UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the Fiscal Year Ended December 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
Commission File Number: 0-28389
CONNECTICUT BANCSHARES, INC.
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(Exact name of registrant as specified in its charter)
Delaware 06-1564613
- --------------------------------------------- -----------------------------------
(State or other jurisdiction of incorporation (I.R.S.Employer Identification No.)
or organization)
923 Main Street, Manchester, Connecticut 06040
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number: (860) 646-1700
---------------------------
Securities registered pursuant to Section 12(b) of the Act:
None.
Securities registered pursuant to Section 12(g)of the Act:
Common Stock, par value $0.01 per share.
Indicate by check mark whether the registrant 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 has been subject to such
filing requirements for the past 90 days. YES X NO
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Indicate by check mark if disclosure of delinquent filers pursuant to Item
405 of Regulation S-K is not contained herein, and will not be contained, to the
best of the 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. X
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The aggregate market value of the voting and non-voting common equity held
by non-affiliates as of March 19, 2002 was $293,676,585.
As of March 19, 2002, there were 11,249,826 shares of the registrant's
common stock outstanding.
Documents Incorporated by Reference:
Part III of this Form 10-K incorporates information by reference from the
registrant's definitive proxy statement which will be filed no later than 120
days after December 31, 2001.
INDEX
Page No.
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PART I
Item 1. Business.........................................................................1
Item 2. Properties......................................................................36
Item 3. Legal Proceedings...............................................................42
Item 4. Submission of Matters to a Vote of Security Holders.............................42
PART II
Item 5. Market for the Registrant's Common Equity
and Related Stockholder Matters.................................................42
Item 6. Selected Financial Data.........................................................43
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.............................................46
Item 7A. Quantitative and Qualitative Disclosure About Market Risk.......................58
Item 8. Financial Statements and Supplementary Data.....................................62
Item 9. Changes in and Disagreements With Accountants on
Accounting and Financial Disclosure.............................................62
PART III
Item 10. Directors and Executive Officers of the Registrant..............................63
Item 11. Executive Compensation..........................................................63
Item 12. Security Ownership of Certain Beneficial Owners and Management..................63
Item 13. Certain Relationships and Related Transactions..................................63
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K................64
SIGNATURES
Forward Looking Statements
This Form 10-K contains forward-looking statements that are based on
assumptions and describe future plans, strategies and expectations of
Connecticut Bancshares, Inc. ("CTBS") and its wholly-owned subsidiary, The
Savings Bank of Manchester ("SBM" or the "Bank"), and its wholly-owned
subsidiaries (collectively, the "Company"). These forward-looking statements are
generally identified by use of the words "believe," "expect," "intend,"
"anticipate," "estimate," "project," or similar expressions. The Company's
ability to predict results or the actual effect of future plans or strategies is
inherently uncertain. Factors which could have a material adverse effect on the
operations of the Company include, but are not limited to, changes in interest
rates, general economic conditions, legislative/regulatory changes, monetary and
fiscal policies of the U.S. Government, including policies of the U.S. Treasury
and the Federal Reserve Board, the quality or composition of the loan or
investment portfolios, demand for loan products, deposit flows, competition,
demand for financial services in the Bank's market area and accounting
principles and guidelines. These risks and uncertainties should be considered in
evaluating forward looking statements and undue reliance should not be placed on
such statements. Subject to applicable laws and regulations, the Company does
not undertake - and specifically disclaims any obligation - to publicly release
the result of any revisions which may be made to any forward looking statements
to reflect events or circumstances after the date of the statements or to
reflect the occurrence of anticipated or unanticipated events.
PART I
Item 1. Business.
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CTBS, a Delaware corporation, was organized in October 1999 for the purpose
of becoming the holding company for SBM upon the conversion of the Bank's former
parent holding company, Connecticut Bankshares, M.H.C. ("M.H.C."), from a mutual
to stock form of organization (the "Conversion"). The Conversion was completed
on March 1, 2000. In connection with the Conversion, the Company sold 10,400,000
shares of its common stock, par value $0.01 per share ("Common Stock") at a
purchase price of $10 per share, to depositors of the Bank in a subscription
offering. In addition, the Company issued an additional 832,000 shares,
representing 8% of the shares sold in the subscription offering, to SBM
Charitable Foundation, Inc., a charitable foundation established by the Bank.
The Company does not transact any material business other than through the Bank.
The Company used 50% of the net proceeds from the conversion to buy all of the
common stock of the Bank and retained the remaining 50% which was primarily
invested in fixed income securities.
On August 31, 2001, the Bank acquired First Federal Savings and Loan
Association of East Hartford ("First Federal") for $106.75 million in cash.
Immediately after the completion of the acquisition, First Federal was merged
into the Bank. The results of First Federal are included in the historical
results of the Company subsequent to August 31, 2001.
The Bank was founded in 1905 as a Connecticut-chartered mutual savings
bank. In 1996, the Bank converted to stock form as part of the M.H.C.'s mutual
holding company formation. The Bank is regulated by the Connecticut Department
of Banking and the Federal Deposit Insurance Corporation. The Bank's deposits
are insured to the maximum allowable amount by the Bank Insurance Fund of the
Federal Deposit Insurance Corporation. The Bank is a member of the Federal Home
Loan Bank System.
The Bank is a traditional savings association that accepts retail deposits
from the general public in the areas surrounding its 28 full-service banking
offices and uses those funds, together with funds generated from operations and
borrowings, to originate residential mortgage loans, commercial loans and
consumer loans, primarily home equity loans and lines of credit. The Bank
primarily holds the loans that it originates for investment. However, the Bank
also sells loans, primarily fixed-rate mortgage loans, in the secondary market,
while generally retaining the servicing rights. The Bank also invests in
mortgage-backed securities, debt and equity securities and other permissible
investments. The Bank's revenues are derived principally from the generation of
interest and fees on loans originated and, to a lesser extent, interest and
dividends on investment and mortgage-backed securities. The
1
Bank's primary sources of funds are deposits, principal and interest payments on
loans and investments and mortgage-backed securities and advances from the
Federal Home Loan Bank of Boston.
Market Area
The Bank is headquartered in Manchester, Connecticut in Hartford County.
The Bank's primary deposit gathering and lending areas are concentrated in the
communities surrounding its 28 banking offices located in Hartford, Tolland and
Windham Counties.
Hartford County is located in central Connecticut approximately two hours
from both Boston and New York City and contains the city of Hartford. The region
serves as the governmental and as a financial center of Connecticut. Hartford
County has a diversified mix of industry groups, including insurance and
financial services, manufacturing, service, government and retail. The major
employers in the area include several prominent international and national
insurance and manufacturing companies, such as Aetna, Inc., The Hartford
Financial Services Group, Inc., United Technologies Corp., Stanley Works, as
well as many regional banks and the Connecticut State Government.
Competition
The Bank faces intense competition in attracting deposits and loans in its
primary market area. Historically, the Bank's most direct competition for
deposits came from the several commercial and savings banks operating in its
primary market area and, to a lesser extent, from other financial institutions,
such as brokerage firms, credit unions and insurance companies. Although these
entities continue to provide a source of competition for deposits, the Bank
faces increasingly significant competition for deposits from the mutual fund
industry as customers seek alternative sources of investment for their funds.
The Bank also must compete for investors' funds which may be used to purchase
short-term money market securities and other corporate and government
securities. While the Bank faces competition for loans from the significant
number of traditional financial institutions, primarily savings banks and
commercial banks in its market area, its most significant competition comes from
other financial services providers, such as the mortgage companies and mortgage
brokers operating in its primary market area. Additionally, the Bank faces
increased competition as a result of recent regulatory actions and legislative
changes, most notably the enactment of the Financial Services Modernization Act
of 1999. These changes have eased and likely will continue to ease restrictions
on interstate banking and entry into the financial services market by
non-depository and non-traditional financial services providers, including
insurance companies, securities brokerage and underwriting firms, and specialty
financial services companies such as Internet-based providers.
Lending Activities
General. The types of loans that the Bank may originate are limited by
federal and state laws and regulations. Interest rates charged by the Bank on
loans are affected principally by the Bank's current asset/liability strategy,
the demand for such loans, the supply of money available for lending purposes
and the rates offered by competitors. These factors are, in turn, affected by
general and economic conditions, monetary policies of the federal government,
including the Federal Reserve Board, legislative tax policies and governmental
budgetary matters.
2
Loan Portfolio Analysis. The following table sets forth the composition of
the Bank's loan portfolio in dollar amounts and as a percentage of the portfolio
at the dates indicated.
At December 31,
-------------------------------------------------------------------------
2001 2000 1999
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Percent of Percent of Percent of
Amount Total Amount Total Amount Total
---------- ---------- ---------- ---------- -------- ----------
(Dollars in thousands)
Real estate loans:
One- to four-family $ 841,895 58.61% $ 586,536 58.22% $544,732 57.40%
Construction (1) 76,551 5.33 32,590 3.24 40,690 4.29
Commercial and multi-
family 231,644 16.13 162,411 16.12 155,085 16.34
---------- ------ ---------- ------ -------- ------
Total real estate loans 1,150,090 80.07 781,537 77.58 740,507 78.03
---------- ------ ---------- ------ -------- ------
Commercial loans 166,314 11.58 146,360 14.52 134,637 14.19
---------- ------ ---------- ------ -------- ------
Consumer loans:
Home equity lines of credit 35,592 2.48 27,203 2.70 23,019 2.43
Other 84,375 5.87 52,358 5.20 50,794 5.35
---------- ------ ---------- ------ -------- ------
Total consumer loans 119,967 8.35 79,561 7.90 73,813 7.78
---------- ------ ---------- ------ -------- ------
Total loans 1,436,371 100.00% 1,007,458 100.00% 948,957 100.00%
====== ====== ======
Allowance for loan losses (15,228) (11,694) (10,617)
---------- ---------- --------
Total loans, net $1,421,143 $ 995,764 $938,340
========== ========== ========
At December 31,
---------------------------------------------
1998 1997
--------------------- ---------------------
Percent of Percent of
Amount Total Amount Total
-------- ---------- -------- ----------
(Dollars in thousands)
Real estate loans:
One- to four-family $464,623 56.85% $489,105 60.53%
Construction (1) 35,860 4.39 23,524 2.90
Commercial and multi-
family 131,717 16.11 117,622 14.55
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Total real estate loans 632,200 77.35 630,251 77.98
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Commercial loans 114,650 14.03 106,874 13.22
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Consumer loans:
Home equity lines of credit 21,605 2.64 20,559 2.54
Other 48,917 5.98 50,553 6.26
-------- ------ -------- ------
Total consumer loans 70,522 8.62 71,112 8.80
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Total loans 817,372 100.00% 808,237 100.00%
====== ======
Allowance for loan losses (10,585) (9,945)
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Total loans, net $806,787 $798,292
======== ========
- ----------
(1) Includes construction to permanent residential and commercial real estate
loans.
3
One- to Four-Family Real Estate Loans. The Bank's primary lending activity
is to originate loans secured by one- to four-family residences located in its
primary market area. Of the one- to four-family loans outstanding at December
31, 2001, 70.79% were fixed-rate mortgage loans and 29.21% were adjustable-rate
loans.
The Bank originates fixed-rate fully amortizing loans with maturities
ranging between ten and thirty years. Management establishes the loan interest
rates based on market conditions. The Bank offers mortgage loans that conform to
Fannie Mae and Freddie Mac guidelines, as well as jumbo loans, which are
presently loans in amounts over $300,700. Fixed-rate conforming loans are
generally originated to be held in the Bank's portfolio. However, the Bank may
sell such loans from time to time. Management periodically determines whether or
not to sell loans based on changes in prevailing market interest rates. Loans
that are sold are generally sold to Freddie Mac, with the servicing rights
retained.
Currently, the Bank also offers adjustable-rate mortgage loans, with an
interest rate based on the one year Constant Maturity Treasury index, which is
adjusted annually at the outset of the loan or which is adjusted annually after
a three or five year initial fixed period and with terms of up to 30 years.
Interest rate adjustments on such loans are limited to no more than 2% during
any adjustment period and 6% over the life of the loan. Adjustable-rate loans
may possess a conversion option, whereby the borrower may opt to convert the
loan to a fixed interest rate after a predetermined period of time, generally
within the first 60 months of the loan term.
Adjustable-rate mortgage loans help reduce the Bank's exposure to changes
in interest rates. There are, however, unquantifiable credit risks resulting
from the potential of increased costs due to changed rates to be paid by
borrowers. It is possible that during periods of rising interest rates the risk
of default on adjustable-rate mortgage loans may increase as a result of
repricing and the increased payments required to be paid by borrowers. In
addition, although adjustable-rate mortgage loans allow the Bank to adjust the
sensitivity of its asset base to changes in interest rates, the extent of this
interest sensitivity is limited by the annual and lifetime interest rate
adjustment limits. Because of these considerations, the Bank has no assurance
that yields on adjustable-rate mortgage loans will be sufficient to offset
increases in the Bank's cost of funds during periods of rising interest rates.
The Bank believes these risks, which have not had a material adverse effect on
the Bank to date, are generally less than the risks associated with holding
fixed-rate loans in its portfolio in a rising interest rate environment.
The Bank underwrites fixed- and variable-rate one- to four-family
residential mortgage loans with loan-to-value ratios of up to 97% and 95%,
respectively, provided that a borrower obtains private mortgage insurance on
loans that exceed 80% of the appraised value or sales price, whichever is less,
of the secured property. The Bank also requires that fire, casualty, title,
hazard insurance and, if appropriate, flood insurance be maintained on all
properties securing real estate loans made by the Bank. An independent licensed
appraiser generally appraises all properties.
In an effort to provide financing for moderate income and first-time home
buyers, the Bank offers FHA (Federal Housing Authority) and CHFA (Connecticut
Housing Finance Authority) loans and has its own First-Time Home Buyer loan
program. These programs offer residential mortgage loans to qualified
individuals. These loans are offered with adjustable- and fixed-rates of
interest and terms of up to 30 years. Such loans may be secured by one- to
four-family residential property, in the case of FHA and CHFA loans, and must be
secured by a single-family owner-occupied unit in the case of First-Time Home
Buyer loans. All of these loans are originated using modified underwriting
guidelines. FHA loans are closed in the name of the Bank and immediately sold in
the secondary market to Countrywide Mortgage Company with the loan servicing
rights released. CHFA loans are immediately assigned after closing to the
Connecticut Housing Finance Authority with servicing rights retained by the
Bank. Countrywide Mortgage and CHFA establish their respective rates and terms
upon which such loans are offered. First-Time Home Buyer loans are offered with
a discounted interest rate (approximately 50 basis points) and usually with no
application or loan origination fees. All such loans are originated in amounts
of up to 97% of the lower of the property's appraised value or the sale price.
Private mortgage insurance is required on all such loans.
4
The Bank also offers to its full-time employees who satisfy certain
criteria and the general underwriting standards of the Bank fixed and
adjustable-rate mortgage loans with reduced interest rates, which are currently
50 to 100 basis points below the rates offered to the Bank's other customers.
The Employee Mortgage Rate is limited to the purchase, construction or
refinancing of an employee's owner-occupied residence. The Employee Mortgage
Rate normally ceases upon termination of employment or if the property no longer
is the employee's residence. Upon termination of the Employee Mortgage Rate, the
interest rate reverts to the contract rate in effect at the time that the loan
was extended. All other terms and conditions contained in the original mortgage
and note continue to remain in effect. As of December 31, 2001, the Bank had
$13.12 million of Employee Mortgage Rate loans, or 0.91% of total loans.
Construction Loans. The Bank originates construction loans to individuals
for the construction and acquisition of personal residences. At December 31,
2001, the unadvanced portion of construction loans totaled $9.52 million.
The Bank's residential construction loans generally provide for the payment
of interest only during the construction phase, which is usually twelve months.
At the end of the construction phase, the loan converts to a permanent mortgage
loan. Loans can be made with a maximum loan-to-value ratio of 90%, provided that
the borrower obtains private mortgage insurance on the loan if the loan balance
exceeds 80% of the appraised value or sales price, whichever is less, of the
secured property. Construction loans to individuals are generally made on the
same terms as the Bank's one- to four-family mortgage loans.
Before making a commitment to fund a residential construction loan, the
Bank requires an appraisal of the property by an independent licensed appraiser.
The Bank also reviews and inspects each property before disbursing any funds
during the term of the construction loan. Loan proceeds are disbursed after each
inspection based on the percentage-of-completion method.
The Bank also originates residential development loans primarily to finance
the construction of single-family homes and subdivisions. At December 31, 2001,
residential development loans totaled $27.08 million, or 1.89% of the Bank's
total loans. These loans are generally offered to experienced builders with whom
the Bank has an established relationship. Residential development loans are
typically offered with terms of up to 24 months. The maximum loan-to-value limit
applicable to these loans is 80% for contract sales and 75% for speculative
properties. Construction loan proceeds are disbursed periodically in increments
as construction progresses and as inspection by an approved appraiser of the
Bank warrants.
The Bank also makes construction loans for commercial development projects.
The projects include multi-family, apartment, industrial, retail and office
buildings. These loans generally have an interest-only phase during construction
and then convert to permanent financing. Disbursement of funds are at the sole
discretion of the Bank and are based on the progress of construction. The
maximum loan-to-value limit applicable to these loans is 80%. At December 31,
2001, commercial construction loans totaled $27.30 million, or 1.90% of total
loans.
The Bank also originates land loans to local contractors and developers for
the purpose of improving the property, or for the purpose of holding or
developing the land for sale. Such loans are secured by a lien on the property,
are limited to 70% of the lower of the acquisition price or the appraised value
of the land and have a term of up to two years with a floating interest rate
based on the Bank's internal base rate. The Bank's land loans are generally
secured by property in its primary market area. The Bank requires title
insurance and, if applicable, a hazardous waste survey reporting that the land
is free of hazardous or toxic waste.
Construction and development financing is generally considered to involve a
higher degree of credit risk than long-term financing on improved,
owner-occupied real estate. Risk of loss on a construction loan depends largely
upon the accuracy of the initial estimate of the property's value at completion
of construction compared to the estimated cost (including interest) of
construction and other assumptions. If the estimate of construction cost proves
to be inaccurate, the Bank may be required to advance funds beyond the amount
originally committed in
5
order to protect the value of the property. Additionally, if the estimate of
value proves to be inaccurate, the Bank may be confronted with a project, when
completed, having a value which is insufficient to assure full repayment.
Commercial and Multi-Family Real Estate Loans. The Bank originates
multi-family and commercial real estate loans that are generally secured by five
or more unit apartment buildings and properties used for business purposes such
as small office buildings, industrial facilities or retail facilities primarily
located in the Bank's primary market area. The Bank's multi-family and
commercial real estate underwriting policies provide that such real estate loans
may be made in amounts of up to 80% of the appraised value of the property
provided such loan complies with the Bank's current loans-to-one-borrower limit,
which at December 31, 2001 was $32.69 million. The Bank's multi-family and
commercial real estate loans may be made with terms of up to 25 years and are
offered with interest rates that adjust periodically and are generally indexed
to the one, three or five year Constant Maturity Treasury index or Federal Home
Loan Bank Advance rates with a comparable term. In reaching its decision on
whether to make a multi-family or commercial real estate loan, the Bank
considers the net operating income of the property, the borrower's expertise,
credit history and profitability and the value of the underlying property. In
addition, with respect to commercial real estate rental properties, the Bank
will also consider the term of the lease and the quality of the tenants. The
Bank has generally required that the properties securing these real estate loans
have debt service coverage ratios (the ratio of earnings before debt service to
debt service) of at least 1.20x. Environmental surveys are generally required
for commercial real estate loans. Generally, multi-family and commercial real
estate loans made to corporations, partnerships and other business entities
require personal guarantees by the principals.
Loans secured by multi-family and commercial real estate properties
generally involve larger principal amounts and a greater degree of risk than
one- to four-family residential mortgage loans. Because payments on loans
secured by multi-family and commercial real estate properties often depend on
the successful operation or management of the properties, repayment of such
loans may be affected by adverse conditions in the real estate market or the
economy. The Bank tries to minimize these risks through its underwriting
standards.
Commercial Loans. The Bank makes commercial business loans primarily in its
market area to a variety of professionals, sole proprietorships and small
businesses. The Bank offers a variety of commercial lending products, including
term loans for fixed assets and working capital, revolving lines of credit,
letters of credit, and Small Business Administration guaranteed loans. The
maximum amount of a commercial business loan is limited by the Bank's
loans-to-one-borrower limit which at December 31, 2001, was $32.69 million. Term
loans are generally offered with initial fixed rates of interest for one to five
years and with terms of up to ten years. Business lines of credit have
adjustable rates of interest and are payable on demand, subject to annual review
and renewal. Business loans with variable rates of interest adjust on a daily
basis and are indexed to the Bank's base rate. At December 31, 2001, the Bank
had $66.26 million of unadvanced commercial lines of credit.
When making commercial business loans, the Bank considers the financial
statements of the borrower, the Bank's lending history with the borrower, the
debt service capabilities of the borrower, the projected cash flows of the
business and the value of the collateral. Commercial business loans are
generally secured by a variety of collateral, primarily accounts receivable,
inventory and equipment, and are supported by personal guarantees. Depending on
the collateral used to secure the loans, commercial loan relationships are made
in amounts of up to 90% of the value of the collateral securing the loan. The
Bank generally does not make unsecured commercial loans.
Unlike residential mortgage loans, which generally are made on the basis of
the borrower's ability to make repayment from his or her employment or other
income, and which are secured by real property whose value tends to be more
easily ascertainable, commercial loans are of higher risk and typically are made
on the basis of the borrower's ability to make repayment from the cash flow of
the borrower's business. As a result, the availability of funds for the
repayment of commercial loans may depend substantially on the success of the
business itself. Further, any collateral securing such loans may depreciate over
time, may be difficult to appraise and may fluctuate in value.
6
Consumer Loans. The Bank offers a variety of consumer loans, including
second mortgage loans and home equity lines of credit, both of which are secured
by owner-occupied one- to four-family residences. At December 31, 2001, second
mortgage loans and equity lines of credit totaled $74.83 million, or 5.21% of
the Bank's total loans and 62.37% of consumer loans. Additionally, at December
31, 2001, the unadvanced amounts of home equity lines of credit totaled $36.64
million. The underwriting standards employed by the Bank for second mortgage
loans and equity lines of credit include a determination of the applicant's
credit history, an assessment of the applicant's ability to meet existing
obligations and payments on the proposed loan and the value of the collateral
securing the loan. Home equity lines of credit have adjustable rates of interest
which are indexed to the prime rate as reported in The Wall Street Journal.
Interest rate adjustments on home equity lines of credit are limited to no more
than a maximum of 17%. Generally, the maximum loan-to-value ratio on home equity
lines of credit is 90%. A home equity line of credit may be drawn down by the
borrower for a period of 10 years from the date of the loan agreement. During
this period, the borrower has the option of paying, on a monthly basis, either
principal and interest or only the interest. The borrower has to pay back the
amount outstanding under the line of credit at the end of a 20-year period. The
Bank offers fixed- and adjustable-rate second mortgage loans with terms up to 20
years. The loan-to-value ratios of both fixed-rate and adjustable-rate home
equity loans are generally limited to 90%.
The Bank offers fixed-rate automobile loans through local dealerships for
new or used vehicles with terms of up to 72 months and loan-to-value ratios of
the lesser of the purchase price or the retail value shown in the NADA Used Car
Guide. At December 31, 2001, automobile loans totaled $28.27 million, or 1.97%
of the Bank's total loans and 23.56% of consumer loans. For the year ended
December 31, 2001, the Bank purchased $5.03 million of automobile loans from
local dealerships.
Other consumer loans at December 31, 2001 amounted to $16.87 million, or
1.17% of the Bank's total loans and 14.06% of consumer loans. These loans
include unsecured personal loans, collateral loans, credit card loans and
education loans. Unsecured personal loans generally have a fixed-rate, a maximum
borrowing limitation of $25,000 and a maximum term of five years. Collateral
loans are generally secured by a passbook account, a certificate of deposit or
marketable securities.
Consumer loans entail greater risk than do residential mortgage loans,
particularly in the case of loans that are unsecured or secured by rapidly
depreciating assets such as automobiles. In these cases, any repossessed
collateral for a defaulted consumer loan may not provide an adequate source of
repayment of the outstanding loan balance as a result of the greater likelihood
of damage, loss or depreciation. The remaining deficiency often does not warrant
further substantial collection efforts against the borrower beyond obtaining a
deficiency judgment. In addition, consumer loan collections depend on the
borrower's continuing financial stability, and thus are more likely to be
adversely affected by job loss, divorce, illness or personal bankruptcy.
Loans to One Borrower. The maximum amount that the Bank may lend to one
borrower is limited by statute. At December 31, 2001, the Bank's statutory limit
on loans to one borrower was $32.69 million. At that date, the Bank's largest
relationship was $14.68 million committed, of which $12.67 million was
outstanding. The loan was performing according to its terms as of December 31,
2001.
7
Maturity of Loan Portfolio. The following table shows the remaining
contractual maturity of the Bank's total loans at December 31, 2001, excluding
the effect of prepayments.
At December 31, 2001
---------------------------------------------------------------------------------
Commercial
One- and multi-
to four- Cons- family
family truction (1) real estate Commercial Consumer Total
---------- ------------ ----------- ----------- ---------- ------------
(in thousands)
Amounts due in:
One year or less $ 590 $ 15,255 $ 1,811 $ 37,939 $ 1,479 $ 57,074
After one year:
More than one year to three years 2,547 24,364 3,724 36,814 18,364 85,813
More than three years to five years 6,121 -- 6,273 32,434 26,362 71,190
More than five years to 10 years 48,662 4,388 55,234 28,395 23,850 160,529
More than 10 years to 15 years 173,271 1,372 73,873 14,811 15,201 278,528
More 15 years 610,704 31,172 90,729 15,921 34,711 783,237
---------- ------------ ----------- ----------- ---------- ------------
Total amounts due $ 841,895 $ 76,551 $ 231,644 $ 166,314 $ 119,967 $ 1,436,371
========== ============ =========== =========== ========== ============
- --------------
(1) Includes construction to permanent residential and commercial real estate
loans.
The following table sets forth, at December 31, 2001, the dollar amount of
loans contractually due after December 31, 2002 and whether such loans have
fixed interest rates or adjustable interest rates. Adjustable rate loans in the
table below refer to loans in which the interest rate is subject to adjustment
prior to the loan's final maturity dates.
Due After December 31, 2002
--------------------------------------
Fixed Adjustable Total
---------- ---------- ------------
(in thousands)
Real estate loans:
One- to four- family $ 595,398 $ 245,907 $ 841,305
Construction (1) 29,337 31,959 61,296
Commercial and multi-family 31,625 198,208 229,833
---------- ---------- ------------
Total real estate loans 656,360 476,074 1,132,434
Commercial loans 46,553 81,822 128,375
Consumer loans 84,446 34,042 118,488
---------- ---------- ------------
Total loans $ 787,359 $ 591,938 $ 1,379,297
========== ========== ============
- --------------
(1) Includes construction to permanent residential and commercial real estate
loans.
The average life of a loan is substantially less than its contractual term
because of prepayments. In addition, due-on-sale clauses on loans generally give
the Bank the right to declare loans immediately due and payable if, among other
things, the borrower sells the real property with the mortgage and the loan is
not repaid. The average life of a mortgage loan tends to increase, however, when
current mortgage loan market rates are substantially higher than rates on
existing mortgage loans and, conversely, tends to decrease when rates on
existing mortgage loans are substantially higher than current mortgage loan
market rates.
8
Loan Approval Procedures and Authority. The Bank's lending activities
follow written, non-discriminatory, underwriting standards and loan origination
procedures established by the Bank's Board of Directors and management. The
Bank's policies and loan approval limits are established by management and are
approved by the Board of Directors. The Board of Directors has designated
certain individuals of the Bank and certain branch managers to consider and
approve loans within their designated authority.
All one- to four-family mortgage loans secured by the borrower's primary
residence in amounts of up to $500,000 and all residential construction and
second mortgage loans and home equity lines of credit in amounts of up to
$250,000 may be approved by a designated individual. All second mortgage loans
and home equity lines of credit in excess of $250,000 and up to $500,000 require
the approval of the Bank's loan committee. All residential and residential
construction loans in excess of $500,000 and up to $1.00 million require the
approval of the Bank's loan committee. All residential loans in excess of $1.00
million require the approval of the Executive Committee of the Board of
Directors.
All commercial loans, including commercial real estate loans, multifamily
loans, commercial construction and development loans and commercial business
loans in amounts of up to $500,000 may be approved by any two of the designated
individuals with the appropriate authority. All commercial loans in excess of
$500,000 and up to $3.00 million require the approval of the Bank's loan
committee; and all commercial loans where an individual loan is in excess of
$1.00 million or the aggregate indebtedness exceeds $3.00 million require the
approval of the Executive Committee of the Board of Directors.
With regard to consumer loans, automobile loans in amounts of up to $50,000
and unsecured personal loans in amounts of up to $25,000 may be approved by
either one or two of the designated individuals depending on the credit score;
automobile loans in excess of $50,000 and unsecured personal loans in excess of
$25,000 must be approved by the Bank's loan committee. Collateral loans of up to
$25,000 may be approved by any branch manager.
Loan Originations, Purchases and Sales. The Bank's lending activities are
conducted by its salaried and commissioned loan personnel and through non-bank
third-party correspondents. Currently, the Bank uses 16 loan originators who
solicit and originate mortgage loans on behalf of the Bank. These loan
originators accounted for approximately 75% of the adjustable-rate and
fixed-rate mortgage loans originated by the Bank in 2001. Loan originators are
compensated by a commission that is based on product, mortgage type, and new or
existing customer relationship. The commission currently ranges from 20 to 60
basis points of the loan amount. All loans originated by the loan originators
are underwritten in conformity with the Bank's loan underwriting policies and
procedures. At December 31, 2001, the Bank serviced $188.02 million of loans for
others.
From time to time, the Bank will purchase loans, primarily secured by one-
to four-family residential properties located outside of the Bank's primary
market area, usually in Fairfield County, Connecticut or in Massachusetts.
Purchased loans are underwritten according to the Bank's own underwriting
criteria and procedures and are generally purchased without the accompanying
servicing rights. Amounts outstanding related to loan purchases totaled $56.53
million and $88.22 million at December 31, 2001 and 2000, respectively.
Substantially all of the Bank's adjustable-rate mortgage loans are
originated for inclusion in the Bank's loan portfolio. Historically, the Bank
originated fixed-rate mortgage loans for sale in the secondary market. However,
since 1998 and due to the low demand for adjustable-rate mortgage loans, the
Bank has begun to retain for its portfolio a significant portion of fixed-rate
mortgage loans. Sales are generally to Freddie Mac, with servicing rights
retained. Loan sale decisions are made by the Bank's management and are
generally based on prevailing market interest rates and the Bank's loan-to-asset
ratio.
9
The following table presents total loans originated, sold, purchased and
repaid during the periods indicated.
For the Year Ended December 31,
----------------------------------------
2001 2000 1999
------------ ------------ ----------
(in thousands)
Loans at beginning of year $ 1,007,458 $ 948,957 $ 817,372
------------ ------------ ----------
Originations:
Real estate:
One- to four- family 226,876 81,722 128,630
Construction (1) 90,364 53,376 60,500
Commercial and multi-family 51,381 15,915 31,571
------------ ------------ ----------
Total real estate loans 368,621 151,013 220,701
Commercial 110,032 93,537 97,246
Consumer 45,818 35,485 33,926
------------ ------------ ----------
Total loans originated 524,471 280,035 351,873
Loans acquired from First Federal 279,956 -- --
Fair market adjustment for loans acquired
from First Federal, net of amortization 4,202 -- --
Loans purchased -- 27,337 36,911
------------ ------------ ----------
Total loans originated and purchased 808,629 307,372 388,784
Deduct:
Principal loan repayments and prepayments 371,305 228,245 236,869
Loan sales 6,976 19,989 18,646
Charge-offs 1,131 433 1,360
Transfers to other real estate owned 304 204 324
------------ ------------ ----------
Total deductions 379,716 248,871 257,199
------------ ------------ ----------
Net increase in loans 428,913 58,501 131,585
------------ ------------ ----------
Loans at end of year $ 1,436,371 $ 1,007,458 $ 948,957
============ ============ ==========
- --------------
(1) Includes construction to permanent residential and commercial real estate
loans.
Loan Commitments. The Bank issues loan commitments to prospective borrowers
on the condition that certain events occur. Commitments are made in writing on
specified terms and conditions and are generally honored for up to 60 days from
approval. At December 31, 2001, the Bank had loan commitments and unadvanced
loans and lines of credit totaling $235.52 million.
Loan Fees. In addition to interest earned on loans, the Bank receives
income from fees derived from loan originations, loan modifications, late
payments and for miscellaneous services related to its loans. Income from these
activities varies from period to period depending upon the volume and type of
loans made and competitive conditions. On loans originated by third-party
originators, the Bank may pay a premium to compensate an originator for loans
where the borrower is paying a higher rate on the loan.
The Bank charges loan origination fees which are calculated as a percentage
of the amount borrowed. As required by applicable accounting principles, loan
origination fees, discount points and certain loan origination costs are
deferred and recognized over the contractual remaining lives of the related
loans on a level yield basis. At December 31, 2001, the Bank had $1.36 million
of net deferred loan fees. The Bank amortized approximately $157,000 of net
deferred loan fees during the year ended December 31, 2001.
10
Nonperforming Assets, Delinquencies and Impaired Loans. All loan payments
are due on the first day of each month. When a borrower fails to make a required
loan payment, the Bank attempts to cure the deficiency by contacting the
borrower and seeking the payment. A late notice is mailed on the 16th day of the
month. In most cases, deficiencies are cured promptly. If a delinquency
continues beyond the 30th day of the month, the account is referred to an
in-house collector. The Bank generally prefers to work with borrowers to resolve
problems, but the Bank will institute foreclosure or other proceedings, as
necessary, to minimize any potential loss.
