31, 2000, as a result of declining market interest rates and a corresponding increase in the unrealized gain on securities available for sale. "Tier One" capital, consisting entirely of common equity, measured 9.88% of risk-weighted assets at June 30, 2001. Total capital, including the "Tier Two" allowance for loan losses, was 11.13% of risk-weighted assets. The leverage capital ratio was 8.13%. These ratios placed Chittenden in the "well- capitalized" category according to regulatory standards. Liquidity The Company's liquidity and rate sensitivity are monitored by the executive management committee, based upon policies approved by the Board of Directors. Strategies are implemented by the Company's executive management committee. This committee meets periodically to review and direct the Banks' lending and deposit-gathering functions. Investment and borrowing activities are managed by the Company's Treasury function. The measure of an institution's liquidity is its ability to meet its cash commitments at all times with available cash or by conversion of other assets to cash at a reasonable price. At June 30, 2001, the Company maintained cash balances and short-term investments of approximately $228.1 million, compared with $178.6 million at December 31, 2000. Interest-rate risk is the sensitivity of income to variations in interest rates over both short-term and long-term horizons. The primary goal of interest- rate management is to control this risk within limits approved by the Board of Directors. These limits and guidelines reflect the Company's tolerance for interest-rate risk. The Company attempts to control interest-rate risk by identifying exposures, quantifying them and taking appropriate actions. The Company quantifies its interest-rate risk exposure using sophisticated simulation and valuation models, as well as simpler gap analyses. For a full discussion of interest-rate risk see "Liquidity and Rate Sensitivity" in the Company's 2000 annual report on Form 10-K. There has not been a material change in the Company's interest-rate exposure or its anticipated market risk during the current period. Impact of Future Changes to Generally Accepted Accounting Principles In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, Business Combinations ("SFAS 141"), and No. 142, Goodwill and Other Intangible Assets ("SFAS 142"). Statement No. 141 requires that the purchase accounting method be used for all business combinations initiated after June 30, 2001. Statement No. 142 establishes new accounting and reporting standards for goodwill and intangible assets. Under the new statement, goodwill is no longer subject to amortization over its useful life. It will be subject to periodic (at least annual) assessments for impairment by applying a fair-value-based test. In the event that the recorded amount of goodwill exceeds its fair value, an impairment loss would be recorded. The Company will adopt SFAS 142 effective January 1, 2002. The Company anticipates that the elimination of goodwill amortization in 2002 will increase net income by approximately $2.6 million, or approximately 10 cents per share for the year. 14 PART II - OTHER INFORMATION Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS Annual Meeting, April 18, 2001 Proposal 1: ---------- Election of four directors, each to serve for a term of three years: DIRECTOR FOR AUTHORITY WITHHELD - ---------------------------------------------------------------------------------------------------- Frederic H. Bertrand 23,448,353 129,901 David M. Boardman 23,454,400 123,854 Pall D. Spera 23,455,143 123,111 Martel D. Wilson, Jr. 23,455,356 122,898 Election of two directors, each to serve for a term of one year: John K. Dwight 23,456,668 121,586 Ernest A. Pomerleau 23,455,779 122,476 Proposal 2 ---------- Ratification of the Amendment to the 1997 Restatement and Amendment of the 1993 Stock Incentive Plan : For: 23,443,987 Against: 877,547 Abstain: 256,721 Item 6. EXHIBITS AND REPORTS ON FORM 8-K (a) EXHIBITS None. (b) REPORTS ON FORM 8-K The Company's first quarter 2001 press release announcing earnings and quarterly dividends was filed on Form 8-K on April 18, 2001. The Company's quarterly financial statements were filed on Form 8-K on April 18, 2001. The Company's press release announcing the completion of the acquisition of Maine Bank & Trust was filed on form 8-K on April 30, 2001. The Company's press release announcing the appointment of Owen W. Wells to the Board of Chittenden Corporation and Chittenden Bank was filed on form 8-K on May 2, 2001. 15 CHITTENDEN CORPORATION SIGNATURES Pursuant to the requirement 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. CHITTENDEN CORPORATION Registrant August 13, 2001 /S/ PAUL A. PERRAULT - --------------- ------------------- Date Paul A. Perrault, Chairman, President and Chief Executive Officer August 13, 2001 /S/ KIRK W. WALTERS - --------------- ------------------ Date Kirk W. Walters Executive Vice President, Treasurer, and Chief Financial Officer 16