On a monthly basis, management informs the Board of Directors of the amount
of loans delinquent for more than 30 days, all loans in foreclosure and all
foreclosed and repossessed property that the Bank owns. The Bank ceases accruing
interest on mortgage loans when principal or interest payments are delinquent 90
days or more unless management determines that the loan principal and interest
is fully secured and in the process of collection. Once the accrual of interest
on a loan is discontinued, all interest previously accrued is reversed against
current period interest income once management determines that interest is
uncollectable.
On January 1, 1995, the Bank adopted SFAS No. 114, "Accounting by Creditors
for Impairment of a Loan," as amended by SFAS No. 118 "Accounting by Creditors
for Impairment of a Loan--an amendment to SFAS No. 114." At December 31, 2001,
2000 and 1999, the Bank had a $7.68 million, $6.92 million, and $11.49 million,
respectively, recorded investment in impaired loans for which an additional
valuation allowance of $157,000, $771,000 and $1,430,000, respectively, was
required.
At December 31, 2001, the Bank's largest nonperforming loan was a
residential development relationship with $3.63 million committed and
outstanding, and $2.39 million classified as nonperforming. The nonperforming
loan is secured by a retirement facility located in Central New England. The
remaining loans of the relationship are well secured and are performing
according to their respective terms as of December 31, 2001.
The following table sets forth information regarding nonperforming loans,
troubled debt restructurings and other real estate owned at the dates indicated.
At December 31,
---------------------------------------------------------
2001 2000 1999 1998 1997
-------- --------- ---------- --------- --------
(dollars in thousands)
Nonperforming loans:
One- to four- family real estate $ 1,272 $ 485 $ 501 $ 456 $ 1,732
Commercial and multi-family real estate 2,601 3,685 10,513 388 408
Commercial 3,262 2,529 454 665 680
Consumer 544 222 17 15 15
-------- -------- --------- -------- --------
Total nonperforming loans 7,679 6,921 11,485 1,524 2,835
Other real estate owned 84 125 604 1,759 4,708
-------- -------- --------- -------- --------
Total nonperforming assets 7,763 7,046 12,089 3,283 7,543
Troubled debt restructurings -- -- -- -- --
-------- -------- --------- -------- --------
Total nonperforming assets and troubled
debt restructurings $ 7,763 $ 7,046 $ 12,089 $ 3,283 $ 7,543
======== ======== ========= ======== ========
Total nonperforming loans and troubled
debt restructurings as a percentage of
total loans 0.53% 0.69% 1.21% 0.19% 0.35%
Total nonperforming assets and troubled
debt restructurings as a percentage of
total assets 0.32% 0.50% 0.98% 0.30% 0.73%
11
Interest income that would have been recorded for the years ended December
31, 2001, 2000 and 1999 had nonaccruing loans been current according to their
original terms amounted to approximately $446,000, $568,000 and $635,000,
respectively. No interest related to these loans was included in interest income
in any year.
The following tables set forth the delinquencies in the Bank's loan
portfolio as of the dates indicated.
At December 31, 2001 At December 31, 2000
--------------------------------------------- ---------------------------------------------
60-89 Days 90 Days or More 60-89 Days 90 Days or More
--------------------- --------------------- --------------------- ---------------------
Principal Principal Principal Principal
Number Balance of Number Balance of Number Balance of Number Balance of
of Loans Loans of Loans Loans of Loans Loans of Loans Loans
-------- ---------- -------- ---------- -------- ---------- -------- ----------
(dollars in thousands)
Real estate loans:
One- to four- family 4 $ 660 6 $ 727 2 $ 42 6 $ 301
Commercial and multi-
family 3 740 -- -- -- -- -- --
-- -------- -- ------ -- ------ -- ------
Total real estate loans 7 1,400 6 727 2 42 6 301
-- -------- -- ------ -- ------ -- ------
Commercial loans 7 783 7 217 7 310 3 139
-- -------- -- ------ -- ------ -- ------
Consumer loans 54 476 59 160 24 71 63 212
-- -------- -- ------ -- ------ -- ------
Total 68 $ 2,659 72 $1,104 33 $ 423 72 $ 652
== ======== == ====== == ====== == ======
Delinquent loans to total
loans 0.19% 0.08% 0.04% 0.06%
======== ====== ====== ======
At December 31, 1999
------------------------------------------------
60-89 Days 90 Days or More
----------------------- ---------------------
Principal Principal
Number Balance of Number Balance of
of Loans Loans of Loans Loans
-------- ---------- -------- ----------
(dollars in thousands)
Real estate loans:
One- to four- family 1 $ 32 3 $227
Commercial and multi-
family -- -- -- --
-- ---- -- ----
Total real estate loans 1 32 3 227
-- ---- -- ----
Commercial loans 5 223 3 124
-- ---- -- ----
Consumer loans 3 5 7 7
-- ---- -- ----
Total 9 $260 13 $358
-- ---- -- ----
Delinquent loans to total
loans 0.03% 0.04%
==== ====
Real Estate Owned. Real estate acquired by the Bank as a result of
foreclosure or by deed in lieu of foreclosure is classified as real estate owned
until sold. When property is acquired, it is recorded at fair market value at
the date of foreclosure, establishing a new cost basis. Holding costs and
declines in fair value after acquisition are expensed. At December 31, 2001, the
Bank had $84,000 of real estate owned, consisting of a one- to four-family
residence.
Asset Classification. Banking regulators have adopted various regulations
and practices regarding problem assets of savings institutions. Under such
regulations, federal and state examiners have authority to identify problem
assets during examinations and, if appropriate, require their classification.
12
There are three classifications for problem assets: substandard, doubtful
and loss. Substandard assets have one or more defined weaknesses and are
characterized by the distinct possibility that the insured institution will
sustain some loss if the deficiencies are not corrected. Doubtful assets have
the weaknesses of substandard assets with the additional characteristic that the
weaknesses make collection or liquidation in full on the basis of currently
existing facts, conditions and values questionable, and there is a high
possibility of loss. An asset classified as loss is considered uncollectable and
of such little value that it's continued status as an asset of the institution
is not warranted. If an asset or portion thereof is classified as loss, the
insured institution establishes specific allowances for loan losses for the full
amount of the portion of the asset classified as loss. All or a portion of
general loan loss allowances established to cover probable losses related to
assets classified substandard or doubtful can be included in determining an
institution's regulatory capital, while specific valuation allowances for loan
losses generally do not qualify as regulatory capital. Assets that do not
currently expose the insured institution to sufficient risk to warrant
classification in one of the aforementioned categories but possess weaknesses
are designated "special mention." The Bank performs an internal analysis of its
loan portfolio and assets to classify such loans and assets similar to the
manner in which such loans and assets are classified by the federal banking
regulators. In addition, the Bank regularly analyzes the losses inherent in its
loan portfolio and its nonperforming loans in determining the appropriate level
of the allowance for loan losses.
Allowance for Loan Losses. The Bank devotes significant attention to
maintaining high loan quality through its underwriting standards, active
servicing of loans and aggressive management of nonperforming assets. The
allowance for loan losses is maintained at a level estimated by management to
provide adequately for possible loan losses which are inherent in the loan
portfolio. Possible loan losses are estimated based on a quarterly review of the
loan portfolio, loss experience, specific problem loans, economic conditions and
other pertinent factors. In assessing risks inherent in the portfolio,
management considers the risk of loss on nonperforming and classified loans
including an analysis of collateral in each situation. The Bank's methodology
for assessing the appropriateness of the allowance includes several key
elements. Problem loans are identified and analyzed individually to estimate
specific losses. The loan portfolio is also segmented into pools of loans that
are similar in type and risk characteristics (i.e., commercial, consumer and
mortgage loans). Loss factors are applied using the Bank's historic experience
and may be adjusted for significant factors that in management's judgment affect
the collectability of the portfolio as of the evaluation date. Additionally, the
portfolio is segmented into pools based on internal risk ratings with loss
factors applied to each rating category. Other factors considered in determining
possible loan losses are the impact of larger concentrations in the portfolio,
trends in loan growth, the relationship and trends in recent years of recoveries
as a percentage of prior chargeoffs and peer bank's loss experience.
The allowance for loan losses is increased or decreased by provisions or
credits charged to operations, which represent an estimate of losses that
occurred during the period and a correction of estimates of losses recorded in
prior periods. Confirmed losses, net of recoveries, are charged directly to the
allowance and the loans are written down.
The allowance for loan losses consists of a formula allowance for various
loan portfolio classifications and a valuation allowance for loans identified as
impaired, if necessary. The allowance is an estimate, and ultimate losses may
vary from current estimates. Changes in the estimate are recorded in the results
of operations in the period in which they become known, along with provisions
for estimated losses incurred during that period.
A portion of the allowance for loan losses is not allocated to any specific
segment of the loan portfolio. This non-specific reserve is maintained for two
primary reasons: there exists an inherent subjectivity and imprecision to the
analytical processes employed and the prevailing business environment, as it is
affected by changing economic conditions and various external factors, which may
impact the portfolio in ways currently unforeseen. Moreover, management has
identified certain risk factors, which could impact the degree of loss sustained
within the portfolio. These include: market risk factors, such as the effects of
economic variability on the entire portfolio, and unique portfolio risk factors
that are inherent characteristics of the Bank's loan portfolio. Market risk
factors may consist of changes to general economic and business conditions that
may impact the Bank's loan portfolio customer base in terms of ability to repay
and that may result in changes in value of underlying collateral. Unique
portfolio risk factors may include industry or geographic concentrations, or
trends that may
13
exacerbate losses resulting from economic events which the Bank may not be able
to fully diversify out of its portfolio.
Due to the imprecise nature of the loan loss estimation process and ever
changing conditions, these risk attributes may not be adequately captured in
data related to the formula-based loan loss components used to determine
allocations in the Bank's analysis of the adequacy of the allowance for loan
losses. Management, therefore, has established and maintains a non-specific
allowance for loan losses. The amount of the non-specific allowance was $3.05
million at December 31, 2001 compared to $3.16 million at December 31, 2000. As
a percentage of the allowance for loan losses, the unallocated was 20.02% of the
total allowance for loan losses at December 31, 2001 and 27.03% of the total
allowance for loan losses at December 31, 2000.
The Bank uses three separate methods to estimate the allowance for loan
losses and then uses a weighted average formula to estimate the final allowance
for loan losses. The Bank uses a portfolio segmentation method, a risk rating
method, and a historical method for estimating the allowance for loan losses. In
2000, the Bank's weighting factors for these three methods was 40%, 40% and 20%,
respectively, while in 2001 the weighting factors were 45%, 45% and 10%,
respectively. The historic method weighting factor was reduced during 2001 as it
has consistently and substantially produced a lower reserve amount than the
other two methods and management believes less emphasis should be placed on this
method given the economic environment at December 31, 2001.
Although management believes that it uses the best information available to
establish the allowance for loan losses, future adjustments to the allowance for
loan losses may be necessary, and results of operations could be adversely
affected if circumstances differ substantially from the assumptions used in
making the determinations. Furthermore, while the Bank believes it has
established its existing allowance for loan losses consistent with generally
accepted accounting principles, there can be no assurance that regulators, in
reviewing the Bank's loan portfolio, will not request the Bank to increase its
allowance for loan losses. In addition, because future events affecting
borrowers and collateral cannot be predicted with certainty, there can be no
assurance that the existing allowance for loan losses is adequate or that
increases will not be necessary should the quality of any loans deteriorate as a
result of the factors discussed above. Material increases in the allowance for
loan losses will adversely affect the Bank's financial condition and results of
operations.
14
The following table presents an analysis of the Bank's allowance for loan
losses at and for the periods indicated.
At or For the Year Ended December 31,
--------------------------------------------------
2001 2000 1999 1998 1997
------- ------- ------- ------- ------
(dollars in thousands)
Allowance for loan losses,
beginning of year $11,694 $10,617 $10,585 $ 9,945 $9,131
------- ------- ------- ------- ------
Acquisition of First Federal Savings and
Loan Association of East Hartford 2,174 -- -- -- --
Charged-off loans:
One- to four- family real estate 327 84 110 340 299
Commercial and multi-family
real estate 102 14 790 112 133
Commercial 488 244 337 483 311
Consumer 214 91 123 152 203
------- ------- ------- ------- ------
Total charged-off loans 1,131 433 1,360 1,087 946
------- ------- ------- ------- ------
Recoveries on loans previously charged off:
One-to four- family real estate 123 153 55 146 215
Commercial and multi-family
real estate 82 80 98 12 10
Commercial 256 26 96 283 229
Consumer 30 51 43 86 106
------- ------- ------- ------- ------
Total recoveries 491 310 292 527 560
------- ------- ------- ------- ------
Net loans charged-off 640 123 1,068 560 386
------- ------- ------- ------- ------
Provision for loan losses 2,000 1,200 1,100 1,200 1,200
------- ------- ------- ------- ------
Allowance for loan losses,
end of year $15,228 $11,694 $10,617 $10,585 $9,945
======= ======= ======= ======= ======
Net loans charged-off to average
gross loans 0.06% 0.01% 0.12% 0.07% 0.05%
Allowance for loan losses
to total loans 1.06 1.16 1.12 1.30 1.23
Allowance for loan losses to
nonperforming loans and troubled
debt restructurings 198.31 168.96 92.44 694.55 350.79
Net loans charged-off to allowance
for loan losses 4.20 1.05 10.06 5.29 3.88
Recoveries to charge-offs 43.41 71.59 21.47 48.48 59.20
15
The following table presents the approximate allocation of the allowance
for loan losses by loan categories at the dates indicated and the percentage of
such amounts to the total allowance and to total loans. Management believes that
the allowance can be allocated by category only on an approximate basis. The
allocation of the allowance to each category is not indicative of future losses
and does not restrict the use of any of the allowance to absorb losses in any
category. The non-specific allowance previously mentioned has been allocated in
proportion to the allocated allowance for purposes of this table.
At December 31,
---------------------------------------------------------------------------------------------------
2001 2000 1999
------------------------------- ------------------------------- -------------------------------
Percent of Percent Percent of Percent Percent of Percent
Allowance of Loans Allowance of Loans Allowance of Loans
in Each in Each in Each in Each in Each in Each
Category Category Category Category Category Category
to Total to Total to Total to Total to Total to Total
Amount Allowance Loans Amount Allowance Loans Amount Allowance Loans
------- ---------- -------- ------- ---------- -------- ------- ---------- --------
(dollars in thousands)
Real estate $ 9,450 62% 80% $ 6,221 53% 78% $ 5,198 49% 78%
Commercial 4,474 29 12 4,470 38 14 4,473 42 14
Consumer 1,304 9 8 1,003 9 8 946 9 8
------- --- --- ------- --- --- ------- --- ---
Total allowance
for loan losses $15,228 100% 100% $11,694 100% 100% $10,617 100% 100%
======= === === ======= === === ======= === ===
At December 31,
----------------------------------------------------------------
1998 1997
------------------------------- ------------------------------
Percent of Percent Percent of Percent
Allowance of Loans Allowance of Loans
in Each in Each in Each in Each
Category Category Category Category
to Total to Total to Total to Total
Amount Allowance Loans Amount Allowance Loans
------- ---------- -------- ------ ---------- --------
(dollars in thousands)
Real estate $ 4,995 47% 77% $4,310 43% 78%
Commercial 4,714 45 14 4,913 50 13
Consumer 876 8 9 722 7 9
------- --- --- ------ --- ---
Total allowance
for loan losses $10,585 100% 100% $9,945 100% 100%
======= === === ====== === ===
Investment Activities
General. Under Connecticut law, the Company has authority to purchase a
wide range of investment securities. As a result of recent changes in federal
banking laws, however, financial institutions such as the Bank may not engage as
principals in any activities that are not permissible for a national bank,
unless the Federal Deposit Insurance Corporation has determined that the
investments would pose no significant risk to the Bank Insurance Fund and that
the Bank is in compliance with applicable capital standards. In 1993, the
Regional Director of the Federal Deposit Insurance Corporation approved a
request by the Bank to invest in certain listed stocks and/or registered stocks
subject to certain conditions.
The Company's Board of Directors has the overall responsibility for the
Company's investment portfolio, including approval of the Company's investment
policy, appointment of the Company's investment adviser and approval of the
Company's investment transactions. All investment transactions are reviewed by
the Board on a monthly basis. The Company's President and/or Chief Financial
Officer, or their designees are authorized to make investment decisions
consistent with the Company's investment policy and the recommendations of the
Company's
16
investment adviser and the Board's Investment Committee. The Investment
Committee meets quarterly with the President and Chief Financial Officer in
order to review and determine investment strategies.
The Company's investment policy is designed to complement the Bank's
lending activities, provide an alternative source of income through interest,
dividends and capital gains, diversify the Company's assets and improve
liquidity while minimizing the Company's tax liability. Investment decisions are
made in accordance with the Company's investment policy and are based upon the
quality of a particular investment, its inherent risks, the composition of the
balance sheet, market expectations, the Bank's liquidity, income and collateral
needs and how the investment fits within the Company's interest rate risk
strategy. Although the Company utilizes the investment advisory services of a
Boston-based investment firm, management is ultimately and completely
responsible for all investment decisions.
The Company's investment policy divides investments into two categories,
fixed income and equity portfolios. The primary objective of the fixed income
portfolio is to maintain an adequate source of liquidity sufficient to meet
regulatory and operating requirements, and to safeguard against deposit
outflows, reduced loan amortization and increased loan demand. The fixed income
portfolio primarily includes debt issues, including mortgage-backed and
asset-backed securities, as well as collateralized mortgage obligations.
Substantially all of the Company's mortgage-backed securities are issued or
guaranteed by agencies of the U.S. Government. Accordingly, they carry lower
credit risk than mortgage-backed securities of a private issuer. Approximately
81% of the collateralized mortgage obligations are issued or guaranteed by
agencies of the U.S. Government. Accordingly, they carry lower credit risk than
collateralized mortgage obligations of a private issuer. Collateralized mortgage
obligations, due to their inherent structure, may carry more prepayment risk
than mortgage-backed securities. All of the collateralized mortgage obligations
owned by the Bank as of December 31, 2001 were acquired from First Federal. Due
to the low interest rate environment at the time of the acquisition, the
majority of the collateralized mortgage obligations were acquired at a premium.
During the fourth quarter of 2001 the Bank recorded lower than anticipated
yields on these collateralized mortgage obligations due to accelerated
amortization of premiums triggered by prepayments due to the low interest rate
environment. Asset-backed securities are typically collateralized by the cash
flow from a pool of auto loans, credit card receivables, consumer loans and
other similar obligations.
The Company's investment policy permits the Company to be a party to
financial instruments with off-balance sheet risk in the normal course of
business in order to manage interest rate risk. The Company's derivative
position is reviewed by the Investment Committee on a quarterly basis. The
investment policy authorizes the Company to be involved in and purchase various
types of derivative transactions and products including interest rate swap, cap
and floor agreements investment conduits. At December 31, 2001 and 2000, the
Company was not party to any interest rate swap, cap or floor arrangements.
The marketable equity securities portfolio has the objective of producing
capital appreciation through long-term investment, with safety of principal and
prudent risk taking. The total market value of the marketable equity securities
portfolio, excluding Federal Home Loan Bank stock, is limited by the investment
policy to 50% of the Bank's Tier 1 capital. At December 31, 2001, the marketable
equity securities portfolio totaled $37.67 million, or 24.01%, of the Bank's
Tier 1 capital. At December 31, 2001, the net unrealized gains associated with
the marketable equity securities portfolio were $11.32 million.
SFAS No. 115, "Accounting for Certain Investments in Debt and Equity
Securities" requires that investments be categorized as "held to maturity,"
"trading securities" or "available for sale," based on management's intent as to
the ultimate disposition of each security. SFAS No. 115 allows debt securities
to be classified as held to maturity and reported in financial statements at
amortized cost only if the reporting entity has the positive intent and ability
to hold those securities to maturity. Securities that might be sold in response
to changes in market interest rates, changes in the security's prepayment risk,
increases in loan demand, or other similar factors cannot be classified as held
to maturity. Debt and equity securities held for current resale are classified
as trading securities. These securities are reported at fair value, and
unrealized gains and losses on the securities would be included in earnings. The
Company does not currently use or maintain a trading account. Debt and equity
securities not
17
classified as either held to maturity or trading securities are classified as
available for sale. These securities are reported at fair value, and unrealized
gains and losses on the securities are excluded from earnings and reported, net
of deferred taxes, as a separate component of stockholders' equity.
On a quarterly basis, the Company reviews available-for-sale investment
securities with unrealized depreciation for six consecutive months to assess
whether the decline in fair value is temporary or other than temporary. The
Company judges whether the decline in value is from company-specific events,
industry developments, general economic conditions or other reasons. Once the
estimated reasons for the decline are identified, further judgments are required
as to whether those causal events are likely to reverse and, if so, whether that
reversal is likely to result in a recovery of the fair value of the investment
in the near term. In accordance with this policy, during the years ended
December 31, 2001 and 2000 the Company recorded other than temporary impairment
of $4.08 million and $0, respectively.
All of the Company's debt, collateralized mortgage obligations,
mortgage-backed and asset-backed securities carry market risk insofar as
increases in market rates of interest may cause a decrease in their market
value. They also carry prepayment risk insofar as they may be called or repaid
before maturity in times of low market interest rates, so that the Bank may have
to invest the funds at a lower interest rate. The marketable equity securities
portfolio also carries equity price risk in that, if equity prices decline due
to unfavorable market conditions or other factors, the Bank's capital would
decrease.
18
The following table presents the amortized cost and fair value of the
Company's securities, by type of security, at the dates indicated.
At December 31,
------------------------------------------------------------------
2001 2000 1999
-------------------- -------------------- --------------------
Amortized Fair Amortized Fair Amortized Fair
Cost Value Cost Value Cost Value
--------- -------- --------- -------- --------- --------
(in thousands)
Debt securities held to maturity:
Asset-backed securities $ -- $ -- $ -- $ -- $ 17,481 $ 17,418
U.S. Government and agency
obligations -- -- -- -- -- --
Other debt securities -- -- -- -- 3,105 2,950
-------- -------- -------- -------- -------- --------
Total -- -- -- -- 20,586 20,368
-------- -------- -------- -------- -------- --------
Debt securities available for sale:
Asset-backed securities 23,907 25,208 32,717 33,816 -- --
U.S. Government and agency
obligations 180,106 183,813 82,068 85,254 82,486 81,328
Municipal obligations 23,717 23,194 2,915 2,949 -- --
Corporate securities 53,138 55,420 55,398 56,263 33,870 33,345
-------- -------- -------- -------- -------- --------
Total 280,868 287,635 173,098 178,282 116,356 114,673
-------- -------- -------- -------- -------- --------
Equity securities available for sale:
Marketable equity securities 26,349 37,670 35,221 49,144 32,273 50,545
Debt mutual funds 23,872 23,886 -- -- -- --
Other equity securities 992 992 432 432 432 432
-------- -------- -------- -------- -------- --------
Total 51,213 62,548 35,653 49,576 32,705 50,977
-------- -------- -------- -------- -------- --------
Total debt and equity securities 332,081 350,183 208,751 227,858 169,647 186,018
-------- -------- -------- -------- -------- --------
Mortgage-backed securities:
Mortgage-backed securities
held to maturity -- -- -- -- 25,474 24,630
Mortgage-backed securities
available for sale 147,901 149,750 79,079 80,223 16,741 16,204
Collateralized mortgage obligations 257,581 258,601 -- -- -- --
-------- -------- -------- -------- -------- --------
Total mortgage-backed
securities 405,482 408,351 79,079 80,223 42,215 40,834
-------- -------- -------- -------- -------- --------
Total investment securities $737,563 $758,534 $287,830 $308,081 $211,862 $226,852
======== ======== ======== ======== ======== ========
At December 31, 2001, the Company did not own any investment or
mortgage-backed securities of a single issuer, other than U.S. Government and
agency securities, which had an aggregate book value in excess of 10% of the
Company's capital at that date.
19
The following presents the activity in the investment securities and
mortgage-backed securities portfolios for the periods indicated.
For the Year Ended December 31,
-----------------------------------
2001 2000 1999
--------- --------- ---------
(in thousands)
Mortgage-backed and asset-backed securities (1):
Mortgage-backed and asset-backed securities, beginning of year $ 114,039 $ 59,159 $ 57,898
Purchases:
Asset-backed securities - available for sale -- 25,136 --
Mortgage-backed securities - held to maturity -- -- 6,876
Mortgage-backed securities - available for sale 17,403 57,220 7,278
Sales:
Mortgage-backed securities - available for sale -- (14,256) --
Collateralized mortgage obligations - available for sale (75,033) -- --
Asset-backed securities - available for sale (2,149) (5,418) --
Repayments and prepayments (91,129) (10,713) (13,249)
Asset-backed securities called prior to maturity (3,014) -- --
Mortgage-backed and asset-backed securities
acquired from First Federal 472,923 -- --
Increase (decrease) in net premium (1,408) 132 13
Change in unrealized net gain on securities available for sale 1,927 2,779 (564)
--------- --------- ---------
Net increase in mortgage-backed and asset-backed securities 319,520 54,880 354
--------- --------- ---------
Mortgage-backed and asset-backed securities, end of year 433,559 114,039 58,252
--------- --------- ---------
Investment securities (1):
Investment securities, beginning of year 194,042 168,755 161,788
Purchases:
Investment securities - available for sale 88,197 127,592 49,875
Sales:
Investment securities - available for sale (67,387) (72,566) (18,530)
Maturities and calls:
Investment securities - held to maturity -- -- (3,535)
Investment securities - available for sale (24,468) (31,774) (21,778)
Other than temporary impairment of investment securities (4,076) -- --
Investment securities acquired from First Federal 139,570 -- --
(Decrease) increase in net premium 304 615 (1,031)
Change in unrealized net gain on securities available for sale (1,207) 1,420 1,811
--------- --------- ---------
Net increase in investment securities 130,933 25,287 6,812
--------- --------- ---------
Investment securities, end of year 324,975 194,042 168,600
--------- --------- ---------
Total mortgage-backed, asset-backed and investment
securities, end of year $ 758,534 $ 308,081 $ 226,852
========= ========= =========
- ----------
(1) Available for sale securities are presented at market value and held to
maturity securities are presented at amortized cost. For purposes of this
schedule, collateralized mortgage obligations are included in
mortgage-backed securities.
20
The following table presents certain information regarding the carrying
value, weighted average coupon yields and maturities of the Company's debt
securities at December 31, 2001.
At December 31, 2001
---------------------------------------------------------------
More than One More than Five
One Year or Less Year to Five Years Years to Ten Years
------------------- ------------------- -------------------
Weighted Weighted Weighted
Carrying Average Carrying Average Carrying Average
Value Yield Value Yield Value Yield
-------- -------- -------- -------- -------- --------
(dollars in thousands)
Available for sale
securities:
U.S. Government and
agency obligations $19,344 6.40% $ 85,292 5.68% $ 66,082 4.29%
Municipal obligations -- -- -- -- -- --
Corporate securities 8,747 6.82 32,592 6.28 9,294 6.92
Mortgage-backed
securities -- -- 1,083 6.11 6,316 7.31
Collateralized mortgage
obligations -- -- 548 6.50 102,962 6.36
Asset-backed securities -- -- 22,203 7.03 2,121 6.66
------- -------- --------
Total debt securities
at fair value $28,091 6.53% $141,718 6.04% $186,775 5.69%
======= ======== ========
At December 31, 2001
------------------------------------------
More than
Ten Years Total
------------------- -------------------
Weighted Weighted
Carrying Average Carrying Average
Value Yield Value Yield
-------- -------- -------- --------
(dollars in thousands)
Available for sale
securities:
U.S. Government and
agency obligations $ 13,095 5.92% $183,813 5.27%
Municipal obligations 23,194 5.65 23,194 5.65
Corporate securities 4,787 6.22 55,420 6.47
Mortgage-backed
securities 142,351 7.56 149,750 7.54
Collateralized mortgage
obligations 155,091 6.81 258,601 6.63
Asset-backed securities 884 7.16 25,208 7.00
-------- --------
Total debt securities
at fair value $339,402 7.00% $695,986 6.44%
======== ========
Cash Surrender Value of Life Insurance. In 2001, the Bank purchased $20.00
million of Bank Owned Life Insurance ("BOLI"). The Bank purchased these policies
for the purpose of protecting itself against the cost/loss due to the death of
key employees and to offset the Bank's future obligations to its employees under
various retirement and benefit plans. On August 31, 2001, the Bank acquired
$20.36 million of BOLI as a result of the acquisition of First Federal. The
total value of BOLI at December 31, 2001 was $41.39 million. The Bank recorded
income from BOLI of $1.03 million in 2001.
Deposit Activities and Other Sources of Funds
General. Deposits are the major external source of funds for the Bank's
lending and other investment activities. In addition, the Bank also generates
funds internally from loan principal repayments and prepayments and maturing
investment securities. Scheduled loan repayments are a relatively stable source
of funds, while deposit inflows and outflows and loan prepayments are influenced
significantly by general interest rates and money market conditions. The Bank
may use borrowings from the Federal Home Loan Bank of Boston to compensate for
reductions in the availability of funds from other sources.
Deposit Accounts. Substantially all of the Bank's depositors reside in
Connecticut. The Bank offers a wide variety of deposit accounts with a range of
interest rates and terms. The Bank's deposit accounts consist of
interest-bearing checking, noninterest-bearing checking, regular savings, money
market savings and certificates of deposit. The maturities of the Bank's
certificate of deposit accounts range from seven days to five years. In
addition, the Bank offers retirement accounts, including IRAs and Keogh accounts
and simplified employee pension plan accounts. The Bank also offers commercial
business products to small businesses operating within its primary market area.
Deposit account terms vary with the principal differences being the minimum
balance deposit, early withdrawal penalties, limits on the number of
transactions and the interest rate. The Bank reviews its deposit mix and pricing
on a weekly basis.
21
The Bank believes it offers competitive interest rates on its deposit
products. The Bank determines the rates paid based on a number of factors,
including rates paid by competitors, the Bank's need for funds and cost of
funds, borrowing costs and movements of market interest rates. While certificate
accounts in excess of $100,000 are accepted by the Bank, and may receive
preferential rates, the Bank does not actively seek such deposits as they are
more difficult to retain than core deposits. The Bank does not utilize brokers
to obtain deposits and at December 31, 2001, had no brokered deposits.
In the unlikely event the Bank is liquidated since its Conversion,
depositors will be entitled to full payment of their deposit accounts before any
payment is made to the Company as the sole stockholder of the Bank.
The following table presents the deposit activity of the Bank for the
periods indicated.
For the Year Ended
December 31,
--------------------------------
2001 2000 1999
---------- -------- --------
(in thousands)
Beginning balance $ 933,370 $906,591 $855,117
Increase (decrease) before interest credited 620,980 (6,329) 20,565
Interest credited 36,588 33,108 30,909
---------- -------- --------
Net increase 657,568 26,779 51,474
---------- -------- --------
Ending balance $1,590,938 $933,370 $906,591
========== ======== ========
At December 31, 2001, the Bank had $93.41 million in certificate of deposit
accounts in amounts of $100,000 or more maturing as follows:
Weighted
Average
Maturity Period Amount Rate
- -------------------------------------- -------------- --------
(in thousands)
Three months or less $ 14,837 4.37%
Over 3 months through 6 months 23,293 4.12
Over 6 months through 12 months 24,903 4.39
Over 12 months 30,377 5.48
--------
Total $ 93,410 4.68%
========
22
The following table presents information concerning average balances and
weighted average interest rates for the periods indicated.
For the Year Ended December 31,
--------------------------------------------------------------------------------------------------
2001 2000 1999
-------------------------------- ------------------------------ ------------------------------
Percent Percent Percent
of of of
Total Weighted Total Weighted Total Weighted
Average Average Average Average Average Average Average Average Average
Balance Deposits Rate Balance Deposits Rate Balance Deposits Rate
---------- -------- -------- -------- -------- -------- -------- -------- --------
(dollars in thousands)
Savings accounts $ 268,162 23.2% 1.80% $223,700 24.8% 2.28% $226,477 26.0% 2.26%
Money market accounts 113,883 9.9 3.15 73,576 8.1 4.24 51,088 5.8 3.52
NOW accounts 150,693 13.0 0.70 115,819 12.8 1.19 105,916 12.1 1.42
Certificates of deposits 542,888 47.0 4.99 432,624 47.9 5.47 444,550 51.0 5.06
Demand deposits 80,142 6.9 0.00 57,871 6.4 0.00 44,358 5.1 0.00
---------- ----- -------- ------ -------- -----
Total $1,155,768 100.0% 3.15% $903,590 100.0% 3.68% $872,389 100.0% 3.54%
========== ===== ======== ====== ======== =====
Certificates of Deposit by Rates and Maturities. The following table
presents by various rate categories, the amount of certificate accounts
outstanding at the dates indicated and the periods to maturity of the
certificate accounts outstanding at December 31, 2001.
Period Maturity from December 31, 2001 Total at December 31,
------------------------------------------ ------------------------------
One to Two to Over
Less than Two Three Three
One Year Years Years Years 2001 2002 1999
--------- -------- -------- -------- -------- -------- --------
(in thousands)
0.00-2.00% $ 8,554 $ 15 $ -- $ -- $ 8,569 $ 42 $ 18
2.01-4.00% 218,334 21,354 2,103 14 241,805 1,375 2,329
4.01-5.00% 130,530 38,755 12,560 17,545 199,390 88,585 207,163
5.01-6.00% 55,599 54,065 8,571 24,155 142,390 99,525 195,403
6.01-7.00% 90,087 11,852 8,595 34,257 144,791 250,312 39,129
7.01-8.00% -- -- -- 6 6 -- 6,305
-------- -------- -------- -------- -------- -------- --------
Total $503,104 $126,041 $ 31,829 $ 75,977 $736,951 $439,839 $450,347
======== ======== ======== ======== ======== ======== ========
Borrowings. The Bank may use advances from the Federal Home Loan Bank of
Boston to supplement its supply of lendable funds and to meet deposit withdrawal
requirements. The Federal Home Loan Bank of Boston functions as a central
reserve bank providing credit for savings banks and certain other member
financial institutions. As a member of the Federal Home Loan Bank of Boston, the
Bank is required to own capital stock in the Federal Home Loan Bank of Boston
and is authorized to apply for advances on the security of the capital stock and
certain of its mortgage loans and other assets, principally securities that are
obligations of, or guaranteed by, the U.S. Government or its agencies, provided
certain creditworthiness standards have been met. Advances are made under
several different credit programs. Each credit program has its own interest rate
and range of maturities. Depending on the program, limitations on the amount of
advances are based on the financial condition of the member institution and the
adequacy of collateral pledged to secure the credit. At December 31, 2001, the
Bank had the ability to borrow a total of approximately $603.17 million from the
Federal Home Loan Bank of Boston. Of the total maximum borrowing capacity, the
Bank had $457.03 million outstanding as of December 31, 2001. In
23
accordance with generally accepted accounting principles, the Bank recorded the
FHLB advances acquired from First Federal at the-then market value on the date
of acquisition. The bank recorded an adjustment of $9.47 million to record the
advances at market value. The Bank is amortizing this premium on a level yield
basis over the remaining lives of the advances. The remaining amount of the
premium at December 31, 2001 was $8.32 million.
Federal banking laws and regulations prohibit a bank from paying interest
on commercial checking accounts. However, the Bank offers to its commercial
customers a transactional repurchase agreement, a form of non-deposit borrowing
by the Bank, that is designed as a mechanism to offer business customers the
functional equivalent of a commercial checking account that pays interest. This
account, overseen by an outside agent, is not a FDIC-insured deposit account,
but is backed by a security interest in U.S. Government and agency securities at
a ratio of 1.10 to 1.00 or higher. At December 31, 2001, the Bank had such
accounts with balances aggregating $116.48 million backed by a security interest
of $190.31 million, or a ratio of 1.63 to 1.00.
The following table presents certain information regarding the Bank's FHLB
advances and short-term borrowed funds at the dates or for the periods
indicated.
At or For the Year Ended December 31,
-------------------------------------
2001 2000 1999
-------- -------- ---------
(dollars in thousands)
Average balance outstanding:
Federal Home Loan Bank advances $235,440 $105,692 $ 58,761
Short-term borrowed funds 110,823 110,520 89,133
Maximum amount outstanding at any
month-end during the period:
Federal Home Loan Bank advances 457,033 124,000 95,962
Short-term borrowed funds 125,866 119,821 104,575
Balance outstanding at end of period:
Federal Home Loan Bank advances 457,033 100,000 84,000
Short-term borrowed funds 117,180 106,493 95,814
Weighted average interest rate during the period:
Federal Home Loan Bank advances 5.20% 6.39% 6.09%
Short-term borrowed funds 2.60 3.31 3.06
Weighted average interest rate at end of period:
Federal Home Loan Bank advances 5.01 6.15 6.03
Short-term borrowed funds 1.77 3.20 3.12
Subsidiary Activities
The following are descriptions of the Bank's wholly owned subsidiaries,
which are indirectly owned by the Company.
SBM, Ltd. SBM, Ltd., a Connecticut corporation, was organized in February
1983 for the purpose of acquiring and holding real estate acquired by the Bank.
In 1990, the purpose changed to acquire, hold and dispose of real estate
acquired through foreclosure. At December 31, 2001, SBM, Ltd. held no properties
and had no assets.
923 Main, Inc. 923 Main, a Connecticut corporation, was incorporated in
December, 1994 for the purpose of maintaining an ownership interest in a third
party registered broker-dealer, Infinex Financial Group (Infinex). Infinex
maintains an office at the Bank and offers to customers a complete range of
nondeposit investment products, including mutual funds, debt, equity and
government securities, retirement accounts, insurance products and fixed
24
and variable annuities. The Bank receives a portion of the commissions generated
by Infinex from sales to customers. For the years ended December 31, 2001 and
2000, the Bank received fees of $1.15 million and $1.38 million, respectively,
through its relationship with Infinex.
Savings Bank of Manchester Mortgage Company, Inc. SBM Mortgage, a
Connecticut corporation, was established in January 1999 to service and hold
loans secured by real property. SBM Mortgage was established and is managed to
qualify as a "passive investment company " for Connecticut income tax purposes.
Income earned by a qualifying passive investment company is exempt from
Connecticut income tax. Accordingly, no state income taxes were provided since
December 31, 1998. However, proposed legislation would eliminate the exemption
as of January 1, 2002. If the legislation were enacted, the Company would be
subject to state income taxes in Connecticut.
SBM Charitable Foundation, Inc.
During 2000, the Bank funded and formed SBM Charitable Foundation, Inc.
(the "New Foundation"), a not-for-profit organization in connection with the
conversion. This foundation, which is not a subsidiary of the Bank, provides
grants to individuals and not-for-profit organizations within the communities
that the Bank serves. The New Foundation was funded with a contribution of
832,000 common shares, with a cost basis and fair market value of $8.32 million
at the date of contribution and transfer, or an amount equal to 8% of the common
stock sold in the conversion. In 1998, the Bank contributed marketable equity
securities with a cost basis and fair market value of $700,000 and $3.0 million,
respectively, at the date of contribution and transfer to the Savings Bank of
Manchester Foundation, Inc. (the "Old Foundation"), also a not-for-profit
organization. In 2001, the Old Foundation was merged into the New Foundation,
with the New Foundation being the surviving entity. At December 31, 2001, the
New Foundation had assets of approximately $24.37 million, consisting primarily
of the Company stock. The New Foundation's Board of Trustees consists of current
directors, officers and employees of the Company. The Company intends to
maintain the New Foundation, but does not expect to make any further
contributions to the New Foundation in the future.
REGULATION AND SUPERVISION
General
As a savings bank chartered by the State of Connecticut, the Bank is
extensively regulated under state law by the Connecticut Banking Commissioner
("Commissioner") with respect to many aspects of its banking activities. In
addition, as a bank whose deposits are insured by the Federal Deposit Insurance
Corporation ("FDIC") through the Bank Insurance Fund ("BIF"), the Bank must pay
deposit insurance assessments and is examined and supervised by the FDIC. These
laws and regulations have been established primarily for the protection of
depositors, customers and borrowers of the Bank, not its stockholders.
The Company is also required to file reports with, and otherwise comply
with the rules and regulations of, the Office of Thrift Supervision ("OTS"), the
Commissioner, and the Securities and Exchange Commission ("SEC") under the
federal securities laws. The following discussion of the laws and regulations
material to the operations of the Company and the Bank is a summary and is
qualified in its entirety by reference to such laws and regulations.
The Bank and the Company, as a savings and loan holding company, are
extensively regulated and supervised. Regulations, which affect the Bank on a
daily basis, may be changed at any time and the interpretation of the relevant
law and regulations also may change because of new interpretations by the
authorities who interpret those laws and regulations. Any change in the
regulatory structure or the applicable statutes or regulations, whether by the
Commissioner, the State of Connecticut, the OTS, the FDIC or the U.S. Congress,
could have a material impact on the Company and the Bank.
25
Connecticut Banking Laws and Supervision
The Commissioner regulates the Bank's internal organization as well as its
deposit, lending and investment activities. The approval of the Commissioner is
required for, among other things, the establishment of branch offices and
business combination transactions. The Commissioner conducts periodic
examinations of the Bank. The FDIC also regulates many of the areas regulated by
the Commissioner, and federal law may limit some of the authority provided to
the Bank by Connecticut law.
Lending Activities. Connecticut banking laws grant banks broad lending
authority. With certain limited exceptions, however, total secured and unsecured
loans made to any one obligor under this statutory authority may not exceed 10%
and 15%, respectively, of the Bank's equity capital and reserves for loan and
lease losses.
A savings bank may pay cash dividends out of its net profits. For purposes
of this restriction, "net profits" represents the remainder of all earnings from
current operations. Further, the total amount of all dividends declared by a
savings bank in any calendar year may not exceed the sum of the Bank's net
profits for the year in question combined with its retained net profits from the
preceding two calendar years. Additionally, earnings appropriated to reserves
for loan losses and deducted for federal income tax purposes are not available
for cash dividends without the payment of taxes at then-current income tax rates
on the amount used. Federal law also prevents an institution from paying
dividends or making other capital distributions that, if by doing so, would
cause it to become "undercapitalized." The FDIC may limit a savings bank's
ability to pay dividends. No dividends may be paid to the Bank's stockholders if
such dividends would reduce stockholders' equity below the amount of the
liquidation account required by the Connecticut conversion regulations.
Branching Activities. Any Connecticut-chartered bank meeting certain
statutory requirements may, with the Commissioner's approval, establish and
operate branches in any town or towns within the state and establish mobile
branches.
Investment Activities. Connecticut law requires the board of directors of
each Connecticut bank to adopt annually an investment policy to govern the types
of investments the bank makes, and to periodically review a bank's adherence to
its investment policy. The investment policy must establish standards for the
making of prudent investments and procedures for divesting investments no longer
deemed consistent with a bank's investment policy. In recent years, Connecticut
law has expanded bank investment activities.
Connecticut banks may invest in debt securities and debt mutual funds
without regard to any other liability to the Connecticut bank of the maker or
issuer of the debt securities and debt mutual funds, if the debt securities and
debt mutual funds are rated in the three highest rating categories or otherwise
deemed to be a prudent investment, and so long as the total amount of debt
securities and debt mutual funds of any one issuer will not exceed 25% of the
Bank's total equity capital and reserves for loan and lease losses and the total
amount of all its investments in debt securities and debt mutual funds will not
exceed 25% of its assets. In addition, a Connecticut bank may invest in certain
government and agency obligations according to the same standards as debt
securities and debt mutual funds except without any percentage limitation.
Similarly, Connecticut banks may invest in equity securities and equity
mutual funds without regard to any other liability to the Connecticut bank of
the issuer of equity securities and equity mutual funds, so long as the total
amount of equity securities and equity mutual funds of any one issuer does not
exceed 25% of the bank's total equity capital and reserves for loan and lease
losses and the total amount of the bank's investment in all equity securities
and equity mutual funds does not exceed 25% of its assets.
Powers. In recent years, Connecticut law has expanded bank's powers.
Connecticut law permits Connecticut banks to sell insurance and fixed- and
variable-rate annuities if licensed to do so by the Connecticut Insurance
Commissioner. Connecticut law authorizes a new form of Connecticut bank known as
an uninsured bank. An uninsured bank has the same powers as insured banks except
that it does not accept retail deposits and is
26
not required to insure deposits with the FDIC. With the prior approval of the
Commissioner, Connecticut banks are also authorized to engage in a broad range
of activities related to the business of banking, or that are financial in
nature or that are permitted under the Bank Holding Company Act ("BHCA") or the
Home Owners' Loan Act ("HOLA"), both federal statutes, or the regulations
promulgated as a result of these statutes. Connecticut banks are also authorized
to engage in any activity permitted for a national bank or a federal savings
association upon filing notice with the Commissioner unless the Commissioner
disapproves the activity.
Assessments. Connecticut banks may be required to pay annual assessments to
the Connecticut Department of Banking to fund the Department's operations. The
general assessments are paid pro-rata based upon a bank's asset size. The
assessments paid by the Bank for the fiscal years ended December 31, 2001 and
2000 were $14,000 and $0, respectively.
Enforcement. Under Connecticut law, the Commissioner has extensive
enforcement authority over Connecticut banks and, under certain circumstances,
affiliated parties, insiders, and agents. The Commissioner's enforcement
authority includes cease and desist orders, fines, receivership,
conservatorship, removal of officers and directors, emergency closures,
dissolution and liquidation.
Federal Regulations
Capital Requirements. Under FDIC regulations, federally insured
state-chartered banks that are not members of the Federal Reserve System ("state
non-member banks"), such as the Bank, are required to comply with minimum
leverage capital requirements. For an institution determined by the FDIC to not
be anticipating or experiencing significant growth and to be, in general, a
strong banking organization, rated composite 1 under the Uniform Financial
Institutions Ranking System established by the Federal Financial Institutions
Examination Council, the minimum capital leverage requirement is a ratio of Tier
1 capital to total assets of 3%. For all other institutions, the minimum
leverage capital ratio is not less than 4%. Tier 1 capital is the sum of common
stockholders' equity, noncumulative perpetual preferred stock (including any
related surplus) and minority investments in certain subsidiaries, less
intangible assets (except for certain servicing rights and credit card
relationships). Recent regulatory amendments also require the deduction from
Tier 1 capital of a percentage of the carrying value of nonfinancial equity
investments acquired by a bank after March 13, 2000.
The FDIC regulations require state non-member banks to maintain certain
levels of regulatory capital in relation to regulatory risk-weighted assets. The
ratio of regulatory capital to regulatory risk-weighted assets is referred to as
the Bank's "risk-based capital ratio." Risk-based capital ratios are determined
by allocating assets and specified off-balance sheet items to four risk-weighted
categories ranging from 0% to 100%, with higher levels of capital being required
for the categories perceived as representing greater risk. For example, under
the FDIC's risk-weighting system, cash and securities backed by the full faith
and credit of the U.S. government are given a 0% risk weight, loans secured by
one- to four-family residential properties generally have a 50% risk weight, and
commercial loans have a risk weighting of 100%.
State non-member banks must maintain a minimum ratio of total capital to
risk-weighted assets of at least 8%, of which at least one-half must be Tier 1
capital. Total capital consists of Tier 1 capital plus Tier 2 or supplementary
capital items, which include allowances for loan losses in an amount of up to
1.25% of risk-weighted assets, cumulative preferred stock and certain other
capital instruments, and a portion of the net unrealized gain on equity
securities. The includable amount of Tier 2 capital cannot exceed the amount of
the institution's Tier 1 capital.
The Federal Deposit Insurance Corporation Improvement Act (the "FDICIA")
required each federal banking agency to revise its risk-based capital standards
for insured institutions to ensure that those standards take adequate account of
interest-rate risk, concentration of credit risk, and the risk of nontraditional
activities, as well as to reflect the actual performance and expected risk of
loss on multi-family residential loans. The FDIC, along with the other federal
banking agencies, has adopted a regulation providing that the agencies will take
into account the
27
exposure of a bank's capital and economic value to changes in interest rate risk
in assessing a bank's capital adequacy.
As a savings and loan holding company regulated by the OTS, the Company is
not, under current law, subject to any separate regulatory capital requirements.
Standards for Safety and Soundness. As required by statute, the federal
banking agencies adopted final regulations and Interagency Guidelines
Establishing Standards for Safety and Soundness to implement safety and
soundness standards. The guidelines set forth the safety and soundness standards
that the federal banking agencies use to identify and address problems at
insured depository institutions before capital becomes impaired. The guidelines
address internal controls and information systems, internal audit system, credit
underwriting, loan documentation, interest rate risk exposure, asset growth,
asset quality, earnings and compensation, and fees and benefits. If the
appropriate federal banking agency determines that an institution fails to meet
any standard prescribed by the guidelines, the agency may require the
institution to submit to the agency an acceptable plan to achieve compliance
with the standard.
Investment Activities
Since the enactment of the FDICIA, all state-chartered FDIC insured banks,
including savings banks, have generally been limited to activities as principal
and equity investments of the type and in the amount authorized for national
banks, notwithstanding state law. The FDICIA and the FDIC permit exceptions to
these limitations. For example, state chartered banks, such as the Bank, may,
with FDIC approval, continue to exercise state authority to invest in common or
preferred stocks listed on a national securities exchange or the NASDAQ National
Market and in the shares of an investment company registered under the
Investment Company Act of 1940, as amended. In addition, the FDIC is authorized
to permit such institutions to engage in state authorized activities or
investments that do not meet this standard (other than non-subsidiary equity
investments) for institutions that meet all applicable capital requirements if
it is determined that such activities or investments do not pose a significant
risk to the BIF. The FDIC has adopted revisions to its regulations governing the
procedures for institutions seeking approval to engage in such activities or
investments. All non-subsidiary equity investments, unless otherwise authorized
or approved by the FDIC, must have been divested by December 19, 1996, under a
FDIC-approved divestiture plan, unless such investments were grandfathered by
the FDIC. The Bank received grandfathered authority from the FDIC in March 1993
to invest in listed stocks and/or registered shares. However, the maximum
permissible investment is 100% of Tier 1 capital, as specified by the FDIC's
regulations, or the maximum amount permitted by Connecticut law, whichever is
less. Such grandfathered authority may be terminated upon the FDIC's
determination that such investments pose a safety and soundness risk to the Bank
or if the Bank converts its charter or undergoes a change in control. As of
December 31, 2001, the Bank had $61.56 million of securities which were held
under such grandfathering authority. The Gramm-Leach-Bliley Act of 1999 (the
"GLB Act") specifies that a nonmember bank may control a subsidiary that engages
in activities as principal that would only be permitted for a national bank to
conduct in a "financial subsidiary" if a bank meets specified conditions and
deducts its investment in the subsidiary for regulatory capital purposes.
Interstate Branching
Beginning June 1, 1997, the Interstate Banking Act (the "IBA") permitted
the responsible federal banking agencies to approve merger transactions between
banks located in different states, regardless of whether the merger would be
prohibited under the law of the two states. The IBA also permitted a state to
"opt in" to the provisions of the IBA before June 1, 1997, and permitted a state
to "opt out" of the provisions of the IBA by adopting appropriate legislation
before that date. In 1995, Connecticut affirmatively "opted-in " to the
provisions of the IBA. Accordingly, beginning June 1, 1997, the IBA permitted a
bank, such as the Bank, to acquire branches in a state other than Connecticut
unless the other state had opted out of the IBA. The IBA also authorizes de novo
branching into another state if the host state enacts a law expressly permitting
out of state banks to establish such branches within its borders.
28
Prompt Corrective Regulatory Action
Federal law requires, among other things, that federal bank regulatory
authorities take "prompt corrective action" with respect to banks that do not
meet minimum capital requirements. For these purposes, the law establishes five
capital categories: well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized, and critically undercapitalized.
The FDIC has adopted regulations to implement the prompt corrective action
legislation. An institution is deemed to be "well capitalized" if it has a total
risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of
6% or greater and a leverage ratio of 5% or greater. An institution is
"adequately capitalized" if it has a total risk-based capital ratio of 8% or
greater, a Tier 1 risk-based capital ratio of 4% or greater, and generally a
leverage ratio of 4% or greater. An institution is "undercapitalized" if it has
a total risk-based capital ratio of less than 8%, a Tier 1 risk-based capital
ratio of less than 4%, or generally a leverage ratio of less than 4%. An
institution is deemed to be "significantly undercapitalized" if it has a total
risk-based capital ratio of less than 6%, a Tier 1 risk-based capital ratio of
less than 3%, or a leverage ratio of less than 3%. An institution is considered
to be "critically undercapitalized" if it has a ratio of tangible equity (as
defined in the regulations) to total assets that is equal to or less than 2%. As
of December 31, 2001, the Bank was a "well capitalized" institution.
"Undercapitalized" banks must adhere to growth, capital distribution
(including dividend) and other limitations and are required to submit a capital
restoration plan. A bank's compliance with such plan is required to be
guaranteed by any company that controls the undercapitalized institution in an
amount equal to the lesser of 5% of the institution's total assets when deemed
undercapitalized or the amount necessary to achieve the status of adequately
capitalized. If an "undercapitalized" bank fails to submit an acceptable plan,
it is treated as if it is "significantly undercapitalized." "Significantly
undercapitalized" banks must comply with one or more of a number of additional
restrictions, including but not limited to an order by the FDIC to sell
sufficient voting stock to become adequately capitalized, requirements to reduce
total assets and cease receipt of deposits from correspondent banks or dismiss
directors or officers, and restrictions on interest rates paid on deposits,
compensation of executive officers and capital distributions by the parent
holding company. "Critically undercapitalized" institutions are subject to
additional measures including, subject to a narrow exception, the appointment of
a receiver or conservator within 270 days after it obtains such status.
Transactions with Affiliates
Under current federal law, transactions between depository institutions and
their affiliates are governed by Sections 23A and 23B of the Federal Reserve Act
(the "FRA"). In a holding company context, at a minimum, the parent holding
company of a savings bank and any companies which are controlled by such parent
holding company are affiliates of the savings bank. Generally, Section 23A
limits the extent to which the savings bank or its subsidiaries may engage in
"covered transactions" with any one affiliate to 10% of such savings bank's
capital stock and surplus, and contains an aggregate limit on all such
transactions with all affiliates to 20% of capital stock and surplus. The term
"covered transaction" includes, among other things, the making of loans or other
extensions of credit to an affiliate and the purchase of assets from an
affiliate. Section 23A also establishes specific collateral requirements for
loans or extensions of credit to, or guarantees, acceptances on letters of
credit issued on behalf of an affiliate. Section 23B requires that covered
transactions and a broad list of other specified transactions be on terms
substantially the same, or no less favorable, to the savings bank or its
subsidiary as similar transactions with nonaffiliates.
Further, Section 22(h) of the FRA restricts an institution with respect to
loans to directors, executive officers, and principal stockholders ("insiders").
Under Section 22(h), loans to insiders and their related interests may not
exceed, together with all other outstanding loans to such persons and affiliated
entities, the institution's total capital and surplus. Loans to insiders above
specified amounts must receive the prior approval of the board of directors.
Further, under Section 22(h), loans to directors, executive officers and
principal shareholders must be made on terms substantially the same as offered
in comparable transactions to other persons, except that such
29
insiders may receive preferential loans made under a benefit or compensation
program that is widely available to the Bank's employees and does not give
preference to the insider over the employees. Section 22(g) of the FRA places
additional limitations on loans to executive officers.
Enforcement
The FDIC has extensive enforcement authority over insured savings banks,
including the Bank. This enforcement authority includes, among other things, the
ability to assess civil money penalties, to issue cease and desist orders and to
remove directors and officers. In general, these enforcement actions may be
initiated in response to violations of laws and regulations and unsafe or
unsound practices.
The FDIC has authority under Federal law to appoint a conservator or
receiver for an insured bank under limited circumstances. The FDIC is required,
with certain exceptions, to appoint a receiver or conservator for an insured
state non-member bank if that bank was "critically undercapitalized" on average
during the calendar quarter beginning 270 days after the date on which the
institution became "critically undercapitalized." The FDIC may also appoint
itself as conservator or receiver for an insured state non-member institution
under specific circumstances on the basis of the institution's financial
condition or upon the occurrence of other events, including: (1) insolvency; (2)
substantial dissipation of assets or earnings through violations of law or
unsafe or unsound practices; (3) existence of an unsafe or unsound condition to
transact business; and (4) insufficient capital, or the incurring of losses that
will deplete substantially all of the institution's capital with no reasonable
prospect of replenishment without federal assistance.
Insurance of Deposit Accounts
The FDIC has adopted a risk-based insurance assessment system. The FDIC
assigns an institution to one of three capital categories based on the
institution's financial condition consisting of (1) well capitalized, (2)
adequately capitalized or (3) undercapitalized, and one of three supervisory
subcategories within each capital group. The supervisory subgroup to which an
institution is assigned is based on a supervisory evaluation provided to the
FDIC by the institution's primary federal regulator and information which the
FDIC determines to be relevant to the institution's financial condition and the
risk posed to the deposit insurance funds. An institution's assessment rate
depends on the capital category and supervisory category to which it is
assigned. Assessment rates for insurance fund deposits currently range from 0
basis points for the strongest institution to 27 basis points for the weakest.
BIF members are also required to assist in the repayment of bonds issued by the
Financing Corporation in the late 1980's to recapitalize the Federal Savings and
Loan Insurance Corporation. For 2001, the total FDIC assessment was $208,000.
The FDIC is authorized to raise the assessment rates. The FDIC has exercised
this authority several times in the past and may raise insurance premiums in the
future. If such action is taken by the FDIC, it could have an adverse effect on
the earnings of the Bank.
The FDIC may terminate insurance of deposits if it finds that the
institution is in an unsafe or unsound condition to continue operations, has
engaged in unsafe or unsound practices, or has violated any applicable law,
regulation, rule, order or condition imposed by the FDIC. The management of the
Bank does not know of any practice, condition or violation that might lead to
termination of deposit insurance.
Federal Reserve System
The FRB regulations require depository institutions to maintain
non-interest-earning reserves against their transaction accounts (primarily NOW
and regular checking accounts). The FRB regulations generally require that
reserves be maintained against aggregate transaction accounts as follows: for
that portion of transaction accounts aggregating $41.3 million or less (which
may be adjusted by the FRB) the reserve requirement is 3%; and for accounts
greater than $41.3 million, the reserve requirement is $1.24 million plus 10%
(which may be adjusted by the FRB between 8% and 14%) against that portion of
total transaction accounts in excess of $41.3 million. The
30
first $5.7 million of otherwise reservable balances (which may be adjusted by
the FRB) are exempted from the reserve requirements. The Bank is in compliance
with these requirements.
Federal Home Loan Bank System
The Bank is a member of the Federal Home Loan Bank System, which consists
of 12 regional Federal Home Loan Banks. The FHLB provides a central credit
facility primarily for member institutions. The Bank, as a member of the FHLB of
Boston, is required to acquire and hold shares of capital stock in the FHLB of
Boston in an amount at least equal to 1% of the aggregate principal amount of
its unpaid residential mortgage loans and similar obligations at the beginning
of each year, or 1/20 of its advances (borrowings) from the FHLB of Boston,
whichever is greater. The Bank was in compliance with this requirement with an
investment in FHLB of Boston stock at December 31, 2001 of $30.78 million. At
December 31, 2001, the Bank had $457.03 million in FHLB of Boston advances.
The Federal Home Loan Banks are required to provide funds for certain
purposes including the resolution of insolvent thrifts in the late 1980s and to
contributing funds for affordable housing programs. These requirements could
reduce the amount of dividends that the Federal Home Loan Banks pay to their
members and result in the Federal Home Loan Banks imposing a higher rate of
interest on advances to their members. If dividends were reduced, or interest on
future FHLB of Boston advances increased, the Bank's net interest income would
likely also be reduced. Recent legislation has changed the structure of the
Federal Home Loan Banks' funding obligations for insolvent thrifts, revised the
capital structure of the Federal Home Loan Banks and implemented entirely
voluntary membership for Federal Home Loan Banks. For the years ended December
31, 2001 and 2000, cash dividends from the FHLB of Boston to the Bank amounted
to approximately $824,000 and $460,000, respectively. Further, there can be no
assurance that the impact of recent or future legislation on the Federal Home
Loan Banks also will not cause a decrease in the value of the FHLB stock held by
the Bank.
Holding Company Regulation
Federal law allows a state savings bank that qualifies as a "Qualified
Thrift Lender," discussed below, to elect to be treated as a savings association
for purposes of the savings and loan holding company provisions of the HOLA.
Such election allows its holding company to be regulated as a savings and loan
holding company by the OTS rather than as a bank holding company by the FRB. The
Bank has made such election, and the Company is a nondiversified savings and
loan holding company within the meaning of the HOLA. The Company is registered
with the OTS and has adhered to the OTS's regulations and reporting
requirements. In addition, the OTS may examine and supervise the Company, and
the OTS has enforcement authority over the Company and its non-savings
institution subsidiaries. Among other things, this authority permits the OTS to
restrict or prohibit activities that are determined to be a serious risk to the
subsidiary savings institution. Additionally, the Bank is required to notify the
OTS at least 30 days before declaring any dividend to the Company. By
regulation, the OTS may restrict or prohibit the Bank from paying dividends.
The Company is a unitary savings and loan holding company under federal law
because the Bank is its only insured subsidiary. Formerly, a unitary savings and
loan holding company was not restricted as to the types of business activities
in which it could engage, provided that its subsidiary savings association
continued to be a qualified thrift lender. The GLB Act, however, restricts
unitary savings and loan holding companies not existing or applied for before
May 4, 1999 to activities permissible for a financial holding company as defined
under the legislation, including insurance and securities activities, and those
permitted for a multiple savings and loan holding company as described below.
The Company is subject to these activities restrictions. Upon any
non-supervisory acquisition by the Company of another savings association as a
separate subsidiary, the Company would become a multiple savings and loan
holding company. The HOLA limits the activities of a multiple savings and loan
holding company and its non-insured institution subsidiaries primarily to
activities permissible for bank holding companies under Section 4(c)(8) of the
BHCA, provided the prior approval of the OTS is obtained, to activities
permitted for financial holding companies and to other activities authorized by
OTS regulation. Multiple savings and loan
31
holding companies are generally prohibited from acquiring or retaining more than
5% of a non-subsidiary company engaged in activities other than those permitted
by the HOLA.
The HOLA prohibits a savings and loan holding company from, directly or
indirectly, acquiring more than 5% of the voting stock of another savings
association or savings and loan holding company or from acquiring such an
institution or company by merger, consolidation or purchase of its assets,
without prior written approval of the OTS. In evaluating applications by holding
companies to acquire savings associations, the OTS considers the financial and
managerial resources and future prospects of the Company and the institution
involved, the effect of the acquisition on the risk to the insurance funds, the
convenience and needs of the community and competitive factors.
The OTS is prohibited from approving any acquisition that would result in a
multiple savings and loan holding company controlling savings institutions in
more than one state, except: (1) interstate supervisory acquisitions by savings
and loan holding companies; and (2) the acquisition of a savings institution in
another state if the laws of the state of the target savings institution
specifically permit such acquisitions.
To be regulated as a savings and loan holding company by the OTS (rather
than as a bank holding company by the FRB), the Bank must qualify as a Qualified
Thrift Lender ("QTL"). To qualify as a QTL, the Bank must maintain compliance
with the test for a "domestic building and loan association," as defined in the
Internal Revenue Code, or with a QTL Test. Under the QTL Test, a savings
institution is required to maintain at least 65% of its "portfolio assets"
(total assets less: (1) specified liquid assets up to 20% of total assets; (2)
intangibles, including goodwill; and (3) the value of property used to conduct
business) in certain "qualified thrift investments" (primarily residential
mortgages and related investments, including certain mortgage-backed and related
securities) in at least 9 months out of each 12 month period. As of December 31,
2001 the Bank maintained in excess of 74% of its portfolio assets in qualified
thrift investments. The Bank also met the QTL test in each of the last 12 months
and, therefore, met the QTL Test.
Acquisition of the Company. Under the Federal Change in Bank Control Act
(the "CIBCA"), a notice must be submitted to the OTS if any person (including a
company), or group acting in concert, seeks to acquire 10% or more of the
Company's outstanding voting stock, unless the OTS has found that the
acquisition will not result in a change of control of the Company. Under the
CIBCA, the OTS has 60 days from the filing of a complete notice to act, taking
into consideration certain factors, including the financial and managerial
resources of the acquirer and the anti-trust effects of the acquisition. Any
company that so acquires control would then be subject to regulation as a
savings and loan holding company.
Connecticut Holding Company Regulations. Under Connecticut banking law, no
person may acquire beneficial ownership of more than 10% of any class of voting
securities of a Connecticut-chartered bank, or any holding company of such a
bank, without prior notification of, and lack of disapproval by, the
Commissioner. Similar restrictions apply to any person who holds in excess of
10% of any such class and desires to increase its holdings to 25% or more of
such class. The Commissioner will evaluate the effect of the acquisition on the
financial condition of the bank or bank holding company. The Commissioner will
also disapprove the acquisition if the bank or holding company to be acquired
has been in existence for less than five years, unless the Commissioner waives
this requirement, or if the acquisition would result in the acquirer controlling
30% or more of the total amount of deposits in insured depository institutions
in Connecticut.
Federal Securities Laws
Upon the completion of the Conversion in March 2000, the Company's common
stock became registered with the SEC under the Exchange Act. The Company now
observes the information, proxy solicitation, insider trading restrictions and
other requirements under the Exchange Act.
The registration under the Securities Act of shares of the common stock
issued in the Conversion did not
32
cover the resale of such shares. Shares of the common stock purchased by persons
who are not affiliates of the Company may be resold without registration. The
resale restrictions of Rule 144 under the Securities Act govern shares purchased
by an affiliate of the Company. If the Company meets the current public
information requirements of Rule 144 under the Securities Act, each affiliate of
the Company who complies with the other conditions of Rule 144 (including those
that require the affiliate's sale to be aggregated with those of other persons)
would be able to sell in the public market, without registration, a number of
shares not to exceed, in any three-month period, the greater of (1) 1% of the
outstanding shares of the Company or (2) the average weekly volume of trading in
such shares during the preceding four calendar weeks. Provision may be made in
the future by the Company to permit affiliates to have their shares registered
for sale under the Securities Act under specific circumstances.
33
FEDERAL AND STATE TAXATION OF INCOME
Federal Income Taxation
General. The Company and the Bank report their income on a calendar year
basis using the accrual method of accounting. The federal income tax laws apply
to the Company and the Bank in the same manner as to other corporations with
some exceptions, including particularly the Bank's reserve for bad debts
discussed below. The following discussion of tax matters is intended only as a
summary and does not purport to be a comprehensive description of the tax rules
applicable to the Bank or the Company. The Bank's federal income tax returns
have been either audited or closed under the statute of limitations through tax
year 1997. For its 2001 tax year, the Bank's maximum federal income tax rate was
35%.
Bad Debt Reserves. For fiscal years beginning before December 31, 1995,
thrift institutions which qualified under certain definitional tests and other
conditions of the Internal Revenue Code of 1986, as amended, were permitted to
use certain favorable provisions to calculate their deductions from taxable
income for annual additions to their bad debt reserve. A reserve could be
established for bad debts on qualifying real property loans, generally secured
by interests in real property improved or to be improved, under the percentage
of taxable income method or the experience method. The reserve for nonqualifying
loans was computed using the experience method.
Federal legislation enacted in 1996 repealed the reserve method of
accounting for bad debts and the percentage of taxable income method for tax
years beginning after 1995 and require savings institutions to recapture or take
into income certain portions of their accumulated bad debt reserves.
Approximately $18.90 million of the Bank's accumulated bad debt reserves would
not be recaptured into taxable income unless the Bank makes a "non-dividend
distribution" to the Company as described below.
Distributions. If the Bank makes "non-dividend distributions" to the
Company, they will be considered to have been made from the Bank's unrecaptured
tax bad debt reserves, including the balance of its reserves as of December 31,
1987, to the extent of the "non-dividend distributions," and then from the
Bank's supplemental reserve for losses on loans, to the extent of those
reserves, and an amount based on the amount distributed, but not more than the
amount of those reserves, will be included in the Bank's taxable income.
Non-dividend distributions include distributions in excess of the Bank's current
and accumulated earnings and profits, as calculated for federal income tax
purposes, distributions in redemption of stock, and distributions in partial or
complete liquidation. Dividends paid out of the Bank's current or accumulated
earnings and profits will not be so included in the Bank's taxable income.
The amount of additional taxable income triggered by a non-dividend is an
amount that, when reduced by the tax attributable to the income, is equal to the
amount of the distribution. Therefore, if the Bank makes a non-dividend
distribution to the Company, approximately one and one-half times the amount of
the distribution not in excess of the amount of the reserves would be includable
in income for federal income tax purposes, assuming a 35% federal corporate
income tax rate. The Bank does not intend to pay dividends that would result in
a recapture of any portion of its bad debt reserves.
Connecticut Taxation
The Company and its subsidiaries are subject to the Connecticut corporation
business tax. The Company and its subsidiaries are eligible to file a combined
Connecticut corporation business tax return and will pay the regular corporation
business tax (income tax).
34
The Connecticut corporation business tax is based on the federal taxable
income before net operating loss and special deductions of the Company and its
subsidiaries and makes certain modifications to federal taxable income to arrive
at Connecticut taxable income. Connecticut taxable income is multiplied by the
state tax rate (7.5% for 2000 and thereafter) to arrive at Connecticut income
tax.
In May 1998, the State of Connecticut enacted legislation permitting the
formation of passive investment company subsidiaries by financial institutions.
This legislation exempts qualifying passive investment companies from the
Connecticut corporation business tax and excludes dividends paid from a passive
investment company from the taxable income of the parent financial institution.
The Bank established a passive investment company in January 1999 and eliminated
the state income tax expense of the Company effective December 31, 1998 through
December 31, 2001. However, proposed legislation would eliminate the exemption
as of January 1, 2002. If the legislation were enacted, the Company would be
subject to state income taxes in Connecticut.
35
Item 2. Properties.
- ------------------
Properties
The Company and the Bank currently conduct their business through their
main office located in Manchester, Connecticut, and 27 other full-service
banking offices. The Company and the Bank believe that their facilities are
adequate to meet their present and immediately foreseeable needs. (dollars in
thousands)
Net Book
Value of
Property or
Leasehold
Original Date of Improvements
Leased, Year Lease/ at
Licensed Leased or License December 31,
Location or Owned Acquired Expiration 2001
- --------------------------------- ---------- --------- ---------- ------------
Main Branch and Executive Office:
923 Main Street
Manchester, CT 06040 Owned 1932 -- $ 1,924
Branch Offices:
285 East Center Street
Manchester, CT 06040 Leased 1956 2016 $ 213
220 North Main Street
Manchester, CT 06040 Leased 1970 2005 $ 81
344 West Middle Turnpike
Manchester, CT 06040 Owned 2001 (2) -- $ 438
214 Spencer Street
Manchester, CT 06040 Leased 2001 (2) 2015 $ 185
1065 Main Street
East Hartford, CT 06108 Leased 2001 (2) 2010 $ 51
950 Silver Lane
East Hartford, CT 06108 Leased 2001 (2) 2011 $ 424
955 Sullivan Avenue
South Windsor, CT 06074 (1) 1965 2010 $ 517
481 Buckland Road
South Windsor, CT 06074 Leased 2001 (2) 2003 $ --
36
Net Book
Value of
Property or
Leasehold
Original Date of Improvements
Leased, Year Lease/ at
Licensed Leased or License December 31,
Location or Owned Acquired Expiration 2001
- --------------------------------- ---------- --------- ---------- ------------
Eastford Center, County Road
Eastford, CT 06242 Leased 1985 2004 $ --
122A Prospect Hill Road
East Windsor, CT 06088 Leased 1985 2004 $ --
6 Storrs Road
Mansfield, CT 06250 Leased 1986 2015 $ 78
200 Merrow Road
Tolland, CT 06084 Leased 1989 2004 $ 43
1320 Manchester Road
Glastonbury, CT 06033 (1) 1987 2007 $ 247
2510 Main Street
Glastonbury, CT 06033 Owned 2001 (2) -- $ 1,271
902 Main Street
South Glastonbury, CT 06073 Leased 2001 (2) 2005 $ 35
435 Hartford Turnpike
Vernon, CT 06066 Leased 1988 2003 $ 58
35 Talcottville Road
Vernon, CT 06066 Leased 2001 (2) 2002 $ 2
1078 N. Main Street
Dayville (Killingly), CT 06241 Leased 1990 2010 $ --
Route 66
Columbia, CT 06237 Owned 1991 -- $ 227
1671 Boston Turnpike
Coventry, CT 06238 Leased 1993 2013 $ 68
37
Net Book
Value of
Property or
Leasehold
Original Date of Improvements
Leased, Year Lease/ at
Licensed Leased or License December 31,
Location or Owned Acquired Expiration 2001
- --------------------------------- ---------- --------- ---------- ------------
Route 31 & Stonehouse Road
Coventry, CT 06238 Leased 2001 (2) 2007 $ --
596 Middle Turnpike
Storrs, CT 06268 Owned 1995 -- $ 755
49 Hazard Avenue
Enfield, CT 06082 Leased 1995 2007 $ 76
2133 Poquonock Avenue
Windsor, CT 06095 Leased 1996 2006 $ 149
38 Wells Road
Wethersfield, CT 06109 Leased 1996 2008 $ 104
55 South Main Street
West Hartford, CT 06107 Leased 1997 2016 $ 201
175 West Road
Ellington, CT 06029 Leased 2001 (2) 2003 $ 3
Drive/Walk in facility:
Annex - Maple Street
Manchester, CT 06040 Owned 2001 (2) -- $ 14
ATM Facilities:
Rt.6
Andover, CT 06232 Leased 1974 2004 $ --
Junction 44 & 74
Ashford, CT 06278 Leased 1976 2002 $ --
38
Net Book
Value of
Property or
Leasehold
Original Date of Improvements
Leased, Year Lease/ at
Licensed Leased or License December 31,
Location or Owned Acquired Expiration 2001
- --------------------------------- ---------- --------- ---------- ------------
Rt. 44A, 663 Boston Turnpike
Bolton, CT 06043 Leased 1968 2002 $ --
700 Burnside Ave.
East Hartford, CT 06108 Leased 1966 2002 $ --
477 Connecticut Boulevard
East Hartford, CT 06108 Leased 1996 2002 $ --
1 Main Street
East Hartford, CT 06118 Leased 1975 2010 $ --
60 Bidwell Street
Manchester, CT 06040 Licensed(4) 1990 (4) $ --
Buckland Hills Mall
Manchester, CT 06040 Leased 1992 2004 $ --
469 Hartford Rd
Manchester, CT 06040 Leased 1970 2002 $ --
71 Haynes Street
Manchester, CT 06040 Licensed(4) 1989 (4) $ --
317 Highland Street
Manchester, CT 06040 Leased 2001 (2) 2002 $ --
241 West Middle Turnpike
Manchester, CT 06040 (1) 1983 2023 $ 150
62 Buckland Street
Manchester, CT 06040 Leased 1990 2009 $ --
39
Net Book
Value of
Property or
Leasehold
Original Date of Improvements
Leased, Year Lease/ at
Licensed Leased or License December 31,
Location or Owned Acquired Expiration 2001
- --------------------------------- ---------- --------- ---------- ------------
23 Main Street
Manchester, CT 06040 Owned 2001 (2) -- $ 176
31 Union Street
Rockville, CT 06066 Licensed(4) 1995 (4) $ --
95 South Turnpike Road
Wallingford, CT 06492 Leased 2001 2002 $ --
Administrative Offices:
469 Hartford Road
Manchester, CT 06040 Leased 1970 2002 $ 10
50-56 Cottage Street
Manchester, CT 06040 Owned 1986 -- $ --
881 Main Street
Manchester, CT 06040 Leased 1984 2002 $ --
935 Main Street
Manchester, CT 06040 Owned (3) -- $ 2,807
935 Main Street
Units B102 & B102A
Manchester, CT 06040 Leased 1997 2006 $ 82
945 Main Street
Unit 102A
Manchester, CT 06040 Leased 1999 2002 $ --
945 Main Street
Unit 305
Manchester, CT 06040 Owned 1997 -- $ 129
40
Net Book
Value of
Property or
Leasehold
Original Date of Improvements
Leased, Year Lease/ at
Licensed Leased or License December 31,
Location or Owned Acquired Expiration 2001
- --------------------------------- ---------- --------- ---------- ------------
945 Main Street
Unit 309
Manchester, CT 06040 Owned 1998 -- $ 91
903 Main Street
Manchester, CT 06040 Owned 2001 -- $ 499
35-43 Oak Street
Manchester, CT 06040 Owned 1995 -- $ 704
1007-1011 Main Street
Manchester, CT 06040 Owned 2001 (2) -- $ 573
12 Howard Street
East Hartford, CT 06108 Owned 2001 (2) -- $ 49
16-34 Orchard Street
East Hartford, CT 06108 Owned 2001 (2) -- $ 156
1125-1137 Main Street
East Hartford, CT 06108 Owned 2001 (2) -- $ 563
681 Main Street
Plantsville, CT 06479 Leased 1997 (4) $ --
-------
$13,153
=======
(1) The Bank owns the building and leases the land and only owns the building
as long as the lease is in effect.
(2) The Bank acquired these properties on August 31, 2001 from First Federal.
(3) The Bank owns seventeen commercial condominiums, which were all acquired at
various times between 1990 and 2000.
(4) The Bank maintains a license to possess the property. Generally, the holder
of a license has less property rights than the possessor of a leasehold
interest. The license has no expiration date.
41
Item 3. Legal Proceedings.
- --------------------------
Periodically, there have been various claims and lawsuits involving the
Bank, such as claims to enforce liens, condemnation proceedings on properties in
which the Bank holds security interests, claims involving the making and
servicing of real property loans and other issues incident to the Bank's
business. The Company is not a party to any pending legal proceedings that it
believes would have a material adverse effect on the financial condition or
operations of the Company.
Item 4. Submission of Matters to a Vote of Security Holders.
- ------------------------------------------------------------
None.
PART II
Item 5. Market for the Registrant's Common Equity and Related Stockholder
- -------------------------------------------------------------------------
Matters.
--------
The Company's Common Stock has been traded on the NASDAQ National Market
under the symbol "SBMC" since the Company's initial public offering closed on
March 1, 2000 and the Common Stock began trading on March 2, 2000. The initial
offering price was $10.00 per share. The following table sets forth the high and
low last sale prices of the Common Stock from March 2, 2000 to December 31,
2001, as reported by NASDAQ and any dividends that the Company paid in the
respective period.
Cash Dividend
Quarter ended Paid High Low
- ------------------ ------------- ------ ------
March 31, 2000 $0.00 $10.81 $ 9.81
June 30, 2000 0.00 14.69 10.75
September 30, 2000 0.00 18.94 15.00
December 31, 2000 0.00 18.94 16.50
March 31, 2001 $0.00 $21.00 $17.88
June 30, 2001 0.09 26.18 19.88
September 30, 2001 0.09 26.52 20.45
December 31, 2001 0.11 26.70 22.09
As of December 31, 2001 the Company had approximately 5,016 stockholders of
record.
Declarations of dividends by the Board of Directors, if any, will depend
upon a number of factors, investment opportunities available to the Company,
capital requirements, regulatory limitations, the Company's financial condition
and results of operations, tax considerations and general economic conditions.
No assurances can be given, however, that any dividends will continue to be
paid.
The Company's ability to declare dividends is subject to the requirements
of Delaware law, which generally limits dividends to an amount equal to the
excess of the net assets of the Company (the amount by which total assets exceed
total liabilities) over its statutory capital or, if there is no excess, to its
net profits for the current and/or immediately preceding fiscal year.
42
Item 6. Selected Financial Data.
- --------------------------------
The Company has derived the following selected consolidated financial and
other data in part from the consolidated financial statements and notes
appearing elsewhere in this Form 10-K.
At December 31,
--------------------------------------------------------------
2001 2000 1999 1998 1997
---------- ---------- ---------- ---------- ----------
(in thousands)
Selected Consolidated Financial Data:
Total assets $2,446,424 $1,403,311 $1,227,798 $1,108,287 $1,033,086
Cash and cash equivalents 122,624 64,797 26,678 45,048 14,660
Loans, net 1,421,143 995,764 938,340 806,787 798,292
Securities held to maturity:
Mortgage-backed securities -- -- 25,474 22,742 14,409
Other investment securities -- -- 20,586 29,855 35,874
---------- ---------- ---------- ---------- ----------
Total securities held to maturity -- -- 46,060 52,597 50,283
---------- ---------- ---------- ---------- ----------
Securities available for sale:
Mortgage-backed securities 149,750 80,223 16,204 12,859 17,985
Collateralized mortgage obligations 258,601 -- -- -- --
U.S. Government and agency
obligations 183,813 85,254 81,328 71,703 48,767
Common stock and mutual funds 61,556 49,144 50,545 42,773 40,635
Other securities 104,814 93,460 33,777 40,816 24,202
---------- ---------- ---------- ---------- ----------
Total securities available for sale 758,534 308,081 181,854 168,151 131,589
---------- ---------- ---------- ---------- ----------
Deposits 1,590,938 933,370 906,591 855,117 827,667
Short-term borrowed funds 117,180 106,493 95,814 79,545 71,179
Advances from Federal Home Loan Bank 465,355 100,000 84,000 45,000 17,987
Stockholders' equity 235,374 232,539 123,223 112,807 101,191
Premises and equipment, net 19,348 13,197 14,436 15,621 15,709
Nonperforming assets (1) 7,763 7,046 12,089 3,283 7,543
43
For the Year Ended December 31,
------------------------------------------------
2001 2000 1999 1998 1997
-------- ------- ------- ------- -------
(in thousands)
Selected Operating Data:
Total interest and dividend income $115,387 $95,092 $78,834 $76,858 $73,931
Total interest expense 51,932 43,842 37,374 37,200 35,856
-------- ------- ------- ------- -------
Net interest income 63,455 51,250 41,460 39,658 38,075
Provision for loan losses 2,000 1,200 1,100 1,200 1,200
-------- ------- ------- ------- -------
Net interest income after provision
for loan losses 61,455 50,050 40,360 38,458 36,875
-------- ------- ------- ------- -------
Noninterest income:
Gains on sales of securities, net 481 445 1,372 2,621 4,007
Other than temporary impairment of
securities (4,076) -- -- -- --
Increase in cash surrender value of life
insurance 1,032 -- -- -- --
Other 11,560 9,824 8,034 9,539 7,460
-------- ------- ------- ------- -------
Total noninterest income 8,997 10,269 9,406 12,160 11,467
-------- ------- ------- ------- -------
Noninterest expense 51,313 49,277 36,586 37,092 31,556
-------- ------- ------- ------- -------
Income before provision for income taxes 19,139 11,042 13,180 13,526 16,786
Provision for income taxes 6,375 3,659 4,426 4,208 6,584
-------- ------- ------- ------- -------
Net income $ 12,764 $ 7,383 $ 8,754 $ 9,318 $10,202
======== ======= ======= ======= =======
44
At or For the Year Ended December 31,
------------------------------------------
2001 2000 1999 1998 1997
------ ------ ------ ------ ------
Selected Operating Ratios and
Other Data (2):
Performance Ratios:
Average yield on interest-earning assets 6.78% 7.26% 7.09% 7.54% 7.75%
Average rate paid on interest-bearing
liabilities 3.63 4.11 3.81 4.02 4.11
Average interest rate spread (3) 3.15 3.15 3.28 3.52 3.64
Net interest margin (4) 3.73 3.91 3.73 3.89 3.96
Interest-earning assets to interest-
bearing liabilities 119.11 122.63 113.22 110.29 109.47
Net interest income after provision for
loan losses to noninterest expense 119.76 101.57 110.32 103.68 116.86
Noninterest expense as a percentage
of average assets 2.91 3.65 3.18 3.46 3.15
Return on average assets 0.72 0.55 0.76 0.87 1.02
Return on average equity 5.50 3.59 7.53 8.71 10.75
Ratio of average equity to average assets 13.19 15.24 10.11 9.99 9.48
Dividend payout ratio 36.96 0.00 0.00 0.00 0.00
Regulatory Capital Ratios:
Leverage capital ratio 6.63 12.82 9.10 9.33 8.98
Total risk-based capital ratio (2) 10.85 19.63 13.96 13.89 13.67
Asset Quality Ratios (2):
Nonperforming loans and troubled debt
restructurings as a percentage
of total loans (5) 0.53 0.69 1.21 0.19 0.35
Nonperforming assets and troubled debt
restructurings as a percentage
of total assets 0.32 0.50 0.98 0.30 0.73
Allowance for loan losses as a
percentage of total loans 1.06 1.16 1.12 1.30 1.23
Allowance for loan losses as a
percentage of nonperforming loans
and troubled debt restructurings 198.31 168.96 92.44 694.55 350.79
Net loans charged-off to average
interest-earning loans 0.06 0.01 0.12 0.07 0.05
Full service offices at end of period 28 23 23 23 23
- ----------
(1) Nonperforming assets consist of nonperforming loans, troubled debt
restructurings, and other real estate owned.
(2) Asset quality and total risk-based capital ratios are end of period ratios.
Except for end of period ratios, all ratios are based on average daily
balances during the indicated periods.
(3) Average interest rate spread represents the difference between the average
yield on interest-earning assets and the average rate paid on
interest-bearing liabilities.
(4) Net interest margin represents net interest income as a percentage of
average interest-earning assets.
(5) Nonperforming loans consist of nonaccrual loans and loans 90 days or more
past due and accruing interest.
45
Item 7. Management's Discussion and Analysis of Financial Condition and Results
- -------------------------------------------------------------------------------
of Operations.
-------------
The following discussion should be read in conjunction with "Selected
Financial Data" and the Consolidated Financial Statements and related Notes
appearing elsewhere in this Form 10-K.
General
The Company has only one subsidiary, The Savings Bank of Manchester. The
Bank's results of operations depend primarily on net interest income, which is
the difference between the interest income earned on its interest-earning
assets, such as loans and securities, and the interest expense on its
interest-bearing liabilities, such as deposits and borrowings. The Bank also
generates noninterest income primarily from fees charged on customers' accounts
and fees earned on activities such as investment services provided through a
third party registered broker-dealer. Gains on sales of securities are another
source of noninterest income. The Bank's noninterest expenses primarily consist
of employee compensation and benefits, occupancy expense, advertising and other
operating expenses. The Bank's results of operations are also affected by
general economic and competitive conditions, notably changes in market interest
rates, government policies and regulations. The Bank exceeded all of its
regulatory capital requirements at December 31, 2001.
Acquisition of First Federal
On August 31, 2001, the Company completed its acquisition of First Federal
in a transaction accounted for under the purchase method of accounting.
Accordingly, the assets and liabilities of First Federal are reflected in the
Company's consolidated balance sheet at December 31, 2001, and the results of
operations of First Federal since August 31, 2001 are included in the
consolidated statement of operations for the year ended December 31, 2001, as
required by the purchase method of accounting.
Significant Accounting Policies
Financial Reporting Release No. 60, which was released by the SEC, requires
all companies to include a discussion of critical accounting policies or methods
used in preparation of financial statements. Note 1 of the Notes to Consolidated
Financial Statements includes a summary of the significant accounting policies
and methods used in the preparation of the Company's consolidated financial
statements. The following is a brief discussion of the more significant
accounting policies and methods used by the Company.
General. The preparation of financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the reported amounts of
assets and liabilities and the disclosure of contingent assets and liabilities
at the dates of the financial statements and the reported amounts of income and
expenses during the reporting periods. The most significant estimates and
assumptions relate to determining the allowance for loan losses, other than
temporary impairment of securities, income taxes, impairments of intangible
assets and pension and other postretirement benefits. Actual amounts could
differ significantly from these estimates.
Allowance for Loan Losses. The Bank devotes significant attention to
maintaining high loan quality through its underwriting standards, active
servicing of loans and aggressive management of nonperforming assets. The
allowance for loan losses is maintained at a level estimated by management to
provide adequately for possible loan losses which are inherent in the loan
portfolio. Possible loan losses are estimated based on a quarterly review of the
loan portfolio, loss experience, specific problem loans, economic conditions and
other pertinent factors. In assessing risks inherent in the portfolio,
management considers the risk of loss on nonperforming and classified loans
including an analysis of collateral in each situation. The Bank's methodology
for assessing the appropriateness of the allowance for loan losses includes
several key elements. Problem loans are identified and analyzed individually to
detect specific losses. The loan portfolio is also segmented into pools of loans
that are similar in type and risk characteristics (i.e., commercial, consumer
and mortgage loans). Loss factors are applied using the Bank's historical
46
experience and may be adjusted for significant factors that, in management's
judgment, affect the collectability of the portfolio as of the evaluation date.
Additionally, the portfolio is segmented into pools based on internal risk
ratings with loss factors applied to each rating category. Other factors
considered in determining possible loan losses are the impact of larger
concentrations in the portfolio, trends in loan growth, the relationship and
trends in recent years of recoveries as a percentage of prior chargeoffs and
peer banks' loss experience. While management believes that, based on
information currently available, the allowance for loan losses is sufficient to
cover probable losses inherent in its loan portfolio at this time, no assurances
can be given that the Bank's level of allowance for loan losses will be
sufficient to cover loan losses incurred by the Bank or that future adjustments
to the allowance for loan losses will not be necessary if economic and other
conditions differ substantially from the economic and other conditions used by
management to determine the current level of the allowance for loan losses.
Other than Temporary Impairment of Securities. On a quarterly basis, the
Company reviews available for sale investment securities with unrealized
depreciation for six consecutive months to assess whether the decline in fair
value is temporary or other than temporary. The Company judges whether the
decline in value is from company-specific events, industry developments, general
economic conditions or other reasons. Once the estimated reasons for the decline
are identified, further judgments are required as to whether those conditions
are likely to reverse and, if so, whether that reversal is likely to result in a
recovery of the fair value of the investment in the near term.
Income Taxes. The Company has not provided for Connecticut state income
taxes since December 31, 1998 since it has a passive investment company (PIC) as
permitted by Connecticut law. The Company believes it complies with the state
PIC requirements and that no state taxes are due from December 31, 1998 through
December 31, 2001; however, the Company has not been audited by the state for
such periods. If the state were to determine that the PIC was not in compliance
with statutory requirements a material amount of taxes could be due.
Additionally, legislation has been proposed which if enacted would eliminate the
exemption for PIC's as of January 1, 2002 and increase the future state tax
expense of the Company thereafter.
Impairment of Intangibles. The Company periodically evaluates intangible
assets for potential impairment indicators. The Company's judgements regarding
the existence of impairment indicators are based on legal factors, market
conditions and operational performance of acquired operations. Future events
could cause the Company to conclude that impairment indicators exist and that
intangible assets associated with the Company's acquired operations is impaired.
Any resulting impairment loss could have a material adverse impact on the
Company's consolidated financial condition and results of operations.
Pension and other Postretirement Employee Benefits. The determination of
the Company's obligation and expense for pension and other postretirement
benefits is dependent on the Company's selection of certain assumptions used by
actuaries in calculating such amounts. Those assumptions are described in Note
14 to the consolidated financial statements and include, among others, the
discount rate, expected long-term rate of return on plan assets and rates of
increase in compensation and healthcare costs. In accordance with accounting
principles generally accepted in the United States, actual results that differ
from the Company's assumptions are accumulated and amortized over future periods
and therefore, generally affect the Company's recognized expense and recorded
obligation in such future periods. While the Company believes that the
assumptions are appropriate, significant differences in actual experience or
significant changes in assumptions may materially affect pension and other
postretirement obligations and the Company's future expense.
Comparison of Financial Condition at December 31, 2001 and 2000
Total assets increased $1.05 billion, or 74.33%, to $2.45 billion at
December 31, 2001 as compared to $1.40 billion at December 31, 2000. The
increase was primarily due to the acquisition of First Federal which added
$960.48 million in assets. The major increases were due to a $450.45 million
increase in securities, a $425.38 million increase in net loans, a $57.82
million increase in cash and cash equivalents, a $41.40 million increase in the
cash surrender value of life insurance, and a $30.93 million increase in
intangible assets, including goodwill. Securities acquired from First Federal
totaled $612.49 million which was partially offset by sales, maturities and
47
principal payments. The increase in loans was primarily due to real estate
loans, as one- to four-family mortgages increased $255.36 million ($204.81
million from First Federal) and construction, commercial and multi-family
mortgages increased $113.19 million ($28.96 million from First Federal).
Consumer loans increased $40.41 million as $42.60 million were acquired from
First Federal. Cash and cash equivalents increased as the Bank sold
collateralized mortgage obligations in December 2001 previously acquired from
First Federal and had yet to reinvest the funds in longer term securities.
During June 2001, the Bank purchased $20.00 million in life insurance, and the
Bank acquired $20.36 million in life insurance from First Federal. In
conjunction with the acquisition of First Federal, the Bank recorded intangible
assets of $32.37 million, consisting of $19.97 million of goodwill, $8.85
million of core deposit intangibles and $3.55 million of non-compete agreements
with former First Federal executives. The growth in assets was funded by an
increase in deposits of $657.57 million ($634.17 million from First Federal) and
advances from Federal Home Loan Bank ("FHLB") of $365.36 million ($316.55
million from First Federal). Stockholders' equity increased $2.83 million,
primarily due to net income for the period, partially offset by the funding of
the trustees' repurchase of restricted stock associated with the January 2, 2001
restricted stock awards under the Company's 2000 Stock-Based Incentive Plan, and
the declaration of $0.42 of dividends during 2001.
Deposits totaled $1.59 billion at December 31, 2001, an increase of $657.57
million, or 70.45%, compared to $933.37 million at December 31, 2000. The
deposit growth reflects an increase of $297.11 million, or 67.55%, in
certificates of deposit a $236.02 million, or 80.64%, increase in savings and
money market accounts, a $83.29 million, or 63.32%, increase in NOW accounts and
a $41.14 million, or 59.37%, increase in demand deposit accounts. The increases
in all deposit types are primarily due to the acquisition of First Federal. In
addition, the Bank continues to market a short-term commercial transactional
repurchase agreement (repo) account to commercial businesses. These repo
accounts increased $10.69 million, or 10.04%, during 2001. Advances from Federal
Home Loan Bank increased $365.36 million, or 365.36%, from $100.00 million in
2000, to $465.36 million at December 31, 2001, as $316.55 million was acquired
from First Federal.
Nonperforming assets totaled $7.76 million at December 31, 2001 compared to
$7.05 million at December 31, 2000, representing an increase of $717,000, or
10.18%. The increase in nonperforming loans was in one- to four-family mortgages
of $787,000, commercial loans of $733,000, and consumer loans of $322,000. These
increases were partially offset by a decrease in nonperforming commercial real
estate and multifamily mortgages of $1.09 million. Nonperforming loans as a
percentage of gross loans decreased to 0.53% at December 31, 2001 from 0.69% at
December 31, 2000. Nonperforming assets as a percentage of total assets
decreased to 0.32% at December 31, 2001 from 0.50% at December 31, 2000. Other
real estate owned declined $41,000, or 32.80%, during 2001 due to property
sales.
Federal Home Loan Bank Stock increased $24.13 million, or 362.86%, from
$6.65 million at December 31, 2000 to $30.78 million at December 31, 2001. The
increase in stock was primarily due to the acquisition of First Federal.
Cash surrender value life insurance increased $41.40 million from $0 at
December 31, 2000 to $41.40 million at December 31, 2001. The Bank acquired
$20.36 million from First Federal during the third quarter of 2001.
Additionally, on June 15, 2001 the Bank purchased $20.00 million of life
insurance with cash surrender value of $20.00 million. The life insurance was
purchased on key Bank officers. The income earned on these policies will be used
to offset the projected cost of the Bank's current and post-retirement benefit
plans for all employees.
Goodwill increased $19.97 million from $0 at December 31, 2000 to $19.97
million at December 31, 2001. The increase is due solely to the acquisition of
First Federal, and is not subject to amortization. Other intangible assets
increased $10.96 million from $1.97 million at December 31, 2000 to $12.93
million at December 31, 2001. The increase is primarily due to the acquisition
of First Federal and consists of a core deposit intangible totaling $8.48
million and a noncompete intangible asset totaling $2.37 million at December 31,
2001. During 2001, the Bank recorded an additional minimum pension liability of
approximately $845,000. The Bank recorded the tax effected
48
intangible asset related to this liability of approximately $549,000. The
additional minimum pension liability relates primarily to a Supplemental
Retirement Plan for the Chief Executive Officer and a Consultation Plan for
Certain Outside Directors. These increases were partially offset by the
amortization of an existing branch premium of $432,000 for the year ended
December 31, 2001. The First Federal core deposit intangible is being amortized
over eight years on a straight line basis and the noncompete intangible is being
amortized over the term of the noncompete agreement of twelve months on a
straight line basis.
Other liabilities increased $5.41 million from $21.59 million at December
31, 2000 to $27.00 million at December 31, 2001. The increase in other
liabilities included severance, executive and other employee benefits resulting
from the acquisition of First Federal that have not yet been paid.
Total capital increased $2.83 million, or 1.22%, to $235.37 million at
December 31, 2001 compared to $232.54 million at December 31, 2000. The increase
was primarily due to net income for the period partially offset by the funding
of the trustees' repurchase of restricted stock associated with the January 2,
2001 restricted stock awards under the Company's 2000 Stock-Based Incentive
Plan, and the declaration of $0.42 of dividends during 2001.
Comparison of Operating Results for the Years Ended December 31, 2001 and 2000
Net Income. Net income increased by $5.38 million, or 72.90%, to $12.76
million for 2001 from $7.38 million for 2000. Earnings per diluted share for the
year ended December 31, 2001 were $1.19 based on 10.70 million weighted average
diluted shares outstanding. During 2001, the Company recorded charges totaling
$6.37 million ($4.14 million, net of tax) that are nonrecurring in nature. These
charges included $4.08 million of other than temporary impairment of investment
securities, $1.42 million of director and employee retirement expenses, and
$872,000 of relocation and branch-closing costs resulting from the recent
acquisition of First Federal. Net income for the year ended December 31, 2000
was reduced by a one-time nonrecurring expense of $8.32 million ($5.41 million,
net of tax) relating to the Company's establishment of SBM Charitable
Foundation, Inc. in March 2000 in connection with the Bank's conversion from the
mutual holding company form of organization to the stock holding company form of
organization. Due to the timing of the conversion, earnings per share for the
year ended December 31, 2000 are not meaningful.
Operating earnings, which exclude gains and losses from securities
transactions and the previously discussed nonrecurring expenses in both 2000 and
2001, net of related tax effects, were significantly higher than the prior
year's levels. Operating earnings, net of tax, for the year 2001 were $16.59
million, or $1.55 per diluted share, compared to operating earnings of $12.50
million for the year 2000.
Net Interest Income. Net interest income increased $12.21 million, or
23.82%, to $63.46 million for 2001 from $51.25 million for 2000. The increase
was primarily a result of higher interest income from an increase in the level
of interest earning assets, partially offset by lower yields. The increase in
interest income was partially offset by higher interest expense resulting from
an increase in the level of interest bearing liabilities, partially offset by
lower rates. The higher levels of interest earning assets and interest bearing
liabilities was primarily due to the acquisition of First Federal. Lower asset
yields and lower deposit and borrowing rates were primarily caused by a lower
overall interest rate environment in 2001 as compared to 2000.
Interest and dividend income increased $20.30 million, or 21.35%, to
$115.39 million for 2001 from $95.09 million for 2000. The average yield on
interest earning assets decreased 48 basis points from 7.26% in 2000 to 6.78% in
2001, primarily due to a decrease in general market interest rates. Interest
income on loans increased $10.20 million, or 13.39%, to $86.36 million for 2001
compared to $76.16 million for 2000. The increase was primarily due to a $170.06
million increase in the average balance of loans outstanding, partially offset
by a 24 basis point decrease in the average yield on loans primarily due to a
lower interest rate environment. Interest and dividend income from investment
securities and other interest-bearing assets increased $10.10 million, or
53.35%, to $29.03 million for 2001 compared to $18.93 million for 2000. The
increase in interest and dividend income from investment securities
49
and other interest-bearing assets was due to an increase in the average balance
of $222.60 million, or 69.89%, to $541.12 million for the year ended December
31, 2001, primarily due to the First Federal acquisition. Investment and other
interest-bearing asset yields decreased 58 basis points in 2001 as compared to
2000 due to a decrease in general market interest rates.
Interest expense increased $8.09 million, or 18.45%, to $51.93 million for
2001 from $43.84 million for 2000. The increase reflects an increase in expense
on advances from FHLB of $5.50 million, and deposits and escrow of $3.36
million, partially offset by a decrease in expense for short-term borrowed funds
of $771,000. Interest expense on advances from FHLB increased primarily due to
increased average volumes of $129.75 million, partially offset by lower rates of
119 basis points. Interest expense on deposits and escrow increased primarily
due to higher average volumes of $231.17 million, partially offset by lower
rates of 53 basis points. The higher volumes were primarily due to the First
Federal acquisition, and the lower rates were due to a decrease in general
market interest rates. Interest expense on short-term borrowed funds represented
by commercial transactional repurchase agreements decreased primarily due lower
rates of 71 basis points. The average cost of funds for the Company decreased 48
basis points from 4.11% in 2000 to 3.63% in 2001, mainly due to lower general
market interest rates.
Provision for Loan Losses. The provision for loan losses was $2.00 million
for 2001 compared to $1.20 million for 2000. The allowance for loan losses was
1.06% of total loans and 198.31% of nonperforming loans at December 31, 2001
compared to 1.16% and 168.96%, respectively, at December 31, 2000. The increase
in provision is due to the allowance for loan loss ratios at First Federal being
lower than the Bank's ratios and uncertainty in the economy. At June 30, 2001
(last quarter-end prior to the acquisition), the Bank's allowance for loan
losses was 1.14% of total loans as compared to First Federal's allowance for
loan losses as a percentage of total loans of 0.74%. Although First Federal had
a different loan portfolio mix, management deemed it prudent to increase the
loan loss provision for the third quarter of 2001 to compensate for First
Federal's lower coverage ratio. The provision for loan losses returned to the
first and second quarter level in fourth quarter 2001.
Noninterest Income. Noninterest income decreased $1.27 million or 12.37% to
$9.00 million for 2001 as compared to $10.27 million for 2000. On a quarterly
basis, the Company reviews available for sale investment securities with
unrealized depreciation for six consecutive months to assess whether the decline
in fair value is temporary or other than temporary. The Company judges whether
the decline in value is from company-specific events, industry developments,
general economic conditions or other reasons. Once the estimated reasons for the
decline are identified, further judgments are required as to whether those
conditions are likely to reverse and, if so, whether that reversal is likely to
result in a recovery of the fair value of the investment in the near term. In
accordance with this policy, for the year ended December 31, 2001 and 2000 the
Company recorded other than temporary impairment charges of $4.08 million and
$0, respectively. Partially offsetting this charge, fee income from service
charges and account fees was $9.56 million in 2001 compared with $7.65 million
for 2000. The increase in fee income and service charges is primarily due to the
acquisition of deposits from First Federal. The Bank had earnings on life
insurance of $1.03 million in 2001 as compared to $0 in 2000. The Bank acquired
$20.36 million of life insurance from First Federal during the third quarter of
2001. Additionally, on June 15, 2001, the Bank purchased $20.00 million of life
insurance with cash surrender value of $20.00 million. The life insurance was
purchased on key Bank officers.
Noninterest Expense. Noninterest expense increased $2.03 million, or 4.12%,
to $51.31 million for 2001 from $49.28 million for 2000. The increase in
noninterest expense for 2001 was primarily due to higher salaries, employee
benefits, fees and services, amortization of other intangible assets and to
nonrecurring charges pertaining to director and employee retirement expenses and
relocation and branch closing costs. Partially offsetting these increases was
the 2000 expense of $8.32 million of securities contributed to SBM Charitable
Foundation, Inc. in connection with the Company's March 2000 initial public
offering. Excluding the nonrecurring charges in 2001 and the contribution to the
New Foundation in 2000, noninterest expenses increased $8.06 million, or 19.68%,
to $49.02 million for 2001 from $40.96 million in 2000. The primary reason for
increases in noninterest expense was the acquisition of First Federal. Salaries
increased $1.91 million, or 11.72%, mainly due to the addition of 108 full time
equivalent employees. Employee benefits increased $2.63 million, or 43.91%, from
$5.99 million for the year ended December 31, 2000 to $8.62 million for the
50
year ended December 31, 2001. The increase was due to the granting of restricted
stock under the 2000 Stock-Based Incentive Plan resulting in a charge of $1.63
million in 2001, increased ESOP expense of $513,000 due to a higher average
stock price, an increase in cost of nonqualified benefit plans of $246,000 and
an increase in health insurance costs of $207,000. Fees and services increased
$912,000, or 18.96%, from $4.81 million for 2000 to $5.72 million for 2001. The
increase in this category was mainly due to increased legal, director, software
licensing and franchise tax fees. Many of these increases resulted directly and
indirectly from the conversion from mutual holding company form to stock holding
company form of organization as well as the acquisition of First Federal.
Amortization of other intangible assets increased $1.55 million, or 360.47%,
during 2001. Due to the acquisition of First Federal, the Company recorded other
intangible assets for noncompete agreements with former First Federal executives
and a core deposit intangible. The noncompete agreement intangible totaled $2.37
million at December 31, 2001, and is being amortized on a straight line basis
over its term of twelve months. The core deposit intangible totaled $8.48
million at December 31, 2001, and is being amortized on a straight line basis
over its estimated life of eight years. During the third quarter of 2001, the
Company recorded noninterest expenses totaling $2.29 million that are
nonrecurring in nature. The Company recorded director and employee retirement
expenses of $1.42 million and $872,000 of relocation and branch closing costs.
The Bank offered an early retirement package to certain employees resulting in a
charge of $547,000. CTBS granted stock options and restricted stock to the
former Chairman of the Board, incurring $541,000 of expense. CTBS also
accelerated the vesting of previously granted stock options and restricted stock
to a director who retired on December 31, 2001. The charge incurred with the
vesting acceleration was $331,000. The Bank recorded $872,000 of relocation and
branch closing costs primarily due to the closing of five SBM branches that were
no longer necessary due to overlap of market areas caused by the acquisition of
First Federal.
Provision for Income Taxes. The provision for income taxes increased $2.72
million, or 74.32%, to $6.38 million for 2001 from $3.66 million for 2000. The
effective tax rates were 33.31% for 2001 and 33.14% for 2000. The increase in
tax expense is due to an increase in taxable income.
Comparison of Operating Results for the Years Ended December 31, 2000 and 1999
Net Income. Net income decreased by $1.37 million, or 15.66%, to $7.38
million for 2000 from $8.75 million for 1999. Net income for the year 2000 was
reduced by a one-time nonrecurring expense of $8.32 million ($5.41 million after
tax) relating to the Company's establishment of SBM Charitable Foundation, Inc.
in March 2000 in connection with the Bank's conversion from the mutual holding
company form of organization to the stock holding company form of organization.
Due to the timing of the Conversion, earnings per share for the twelve months
ended December 31, 2000 and prior periods are not presented. Earnings per
diluted share were $0.59 for the ten months ended December 31, 2000.
Operating earnings, excluding securities gains and the previously discussed
nonrecurring expense of $8.32 million net of related tax effect, were
significantly higher than prior year's levels. Operating earnings, net of tax,
for the year ended December 31, 2000 were $12.50 million, a $4.64 million, or
59.03% increase, compared to $7.86 million for the year ended December 31, 1999.
Net interest income after provision for loan losses increased $9.69 million, or
24.01%, to $50.05 million for 2000 compared to $40.36 million for 1999. Service
charges and fees and other noninterest income increased $2.11 million, or
28.21%, from $7.48 million to $9.59 million for 2000. Noninterest expense,
excluding nonrecurring expenses of $8.32 million, increased $4.37 million, or
11.94%, to $40.96 million for 2000 from $36.59 million for 1999.
Net Interest Income. Net interest income increased $9.79 million, or
23.61%, to $51.25 million for 2000 from $41.46 million for 1999. The increase
was primarily a result of higher interest income from an increase in the level
of interest earning assets, primarily funded by the net proceeds from the public
offering. Loan and investment yields also increased in 2000 as compared to 1999.
These increases were partially offset by higher levels of FHLB advances and
short-term borrowed funds, and an increased cost of funds. Interest and dividend
income increased $16.26 million, or 20.63%, to $95.09 million for 2000 from
$78.83 million for 1999. The average yield on interest earning assets increased
17 basis points to 7.26% in 2000 from 7.09% in 1999, primarily due to an
increase in general market interest rates. Interest income on loans increased
$9.73 million, or 14.65%, to $76.16 million for
51
2000 compared to $66.43 million for 1999. The increase was primarily due to a
$111.93 million increase in the average balance of loans outstanding, as well as
a 12 basis point increase in the average yield on loans primarily due to a
higher interest rate environment. Interest and dividend income from investment
securities and other interest-bearing assets increased $6.52 million, or 52.54%,
to $18.93 million for 2000 compared to $12.41 million for 1999. The increase in
interest and dividend income from investment securities and other
interest-bearing assets was due to an increase in the average balance of $86.39
million, or 37.22%, to $318.52 million for the year ended December 31, 2000, as
more funds were available for investment due to the net proceeds received from
the public offering. Investment and other interest-bearing asset yields
increased 59 basis points in 2000 as compared to 1999 due to an increase in
general market interest rates.
Interest expense increased $6.47 million, or 17.31%, to $43.84 million for
2000 from $37.37 million for 1999. The increase reflects an increase in expense
on advances from FHLB of $3.17 million, deposits and escrow of $2.37 million and
short-term borrowed funds of $923,000. Interest expense on advances from FHLB
increased primarily due to increased average volumes of $46.93 million as well
as higher costs of 30 basis points. Interest expense on deposits and escrow
increased primarily due to higher costs of certificates of deposit of 41 basis
points and savings and money market accounts of 28 basis points. Interest
expense on short-term borrowed funds represented by commercial transactional
repurchase agreements increased primarily due to increased average volumes of
$21.39 million as well as higher costs of 25 basis points. The average cost of
funds for the Bank increased 30 basis points from 3.81% in 1999 to 4.11% in
2000, mainly due to higher general market interest rates.
Provision for Loan Losses. The provision for loan losses was $1.20 million
for 2000 compared to $1.10 million for 1999. The allowance for loan losses was
1.16% of total loans and 168.96% of nonperforming loans at December 31, 2000
compared to 1.12% and 92.44%, respectively, at December 31, 1999. The increase
in the allowance for loan losses as a percentage of nonperforming loans is
primarily due to the full repayment of a nonperforming commercial real estate
loan for $4.29 million during April 2000.
Noninterest Income. Noninterest income increased $863,000, or 9.17%, to
$10.27 million for 2000 as compared to $9.41 million for 1999. Fee income from
service charges and account fees was $7.65 million in 2000 compared with $5.87
million for 1999. The increase in fee income and service charges is primarily
due to the introduction of debit cards, and increases in merchant services and
individual account fees. Other fee income increased from $1.62 million in 1999
to $1.94 million in 2000 and reflects increases in fees earned from brokerage
services. Gains on sales of securities and mortgage loans declined $927,000 and
$314,000 respectively, as management chose to retain higher yielding securities
and loans rather than sell them and receive one-time gains.
Noninterest Expense. Noninterest expense increased $12.69 million, or
34.68%, to $49.28 million for 2000 from $36.59 million for 1999. The increase is
primarily due to a nonrecurring one-time contribution of securities to SBM
Charitable Foundation of $8.32 million in 2000. Other increases in noninterest
expense include $1.69 million, or 39.30%, for pension and other employee
benefits, $1.09 million, or 7.17%, for salaries, and $1.02 million, or 26.91%,
for fees and services. Pension and other employee benefits increased due to new
qualified and non-qualified benefit plans formed in connection with the public
offering. Salaries increased due to annual wage increases and additional
staffing necessary for a public entity. Fees and services increased due to
director, legal, and miscellaneous fees of the new public holding company, other
legal fees, and debit card service fees.
Provision for Income Taxes. The provision for income taxes decreased
$767,000, or 17.31%, to $3.66 million for 2000 from $4.43 million for 1999. The
effective tax rates were 33.14% for 2000 and 33.58% for 1999. The decrease in
tax expense is due to a decrease in taxable income.
52
Average Balances, Interest and Average Yields/Cost
The following table presents certain information for the periods indicated
regarding average balances of assets and liabilities, as well as the total
dollar amounts of interest income from average interest-earning assets and
interest expense on average interest-bearing liabilities and the resulting
average yields and costs. The yields and costs for the periods indicated are
derived by dividing income or expense by the average balances of assets or
liabilities, respectively, for the periods presented. Average balances were
derived from average daily balances. The yields and rates include fees which are
considered adjustments to yields.
For the Year Ended December 31,
-----------------------------------------------------------------
2001 2000
------------------------------- -------------------------------
Average Average
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
---------- -------- ------- ---------- -------- -------
(dollars in thousands)
Interest-earning assets:
Loans (1):
Real estate $ 914,824 $ 66,802 7.30% $ 773,358 $57,200 7.40%
Consumer 95,133 7,228 7.60 76,588 6,321 8.25
Commercial 151,267 12,329 8.15 141,212 12,642 8.95
---------- -------- ---- ---------- ------- ----
Total loans 1,161,224 86,359 7.44 991,158 76,163 7.68
---------- -------- ---- ---------- ------- ----
Mortgage-backed
securities (2) 105,940 6,792 6.41 62,083 4,499 7.25
Collateralized mortgage
obligations (2) 116,938 6,111 5.23 -- -- --
Investment securities (2):
U.S. Government and
agency obligations 99,347 5,509 5.55 86,261 5,399 6.26
Municpal obligations 9,406 500 5.32 2,954 173 5.86
Corporate securities 53,784 3,848 7.15 51,833 3,584 6.91
Common stock and
mutual funds 49,960 1,155 2.31 45,612 1,017 2.23
Other equity securities 702 3 0.43 432 -- --
Asset-backed securities 28,327 1,986 7.01 28,258 1,796 6.36
Other interest-bearing
assets:
Federal Home Loan
Bank stock 15,227 824 5.41 6,477 460 7.10
Federal funds sold 61,492 2,300 3.74 34,607 2,001 5.78
---------- -------- ---- ---------- ------- ----
Total interest-
earning assets 1,702,347 $115,387 6.78% 1,309,675 $95,092 7.26%
======== =======
Noninterest-earning assets 58,260 38,575
---------- ----------
Total assets $1,760,607 $1,348,250
========== ==========
For the Year Ended December 31,
-------------------------------
1999
-------------------------------
Average
Average Yield/
Balance Interest Rate
---------- -------- -------
(dollars in thousands)
Interest-earning assets:
Loans (1):
Real estate $ 684,617 $50,086 7.32%
Consumer 71,537 5,653 7.90
Commercial 123,071 10,686 8.68
---------- ------- ----
Total loans 879,225 66,425 7.56
---------- ------- ----
Mortgage-backed
securities (2) 36,295 2,460 6.78
Collateralized mortgage
obligations (2) -- -- --
Investment securities (2):
U.S. Government and
agency obligations 71,243 4,169 5.85
Municpal obligations 2,990 175 5.85
Corporate securities 35,890 2,348 6.54
Common stock and
mutual funds 44,513 999 2.24
Other equity securities 419 -- --
Asset-backed securities 20,244 1,265 6.25
Other interest-bearing
assets:
Federal Home Loan
Bank stock 5,909 383 6.48
Federal funds sold 14,625 610 4.17
---------- ------- ----
Total interest-
earning assets 1,111,353 $78,834 7.09%
=======
Noninterest-earning assets 38,733
----------
Total assets $1,150,086
==========
53
For the Year Ended December 31,
-----------------------------------------------------------------
2001 2000
------------------------------- -------------------------------
Average Average
Average Yield/ Average Yield/
Balance Interest Rate Balance Interest Rate
---------- -------- ------- ---------- -------- -------
(dollars in thousands)
Interest-bearing
liabilities:
Deposits:
NOW accounts $ 150,693 $ 1,055 0.70% $ 115,819 $ 1,378 1.19%
Savings and money
market accounts 382,045 8,420 2.20 297,276 8,225 2.77
Certificates of deposit 542,888 27,113 4.99 432,624 23,672 5.47
Escrow deposits 7,332 211 2.88 6,069 163 2.69
---------- ------- ------ ---------- ------- ------
Total interest-bearing
deposits 1,082,958 36,799 3.40 851,788 33,438 3.93
Short-term borrowed funds 110,823 2,882 2.60 110,520 3,653 3.31
Advances from Federal
Home Loan Bank 235,440 12,251 5.20 105,692 6,751 6.39
---------- ------- ------ ---------- ------ ------
Total interest-bearing
liabilities 1,429,221 $51,932 3.63% 1,068,000 $43,842 4.11%
======= =======
Noninterest-bearing
liabilities 99,224 74,828
---------- ----------
Total liabilities 1,528,445 1,142,828
Stockholders' equity 232,162 205,422
---------- ----------
Total liabilities and
stockholders' equity $1,760,607 $1,348,250
========== ==========
Net interest-earning
assets $ 273,126 $ 241,675
========== ==========
Net interest income $63,455 $51,250
======= =======
Interest rate spread (3) 3.15% 3.15%
Net interest margin (4) 3.73% 3.91%
Ratio of interest-earning
assets to interest-
bearing liabilities 119.11% 122.63%
For the Year Ended December 31,
-------------------------------
1999
-------------------------------
Average
Average Yield/
Balance Interest Rate
---------- -------- -------
(dollars in thousands)
Interest-bearing
liabilities:
Deposits:
NOW accounts $ 105,916 $ 1,507 1.42%
Savings and money
market accounts 277,565 6,919 2.49
Certificates of deposit 444,550 22,482 5.06
Escrow deposits 5,684 158 2.78
---------- ------- ------
Total interest-bearing
deposits 833,715 31,066 3.73
Short-term borrowed funds 89,133 2,730 3.06
Advances from Federal
Home Loan Bank 58,761 3,578 6.09
---------- ------- ------
Total interest-bearing
liabilities 981,609 $37,374 3.81%
=======
Noninterest-bearing
liabilities 52,175
----------
Total liabilities 1,033,784
Stockholders' equity 116,302
----------
Total liabilities and
stockholders' equity $1,150,086
==========
Net interest-earning
assets $ 129,744
==========
Net interest income $41,460
=======
Interest rate spread (3) 3.28%
Net interest margin (4) 3.73%
Ratio of interest-earning
assets to interest-
bearing liabilities 113.22%
- ----------
(1) Balances are net of undisbursed proceeds of construction loans in process
and include nonperforming loans.
(2) Includes securities available for sale at market value and held to maturity
at cost.
(3) Interest rate spread represents the difference between the weighted average
yield on interest-earning assets and the weighted average cost of
interest-bearing liabilities.
(4) Net interest margin represents net interest income as a percentage of
average interest-earning assets.
54
Rate/Volume Analysis
The following table presents the effects of changing rates and volumes on
the interest income and interest expense of the Bank. The rate column shows the
effects attributable to changes in rate (changes in rate multiplied by prior
volume). The volume column shows the effects attributable to changes in volume
(changes in volume multiplied by prior rate). For purposes of this table,
changes attributable to changes in both rate and volume, which cannot be
segregated, are shown in the rate/vol column.
2001 2000
Compared to Compared to
2000 1999
------------------------------------------ -------------------------------------------
Increase (Decrease) Increase (Decrease)
Due to Due to
------------------------------------------ -------------------------------------------
(in thousands)
Rate Volume Rate/Vol Net Rate Volume Rate/Vol Net
------- ------- -------- -------- ------- -------- -------- --------
Interest-earning assets:
Loans:
Real estate $ (728) $10,463 $ (133) $ 9,602 $ 550 $ 6,493 $ 71 $ 7,114
Consumer (502) 1,531 (122) 907 251 399 18 668
Commercial (1,133) 900 (80) (313) 332 1,575 49 1,956
------- ------- ------- -------- ------- -------- ----- --------
Total loans (2,363) 12,894 (335) 10,196 1,133 8,467 138 9,738
Mortgage-backed securities (519) 3,178 (366) 2,293 170 1,748 121 2,039
Collateralized mortgage
obligations -- 6,111 -- 6,111 -- -- -- --
Investment securities (1,098) 3,609 (816) 1,695 715 3,315 451 4,481
------- ------- ------- -------- ------- -------- ----- --------
Total interest-earning assets (3,980) 25,792 (1,517) 20,295 2,018 13,530 710 16,258
------- ------- ------- -------- ------- -------- ----- --------
Interest-bearing liabilities:
Deposits:
NOW accounts (567) 415 (171) (323) (247) 141 (23) (129)
Savings accounts (1,673) 2,345 (477) 195 761 491 54 1,306
Certificates of deposit (2,066) 6,033 (526) 3,441 1,843 (604) (49) 1,190
Other 12 34 2 48 (5) 10 -- 5
------ ------- ------ -------- ------- -------- ----- --------
Total deposits (4,294) 8,827 (1,172) 3,361 2,352 38 (18) 2,372
Short-term borrowed funds (779) 10 (2) (771) 216 655 52 923
Advances from Federal Home
Loan Bank (1,251) 8,288 (1,537) 5,500 175 2,858 140 3,173
------ ------- ------- -------- ------- -------- ----- --------
Total interest-bearing
liabilities (6,324) 17,125 (2,711) 8,090 2,743 3,551 174 6,468
------- ------- ------- -------- ------- -------- ----- --------
Increase (decrease) in net
interest income $ 2,344 $ 8,667 $ 1,194 $ 12,205 $ (725) $ 9,979 $ 536 $ 9,790
======= ======= ======= ======== ======== ======== ===== ========
55
Liquidity and Capital Resources
Liquidity is the ability to meet current and future financial obligations
of a short-term nature. The Bank further defines liquidity as the ability to
respond to the needs of depositors and borrowers as well as maintaining the
flexibility to take advantage of investment opportunities. Primary sources of
funds consist of deposit inflows, loan repayments, maturities, paydowns, and
sales of collateralized mortgage obligations, investment and mortgage-backed
securities and advances from the FHLB of Boston. While maturities and scheduled
amortization of loans and securities are predictable sources of funds, deposit
outflows and mortgage prepayments are greatly influenced by general interest
rates, economic conditions and competition.
The Bank's primary investing activities are: (1) originating residential
one-to four-family mortgage loans and, to a lesser extent, commercial business
and real estate loans, multi-family loans, single-family construction loans,
home equity loans and lines of credit and consumer loans and (2) investing in
mortgage-backed securities, collateralized mortgage obligations, asset-backed
securities, U.S. Government and agency obligations, corporate equity securities
and debt obligations. These activities are funded primarily by principal and
interest payments on loans, maturities of securities, deposit growth and FHLB of
Boston advances. During 2000, the Company received net proceeds (after expenses)
from the issuance of stock in connection with the Conversion of $90.51 million.
The Company used 50% of the net proceeds from the Conversion to buy all of the
common stock of SBM and retained the remaining 50% which was primarily invested
in fixed income securities. During the years ended December 31, 2001 and 2000,
the Bank's loan originations and purchases, net of repayments totaled $153.17
million and $79.13 million, respectively. During 2001, the Bank also acquired
$284.66 million in gross loans from First Federal. During the years ended
December 31, 2001 and 2000, the Bank purchased securities classified as
available for sale of $115.67 million and $199.88 million, respectively. During
2001, the Bank also acquired $612.49 million in securities from First Federal.
The Bank experienced a net increase in total deposits, exclusive of the First
Federal acquisition, of $24.72 million and $26.78 million for the years ended
December 31, 2001 and 2000, respectively, primarily as a result of retail and
commercial programs designed to attract deposits. Deposit flows are affected by
the overall level of interest rates, the interest rates and products offered by
the Bank and its local competitors and other factors. During 2001, the Bank also
acquired $635.12 million in deposits from First Federal. Proceeds from sales of
loans, maturities, calls and sales of securities, principal payments on
mortgage-backed securities and collateralized mortgage obligations and net FHLB
advances were $7.32 million, $172.53 million, $91.13 million, and $49.96 million
respectively, for the year ended December 31, 2001. During 2001, the Bank also
acquired $316.55 million in FHLB advances from First Federal. Proceeds from
sales of loans, maturities, calls and sales of securities, principal payments on
mortgage-backed securities and collateralized mortgage obligations and net FHLB
advances were $20.23 million, $124.46 million, $10.71 million, and $16.00
million respectively, for the year ended December 31, 2000. The Bank closely
monitors its liquidity position on a daily basis. If the Bank should require
funds beyond its ability to generate them internally, additional sources of
funds are available through FHLB advances and through repurchase agreement
borrowing facilities.
Certificates of deposit that are scheduled to mature in one year or less
from December 31, 2001 totaled $503.10 million. The Bank relies primarily on
competitive rates, customer service, and long-standing relationships with
customers to retain deposits. Occasionally, the Bank will also offer special
competitive promotions to its customers to increase retention and promote
deposit growth. Based upon the Bank's historical experience with deposit
retention, management believes that, although it is not possible to predict
future terms and conditions upon renewal, a significant portion of such deposits
will remain with the Bank.
The Bank must satisfy various regulatory capital requirements administered
by the federal banking agencies including a risk-based capital measure. The
risk-based capital guidelines include both a definition of capital and a
framework for calculating risk-weighted assets by assigning balance sheet assets
and off-balance sheet items to broad risk categories. At December 31, 2001, the
Bank exceeded all of its regulatory capital requirements with a leverage capital
level of $156.89 million, or 6.63% of average quarterly assets, which is above
the required level of $94.61 million, or 4.00%, and total risk-based capital of
$172.12 million, or 10.85% of risk weighted assets, which is above the required
level of $126.87 million, or 8.00%. The Bank is considered "well capitalized"
under regulatory guidelines.
56
Off Balance Sheet Information
The Bank is a party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments included commitments to extend credit of
approximately $235.52 million and $176.67 million as of December 31, 2001 and
2000, respectively, and standby letters of credit of approximately $6.75 million
and $7.36 million as of December 31, 2001 and 2000, respectively. Management of
the Bank anticipates that it will have sufficient funds available to meet its
current loan commitments.
These consolidated financial instruments involve, to varying degrees,
elements of credit and interest rate risk. The Bank's exposure to credit loss in
the event of non-performance by the other party to the financial instrument is
represented by the contractual amount of those instruments. The Bank uses the
same credit policies in making commitments as it does for existing loans.
Management believes that the Bank controls the credit risk of these financial
instruments through credit approvals, lending limits, monitoring procedures and
the receipt of collateral when deemed necessary.
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination clauses
and may require payment of a fee. Since many of the commitments could expire
without being drawn upon, the total commitment amounts do not necessarily
represent future cash requirements. Bank management evaluates each customer's
credit worthiness on a case-by-case basis. The amount of collateral obtained, if
deemed necessary by the Bank, upon extension of credit, is based on management's
credit evaluation of the customer. Collateral held varies but may include income
producing commercial properties, accounts receivable, inventory and property,
plant and equipment.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in existing loan facilities to customers. The Bank holds real estate and
marketable securities as collateral supporting those commitments for which
collateral is deemed necessary.
As of December 31, 2001, minimum rental commitments under noncancellable
operating leases were (in thousands):
Year Commitment
- ---- ----------
2002 $1,214
2003 1,085
2004 945
2005 859
2006 753
Therafter 3,912
------
Total $8,768
======
57
Impact of Inflation and Changing Prices
The consolidated financial statements and related data presented in this
Form 10-K have been prepared in conformity with accounting principles generally
accepted in the United States, which require the measurement of financial
position and operating results in terms of historical dollars, without
considering changes in the relative purchasing power of money over time due to
inflation. Unlike many industrial companies, substantially all of the assets and
liabilities of the Bank are monetary in nature. As a result, interest rates have
a more significant impact on the Bank's performance than the general level of
inflation. Over short periods of time, interest rates may not necessarily move
in the same direction or in the same magnitude as inflation.
Impact of New Accounting Standards
In June 2001, the FASB issued SFAS No. 141, "Business Combinations." SFAS
No. 141 requires all business combinations initiated after June 30, 2001 to be
accounted for using the purchase method. The acquisition of First Federal was
accounted for under the purchase method of accounting.
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other
Intangibles." With the adoption of SFAS No. 142, goodwill will no longer be
subject to amortization over its estimated useful life, but will be subject to
annual assessment for impairment by applying a fair-value-based test. Recognized
intangible assets, such as core deposit intangibles, will continue to be
amortized over their useful lives. On August 31, 2001, the Bank acquired all of
the outstanding common stock of First Federal. The Company has recorded goodwill
of $19.97 million as of December 31, 2001. Under the new standard, this goodwill
which is entirely associated with the First Federal acquisition will not be
amortized but will be subject to an annual fair-value-based impairment test. The
initial fair value test as of January 1, 2002 is required to be completed by
June 30, 2002. The Bank does not expect an impairment charge to result from the
initial test. The core deposit intangible of $8.48 million as of December 31,
2001 will continue to be amortized under the new rules.
In August 2001, the FASB issued SFAS No. 144, "Accounting for the
Impairment or Disposal of Long-Lived Assets." SFAS No. 144 modifies the rules
for accounting for the impairment or disposal of long-lived assets. The new
rules become effective for fiscal years beginning after December 15, 2001, with
earlier application encouraged. These new rules will have no effect on the
Company's consolidated financial statements.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
- --------------------------------------------------------------------
Qualitative Aspects of Market Risk
The Bank's most significant form of market risk is interest rate risk. The
principal objectives of the Bank's interest rate risk management are to evaluate
the interest rate risk inherent in certain balance sheet accounts, determine the
level of risk appropriate given its business strategy, operating environment,
capital and liquidity requirements and performance objectives, and manage the
risk consistent with its established policies. The Bank has an Asset/Liability
Committee, responsible for reviewing its asset/liability policies and interest
rate risk position, which meets quarterly and reports trends and interest rate
risk position to the Executive Committee of the Board of Directors and the Board
of Directors. The extent of the movement of interest rates is an uncertainty
that could have a negative impact on the earnings of the Bank. In recent years,
the Bank has managed interest rate risk by:
(1) originating variable rate commercial real estate loans and prime rate
commercial business loans;
(2) emphasizing shorter-term consumer loans including home equity lines of
credit indexed to the prime rate, as reported in The Wall Street
Journal;
(3) maintaining a high quality securities portfolio that provides adequate
liquidity and flexibility to take advantage of opportunities that may
arise from fluctuations in market interest rates, the
58
overall maturity and duration of which is monitored in relation to the
repricing of its loan portfolio;
(4) promoting lower cost liability accounts such as demand deposits and
business repurchase accounts; and
(5) using Federal Home Loan Bank advances to better structure maturities
of its interest rate sensitive liabilities.
The Bank's market risk also includes equity price risk. The Bank's common
stock and mutual fund portfolio had gross unrealized gains of $11.49 million and
gross unrealized losses of $152,000 at December 31, 2001 which are included, net
of taxes, in accumulated other comprehensive income, a separate component of the
Bank's capital. If equity security prices decline due to unfavorable market
conditions or other factors, the Bank's capital would decrease.
The Bank's investment policy authorizes it to be a party to financial
instruments with off-balance sheet risk in the normal course of business to
reduce its exposure to fluctuations in interest rates. These financial
instruments include interest rate cap agreements. Interest rate cap agreements
generally involve the payment of a premium in return for cash receipts if
interest rates rise above or fall below a specified interest rate level.
Payments are based on a notional principal amount. Caps generally are not
readily available for time periods longer than five years. The Bank's objective
in using interest rate caps is to reduce risk associated with adverse rate
volatility while enabling the Bank to benefit from favorable interest rate
movements. All counter-parties to cap arrangements must be pre-approved by the
Bank's Executive Committee and reported to its Investment Committee. At December
31, 1999, the notional principal amount of the Bank's outstanding interest rate
cap agreement was $25.00 million. Under the terms of the cap agreement, the Bank
paid a premium totaling $123,000 which was included in other assets and was
being amortized over three years which was the term of the agreement.
Amortization for the year ended December 31, 1999 totaled $38,000. The Bank sold
the interest rate cap during the first quarter of 2000. At December 31, 2001 and
2000 the Bank had no derivative instruments.
Quantitative Aspects of Market Risk
The Company analyzes its interest rate sensitivity position to manage the
risk associated with interest rate movements through the use of gap analysis and
balance sheet simulation. The matching of assets and liabilities may be analyzed
by examining the extent to which such assets and liabilities are "interest rate
sensitive" and by monitoring a bank's interest rate sensitivity "gap." An asset
or liability is said to be interest rate sensitive within a specific time period
if it will mature or reprice within that time period. The interest rate
sensitivity gap is defined as the difference between the amount of
interest-earning assets maturing or repricing within a specific time period and
the amount of interest-bearing liabilities maturing or repricing within that
same time period. At December 31, 2001, the Company's one-year gap position, the
difference between the amount of interest-earning assets maturing or repricing
within one year and interest-bearing liabilities maturing or repricing within
one year, was (0.10%) of total assets. A gap is considered positive when the
amount of interest rate sensitive assets exceeds the amount of interest rate
sensitive liabilities. A gap is considered negative when the amount of interest
rate sensitive liabilities exceeds the amount of interest rate sensitive assets.
Accordingly, during a period of rising interest rates, an institution with a
negative gap position would be in a worse position to invest in higher yielding
assets which, consequently, may result in the cost of its interest-bearing
liabilities increasing at a rate faster than its yield on interest-earning
assets than if it had a positive gap. Conversely, during a period of falling
interest rates, an institution with a negative gap would tend to have its
interest-bearing liabilities repricing downward at a faster rate than its
interest-earning assets as compared to an institution with a positive gap which,
consequently, may tend to positively affect the growth of its net interest
income.
The following table sets forth the amount of interest-earning assets and
interest-bearing liabilities outstanding at December 31, 2001, which are
anticipated by the Company, based upon certain assumptions, to reprice or mature
in each of the future time periods shown. Except as stated below, the amount of
assets and
59
liabilities shown which reprice or mature during a particular period were
determined in accordance with the earlier of term to repricing or the
contractual maturity of the asset or liability. The table sets forth an
approximation of the projected repricing of assets and liabilities at December
31, 2001, on the basis of contractual maturities, anticipated prepayments, and
scheduled rate adjustments within a series of time intervals. For residential
mortgages prepayment rates were assumed to range from 0% to 12% annually.
Investment securities, which include callable federal agency obligations, are
presented based on stated maturities. NOW accounts, savings and money market
accounts, and short-term borrowed funds were assumed to decay at 10%, 10%, 10%,
20% and 50%, respectively, for each of the following periods: one year, one to
two years, two to three years, three to five years, and over five years.
Prepayment rates can have a significant impact on the Bank's estimated gap.
While the Bank believes such assumptions to be reasonable, there can be no
assurance that assumed prepayment rates and decay rates will approximate actual
future loan repayment and deposit withdrawal activity.
60
At December 31, 2001
----------------------------------------------------
More than More than More than
One Year Two Years Three Years
One Year to to to
or Less Two Years Three Years Five Years
--------- --------- ----------- -----------
(dollars in thousands)
Interest-earning assets:
Securities (1):
Investment securities (2) $ 130,186 $ 71,851 $ 42,633 $ 38,384
Mortgage-backed securities 42,166 27,146 18,541 22,951
Collateralized mortgage obligations 47,450 45,465 51,732 84,099
Common stock and mutual funds (3) 55,751 100 -- --
--------- --------- ----------- ----------
Total securities 275,553 144,562 112,906 145,434
--------- --------- ----------- ----------
Loans 384,663 133,669 118,114 206,618
--------- --------- ----------- ----------
Total interest-earning assets $ 660,216 $ 278,231 $ 231,020 $ 352,052
========= ========= =========== ==========
Interest-bearing liabilities:
NOW accounts $ 21,483 21,483 21,483 42,966
Savings and money market accounts 52,872 52,872 52,872 105,744
Certificates of deposit 503,104 126,041 31,829 75,705
Mortgagors' escrow accounts -- -- -- --
Advances from Federal
Home Loan Bank 73,466 77,557 111,398 69,614
Short-term borrowed funds 11,718 11,718 11,718 23,436
--------- --------- ----------- ----------
Total interest-bearing liabilities $ 662,643 $ 289,671 $ 229,300 $ 317,465
========= ========= =========== ==========
Interest-earning assets less
interest-bearing liabilities $ (2,427) $ (11,440) $ 1,720 $ 34,587
Cumulative interest-rate
sensitivity gap $ (2,427) $ (13,867) $ (12,147) $ 22,440
Cumulative interest-rate sensitivity gap
as a percentage of total assets (0.10%) (0.57%) (0.50%) 0.92%
Cumulative interest-rate sensitivity gap as a
percentage of total interest-
earning assets (0.10%) (0.60%) (0.52%) 0.96%
Cumulative interest-earning assets as
a percentage of cumulative interest-
bearing liabilities 99.63% 98.54% 98.97% 101.50%
Cumulative interest-earning assets $ 660,216 $ 938,447 $ 1,169,467 $1,521,519
Cumulative interest-bearing liabilities $ 662,643 $ 952,314 $ 1,181,614 $1,499,079
At December 31, 2001
More than Total Fair
Five Years Amount Value
---------- ---------- ----------
(dollars in thousands)
Interest-earning assets:
Securities (1):
Investment securities (2) $ 105,739 $ 388,793 $ 388,793
Mortgage-backed securities 38,946 149,750 149,750
Collateralized mortgage obligations 29,855 258,601 258,601
Common Stock and mutual funds (3) 36,488 92,339 92,339
---------- ---------- ----------
Total securities 211,028 889,483 889,483
---------- ---------- ----------
Loans 594,053 1,437,117 1,459,107
---------- ---------- ----------
Total interest-earning assets $ 805,081 $2,326,600 $2,348,590
========== ========== ==========
Interest-bearing liabilities:
NOW accounts 107,410 $ 214,825 214,825
Savings and money market accounts 264,359 528,719 528,719
Certificates of deposit 272 736,951 730,458
Mortgagors' escrow accounts 10,580 10,580 10,580
Advances from Federal
Home Loan Bank 133,320 465,355 467,369
Short-term borrowed funds 58,590 117,180 117,180
---------- ---------- ----------
Total interest-bearing liabilities $ 574,531 $2,073,610 $2,069,131
========== ========== ==========
Interest-earning assets less
interest-bearing liabilities $ 230,550 $ 252,990
Cumulative interest-rate
sensitivity gap $ 252,990
Cumulative interest-rate sensitivity gap
as a percentage of total assets 10.34%
Cumulative interest-rate sensitivity gap as a
percentage of total interest-
earning assets 10.87%
Cumulative interest-earning assets as
a percentage of cumulative interest-
bearing liabilities 112.20%
Cumulative interest-earning assets $2,326,600
Cumulative interest-bearing liabilities $2,073,610
- ----------
(1) All securities are classified as available for sale and therefore are shown
at market value.
(2) Includes short-term investments.
(3) Includes debt mutual funds and Federal Home Loan Bank stock.
61
As of December 31, 2001, the Bank's estimated exposure as a percentage of
estimated net interest income for the next twelve and twenty-four month periods
is as follows:
Percentage Change in Estimated
Net Interest Income Over
------------------------------
12 months 24 months
--------- ---------
200 basis point increase in rates -1.75% -1.43%
200 basis point decrease in rates 0.55% -7.61%
The two hundred basis point change in rates in the above table is assumed
to occur evenly over the next twelve months. Based on the scenario above, net
income would be adversely affected (within the Bank's internal guidelines) in
both the twelve and twenty-four month periods in a rising rate environment and
positively affected in the twelve month and negatively effected in the
twenty-four month periods in a declining rate environment. For each percentage
point change in net interest income, the effect on net income would be $495,000,
assuming a 35% tax rate.
Item 8. Financial Statements and Supplementary Data.
- ----------------------------------------------------
For a listing of consolidated financial statements which are included in
this document, see page F-1.
Item 9. Changes in and Disagreements with Accountants on Accounting and
- -----------------------------------------------------------------------
Financial Disclosure.
---------------------
None.
62
PART III
Item 10. Directors and Executive Officers of the Registrant.
- ------------------------------------------------------------
Information regarding directors and Section 16(a) Compliance is
incorporated herein by reference from the Sections entitled "Proposal 1 -
Election of Directors" and "Section 16(a) Beneficial Ownership Reporting
Compliance" of the Company's definitive proxy statement which will be filed no
later than 120 days after December 31, 2001.
Item 11. Executive Compensation.
- --------------------------------
Incorporated herein by reference from the Sections entitled "Proposal 1 -
Election of Directors - Directors' Compensation" and "Executive Compensation" of
the Company's definitive proxy statement which will be filed no later than 120
days after December 31, 2001.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
- ------------------------------------------------------------------------
Incorporated herein by reference from the Section entitled "Stock
Ownership" of the Company's definitive proxy statement which will be filed no
later than 120 days after December 31, 2001.
Item 13. Certain Relationships and Related Transactions.
- --------------------------------------------------------
Incorporated herein by reference from the Section entitled "Transactions
with Management" of the Company's definitive proxy statement which will be filed
no later than 120 days after December 31, 2001.
63
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.
- --------------------------------------------------------------------------
(a)(1) Financial Statements
The following consolidated financial statements of Connecticut Bancshares,
Inc. and subsidiaries are filed as part of this document under Item 8:
. Report of Independent Public Accountants
. Consolidated Statements of Condition at December 31, 2001 and 2000
. Consolidated Statements of Operations for the Years Ended December 31,
2001, 2000 and 1999
. Consolidated Statements of Changes in Stockholders' Equity for the
Years Ended December 31, 2001, 2000 and 1999
. Consolidated Statements of Cash Flows for the Years Ended December 31,
2001, 2000 and 1999
. Notes to Consolidated Financial Statements
(2) Financial Statement Schedules
Financial Statement Schedules have been omitted because they are not
applicable or the required information is shown in the Consolidated Financial
Statements or notes thereto.
(b) Reports on Form 8-K filed during the last quarter of 2001
In connection with the Bank's acquisition of First Federal, the Company
filed an amended Current Report on Form 8-K/A dated November 13, 2001 amending
the items, financial statements, exhibits or other portions of its Current
Report on Form 8-K dated August 31, 2001 and filed September 5, 2001.
(c) Exhibits Required by Securities and Exchange Commission Regulation S-K
Exhibit
Number
- ------
2.1 Amended Provisional Plan of Conversion for Connecticut Bankshares, M.H.C.
and The Savings Bank of Manchester (including the Amended and Restated
Stock Articles of Incorporation and Bylaws of The Savings Bank of
Manchester). (1)
3.1 Certificate of Incorporation of Connecticut Bancshares, Inc. (1)
3.2 Second Amended and Restated Bylaws of Connecticut Bancshares, Inc. (2)
4.0 Draft Stock Certificate of Connecticut Bancshares, Inc. (1)
10.1 Connecticut Bancshares, Inc. 2000 Stock-Based Incentive Plan (3)
10.2 Employment Agreement between The Savings Bank of Manchester and Richard P.
Meduski (4)
10.3 Employment Agreement between The Savings Bank of Manchester and Charles L.
Pike (4)
10.4 Employment Agreement between The Savings Bank of Manchester and Douglas K.
Anderson (4)
10.5 Employment Agreement between The Savings Bank of Manchester and Roger A.
Somerville (4)
10.6 Change-In-Control Agreement between The Savings Bank of Manchester and
Michael J. Hartl (filed herewith)
10.7 Employment Agreement between Connecticut Bancshares, Inc. and Richard P.
Meduski (4)
10.8 Employment Agreement between Connecticut Bancshares, Inc. and Charles L.
Pike (4)
10.9 Employment Agreement between Connecticut Bancshares, Inc. and Douglas K.
Anderson (4)
10.10 Employment Agreement between Connecticut Bancshares, Inc. and Roger A.
Somerville (4)
11.0 Statement re: Computation of Per Share Earnings (included on page F-8 of
the Consolidated Financial Statements and accompanying notes)
64
21.0 Subsidiaries Information Incorporated Herein By Reference to Part 1 -
Subsidiaries of the Registrant
23.0 Consent of Independent Public Accountants (filed herewith)
99.0 Letter to commission pursuant to temporary note 3T (filed herewith)
- ----------
(1) Incorporated by reference into this document from the Exhibits filed with
the Registration Statement on Form S-1 and any amendments thereto,
Registration No. 333-90865.
(2) Incorporated by reference into this document from the Quarterly Report on
Form 10-Q dated March 31, 2001 and filed with the Securities and Exchange
Commission on May 4, 2001.
(3) Incorporated by reference into this document from the Registrant's Proxy
Statement dated August 18, 2000 and filed August 18, 2000.
(4) Incorporated by reference into this document from the 1999 Annual Report on
Form 10-K filed March 30, 2000.
65
CONFORMED
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the registrant has duly caused this report to be signed on
its behalf by the undersigned, thereunto duly authorized.
Connecticut Bancshares, Inc.
By: /s/ Richard P. Meduski
---------------------------
Richard P. Meduski
President and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Name Title Date
---- ----- ----
/s/ Richard P. Meduski President, Chief Executive Officer March 25, 2002
- ------------------------------- and Director
Richard P. Meduski (principal executive officer)
/s/ Michael J. Hartl Senior Vice President and Chief March 25, 2002
- ------------------------------- Financial Officer
Michael J. Hartl (principal accounting and
financial officer)
/s/ Laurence P. Rubinow Director and Chairman March 25, 2002
- ------------------------------- of the Board
Laurence P. Rubinow
/s/ A. Paul Berte Director March 25, 2002
- -------------------------------
A. Paul Berte
/s/ Timothy J. Devanney Director March 25, 2002
- -------------------------------
Timothy J. Devanney
/s/ Sheila B. Flanagan Director March 25, 2002
- -------------------------------
Sheila B. Flanagan
/s/ John D. LaBelle, Jr. Director March 25, 2002
- -------------------------------
John D. LaBelle, Jr.
/s/ Eric A. Marziali Director March 25, 2002
- -------------------------------
Eric A. Marziali
66
/s/ Timothy J. Moynihan Director March 25, 2002
- -------------------------------
Timothy J. Moynihan
/s/ Jon L. Norris Director March 25, 2002
- --------------------------------
Jon L. Norris
/s/ William D. O'Neill Director March 25, 2002
- -------------------------------
William D. O'Neill
/s/ John G. Sommers Director March 25, 2002
- -------------------------------
John G. Sommers
/s/ Thomas E. Toomey Director March 25, 2002
- -------------------------------
Thomas E. Toomey
/s/ Gregory S. Wolff Director March 25, 2002
- -------------------------------
Gregory S. Wolff
67
CONNECTICUT BANCSHARES, INC. AND SUBSIDIARY
Index
Page
Report of Independent Public Accountants F-2
Consolidated Statements of Condition
As of December 31, 2001 and 2000 F-3
Consolidated Statements of Operations
For the Years Ended December 31, 2001, 2000 and 1999 F-4
Consolidated Statements of Changes in Stockholders' Equity
For the Years Ended December 31, 2001, 2000 and 1999 F-5
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2001, 2000 and 1999 F-6
Notes to Consolidated Financial Statements F-7
F-1
Report of Independent Public Accountants
To the Board of Directors of
Connecticut Bancshares, Inc.:
We have audited the accompanying consolidated statements of condition of
Connecticut Bancshares, Inc. (a Connecticut stock bank holding company) and its
subsidiary, The Savings Bank of Manchester (collectively, the Bank), as of
December 31, 2001 and 2000, and the related consolidated statements of
operations, changes in stockholders' equity and cash flows for each of the three
years in the period ended December 31, 2001. These consolidated financial
statements are the responsibility of the Bank's management. Our responsibility
is to express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Connecticut
Bancshares, Inc. and subsidiary as of December 31, 2001 and 2000, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2001 in conformity with accounting principles
generally accepted in the United States.
/s/ Arthur Andersen LLP
- ----------------------------
Arthur Andersen LLP
Hartford, Connecticut
January 16, 2002
F-2
CONNECTICUT BANCSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Condition
As of December 31, 2001 and 2000
(Dollars in thousands)
2001 2000
----------- -----------
ASSETS
Cash and cash equivalents $ 122,624 $ 64,797
Securities available for sale at fair value 758,534 308,081
Loans held for sale 746 290
Loans, net 1,421,143 995,764
Federal Home Loan Bank Stock, at cost 30,783 6,654
Premises and equipment, net 19,348 13,197
Accrued interest receivable 12,933 8,747
Other real estate owned 84 125
Cash surrender value of life insurance 41,396 --
Current and deferred income taxes 1,686 --
Goodwill 19,970 --
Other intangible assets 12,927 1,967
Other assets 4,250 3,689
----------- -----------
Total assets $ 2,446,424 $ 1,403,311
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $ 1,590,938 $ 933,370
Short-term borrowed funds 117,180 106,493
Mortgagors' escrow accounts 10,580 8,896
Advances from Federal Home Loan Bank 465,355 100,000
Current and deferred income taxes -- 419
Accrued benefits and other liabilities 26,997 21,594
----------- -----------
Total liabilities 2,211,050 1,170,772
----------- -----------
Commitments and contingencies (Notes 14, 15 and 18)
Stockholders' equity:
Common stock ($.01 par value; 45,000,000 authorized
shares; 11,235,608 and 11,232,000 shares issued and
outstanding at December 31, 2001 and 2000, respectively) 112 112
Additional paid-in capital 108,354 108,257
Retained earnings 127,737 119,691
ESOP unearned compensation (8,065) (8,685)
Restricted stock unearned compensation (6,395) --
Accumulated other comprehensive income 13,631 13,164
----------- -----------
Total stockholders' equity 235,374 232,539
----------- -----------
Total liabilities and stockholders' equity $ 2,446,424 $ 1,403,311
=========== ===========
The accompanying notes are an integral part of these consolidated financial
statements.
F-3
CONNECTICUT BANCSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Operations For the Years Ended December 31, 2001,
2000 and 1999 (Dollars in thousands, except for share and per share data)
2001 2000 1999
--------- -------- --------
Interest and dividend income:
Interest income on loans $ 86,359 $ 76,163 $ 66,425
Interest and dividends on securities 29,028 18,929 12,409
--------- -------- --------
Total interest and dividend income 115,387 95,092 78,834
--------- -------- --------
Interest expense:
Interest on deposits and escrow 36,799 33,438 31,066
Interest on short-term borrowed funds 2,882 3,653 2,730
Interest on advances from Federal Home Loan Bank 12,251 6,751 3,578
--------- -------- --------
Total interest expense 51,932 43,842 37,374
--------- -------- --------
Net interest income 63,455 51,250 41,460
Provision for loan losses 2,000 1,200 1,100
--------- -------- --------
Net interest income after provision for loan losses 61,455 50,050 40,360
--------- -------- --------
Noninterest income:
Service charges and fees 9,556 7,649 5,866
Gains on sales of securities, net 481 445 1,372
Other than temporary impairment of securities (Note 7) (4,076) -- --
Gains on mortgage loan sales, net 346 237 551
Increase in cash surrender value of life insurance 1,032 -- --
Other 1,658 1,938 1,617
--------- -------- --------
Total noninterest income 8,997 10,269 9,406
--------- -------- --------
Noninterest expense:
Salaries 18,196 16,289 15,195
Employee benefits 8,623 5,987 4,297
Fees and services 5,721 4,809 3,790
Occupancy, net 3,401 3,006 3,232
Furniture and equipment 3,340 2,956 2,962
Amortization of other intangible assets 1,983 432 432
Marketing 1,719 1,676 1,784
Director and employee retirement expenses (Notes 3 and 12) 1,419 -- --
Relocation and branch closing costs (Note 13) 872 -- --
Foreclosed real estate expense 137 233 277
Securities contributed to SBM Charitable Foundation, Inc. -- 8,316 --
Net gains on sales of other real estate owned, net (74) (36) (64)
Other operating expenses 5,976 5,609 4,681
--------- -------- --------
Total noninterest expense 51,313 49,277 36,586
--------- -------- --------
Income before provision for income taxes 19,139 11,042 13,180
Provision for income taxes 6,375 3,659 4,426
--------- -------- --------
Net income $ 12,764 $ 7,383 $ 8,754
========= ======== ========
For the Period from
March 1, 2000 to
Earnings per share (Note 1): 2001 December 31, 2000 1999
Basic $ 1.26 $ 0.59 N/A
Diluted $ 1.19 $ 0.59 N/A
Weighted average shares outstanding:
Basic 10,108,483 10,367,476 N/A
Diluted 10,695,366 10,368,049 N/A
The accompanying notes are an integral part of these consolidated financial
statements.
F-4
CONNECTICUT BANCSHARES, INC. AND SUBSIDIARY
Consolidated Statement of Changes in Stockholders' Equity
For the Years Ended December 31, 2001, 2000 and 1999
(Dollars in thousands)
ESOP
Additional Unearned
Common Stock Paid-In Retained Compen-
Shares Amount Capital Earnings sation
---------- ------ ---------- --------- --------
BALANCE, December 31, 1998 -- $ -- $ -- $ 103,554 $ --
Comprehensive income:
Net income -- -- -- 8,754 --
Change in unrealized gain
on securities available for
sale, net of taxes -- -- -- -- --
---------- ----- --------- --------- -------
Total comprehensive income -- -- -- 8,754 --
---------- ----- --------- --------- -------
BALANCE, December 31, 1999 -- -- -- 112,308 --
---------- ----- --------- --------- -------
Proceeds from issuance of
common stock in connection
with conversion, after expenses
of approximately $4,300 10,400,000 104 99,714 -- (9,305)
Common stock issued to SBM
Charitable Foundation, Inc. 832,000 8 8,308 -- --
Change in ESOP unearned
compensation -- -- 235 -- 620
Comprehensive income:
Net income -- -- -- 7,383 --
Change in unrealized gain
on securities available for
sale, net of taxes -- -- -- -- --
---------- ----- --------- --------- -------
Total comprehensive income -- -- -- 7,383 --
---------- ----- --------- --------- -------
BALANCE, December 31, 2000 11,232,000 112 108,257 119,691 (8,685)
---------- ----- --------- --------- -------
Granting of restricted stock awards 460,512 5 8,470 -- --
Funding of trustee repurchases
of restricted stock (460,512) (5) (9,615) -- --
Change in ESOP unearned
compensation -- -- 748 -- 620
Change in restricted stock
unearned compensation -- -- -- -- --
Granting of stock options to former
Chairman of the Board -- -- 266 -- --
Accelerated vesting of restricted stock -- -- 40 -- --
Exercise of stock options 3,608 -- 64 -- --
Accelerated vesting of stock options -- -- 124 -- --
Dividends declared ($0.42 per share) -- -- -- (4,718) --
Comprehensive income:
Net income -- -- -- 12,764 --
Change in unrealized gain
on securities available for
sale, net of taxes -- -- -- -- --
---------- ----- --------- --------- -------
Total comprehensive income -- -- -- 12,764 --
---------- ----- --------- --------- -------
BALANCE, December 31, 2001 11,235,608 $ 112 $ 108,354 $ 127,737 $(8,065)
========== ===== ========= ========= =======
Restricted
Stock Accumulated
Unearned Other
Compen- Comprehensive
sation Income Total
-------- ------------- ---------
BALANCE, December 31, 1998 $ -- $ 9,253 $ 112,807
Comprehensive income:
Net income -- -- 8,754
Change in unrealized gain
on securities available for
sale, net of taxes -- 1,662 1,662
------- ------- ---------
Total comprehensive income -- 1,662 10,416
------- ------- ---------
BALANCE, December 31, 1999 -- 10,915 123,223
------- ------- ---------
Proceeds from issuance of
common stock in connection
with conversion, after expenses
of approximately $4,300 -- -- 90,513
Common stock issued to SBM
Charitable Foundation, Inc. -- -- 8,316
Change in ESOP unearned
compensation -- -- 855
Comprehensive income:
Net income -- -- 7,383
Change in unrealized gain
on securities available for
sale, net of taxes -- 2,249 2,249
------- ------- ---------
Total comprehensive income -- 2,249 9,632
------- ------- ---------
BALANCE, December 31, 2000 -- 13,164 232,539
------- ------- ---------
Granting of restricted stock awards (8,199) -- 276
Funding of trustee repurchases
of restricted stock -- -- (9,620)
Change in ESOP unearned
compensation -- -- 1,368
Change in restricted stock
unearned compensation 1,630 -- 1,630
Granting of stock options to former
Chairman of the Board -- -- 266
Accelerated vesting of restricted stock 174 -- 214
Exercise of stock options -- -- 64
Accelerated vesting of stock options -- -- 124
Dividends declared ($0.42 per share) -- -- (4,718)
Comprehensive income:
Net income -- -- 12,764
Change in unrealized gain
on securities available for
sale, net of taxes -- 467 467
------- ------- ---------
Total comprehensive income -- 467 13,231
------- ------- ---------
BALANCE, December 31, 2001 $(6,395) $13,631 $ 235,374
======= ======= =========
The accompanying notes are an integral part of these consolidated financial
statements.
F-5
CONNECTICUT BANCSHARES, INC. AND SUBSIDIARY
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2001, 2000 and 1999
(In thousands)
2001 2000 1999
--------- --------- ---------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 12,764 $ 7,383 $ 8,754
Adjustments to reconcile net income to net cash provided by operating
activities, excluding effects of acquisition:
Securities contributed to SBM Charitable Foundation, Inc. -- 8,316 --
Provision for loan losses 2,000 1,200 1,100
Depreciation 2,651 2,559 2,658
Amortization/accretion -
Other intangible assets 1,983 432 432
Premium on loans and bonds 1,139 741 654
Amortization/accretion of fair market adjustment from
First Federal acquisition -
Loans 497 -- --
Time deposits (1,323) -- --
Federal Home Loan Bank advances (1,148) -- --
Amortization of mortgage servicing rights 881 387 425
Net (gains) losses on sales of other real estate owned (74) 3 150
Net loss on disposal of fixed assets 9 -- --
Gains on sales of securities, net (481) (445) (1,372)
Other than temporary impairment of investment securities 4,076 -- --
Gains on mortgage loan sales, net (346) (237) (551)
Deferred income tax (benefit) provision (3,290) (3,520) 61
Granting of restricted stock to former Chairman of the Board 276 -- --
Granting of stock options to former Chairman of the Board 266 -- --
Accelerated vesting of restricted stock 214 -- --
Accelerated vesting of stock options 124 -- --
Exercise of stock options 64 -- --
Employee retirement expenses 508 -- --
ESOP compensation expense 1,368 855 --
Change in minimum pension liability (549) -- --
Change in restricted stock unearned compensation 1,630 -- --
Relocation and branch closing costs 872 -- --
Changes in operating assets and liabilities, net of amounts acquired-
Accrued interest receivable 1,127 (1,847) (465)
Other assets (2,511) 505 (1,977)
Other liabilities 2,160 2,534 1,815
--------- --------- ---------
Net cash provided by operating activities 24,887 18,866 11,684
--------- --------- ---------
CASH FLOWS FROM INVESTING ACTIVITIES:
Loan originations and purchases, net of repayments (153,166) (79,127) (151,915)
Proceeds from sales of loans 7,322 20,226 19,197
Proceeds from maturities of held to maturity securities -- -- 3,535
Proceeds from maturities and calls of available for sale securities 27,482 31,774 21,778
Proceeds from sales of available for sale securities 145,050 92,685 19,081
Purchases of held to maturity securities -- -- (6,876)
Purchases of available for sale securities (115,673) (199,875) (57,153)
Purchases of Federal Home Loan Bank stock (4,846) (745) --
Proceeds from principal payments of mortgage-
backed securities and collateralized mortgage obligations 91,129 10,713 13,249
Acquisition of First Federal, net of cash acquired (12,812) -- --
Proceeds from sales of other real estate owned 419 686 1,481
Purchase of cash surrender value life insurance (20,000) -- --
Purchases of premises and equipment (5,247) (1,277) (1,372)
--------- --------- ---------
Net cash used in investing activities (40,342) (124,940) (138,995)
--------- --------- ---------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net proceeds from issuance of common stock -- 90,513 --
Funding of trustee purchases of restricted stock (9,620) -- --
Proceeds from exercise of stock options 64 -- --
Dividends paid (3,257) -- --
Net increase in savings, money market, NOW and
demand deposits 79,692 37,287 47,266
Net (decrease) increase in certificates of deposit (54,974) (10,508) 4,208
Net increase in short-term borrowed funds 10,687 10,679 16,269
Increase in mortgagors' escrow accounts 734 222 2,198
Increase in advances from Federal Home Loan Bank 49,956 16,000 39,000
--------- --------- ---------
Net cash provided by financing activities 73,282 144,193 108,941
--------- --------- ---------
Net increase (decrease) in cash
and cash equivalents 57,827 38,119 (18,370)
CASH AND CASH EQUIVALENTS, beginning of year 64,797 26,678 45,048
--------- --------- ---------
CASH AND CASH EQUIVALENTS, end of year $ 122,624 $ 64,797 $ 26,678
========= ========= =========
SUPPLEMENTAL INFORMATION:
Cash paid for -
Interest and dividends $ 54,541 $ 44,316 $ 37,312
Income taxes 9,350 5,700 4,522
Non-cash transactions -
Transfers from loans to other real estate owned 304 204 324
Dividends declared not paid 1,461 -- --
The accompanying notes are an integral part of these consolidated financial
statements.
F-6
CONNECTICUT BANCSHARES, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements
December 31, 2001, 2000 and 1999
(1) ORGANIZATION AND SIGNIFICANT ACCOUNTING POLICIES
Organization
The accompanying consolidated financial statements include the accounts of
Connecticut Bancshares, Inc. ("CTBS"), successor to Connecticut Bankshares,
M.H.C. ("MHC") and its wholly-owned subsidiary, The Savings Bank of
Manchester ("SBM" or the "Bank"), and its wholly-owned subsidiaries, SBM,
Ltd., 923 Main, Inc. and Savings Bank of Manchester Mortgage Company, Inc.
("SBM Mortgage"). Collectively, all of the aforementioned entities are
referred to herein as "the Company". SBM Mortgage, a passive investment
company for Connecticut income tax purposes, was established in January
1999 to service and hold loans secured by real property. As discussed in
Note 2, MHC adopted a Plan of Reorganization pursuant to which, in March
2000, MHC merged into SBM, with SBM being the surviving corporation, and
SBM continuing as a state-chartered stock savings bank and a wholly-owned
subsidiary of CTBS. All material intercompany balances and transactions
have been eliminated in consolidation.
In 2000, the Bank funded and formed SBM Charitable Foundation, Inc. (the
"New Foundation"), a not-for-profit organization, in connection with the
conversion. The New Foundation was funded with a contribution of 832,000
common shares, or an amount equal to 8% of the common stock sold in the
conversion (see Note 2). The New Foundation is dedicated to charitable
purposes within the Bank's local community, including community development
activities. In 1998, the Bank contributed securities with a fair market
value of $3.00 million to the Savings Bank of Manchester Foundation, Inc.
(the "Old Foundation"), also a not-for-profit organization. In 2001, the
Old Foundation was merged into the New Foundation with the New Foundation
being the surviving entity. In accordance with generally accepted
accounting principles in the United States, the New Foundation is not
consolidated in the accompanying consolidated financial statements.
Business
CTBS does not transact any material business other than through the Bank.
CTBS used 50% of the net proceeds from the conversion to buy all of the
common stock of SBM and retained the remaining 50% (see Note 2), which
primarily was invested in fixed income securities. The Bank, with its main
office located in Manchester, Connecticut, operates through twenty-eight
branches located primarily in eastern Connecticut. The Bank's primary
source of income is interest received on loans to customers, which include
small and middle market businesses and individuals residing within the
Bank's service area.
Cash flows
For purposes of reporting cash flows, cash and cash equivalents include
cash and due from banks and short-term investments.
Earnings per share
Basic earnings per share represents income available to stockholders
divided by the weighted average number of common shares outstanding during
the period. Diluted earnings per share reflects additional common shares
that would have been outstanding if dilutive potential shares had been
issued or earned, determined under the treasury stock method. Earnings per
share data is not presented in these consolidated financial statements
prior to March 1, 2000 since shares of common stock were not issued until
March 1, 2000; therefore, per share information for prior periods is not
meaningful.
F-7
The following table sets forth the calculation of basic and diluted
earnings per share for the periods indicated (dollars in thousands, except
per share amounts):
For the Period from
For the Year Ended March 1, 2000 to
December 31, 2001 December 31, 2000
------------------ -------------------
Net income $ 12,764 $ 6,118
============ ============
Weighted average shares outstanding:
Weighted average shares outstanding 10,919,389 11,232,000
Less: unearned ESOP shares (810,906) (864,524)
------------ ------------
Basic 10,108,483 10,367,476
------------ ------------
Dilutive impact of:
Stock options 179,710 573
Restricted stock 407,173 --
------------ ------------
Diluted 10,695,366 10,368,049
============ ============
Earnings per share:
Basic $ 1.26 $ 0.59
Diluted $ 1.19 $ 0.59
Significant accounting policies
Financial Reporting Release No. 60, which was released by the SEC, requires
all companies to include a discussion of critical accounting policies or
methods used in preparation of financial statements. The following is a
discussion of the more significant accounting policies and methods used by
the Company.
Use of estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States requires management to
make estimates and assumptions that affect the reported amounts of assets
and liabilities and the disclosure of contingent assets and liabilities at
the dates of the financial statements and the reported amounts of income
and expenses during the reporting periods. Operating results in the future
could vary from the amounts derived from management's estimates and
assumptions. The most significant estimates that are particularly
susceptible to changes in the near term relate to the determination of the
allowance for loan losses (See Note 8), other than temporary impairment of
securities (See Note 7), income taxes (See Note 15), intangible assets
acquired and pension and other postretirement benefits (See Note 14).
Actual amounts could differ significantly from these estimates.
Loans and allowance for loan losses
Loans are stated at their principal amounts outstanding net of unearned
income. Interest on loans is recorded as income based on rates applied to
principal amounts outstanding. Some installment and commercial loans are
F-8
made on a discounted basis, and the unearned discount is recorded in income
by use of a method that approximates the effective interest method.
Interest on loans is credited to income as earned based on contractual
rates applied to principal amounts outstanding. The accrual of interest is
discontinued when payments are 90 days or more delinquent and when a
reasonable doubt exists as to the collectability of the principal or
interest. When interest accruals are discontinued, previously recognized
accrued interest income is charged against earnings. When a loan becomes 90
days or more past due, interest income is recognized on the cash basis,
only if in management's judgment all principal is expected to be collected.
Loan origination fees and certain direct loan origination costs are
capitalized, and the net fee or cost is recognized in interest income using
the effective interest method over the contractual life of the loans. When
loans are prepaid, sold or participated out, the unamortized portion of
deferred fees and related origination costs are recognized as income at
that time. As of December 31, 2001 and 2000, net deferred loan fees were
approximately $1.36 million and $1.20 million, respectively.
The Bank devotes significant attention to maintaining high loan quality
through its underwriting standards, active servicing of loans and
aggressive management of nonperforming assets. The allowance for loan
losses is maintained at a level estimated by management to provide
adequately for loan losses which are inherent in the loan portfolio. Loan
losses are estimated based on a quarterly review of the loan portfolio,
loss experience, specific problem loans, economic conditions and other
pertinent factors. In assessing risks inherent in the portfolio, management
considers the risk of loss on nonperforming and classified loans including
an analysis of collateral in each situation. The Bank's methodology for
assessing the appropriateness of the allowance includes several key
elements. Problem loans are identified and analyzed individually to
estimate specific losses. The loan portfolio is also segmented into pools
of loans that are similar in type and risk characteristics (i.e.,
commercial, consumer and mortgage loans). Loss factors are applied using
the Bank's historic experience and may be adjusted for significant factors
that in management's judgment affect the collectability of the portfolio as
of the evaluation date. Additionally, the portfolio is segmented into pools
based on internal risk ratings with loss factors applied to each rating
category. Other factors considered in determining possible loan losses are
the impact of larger concentrations in the portfolio, trends in loan
growth, the relationship and trends in recent years of recoveries as a
percentage of prior chargeoffs and peer bank's loss experience.
The allowance for loan losses is increased or decreased by provisions or
credits charged to operations, which represent an estimate of losses that
occurred during the period and a correction of estimates of losses recorded
in prior periods. Confirmed losses, net of recoveries, are charged directly
to the allowance and the loans are written down.
The allowance for loan losses consists of a formula allowance for various
loan portfolio classifications and a valuation allowance for loans
identified as impaired, if necessary. The allowance is an estimate, and
ultimate losses may vary from current estimates. Changes in the estimate
are recorded in the results of operations in the period in which they
become known, along with provisions for estimated losses incurred during
that period.
A portion of the allowance for loan losses is not allocated to any specific
segment of the loan portfolio. This non-specific reserve is maintained for
two primary reasons: there exists an inherent subjectivity and imprecision
to the analytical processes employed and the prevailing business
environment, as it is affected by changing economic conditions and various
external factors, which may impact the portfolio in ways currently
unforeseen. Moreover, management has identified certain risk factors, which
could impact the degree of loss sustained within the portfolio. These
include: market risk factors, such as the effects of economic variability
on the entire portfolio, and unique portfolio risk factors that are
inherent characteristics of the Bank's loan portfolio. Market risk factors
may consist of changes to general economic and business conditions that may
impact the Bank's loan portfolio customer base in terms of ability to repay
and that may result in changes in value of underlying collateral. Unique
portfolio risk factors may include industry or geographic concentrations,
or trends that may exacerbate losses resulting from economic events which
the Bank may not be able to fully diversify out of its portfolio.
Due to the imprecise nature of the loan loss estimation process and ever
changing conditions, these risk
F-9
attributes may not be adequately captured in data related to the
formula-based loan loss components used to determine allocations in the
Bank's analysis of the adequacy of the allowance for loan losses.
Management, therefore, has established and maintains a non-specific
allowance for loan losses. The amount of the non-specific allowance was
$3.05 million at December 31, 2001 compared to $3.16 million at December
31, 2000. As a percentage of the allowance for loan losses, the unallocated
was 20.02% of the total allowance for loan losses at December 31, 2001 and
27.03% of the total allowance for loan losses at December 31, 2000.
As discussed above, the Bank uses three separate methods to estimate the
allowance for loan losses and then uses a weighted average formula to
estimate the final allowance for loan losses. The Bank uses a portfolio
segmentation method, a risk rating method, and a historical method for
estimating the allowance for loan losses. In 2000, the Bank's weighting
factors for these three methods was 40%, 40% and 20%, respectively, while
in 2001 the weighting factors were 45%, 45% and 10%, respectively. The
historic method weighting factor was reduced during 2001 as it has
consistently and substantially produced a lower reserve amount than the
other two methods and management believes less emphasis should be placed on
this method given the economic environment at December 31, 2001.
Although management believes that it uses the best information available to
establish the allowance for loan losses, future adjustments to the
allowance for loan losses may be necessary, and results of operations could
be adversely affected if circumstances differ substantially from the
assumptions used in making the determinations. Furthermore, while the Bank
believes it has established its existing allowance for loan losses
consistent with generally accepted accounting principles, there can be no
assurance that regulators, in reviewing the Bank's loan portfolio, will not
request the Bank to increase its allowance for loan losses. In addition,
because future events affecting borrowers and collateral cannot be
predicted with certainty, there can be no assurance that the existing
allowance for loan losses is adequate or that increases will not be
necessary should the quality of any loans deteriorate as a result of the
factors discussed above. Material increases in the allowance for loan
losses will adversely affect the Bank's financial condition and results of
operations.
A loan is considered to be impaired when it is probable that a creditor
will be unable to collect all amounts due according to the contractual
terms of the loan agreement. Impaired loans, as defined, may be measured
based on the present value of expected future cash flows, discounted at the
loan's original effective interest rate, or on the loan's observable market
price or the fair value of the collateral if the loan is
collateral-dependent. When the measurement of the impaired loan is less
than the recorded investment in the loan, the impairment is recorded
through a valuation allowance.
Certain impaired loans are required to be measured based on the present
value of expected future cash flows discounted at the loan's original
effective interest rate. As a practical expedient, impairment also may be
measured based on the loan's observable market price or the fair value of
the collateral if the loan is collateral dependent. When the measure of the
impaired loan is less than the recorded investment in the loan, the
impairment is recorded through a valuation allowance. Interest payments
received on impaired loans are recorded as interest income unless
collection of the remaining recorded investment is doubtful, at which time
payments received are recorded as reductions of principal.
Loans held for sale
Loans held for sale are valued at the lower of acquisition cost (less
principal payments received) or estimated market value. Market is
determined by reference to outstanding commitments from investors
calculated on an individual loan basis. Net unrealized losses are
recognized in a valuation allowance established by charges to noninterest
income.
F-10
Investment and mortgage-backed securities
Investments are classified into one of three categories and accounted for
as follows:
Category Accounting Treatment
Trading, representing debt, equity Reported at fair value, with
and mortgage-backed securities unrealized gains and losses included
which are held for resale in the near in noninterest income
term
Held to maturity, representing debt Reported at amortized cost
and mortgage-backed securities for
which the Company has the positive
intent and ability to hold to maturity
Available for sale, representing debt, Reported at fair value, with
equity and mortgage-backed securities unrealized gains and losses, net of
not classified as trading or held to tax, reported as a separate component
maturity of accumulated other comprehensive
income
On a quarterly basis, the Company reviews investment and mortgage-backed
securities with unrealized depreciation for six consecutive months to
assess whether the decline in fair value is temporary or other than
temporary. The Company judges whether the decline in value is from
company-specific events, industry developments, general economic conditions
or other reasons. Once the estimated reasons for the decline are
identified, further judgments are required as to whether those conditions
are likely to reverse and, if so, whether that reversal is likely to result
in a recovery of the fair value of the investment in the near term. If it
is judged not to be near term, a charge is taken which results in a new
cost basis.
Realized gains and losses from the sale of investments are recorded on the
trade date by specific identification of the security sold.
Income taxes
Items of income and expense recognized in different time periods for
financial reporting purposes and for purposes of computing income taxes
currently payable (temporary differences) give rise to deferred income
taxes which are reflected in the consolidated financial statements. A
deferred tax liability or asset is recognized for the estimated future tax
effects, based upon enacted law, attributed to temporary differences. If
applicable, the deferred tax asset is reduced by the amount of any tax
benefits that, based on available evidence, are not likely to be realized.
The Company has not provided for Connecticut state income taxes since
December 31, 1998 since it has a passive investment company (PIC) as
permitted by Connecticut law. The Company believes it complies with the
state PIC requirements and that no state taxes are due from December 31,
1998 through December 31, 2001; however, the Company has not been audited
by the state for such periods. If the state were to determine that the PIC
was not in compliance with statutory requirements a material amount of
taxes could be due. Additionally, legislation has been proposed which if
enacted would eliminate the exemption for PIC's as of January 1, 2002 and
increase the future state tax expense of the Company thereafter.
Intangible assets
On August 31, 2001, the Bank acquired all of the outstanding common stock
of First Federal Savings and Loan Association of East Hartford ("First
Federal") (see Note 4). In connection with the acquisition, the Company
recorded goodwill of $19.97 million, a core deposit intangible of $8.85
million and a noncompete intangible asset of $3.55 million. The core
deposit intangible is being amortized over eight years on a straight line
basis,
F-11
and the noncompete agreement intangible is being amortized over the term of
the agreement of twelve months on a straight line basis. In accordance with
Statement of Financial Accounting Standards ("SFAS") No. 142, "Goodwill and
Other Intangibles", goodwill has not been amortized, but will be subject to
an annual fair-value-based impairment test commencing January 1, 2002.
The Company periodically evaluates acquired businesses for potential
impairment indicators. The Company's judgements regarding the existence of
impairment indicators are based on legal factors, market conditions and
operational performance of our acquired businesses. Future events could
cause the Company to conclude that impairment indicators exist and that
goodwill associated with the Company's acquired businesses is impaired. Any
resulting impairment loss could have a material adverse impact on the
Company's financial condition and results of operations.
During 2001, the Bank recorded an additional minimum pension liability of
approximately $845,000. The Bank recorded the tax effected intangible asset
related to this liability of approximately $549,000. The additional minimum
pension liability relates primarily to a Supplemental Executive Retirement
Plan for the Chief Executive Officer and a Consultation Plan for Certain
Outside Directors.
In 1997, the Bank acquired certain assets of a branch in West Hartford,
Connecticut. The premium of $250,000, for lease rights acquired, is being
amortized over the remaining term of the lease (10 years) using the
straight line method.
In 1995, the Bank acquired certain fixed assets and assumed certain deposit
liabilities of two branches in Storrs and Enfield, Connecticut. In
consideration of the assumption of certain deposit liabilities, the Bank
received cash and other assets. The resultant premium of approximately
$4.06 million is being amortized over 10 years using the straight line
method.
The following table shows the activity in intangible assets for the year
ended December 31, 2001:
Minimum
Core Deposit Noncompete Pension Branch
Goodwill Intangible Agreements Liability Premiums Total
-------- ------------ ---------- --------- -------- --------
Balance at December 31, 2000 $ -- $ -- $ -- $ -- $ 1,967 $ 1,967
First Federal acquisition 19,970 8,846 3,548 -- -- 32,364
Recognition of minimum
pension liability -- -- -- 549 -- 549
Amortization -- (369) (1,182) -- (432) (1,983)
------- ------- ------- ---- ------- --------
Balance at December 31, 2001 $19,970 $ 8,477 $ 2,366 $549 $ 1,535 $ 32,897
======= ======= ======= ==== ======= ========
Pension and Other Postretirement Employee Benefits
The determination of the Company's obligation and expense for pension and
other postretirement benefits is dependent on the Company's selection of
certain assumptions used by actuaries in calculating such amounts. Those
assumptions are described in Note 14 to the consolidated financial
statements and include, among others, the discount rate, expected long-term
rate of return on plan assets and rates of increase in compensation and
healthcare costs. In accordance with accounting principles generally
accepted in the United States, actual results that differ from the
Company's assumptions are accumulated and amortized over future periods and
F-12
therefore, generally affect the Company's recognized expense and recorded
obligation in such future periods. While the Company believes that the
assumptions are appropriate, significant differences in actual experience
or significant changes in assumptions may materially affect pension and
other postretirement obligations and the Company's future expense.
Mortgage servicing rights
The Bank applies the provisions of SFAS No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities - A
Replacement of FASB Statement No. 125", which requires that the cost of
mortgage servicing rights be amortized in proportion to, and over the
period of, estimated net servicing revenues. Impairment of mortgage
servicing rights is assessed based on the fair value of those rights. Fair
values are estimated using discounted cash flows based on a current market
interest rate adjusted for a prepayment default factor. The amount of
impairment recognized is the amount by which the capitalized mortgage
servicing rights for a stratum exceed their fair value.
When participating interests in loans sold have an average contractual
interest rate, adjusted for normal servicing fees, that differs from the
agreed yield to the purchaser, gains or losses are recognized equal to the
present value of such differential over the estimated remaining life of
such loans. The resulting "deferred servicing revenue" is amortized over
the estimated life using a method approximating the effective interest
method.
Quoted market prices are not available for the servicing receivables. Thus,
the servicing receivables and the amortization thereon periodically are
evaluated in relation to estimated future servicing revenues, taking into
consideration changes in interest rates, current prepayment rates and
expected future cash flows. The Bank evaluates the carrying value of the
servicing receivables by estimating the future servicing income of the
servicing receivables based on management's best estimate of remaining loan
lives and discounted at the original discount rate.
Stock-based compensation
SFAS No. 123, "Accounting for Stock-Based Compensation" encourages all
entities to adopt a fair value based method of accounting for employee
stock compensation plans, whereby compensation cost is measured at the
grant date based on the value of the award and is recognized over the
service period, which is usually the vesting period. However, it also
allows an entity to continue to measure compensation costs for those plans
using the intrinsic value based method of accounting prescribed by
Accounting Principles Board ("APB") Opinion No. 25, "Accounting for Stock
Issued to Employees," whereby compensation cost is the excess, if any, of
the quoted market price of the stock at the grant date (or other
measurement date) over the amount an employee must pay to acquire the
stock. Stock options issued under the Company's stock option plan generally
have no intrinsic value at the grant date, and under APB Opinion No. 25 no
compensation cost is recognized for them. The Company has elected to
continue with the accounting methodology in APB Opinion No. 25 and, as a
result, must make pro forma disclosures of net income and earnings per
share and other disclosures as if the fair value based method of accounting
had been applied.
Related party transactions
Directors and officers of the Bank and their associates have been customers
of, and have had transactions with the Bank, and management expects that
such persons will continue to have such transactions in the future. All
deposit accounts, loans, services and commitments comprising such
transactions were made in the ordinary course of business, on substantially
the same terms, including interest rates and collateral, as those
prevailing at the time for comparable transactions with other customers who
are not directors or officers, and, in the opinion of management, the
transactions did not involve more than normal risks of collectability,
favored treatment or terms, or present other unfavorable features (see Note
8 for further details regarding related party transactions).
F-13
Premises and equipment
Depreciation of premises and equipment and amortization of leasehold
improvements are computed using the straight line basis over the estimated
useful lives of the assets (3-39 years) or in the case of leasehold
improvements, the lease term if shorter.
Short-term borrowed funds
Short-term borrowings are comprised of uninsured accounts which are secured
by investment securities.
Other real estate owned
Other real estate owned, comprised of real estate acquired through
foreclosure or acceptance of a deed in lieu of foreclosure, is carried at
the lower of cost or fair market value, net of estimated costs to sell.
Property is transferred to other real estate owned at the lower of cost or
fair market value, net of estimated selling costs, with any excess over
cost charged to the allowance for loan losses. Any further decline in value
based on subsequent changes to estimated fair market value or any loss upon
ultimate disposition of the property is charged to expense.
Comprehensive income
SFAS No. 130, "Reporting Comprehensive Income", establishes standards for
separately reporting comprehensive income and its components. Components of
comprehensive income represent changes in equity resulting from
transactions and other events and circumstances from non-owner sources. A
reconciliation of other comprehensive income for the years ended December
31, 2001, 2000 and 1999 was as follows (in thousands):
2001 2000 1999
Unrealized gains on securities:
Change in unrealized holding gains
arising during the period, net of tax $(1,870) $2,538 $2,554
Reclassification adjustment for gains and other
than temporary impairment included in net income,
net of tax 2,337 (289) (892)
------- ------ ------
Other comprehensive income $ 467 $2,249 $1,662
======= ====== ======
Segment information
SFAS No. 131, "Disclosures about Segments of an Enterprise and Related
Information", requires public companies to report certain financial
information about significant revenue-producing segments of the business
for which such information is available and utilized by the chief operating
decision-maker. Specific information to be reported for individual
operating segments includes a measure of profit and loss, certain revenue
and expense items and total assets. As a community-oriented financial
institution, substantially all of the Bank's operations involve the
delivery of loan and deposit products to customers. Management makes
operating decisions and assesses performance based on an ongoing review of
these community-banking operations, which constitutes the Bank's only
operating segment for financial reporting purposes under SFAS No. 131.
F-14
Recent accounting pronouncements
In June 2001, the FASB issued SFAS No. 141, "Business Combinations." SFAS
No. 141 requires all business combinations initiated after June 30, 2001 to
be accounted for using the purchase method. The acquisition of First
Federal, which occurred on August 31, 2001, was accounted for using the
purchase method of accounting.
In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other
Intangibles." With the adoption of SFAS No. 142, goodwill will no longer be
subject to amortization over its estimated useful life, but will be subject
to annual assessment for impairment by applying a fair-value-based test.
Recognized intangible assets, such as core deposit intangibles, will
continue to be amortized over their useful lives. On August 31, 2001, the
Bank acquired all of the outstanding common stock of First Federal. The
Company has recorded goodwill of $19.97 million as of December 31, 2001.
Under the new standard, this goodwill which is entirely associated with the
First Federal acquisition will not be amortized but will be subject to an
annual fair-value-based impairment test. The initial fair value test as of
January 1, 2002 is required to be completed by June 30, 2002. The Bank does
not expect an impairment charge to result from the initial test. The core
deposit intangible of $8.48 million as of December 31, 2001 will continue
to be amortized under the new rules.
Reclassifications
Certain prior year amounts have been reclassified to conform to the current
year presentation.
(2) CONVERSION TO STOCK FORM OF OWNERSHIP
On August 30, 1999, the Boards of Directors of MHC and SBM adopted a Plan
of Reorganization and, on October 6, 1999 and October 26, 1999, unanimously
amended the Plan of Reorganization (as amended, the Plan), pursuant to
which, on March 1, 2000, MHC converted from the mutual holding company form
to the stock holding company form of organization. All of the outstanding
common stock of SBM was sold to CTBS which issued and sold its stock
pursuant to the Plan. The net proceeds of the offering were $90.50 million,
after expenses of approximately $4.30 million. All of the stock of CTBS
sold in the conversion was offered to eligible account holders, employee
benefit plans of the Bank and certain other eligible subscribers in
subscription and direct community offerings pursuant to subscription rights
in order of priority as set forth in the Plan. Additionally, the Bank
established an Employee Stock Ownership Plan ("ESOP") for the benefit of
eligible employees, which became effective upon the conversion (see Note
14).
The Plan provided for the establishment of the New Foundation. The New
Foundation was funded with a contribution of 832,000 common shares, or an
amount equal to 8% of the common stock sold in the conversion. This
contribution resulted in the recognition of an expense of $8.32 million in
March 2000, related to the fair value of the shares contributed, which is
reflected as such in the accompanying consolidated statement of operations
for the year ended December 31, 2000.
Effective upon the conversion, the Company entered into employment and
change in control agreements with certain executives and certain eligible
employees of the Company and the Bank. The agreements include, among other
things, provisions for minimum annual compensation and certain lump-sum
severance payments in the event of a "change in control."
The Bank's deposit accounts continue to be insured by the FDIC and were not
affected by the conversion. In accordance with the Plan, upon the
completion of the conversion, the Bank established a special "liquidation
account" for the benefit of eligible account holders and in an amount equal
to the equity of the Bank less any subordinated debt approved as bona fide
capital of the Bank, as of the date of its latest statement of condition
contained in the final prospectus used in connection with the conversion.
The date was September 30, 1999, and the amount established was $117.6
million. The liquidation account which totaled $51.20 million and $61.40
million at December 31, 2001 and 2000, respectively, is reduced annually by
an amount proportionate to the decrease in eligible deposit accounts.
Eligible account holders continuing to maintain deposit accounts at the
Bank are entitled, on a complete liquidation of the Bank after the
conversion, to an interest in the
F-15
liquidation account prior to any payment to the stockholders of the Bank.
The Bank's retained earnings are substantially restricted with respect to
payment of dividends to stockholders due to the liquidation account. The
liquidation account will terminate on the tenth anniversary of the
consummation date of the conversion.
The primary source of funds for the Company to pay dividends is in the form
of dividends received from SBM. Neither the Company nor SBM may declare or
pay dividends on, or repurchase any of its shares of common stock, if the
effect thereof would cause stockholders' equity to be reduced below either
the balance required for the liquidation account or applicable regulatory
capital maintenance requirements, or if such declaration, payment or
repurchase would otherwise violate regulatory requirements.
(3) COMMON STOCK
On January 2, 2001, the Company awarded 449,280 restricted shares of common
stock to various employees and non-employee directors of the Company in
accordance with the Connecticut Bancshares, Inc. 2000 Stock-Based Incentive
Plan (the "Stock Plan"). These awards represent 100% of the restricted
shares available in the Stock Plan. The shares were awarded with a vesting
schedule of five years, with 20% of the shares vesting each year to the
recipient. The first 20% installment vested on January 2, 2002. The closing
market price of the Company's common stock on the date of the awards was
$18.25. The Company is amortizing the unearned restricted stock
compensation on a straight line basis over the vesting period.
In conjunction with the restricted stock awards, the Company established a
trust and hired an independent trustee (the "Trustee") to administer and
maintain records of the restricted stock awards. From March 8, 2001 to
March 30, 2001, the Trustee purchased in the open market 449,280 shares of
common stock of the Company for the benefit of the restricted stock award
recipients. These shares were purchased during the first quarter of 2001 at
prices ranging from $20.13 to $21.13 per share, resulting in an average
cost of $20.84 per share. The Company advanced funds necessary to acquire
these shares in the open market by the trustee.
On August 27, 2001, the Company awarded 11,232 restricted shares of common
stock outside of the Stock Plan to the former Chairman of the Board of
Directors of the Company. The shares were awarded with a vesting schedule
of five years, with 20% of the shares vesting each year. The first 20%
installment vested on January 2, 2002. The shares are not subject to any
performance requirements, and the former Chairman does not provide any
services to the Company. The closing market price of the Company's common
stock on the date of the grant was $24.45. The Company recorded a charge of
$274,622 in the quarter ended September 30, 2001 as a director retirement
expense.
In conjunction with the August 27, 2001 restricted stock award, the Company
established a trust and hired the Trustee to administer and maintain
records of the restricted stock award. On September 18, 2001, the Trustee
purchased in the open market 11,232 shares of common stock of the Company
for the benefit of the restricted stock award recipient. These shares were
purchased at a price of $22.74 per share. The Company advanced funds
necessary to acquire these shares in the open market by the trustee.
On September 24, 2001, the Company granted 28,080 non-qualified stock
options outside of the Stock Plan to the former Chairman of the Board of
Directors of the Company. The shares were awarded with a vesting schedule
of five years, with 20% of the shares vesting each year. The first 20%
installment vested on December 15, 2001. The options are not subject to any
performance requirements, and the former Chairman does not provide any
services to the Company. The closing market price of the Company's common
stock on the date of the awards was $21.80. The exercise price of the stock
options granted is $17.625 per share. The Black-Scholes model resulted in a
fair value of $9.48 per option as of the grant date. The Company recorded a
charge of $266,283 in the quarter ended September 30, 2001 as a director
retirement expense.
On September 24, 2001, the Company accelerated the vesting of 11,232 shares
of restricted stock awarded on January 2, 2001 and 28,080 non-qualified
stock options awarded on December 15, 2000 to an existing director who
retired from the Bank's Board on December 31, 2001. The closing market
price of the Company's common stock on the date of the acceleration was
$21.80. The exercise price for the stock options are $17.625 per share. As
a
F-16
result of the modification, the Company recorded charges of $214,110 for
the restricted stock and $117,234 for the stock options in the quarter
ended September 30, 2001 as director retirement expenses.
On September 14, 2001, CTBS announced that its Board of Directors has
authorized the repurchase of up to 561,600 shares, or approximately 5%, of
its outstanding shares of common stock. It is intended that such shares
will be repurchased in open market transactions, including unsolicited
block purchases, over the next six to twelve months, subject to market
conditions. CTBS had not repurchased any shares under this plan as of
December 31, 2001 and had repurchased 8,922 shares as of January 16, 2002.
(4) ACQUISITION OF FIRST FEDERAL
On August 31, 2001, the Bank acquired all of the outstanding common stock
of First Federal for cash of $106.75 million, excluding transaction costs.
As of December 31, 2001, $2.11 million had yet to be paid to First Federal
shareholders and is included in other liabilities. The Bank expects the
remaining amount to be paid during 2002. The purchase was funded primarily
with proceeds from advances from the Federal Home Loan Bank prior to the
acquisition. Immediately after the completion of the acquisition, First
Federal was merged into the Bank.
The acquisition was accounted for as a purchase and the purchase price was
allocated based on the estimated fair market values of the assets and
liabilities acquired. The preliminary allocation of the purchase price is
as follows (in thousands):
Cash and cash equivalents $ 91,826
Investment securities 612,493
Loans 282,481
FHLB stock 19,283
Cash surrender value life insurance 20,364
Goodwill 19,970
Core deposit intangible 8,846
Noncompete agreement intangible 3,548
Other assets 8,413
Deposits and escrow (635,123)
FHLB Advances (316,547)
Other liabilities (8,808)
---------
Total purchase price $ 106,746
=========
The results of First Federal are included in the historical results of the
Company subsequent to August 31, 2001. The pro forma information below is
theoretical in nature and not necessarily indicative of future consolidated
results of operations of the Company or the consolidated results of
operations which would have resulted had the Company acquired the stock of
First Federal as of the beginning of the years presented.
F-17
The Company's unaudited pro forma condensed consolidated statements of
operations for the years ended December 31, 2001 and 2000, assuming First
Federal had been acquired as of January 1, 2001 and 2000, respectively, are
as follows (in thousands, except per share amounts):
2001 2000
----------- -----------
Interest income $ 161,004 $ 166,529
Interest expense 88,302 93,597
----------- -----------
Net interest income 72,702 72,932
Provision for loan losses 2,000 1,410
Noninterest income 14,444 13,616
Noninterseet expense 65,179 70,427
----------- -----------
Income before provision for income taxes 19,967 14,711
Provision for income taxes 6,799 3,921
----------- -----------
Net income $ 13,168 $ 10,790
=========== ===========
Earnings per share-diluted $ 1.23 $ 1.04
=========== ===========
Weighted average shares outstanding-
diluted 10,695,366 10,364,640
=========== ===========
(5) REGULATORY MATTERS
SBM is subject to various regulatory capital requirements administered by
the federal and state banking agencies. Failure to meet minimum capital
requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a
direct material effect on the Company's consolidated financial statements.
The regulations require SBM to meet specific capital adequacy guidelines
that involve quantitative measures of assets, liabilities and certain
off-balance sheet items as calculated under regulatory accounting
practices. SBM's capital amounts and classification are also subject to
qualitative judgments by the banking regulators about components, risk
weightings and other factors.
Quantitative measures established by regulations to ensure capital adequacy
require SBM to maintain minimum capital ratios (set forth in the table
below) of Tier I leverage capital (as defined in the regulations) to total
average assets (as defined), and minimum ratios of Tier I and total capital
(as defined) to risk weighted assets (as defined). To be considered
adequately capitalized (as defined) under the regulatory framework from
Prompt Corrective Action, SBM must maintain minimum Tier I leverage, Tier I
risk-based and total risk-based ratios as set forth in the table.
The Federal Deposit Insurance Corporation Improvement Act of 1991 (the
"FDICIA") categorizes banks based on capital levels and triggers certain
mandatory and discretionary supervisory responses for institutions that
fall below certain capital levels. A bank generally is categorized as "well
capitalized" if it maintains a leverage capital ratio of at least 5%, a
Tier I risk-based capital ratio of at least 6% and a total risk-based
capital ratio of at least 10%, and it is not subject to a written
agreement, order or capital directive.
As of December 31, 2001 and 2000, management believes that SBM met all
capital adequacy requirements to which it is subject. As of the most recent
notification from the Federal Deposit Insurance Corporation, SBM
F-18
was categorized as well capitalized under the regulatory framework for
Prompt Corrective Action, and the highest capital category, as defined in
the FDICIA regulations. Management believes that there are no events or
conditions which have occurred subsequent to the notification that would
change its category.
Actual capital amounts and ratios for SBM were (dollars in thousands):
To Be Well Capitalized
Under Prompt
Capital Adequacy Corrective Action
------------------------------------------------------------
Required Actual Required
------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
-----------------------------------------------------------
As of December 31, 2001:
Tier 1 Capital (to Total Average Assets) $ 94,611 4.0% $156,890 6.6% $118,264 5.0%
Tier 1 Capital (to Risk Weighted Assets) 63,437 4.0% 156,890 9.9% 95,156 6.0%
Total Capital (to Risk Weighted Assets) 126,875 8.0% 172,118 10.9% 158,594 10.0%
As of December 31, 2000:
Tier 1 Capital (to Total Average Assets) $ 53,926 4.0% $172,847 12.8% $ 67,407 5.0%
Tier 1 Capital (to Risk Weighted Assets) 37,609 4.0% 172,847 18.4% 56,414 6.0%
Total Capital (to Risk Weighted Assets) 75,218 8.0% 184,541 19.6% 94,023 10.0%
F-19
(6) INVESTMENT SECURITIES
As of December 31, 2001 and 2000, the amortized cost and market value of
available for sale investment securities were (in thousands):
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- --------
December 31, 2001
U.S. Government and
agency obligations $180,106 $ 4,034 $ (327) $183,813
Municipal obligations 23,717 43 (566) 23,194
Corporate securities 53,138 2,297 (15) 55,420
Mortgage-backed
securities 147,901 2,027 (178) 149,750
Collateralized mortgage
obligations 257,581 1,436 (416) 258,601
Asset-backed securities 23,907 1,301 -- 25,208
Common stock and
mutual funds (1) 50,221 11,487 (152) 61,556
Other investment
securities 992 -- -- 992
-------- ------- ------- --------
Total $737,563 $22,625 $(1,654) $758,534
======== ======= ======= ========
Gross Gross
Amortized Unrealized Unrealized Market
Cost Gains Losses Value
--------- ---------- ---------- --------
December 31, 2000
U.S. Government and
agency obligations $ 82,068 $ 3,187 $ (1) $ 85,254
Municipal obligations 2,915 34 -- 2,949
Corporate securities 55,398 1,080 (215) 56,263
Mortgage-backed
securities 79,079 1,356 (212) 80,223
Asset-backed securities 32,717 1,100 (1) 33,816
Common stock and
mutual funds 35,221 15,200 (1,277) 49,144
Other investment
securities 432 -- -- 432
-------- ------- ------- --------
Total $287,830 $21,957 $(1,706) $308,081
======== ======= ======= ========
(1) Includes both debt and equity mutual funds.
F-20
The Company had no securities classified as held to maturity or trading at
December 31, 2001 and 2000, respectively.
As of December 31, 2001, the amortized cost and market values of debt
securities, by contractual maturity, are shown below (in thousands).
Expected maturities may differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without
call or prepayment penalties.
As of December 31, 2001
------------------------
Amortized Market
Cost Value
--------- --------
Due in one year or less $ 27,677 $ 28,091
Due after one year through five years 136,179 141,718
Due after five years through ten years 184,897 186,775
Due after ten years 337,597 339,402
-------- --------
Total $686,350 $695,986
======== ========
For the years ended December 31, 2001 and 2000, proceeds from the sales of
available for sale securities were approximately $145.05 million and $92.69
million, respectively. Gross gains of approximately $4.06 million and $2.73
million, respectively, and gross losses of approximately $3.58 million and
$2.29 million respectively, were realized on those sales for the years
ended December 31, 2001 and 2000.
As of December 31, 2001 and 2000, investment securities with a book value
of approximately $206.34 million and $130.29 million were pledged as
security for short-term borrowed funds, U.S. Treasury tax and loan payments
and municipal deposits held by the Bank, respectively.
(7) OTHER THAN TEMPORARY IMPAIRMENT OF SECURITIES
On a quarterly basis, the Company reviews available for sale investment
securities with unrealized depreciation for six consecutive months to
assess whether the decline in fair value is temporary or other than
temporary. The Company judges whether the decline in value is from
company-specific events, industry developments, general economic conditions
or other reasons. Once the estimated reasons for the decline are
identified, further judgments are required as to whether those conditions
are likely to reverse and, if so, whether that reversal is likely to result
in a recovery of the fair value of the investment in the near term. In
accordance with this policy, during the year ended December 31, 2001 the
Company recorded an other than temporary impairment charge of $4.08
million.
(8) LOANS
As of December 31, 2001 and 2000, the Bank's residential mortgage loan
portfolio was entirely secured by one- to four-family homes, located
primarily in central and eastern Connecticut. The commercial mortgage loan
portfolio was secured primarily by multi-family, commercial and
manufacturing properties located in Connecticut and surrounding states. A
variety of different assets, including business assets, rental income
properties, and manufacturing and commercial properties, secured a majority
of the commercial loans. The composition of the Bank's loan portfolio as of
December 31, 2001 and 2000 is as follows (in thousands):
F-21
2001 2000
----------- -----------
One- to four-family residential mortgages $ 841,895 $ 586,536
Construction mortgages 76,551 32,590
Commercial and multifamily mortgages 231,644 162,411
Commercial business loans 166,314 146,360
Installment loans 119,967 79,561
----------- -----------
Total loans 1,436,371 1,007,458
Less - Allowance for loan losses (15,228) (11,694)
----------- -----------
Total loans, net $ 1,421,143 $ 995,764
=========== ===========
The Bank services certain loans that it has sold without recourse to third
parties. The aggregate amount of loans serviced for others approximated
$188.02 million and $210.15 million as of December 31, 2001 and 2000,
respectively. Fee income from servicing loans for others was approximately
$555,000, $544,000 and $576,000 for the years ended December 31, 2001, 2000
and 1999, respectively. Mortgage servicing rights of approximately $1.92
million and $2.56 million were capitalized as of December 31, 2001 and
2000, respectively. Amortization of mortgage servicing rights was
approximately $881,000, $387,000 and $425,000 for the years ended December
31, 2001, 2000 and 1999, respectively. During 2001, in response to the
current low interest rate environment, the Bank reduced its estimate of
remaining loan lives on serviced loans. This reduction in estimate resulted
in a charge of approximately $370,000 to earnings in the fourth quarter.
As of December 31, 2001 and 2000, loans to related parties totaled
approximately $6.80 million and $6.30 million, respectively. For the year
ended December 31, 2001, new loans of approximately $1.50 million were
granted to these parties and principal payments of approximately $1,000
were received on those new loans. Related parties include directors and
officers of the Company, their respective affiliates in which they have a
controlling interest and their immediate family members. For the years
ended December 31, 2001 and 2000, all loans to related parties were
performing.
Allowance for loan losses
For the years ended December 31, 2001, 2000 and 1999, an analysis of the
allowance for loan losses is as follows (in thousands):
2001 2000 1999
-------- -------- --------
Balance, beginning of year $ 11,694 $ 10,617 $ 10,585
Acquisition of First Federal 2,174 -- --
Provision for loan losses 2,000 1,200 1,100
Loans charged off (1,131) (433) (1,360)
Recoveries 491 310 292
-------- -------- --------
Balance, end of year $ 15,228 $ 11,694 $ 10,617
======== ======== ========
F-22
(9) NONPERFORMING ASSETS
Nonperforming assets include loans for which the Bank does not accrue
interest ("nonaccrual loans"), loans 90 days past due and still accruing
interest and other real estate owned. Nonaccrual loans and loans 90 days
past due and still accruing interest represent the Bank's impaired loans.
For the years ended December 31, 2001, 2000 and 1999, the average recorded
investment in impaired loans was approximately $6.88 million, $9.39 million
and $6.42 million, respectively. As of December 31, 2001 and 2000,
nonperforming assets were (in thousands):
2001 2000
------ ------
Nonaccrual loans $6,575 $6,269
Loans 90 days past due and accruing interest 1,104 652
Other real estate owned 84 125
------ ------
Total nonperforming assets $7,763 $7,046
====== ======
For the years ended December 31, 2001, 2000 and 1999, had interest income
been accrued on nonaccrual loans at contractual rates, interest income
would have increased by approximately $446,000, $568,000 and $635,000,
respectively. For the years ended December 31, 2001, 2000 and 1999,
interest income on impaired loans of approximately $79,000, $60,000 and
$125,000, respectively, was recognized. As of years ended December 31,
2001, 2000 and 1999, no significant additional funds were committed to
customers whose loans were nonperforming.
As of December 31, 2001 and 2000, the Bank had impaired loans of
approximately $7.68 million and $6.92 million, respectively, for which a
valuation allowance of $157,000 and $771,000, respectively, was required.
For the years ended December 31, 2001, 2000, and 1999, approximately $1.13
million, $269,000 and $700,000, respectively was charged off on nonaccrual
loans.
(10) DEPOSITS
As of December 31, 2001 and 2000, deposits consisted of the following
(in thousands):
2001 2000
---------- --------
Certificates of Deposit:
Original maturity of less than one year $ 145,200 $ 94,481
Original maturity of one year or more 498,341 287,596
Time certificates in denominations of $100,000 or more 93,410 57,762
---------- --------
Total certificates of deposit 736,951 439,839
---------- --------
Savings accounts 357,512 219,498
Money market accounts 171,207 73,202
NOW accounts 214,825 131,536
Demand deposits 110,443 69,295
---------- --------
Total deposits $1,590,938 $933,370
========== ========
F-23
At December 31, 2001, the scheduled maturities of time deposits were as
follows (in thousands):
2002 $503,104
2003 126,041
2004 31,829
Thereafter 75,977
--------
Total $736,951
========
For the years ended December 31, 2001, 2000 and 1999, interest expense on
time deposits in denominations greater than $100,000 was approximately
$3.68 million, $3.08 million and $2.59 million, respectively.
F-24
(11) ADVANCES FROM FEDERAL HOME LOAN BANK AND SHORT-TERM BORROWED FUNDS
As of December 31, 2001 and 2000, SBM had the following borrowings from
Federal Home Loan Bank of Boston (FHLB) (dollars in thousands):
Interest
Rate Maturity Date 2001 2000
-------- ------------------- --------- ---------
6.67% April 25, 2001 $ -- $ 20,000
6.51% April 25, 2001 -- 10,000
5.96% September 26, 2001 -- 20,000
4.53% March 28, 2002 10,000 --
5.80% June 26, 2002 20,000 20,000
5.19% August 2, 2002 10,000 --
6.80% August 14, 2002 10,000 --
6.71% September 5, 2002 10,000 --
2.70% September 20, 2002 10,000 --
5.84% April 22, 2003 20,000 --
6.84% August 11, 2003 10,000 --
6.45% August 15, 2003 25,000 --
5.44% September 16, 2003 10,000 --
6.68% September 29, 2003 10,000 --
3.60% April 12, 2004 10,000 --
6.48% May 17, 2004 10,000 --
6.66% October 4, 2004 25,000 --
3.97% October 25, 2004 15,000 --
6.65% November 8, 2004 20,000 --
3.97% November 22, 2004 15,000 --
6.40% November 30, 2004 5,000 --
4.19% December 7, 2004 5,000 --
4.52% December 21, 2004 5,000 --
6.05% May 2, 2005 30,000 30,000
6.52% November 30, 2005 4,000 --
6.39% December 6, 2005 5,000 --
6.53% October 2, 2006 * 20,000 --
4.91% December 7, 2006 5,000 --
5.28% December 21, 2006 5,000 --
5.88% July 9, 2008 10,000 --
5.63% September 16, 2008 13,056 --
4.99% October 30, 2008 * 20,000 --
5.49% December 8, 2008 5,000 --
5.90% December 22, 2008 5,000 --
7.10% September 10, 2009 4,977 --
5.91% January 13, 2010 * 20,000 --
6.56% April 12, 2010 * 20,000 --
6.58% February 27, 2012 * 20,000 --
5.39% December 16, 2013 * 15,000 --
Unamortized premium 8,322
--------- ---------
Total advances from Federal Home Loan Bank $ 465,355 $ 100,000
========= =========
* These advances have call dates ranging from January 2002 through December
2008
F-25
The advances on the previous page are contractual agreements with the FHLB.
If the Bank were to opt to prepay any of the advances prior to their
maturity date, the Bank may incur a prepayment penalty.
In accordance with generally accepted accounting principles, the Bank
recorded the FHLB advances acquired from First Federal at the
then-market-value on the date of acquisition. The Bank recorded an
adjustment of $9.47 million to record the advances at market value. The
Bank is amortizing this premium on a level-yield basis over the remaining
lives of the advances.
SBM's FHLB stock collateralizes the FHLB advances. In addition, mortgage
loans and otherwise unencumbered investment securities qualified as
collateral available to the FHLB were pledged to secure these advances,
unused credit lines and letters of credit issued by the FHLB. As of
December 31, 2001, SBM had the ability to borrow a total of approximately
$603.17 million from FHLB.
SBM maintains a line of credit of $34.00 million with the FHLB which
accrues interest at variable rates determined by the FHLB on a daily basis.
Amounts drawn against the line of credit are due within one day of
withdrawal; however, such amounts are automatically renewed provided that
SBM has sufficient cash balances deposited with the FHLB. Borrowings under
the line of credit are secured by U.S. Government treasury and/or agency
bonds. There were no outstanding borrowings on the FHLB line of credit at
December 31, 2001 or 2000. The Bank also maintains a $15.00 million line of
credit with a correspondent bank. No amounts were outstanding on the
correspondent line as of December 31, 2001 or 2000.
Short-term borrowed funds primarily represents commercial transactional
repurchase accounts (business checking accounts, which are not Federal
Deposit Insurance Corporation insured).
(12) DIRECTOR AND EMPLOYEE RETIREMENT EXPENSES
During the third quarter of 2001, the Company recorded $1.42 million of
director and employee retirement expenses which represents $872,000 of
director (see Note 3) and $547,000 of employee retirement expenses. In
September 2001, the Bank offered an early retirement package to eligible
employees. Ten Bank employees opted for the package. The employee
retirement expense includes a pension charge of $264,000 and vacation time
of $283,000.
(13) RELOCATION AND BRANCH CLOSING COSTS
During the third quarter of 2001, the Bank recorded $872,000 of relocation
and branch closing costs. In conjunction with the acquisition of First
Federal, the Bank closed five of its existing branch offices which were
located near First Federal branch locations. The Bank expensed $431,000 in
future lease payments, $172,000 in furniture and equipment and $164,000 in
leasehold improvements relating to these branch location closings. In
addition, the Bank is relocating certain back office operational
departments from a building that is currently leased to a building that the
Bank owns. The Bank expensed $105,000 in the third quarter of 2001 relating
to leasehold improvements which will no longer be used.
(14) BENEFIT PLANS
The Bank has a non-contributory defined benefit pension plan ("the Plan")
covering substantially all employees. The benefits are based on years of
service and average compensation, as defined in the Plan.
The following table sets forth the change in benefit obligation, change in
plan assets and the funded status of the Bank's pension plan for the years
ended December 31, 2001 and 2000. The table includes the effect from the
First Federal acquisition. At December 31, 2001, there were 261 former
First Federal active and inactive employees whose liabilities are included
in the table. The table also provides a reconciliation of the Plan's funded
status and the amounts recognized in the Bank's consolidated statements of
condition (in thousands):
F-26
2001 2000
-------- --------
Change in benefit obligation:
Benefit obligation, beginning of year $ 18,800 $ 17,835
Service cost 1,348 1,363
Interest cost 1,438 1,321
Actuarial loss (gain) 2,925 (1,236)
Plan amendments 168 --
Early retirement expenses (see Note 12) 264 --
First Federal benefit obligation at acquisition date 12,956 --
Benefits paid (614) (483)
-------- --------
Benefit obligation, end of year $ 37,285 $ 18,800
======== ========
2001 2000
-------- --------
Change in plan assets:
Fair value of plan assets, beginning of year $ 22,019 $ 19,526
Actual return on plan assets (3,485) 2,879
Employer contribution -- 97
First Federal plan assets 12,447 --
Benefits paid (614) (483)
-------- --------
Fair value of plan assets, end of year $ 30,367 $ 22,019
======== ========
2001 2000
-------- --------
Funded status $ (6,918) $ 3,219
Unrecognized transition asset (117) (194)
Unrecognized prior service cost 259 99
Unrecognized net actuarial loss (gain) 142 (8,113)
-------- --------
Accrued benefit cost $ (6,634) $ (4,989)
======== ========
F-27
The components of net periodic pension cost for the years ended December 31,
2001, 2000 and 1999 were as follows (in thousands):
2001 2000 1999
-------- -------- -------
Service cost $ 1,348 $ 1,363 $ 1,416
Interest cost 1,438 1,321 1,161
Expected return on plan assets (1,621) (1,454) (1,297)
Recognized net gain (223) (87) --
Amortization and deferral (69) (69) (69)
Additional amount due to settlement or curtailment 773 -- --
-------- -------- -------
Net periodic pension cost $ 1,646 $ 1,074 $ 1,211
======== ======== =======
Significant actuarial assumptions used in determining the actuarial present
value of the projected benefit obligation and the net periodic pension cost were
as follows:
2001 2000 1999
------ ------ -----
Discount rate 7.00% 7.75% 7.50%
Rate of increase in compensation levels 4.50% 4.50% 4.50%
Long-term rate of return on assets 8.50% 8.50% 8.50%
F-28
The Bank has entered into supplemental retirement agreements with certain
officers and outside directors. The following table sets forth the change in
benefit obligation and the funded status of the obligations for the years ended
December 31, 2001 and 2000. The table also provides a reconciliation of the
obligation's funded status and the amounts recognized in the Bank's consolidated
statements of condition (in thousands):
2001 2000
------- -------
Change in benefit obligation:
Benefit obligation, beginning of year $ 3,165 $ 717
Service cost 230 203
Interest cost 270 206
Actuarial loss 466 73
Plan amendments 349 1,966
------- -------
Benefit obligation, end of year 4,480 3,165
Fair value of plan assets, end of year -- --
------- -------
Funded status (4,480) (3,165)
Unrecognized prior service cost 1,902 1,940
Unrecognized net actuarial loss 601 147
Minimum pension liability (845) --
Other (8) (1,291)
------- -------
Accrued benefit cost $(2,830) $(2,369)
======= =======
The components of net periodic pension cost for the years ended December 31,
2001, 2000 and 1999 were as follows (in thousands):
2001 2000 1999
---- ---- ----
Service cost $230 $203 $ 41
Interest cost 270 206 40
Amortization and deferral 399 285 27
---- ---- ----
Net periodic pension cost $899 $694 $108
==== ==== ====
Significant actuarial assumptions used in determining the actuarial present
value of the projected benefit obligation and the net periodic pension cost were
as follows:
2001 2000 1999
------------- ------------- ----
Discount rate 7.00% 7.75% 7.50%
Rate of increase in compensation levels 4.00 and 4.50 4.00 and 4.50 4.00
In addition to providing pension benefits, the Bank provides certain health care
benefits for retired employees ("the Health Care Plan"). Only employees retiring
before January 1, 1989 are eligible for these benefits, provided they attain age
55 while working for the Bank. In addition, all employees who have attained age
55 and have ten years of vested service are covered under the Health Care Plan
until age 65. Effective January 1,
F-29
1993, the Bank began to accrue for the estimated costs of these benefits through
charges to expense during the years that the employees earn these benefits. The
following table reconciles the Health Care Plan's funded status to the accrued
obligation as of December 31, 2001 and 2000 (in thousands):
2001 2000
------- ------
Accumulated postretirement benefit obligation:
Retirees $ 3,038 $ 490
Other fully eligible participants 181 209
Other active participants 833 465
------- ------
4,052 1,164
Unrecognized actuarial gain 123 418
Unrecognized prior service cost (562) (155)
------- ------
Accrued benefit cost $ 3,613 $1,427
======= ======
For the years ended December 31, 2001, 2000 and 1999, net postretirement health
care cost included the following components (in thousands):
2001 2000 1999
----- ----- -----
Service cost $ 78 $ 69 $ 64
Interest cost 86 71 61
Amortization and deferral (5) (16) (17)
----- ----- -----
Net periodic pension cost $ 159 $ 124 $ 108
===== ===== =====
Significant actuarial assumptions used in determining the actuarial present
value of the projected benefit obligation and the net postretirement health care
cost are as follows:
2001 2000 1999
----- ---- -----
Discount rate 7.00% 7.75% 7.50%
The health care cost trend rate used to measure the accumulated postretirement
benefit obligation is 7.00% as of December 31, 2001. Increasing the health care
cost trend rate by 1% would increase the accumulated postretirement benefit cost
by approximately $85,000 and the net postretirement benefit cost by
approximately $20,000 (pretax), annually as of December 31, 2001.
In connection with the Plan of Conversion, the Bank established an ESOP which
acquired 8%, or 898,560, of the shares which were issued in the conversion at a
price of $10.36 per share. The purchase of the shares by the ESOP was funded by
a loan of $9.31 million from the Company. The loan is to be repaid in fifteen
equal annual installments of principal and interest of $1.12 million. Interest
on the loan is fixed at 8.75%. ESOP expense for the years ended December 31,
2001 and 2000 was $1.37 million and $855,000, respectively. ESOP expense is
based on the market value of the Company's common stock at the time shares are
allocated to employees, which may differ from the $10.36 cost of those shares.
F-30
(15) INCOME TAXES
For the years ended December 31, 2001, 2000 and 1999, the provision for
(benefit from) income taxes consisted of the following (in thousands):
2001 2000 1999
------- ------- -------
Current tax provision:
Federal $ 9,665 $ 7,179 $ 4,365
------- ------- -------
Total current 9,665 7,179 4,365
------- ------- -------
Deferred tax (benefit) provision:
Federal (3,290) (3,520) 61
------- ------- -------
Total deferred (3,290) (3,520) 61
------- ------- -------
Total provision for income taxes $ 6,375 $ 3,659 $ 4,426
======= ======= =======
F-31
As of December 31, 2001 and 2000, the components of the net deferred income
tax asset included in current and deferred income taxes in the accompanying
consolidated statements of condition were (in thousands):
2001 2000
-------- --------
Deferred tax assets:
Allowance for loan losses $ 5,330 $ 4,093
Charitable contributions 1,099 2,155
Benefits 5,338 2,856
Branch premiums 324 275
Payments and interest on nonaccrual loans 62 741
Securites writedown 1,076 --
Capital loss 879 --
Compensation 793 --
Other 557 30
-------- --------
15,458 10,150
-------- --------
Deferred tax liabilities:
Unrealized gain on available for sale securities (7,340) (7,087)
Core deposit intangible and noncompete
agreement (2,408) --
Adjustments to mark First Federal
to market (2,688) --
Accretion (187) (210)
Premises and equipment (267) (510)
Mortgage servicing rights (672) (894)
Other (994) (1,043)
-------- --------
(14,556) (9,744)
-------- --------
Net deferred tax asset $ 902 $ 406
======== ========
Effective for taxable years commencing after December 31, 1998, financial
service companies are permitted to establish in the State of Connecticut a
passive investment company ("PIC") to hold and manage loans secured by real
property. In 1999, SBM established a PIC, as a wholly-owned subsidiary, and
transferred a portion of its real estate mortgage portfolio from SBM to the
PIC. Income earned by the PIC is exempt from Connecticut corporation
business tax and dividends received by the financial service company from
the PIC were not taxable through December 31, 2001. However, proposed
legislation would eliminate the exemption as of January 1, 2002. If the
legislation were enacted, the Company would be subject to state income
taxes in Connecticut.
F-32
For the years ended December 31, 2001, 2000 and 1999, the provision for
income taxes differed from the amount computed by applying the statutory
federal income tax rate (35%) to income before provision for income taxes
for the following reasons (in thousands):
2001 2000 1999
------- ------- --------
Tax provision at statutory rate $ 6,699 $ 3,865 $ 4,613
Increase (decrease) in tax resulting from:
Cash surrender value of life insurance (361) -- --
Tax exempt income (90) (60) (26)
ESOP 262 82 --
Dividends received deduction (196) (249) (245)
Other, net 61 21 84
------- ------- -------
$ 6,375 $ 3,659 $ 4,426
======= ======= =======
As of December 31, 2001, the Bank's allowance for loan losses for federal
income tax return purposes was approximately $18.90 million. If any portion
of this allowance is used for purposes other than to absorb loan losses and
write-downs of other real estate owned, such amounts will become subject to
income tax at the then current tax rate. Management does not anticipate
that capital will be used in such a way so as to require the payment of
taxes on taxable income resulting from the recapture of the tax allowance.
As a result, in accordance with SFAS No. 109, no provision for such tax has
been recorded in the accompanying consolidated financial statements.
(16) STOCK-BASED COMPENSATION
In connection with the conversion to stock form of ownership (see Note 2),
the Company established the Connecticut Bancshares, Inc. 2000 Stock-Based
Incentive Plan (the "Stock Plan") to attract and retain qualified personnel
in key positions and to provide employees with an interest in the Company
as an incentive to contribute to its success. The Stock Plan authorizes the
granting of options to purchase common stock of the Company and awards of
restricted shares of common stock. All employees and non-employee directors
of the Company are eligible to receive awards under the Stock Plan. The
Stock Plan is administered by a committee (the Committee). Subject to
certain regulatory conditions, the Committee has the authority to determine
the amount of options granted to any individual and the dates on which each
option will become exercisable. The exercise price of all options is
determined by the Committee but is at least 100% of the fair market value
of the underlying common stock at the time of the grant. In addition,
subject to certain regulatory conditions, the Committee has the authority
to determine the amounts of restricted stock awards granted to any
individual and the dates on which restricted stock awards granted will vest
or any other conditions which must be satisfied before vesting.
F-33
A summary of the status of the Company's Stock Plan as it relates to stock
options as of December 31, 2001 and 2000 and changes during the years ended
on those dates is presented below:
Number of Weighted Average
Shares Exercise Price
--------- ----------------
Options outstanding at December 31, 1999 -- $ --
Granted 1,017,776 17.63
---------
Options outstanding at December 31, 2000 1,017,776 17.63
Granted 35,580 18.51
Forfeited (7,800) 17.63
Exercised (3,608) 17.63
---------
Options outstanding at December 31, 2001 1,041,948 $ 17.66
=========
At December 31, 2001 and 2000, options were exercisable on 201,274 and 0
shares of stock with a weighted average exercise price of $17.63 and $0,
respectively.
The following table summarizes information related to outstanding options
as of December 31, 2001:
Weighted Average
Number Remaining Contractual Weighted Average
Exercise Price Outstanding Life (Years) Exercise Price
- -------------------- ----------- --------------------- ----------------
$17.63 1,034,448 8.98 $ 17.63
$21.80 7,500 9.73 21.80
---------
Total 1,041,948 8.99 $ 17.66
=========
The Company applies APB No. 25 and related interpretations in accounting
for the Stock Plan. Had compensation cost for the Company's Stock Plan been
determined consistent with SFAS No. 123, the Company's pro forma net income
and basic and diluted earnings per share for the year ended December 31,
2001 and for the ten months ended December 31, 2000 would have been:
For the Year Ended For the Ten Months Ended
December 31, 2001 December 31, 2000
------------------ ------------------------
Pro Forma:
Net income $ 11,762 $ 6,076
========== ========
Earnings per share:
Basic $ 1.16 $ 0.59
Diluted $ 1.10 $ 0.59
F-34
Fair value was estimated on the grant date using the Black-Scholes option
pricing model with the following assumptions:
2001 2000
--------- --------
Risk free interest rate 5.16% 5.24%
Expected life 10 years 7 years
Expected volatility 28% 26%
Dividend yield 2.95% 0%
Fair value $ 6.20 $ 7.28
(17) SELECTED QUARTERLY CONSOLIDATED FINANCIAL INFORMATION (UNAUDITED)
The following table presents quarterly consolidated financial information
for the Company for 2001 and 2000 (in thousands):
2001 2000
-------------------------------------------- --------------------------------------------
Fourth Third Second First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
-------- -------- -------- -------- -------- -------- -------- --------
Interest and
dividend income $ 35,765 $ 29,535 $ 25,014 $ 25,073 $ 25,113 $ 24,512 $ 23,722 $ 21,745
Interest expense 16,922 13,215 10,831 10,964 11,381 11,281 10,829 10,351
-------- -------- -------- -------- -------- -------- -------- --------
Net interest income 18,843 16,320 14,183 14,109 13,732 13,231 12,893 11,394
Provision for loan losses 375 875 375 375 375 375 225 225
-------- -------- -------- -------- -------- -------- -------- --------
Net interest income after
provision for loan losses 18,468 15,445 13,808 13,734 13,357 12,856 12,668 11,169
Noninterest income (1) 3,991 (879) 2,993 2,892 3,911 3,417 2,424 517
Noninterest expense (2) 15,076 14,524 10,672 11,041 10,810 10,002 10,259 18,206
-------- -------- -------- -------- -------- -------- -------- --------
Income (loss) before
(provision for) benefit
from income taxes 7,383 42 6,129 5,585 6,458 6,271 4,833 (6,520)
(Provision for) benefit
from income taxes (2,392) -- (2,084) (1,899) (2,139) (2,073) (1,599) 2,152
-------- -------- -------- -------- -------- -------- -------- --------
Net income (loss) $ 4,991 $ 42 $ 4,045 $ 3,686 $ 4,319 $ 4,198 $ 3,234 $ (4,368)
======== ======== ======== ======== ======== ======== ======== ========
(1) Includes net losses on sales of securities of $1.76 million in the first
quarter 2000 and other than temporary impairment of securities charge of
$3.92 million in the third quarter 2001.
(2) Includes expense of $8.32 million related to securities contributed to SBM
Charitable Foundation, Inc. in first quarter 2000.
F-35
(18) COMMITMENTS AND CONTINGENCIES
Cash and due from banks withdrawal and usage reserve requirements
The Bank is required to maintain reserves against its transaction accounts
and non-personal time deposits. As of December 31, 2001 and 2000, cash and
due from banks withdrawal/usage reserve requirements of approximately $6.43
million and $2.14 million, respectively, existed as a result of Federal
Reserve requirements to maintain certain average balances.
Lease commitments
The Bank leases certain of its premises and equipment under lease
agreements which expire at various dates through July 2023. The Bank has
the option to renew certain of the leases at fair rental values. Rental
expense was approximately $1.26 million, $1.13 million and $1.13 million
for the years ended December 31, 2001, 2000 and 1999, respectively.
As of December 31, 2001, minimum rental commitments under noncancellable
operating leases were (in thousands):
Year Commitment
- ---------- ----------
2002 $ 1,214
2003 1,085
2004 945
2005 859
2006 753
Thereafter 3,912
-------
Total $ 8,768
=======
Loan commitments and letters of credit
The Bank is a party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers.
These financial instruments included commitments to extend credit of
approximately $235.52 million and $176.67 million as of December 31, 2001
and 2000, respectively, and standby letters of credit of approximately
$6.75 million and $7.36 million as of December 31, 2001 and 2000,
respectively.
These consolidated financial instruments involve, to varying degrees,
elements of credit and interest rate risk. The Bank's exposure to credit
loss in the event of non-performance by the other party to the financial
instrument is represented by the contractual amount of those instruments.
The Bank uses the same credit policies in making commitments as it does for
existing loans. Management believes that the Bank controls the credit risk
of these financial instruments through credit approvals, lending limits,
monitoring procedures and the receipt of collateral when deemed necessary.
Commitments to extend credit are agreements to lend to a customer as long
as there is no violation of any condition established in the contract.
Commitments generally have fixed expiration dates or other termination
clauses and may require payment of a fee. Since many of the commitments
could expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. Bank management evaluates
each customer's credit worthiness on a case-by-case basis. The amount of
collateral obtained, if deemed necessary by the Bank, upon extension of
credit, is based on management's credit evaluation of the
F-36
customer. Collateral held varies but may include income producing
commercial properties, accounts receivable, inventory and property, plant
and equipment.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. The credit risk
involved in issuing letters of credit is essentially the same as that
involved in existing loan facilities to customers. The Bank holds real
estate and marketable securities as collateral supporting those commitments
for which collateral is deemed necessary.
Interest rate cap agreement
At December 31, 1999, SBM was party to an interest rate cap agreement with
a notional principal amount of $25.00 million. Under the terms of the cap
agreement, SBM paid a premium totaling $123,000 which was included in other
assets and was amortized over the three year term of the agreement.
Amortization for the year ended December 31, 1999 totaled $38,000. In March
2000, the Bank realized a gain of approximately $72,000 on the sale of the
interest rate cap.
(19) LEGAL CONTINGENCIES
Various legal claims also arise from time to time in the normal course of
business which, in the opinion of management, will have no material effect
on the Company's consolidated financial statements.
(20) PARENT COMPANY FINANCIAL INFORMATION
Summarized information relative to the statements of condition as of
December 31, 2001 and 2000 and statements of operations and cash flows for
the years ended December 31, 2001, 2000 and 1999 of Connecticut Bancshares,
Inc. (parent company only) are presented as follows (in thousands):
Statements of Condition 2001 2000
-------- --------
Assets:
Cash and cash equivalents $ 11,226 $ 7,572
Investment in SBM 202,735 187,471
Securities available for sale 20,368 36,495
Current and deferred income taxes 2,333 2,304
Accrued interest receivable 185 325
-------- --------
Total assets $236,847 $234,167
======== ========
Liabilities and stockholders' equity:
Other liabilities $ 1,473 $ 1,628
-------- --------
Total liabilities 1,473 1,628
-------- --------
Stockholders' equity 235,374 232,539
-------- --------
Total liabilities and stockholders' equity $236,847 $234,167
======== ========
F-37
Statements of Operations 2001 2000 1999
-------- -------- ------
Interest and dividend income:
Interest and dividend income on
investment securities $ 2,246 $ 1,744 $ --
-------- -------- ------
Noninterest income:
Gains on sales of securities, net 520 19 --
Other than temporary impairment of securities (Note 7) (160) -- --
-------- -------- ------
Total noninterest income 360 19 --
-------- -------- ------
Noninterest expense:
Salaries and employee benefits 3,511 856 --
Fees and services 992 636 --
Securities contributed to SBM
Charitable Foundation, Inc. -- 8,316 --
Other operating expenses 179 77 --
-------- -------- ------
Total noninterest expense 4,682 9,885 --
-------- -------- ------
Loss before provision for (benefit from)
income taxes and equity in undistributed
earnings of SBM (2,076) (8,122) --
Provision for (benefit from) income taxes 82 (2,692) --
-------- -------- ------
Loss before equity in undistributed
earnings of SBM (2,158) (5,430) --
Equity in undistributed earnings of SBM 14,922 12,813 8,754
-------- -------- ------
Net income $ 12,764 $ 7,383 $8,754
======== ======== ======
F-38
Statements of Cash Flows
2001 2000 1999
-------- -------- -------
Cash flows from operating activities:
Net income $ 12,764 $ 7,383 $ 8,754
Adjustments to reconcile net income to net cash
used in operating activities:
Securities contributed to SBM Charitable Foundation, Inc. -- 8,316 --
Accretion on bonds, net (253) (456) --
Gains on sales of securities, net (520) (19) --
Other than temporary impairment of investment securities 160 -- --
Deferred income tax provision (97) (7,393) --
Granting of restricted stock to former Chairman of the Board 276 -- --
Granting of stock options to former Chairman of the Board 266 -- --
Accelerated vesting of restricted stock 214 -- --
Accelerated vesting of stock options 124 -- --
Exercise of stock options 64 -- --
Change in ESOP unearned compensation 1,368 855 --
Change in restricted stock unearned compensation 1,630 -- --
Changes in operating assets and liabilities -
Accrued interest receivable 140 (325) --
Other liabilities (1,680) 1,628 --
Equity in undistributed earnings of SBM (14,922) (12,813) (8,754)
-------- -------- -------
Net cash used in operating activities (466) (2,824) --
-------- -------- -------
Cash flows from investing activities:
Proceeds from maturities of available for sale securities 5,900 5,000 --
Proceeds from sales of available for sale securities 12,482 983 --
Purchases of available for sale securities (1,858) (40,950) --
Proceeds from principal payments of available
for sale securities 409 57 --
Investment in SBM -- (45,257) --
-------- -------- -------
Net cash provided by (used in) investing activities 16,933 (80,167) --
-------- -------- -------
Cash flows from financing activities:
Net proceeds from issuance of common stock -- 90,513 --
Funding of trustee purchases of restricted stock (9,620) -- --
Proceeds from exercise of stock options 64 -- --
Dividends paid (3,257) -- --
-------- -------- -------
Net cash (used in) provided by financing activities (12,813) 90,513 --
-------- -------- -------
Net increase in cash and cash equivalents 3,654 7,522 --
CASH AND CASH EQUIVALENTS, beginning of year 7,572 50 50
-------- -------- -------
CASH AND CASH EQUIVALENTS, end of year $ 11,226 $ 7,572 $ 50
======== ======== =======
F-39
(21) CASH SURRENDER VALUE OF LIFE INSURANCE
In 2001, the Bank purchased $20.00 million of Bank Owned Life Insurance
("BOLI"). The Bank purchased these policies for the purpose of protecting
itself against the cost/loss due to the death of key employees and to
offset the Bank's future obligations to its employees under various
retirement and benefit plans. On August 31, 2001, the Bank acquired $20.36
million of BOLI as a result of the acquisition of First Federal. The total
value of BOLI at December 31, 2001 was $41.39 million. The Bank recorded
income from BOLI of $1.03 million in 2001.
(22) DISCLOSURES ABOUT FAIR VALUES OF FINANCIAL INSTRUMENTS
SFAS No. 107, "Disclosures About Fair Value of Financial Instruments,"
requires entities to disclose the estimated fair value of financial
instruments, both assets and liabilities recognized and not recognized in
the consolidated statements of condition, for which it is practicable to
estimate fair value.
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to
estimate that value.
Cash and cash equivalents, cash surrender value of life insurance, Federal
Home Loan Bank stock and accrued interest receivable
The carrying amount is a reasonable estimate of fair value.
Securities available for sale
For marketable equity securities and other securities held for investment
purposes, fair values are based on quoted market prices or dealer quotes,
if available. If a quoted market price is not available, fair value is
estimated using quoted market prices for similar securities.
Loans held for sale
The fair value of residential mortgage loans held for sale is estimated
using quoted market prices provided by government agencies.
Loans
The fair value of the net loan portfolio is estimated by discounting the
loans' future cash flows using the prevailing interest rates as of year-end
at which similar loans would be made to borrowers with similar credit
ratings and for the same remaining maturities.
The book and fair values of unrecognized commitments to extend credit and
standby letters of credit were not significant as of December 31, 2001 and
2000.
Deposits and short-term borrowed funds
The fair value of savings, NOW, demand and money market deposits, as well
as short-term borrowed funds and mortgagors' escrow accounts, is the amount
payable on demand as of year-end. The fair value of certificates of deposit
is estimated by discounting the future cash flows using the rates offered
for deposits of similar remaining maturities as of year-end.
Advances from Federal Home Loan Bank
The fair value of the advances is based on the estimated costs to prepay
the debt (prior to maturity) as of year-end.
F-40
Values not determined
SFAS No. 107 excludes certain financial, as well as non-financial,
instruments from its disclosure requirements, including premises and
equipment, the intangible value of the Bank's portfolio of loans serviced
(both for itself and for others) and related servicing network, and the
intangible value inherent in the Bank's deposit relationships (i.e., core
deposits), among other assets and liabilities. Accordingly, the aggregate
fair value amounts presented do not represent the underlying value of the
Bank.
As of December 31, 2001 and 2000, the estimated fair values and recorded
book balances of the Bank's financial instruments were (in thousands):
2001 2000
----------------------- -------------------
Recorded Recorded
Book Fair Book Fair
Balance Value Balance Value
---------- ---------- -------- --------
Assets:
Cash and cash equivalents $ 122,624 $ 122,624 $ 64,797 $ 64,797
Securities available for sale 758,534 758,534 308,081 308,081
Loan held for sale 746 746 290 290
Loans, net 1,421,143 1,443,879 995,764 980,480
Federal Home Loan Bank Stock 30,783 30,783 6,654 6,654
Cash surrender value of life insurance 41,396 41,396 -- --
Accrued interest receivable 12,933 12,933 8,747 8,747
Liabilities:
Deposits -
Savings $ 357,512 $ 357,512 $219,498 $219,498
Money market 171,207 171,207 73,202 73,202
Certificates of deposit 736,951 730,458 439,839 443,205
NOW 214,825 214,825 131,536 131,536
Demand 110,443 110,443 69,295 69,295
Short-term borrowed funds 117,180 117,180 106,493 106,493
Mortgagors' escrow accounts 10,580 10,580 8,896 8,896
Advances from Federal Home Loan Bank 465,355 467,369 100,000 100,197
F-41