EXHIBIT 99.3
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CONVERSION VALUATION APPRAISAL REPORT
Prepared for:
MONADNOCK BANCORP, INC.
PETERBOROUGH, NEW HAMPSHIRE
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As Of:
February 22, 2006
Prepared By:
KELLER & COMPANY, INC.
555 Metro Place North
Suite 524
Dublin, Ohio 43017
(614) 766-1426
KELLER & COMPANY
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CONVERSION VALUATION APPRAISAL REPORT
Prepared for:
MONADNOCK BANCORP, INC.
PETERBOROUGH, NEW HAMPSHIRE
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As Of:
February 22, 2006
KELLER & COMPANY, INC.
Financial Institution Consultants
Investment and Financial Advisors
555 Metro Place North 614-766-1426
Suite 524 614-766-1459 (fax)
Dublin, Ohio 43017
March 16, 2006
Board of Directors
Monadnock Community Bancorp, Inc.
One Jaffrey Road
Peterborough, New Hampshire 03458
To the Board:
We hereby submit an independent appraisal ("Appraisal") of the pro forma market
value of the common stock to be issued by Monadnock Bancorp, Inc. (the
"Corporation") in conjunction with the second stage stock conversion of
Monadnock Mutual Holding Company (the "MHC") from the mutual to the stock form
of ownership. The MHC currently owns 57.4 percent of the stock of Monadnock
Community Bancorp, Inc. (the "Bancorp"), the mid-tier holding company of
Monadnock Community Bank (the "Bank"). The remaining 42.6 percent of the
Corporation's common stock is owned by public shareholders. The Corporation will
also issue shares of common stock to its current public shareholders pursuant to
an exchange ratio that preserves the 42.6 percent aggregate ownership interest
of those public shareholders. The exchange ratio established by the Corporation
as applied to the value established herein is 1.0125 shares, 1.1912 shares,
1.3699 shares, shares and 1.5753 shares for each share of the Corporation's
common stock at the minimum, midpoint, maximum and maximum, as adjusted,
respectively, of the valuation range. This appraisal was prepared and provided
to the Association in accordance with the appraisal requirements of the Office
of Thrift Supervision of the United States Department of the Treasury.
Keller & Company, Inc. is an independent, financial institution consulting firm
that serves both thrift institutions and banks. The firm is a full-service
consulting organization, as described in more detail in Exhibit A, specializing
in business and strategic plans, stock valuations, conversion and reorganization
appraisals, market studies and fairness opinions for thrift institutions and
banks. The firm has affirmed its independence in this transaction with the
preparation of its Affidavit of Independence, a copy of which is included as
Exhibit C.
Our appraisal is based on the assumption that the data provided to us by the
Bancorp and the Bank and the material provided by the independent auditors,
Shatswell, MacLeod & Company, P.C., are both accurate and complete. We did not
verify the financial statements provided to us, nor did we conduct independent
valuations of the Bank's assets and liabilities. We have also used information
from other public sources, but we cannot assure the accuracy of such material.
Board of Directors
Monadnock Community Bancorp, Inc.
March 16, 2006
Page 2
In the preparation of this appraisal, we held discussions with the management of
the Bancorp and the Bank, with the law firm of Luse, Gorman, Pomerenk and
Schick, Washington, D.C., the Bank's conversion counsel, and with Ryan Beck &
Co. Further, we viewed the Bank's local economy and primary market area and also
reviewed the Bank's most recent Business Plan as part of our review process.
This valuation must not be considered to be a recommendation as to the purchase
of stock in the Corporation, and we can provide no guarantee or assurance that
any person who purchases shares of the Corporation's stock will be able to later
sell such shares at a price equivalent to the price designated in this
appraisal.
Our valuation will be updated as required and will give consideration to any new
developments in the Bank's operation that have an impact on operations or
financial condition. Further, we will give consideration to any changes in
general market conditions and to specific changes in the market for
publicly-traded thrift institutions. Based on the material impact of any such
changes on the pro forma market value of the Corporation as determined by this
firm, we will make necessary adjustments to the Corporation's appraised value in
such appraisal update.
It is our opinion that as of February 22, 2006, the pro forma market value or
appraised value of the Corporation was $9,000,000 at the midpoint, with a public
offering of $4,923,000 or 615,375 shares at $8 per share, representing 54.7
percent of the total valuation. The pro forma valuation range of the Corporation
is from a minimum of $7,650,000 to a maximum of $10,350,000, with a maximum, as
adjusted, of $11,902,500, representing public offering ranges of $4,184,550 at
the minimum to a maximum of $5,661,450, with a maximum, as adjusted, of
$6,510,668, representing 523,069 shares, 707,681 shares and 813,833 shares at $8
per share at the minimum, maximum, and maximum, as adjusted, respectively.
The pro forma appraised value of Monadnock Bancorp, Inc., as of February 22,
2006, was $9,000,000, at the midpoint with a midpoint public offering of
$4,923,000.
Very truly yours,
KELLER & COMPANY, INC.
TABLE OF CONTENTS
PAGE
INTRODUCTION 1
I. DESCRIPTION OF MONADNOCK COMMUNITY BANK
General 4
Performance Overview 7
Income and Expense 9
Yields and Costs 13
Interest Rate Sensitivity 14
Lending Activities 16
Nonperforming Assets 21
Investments 23
Deposit Activities 23
Borrowings 24
Subsidiaries 24
Office Properties 25
Management 25
II. DESCRIPTION OF PRIMARY MARKET AREA 26
III. COMPARABLE GROUP SELECTION
Introduction 33
General Parameters
Merger/Acquisition 34
Mutual Holding Companies 34
Trading Exchange 36
IPO Date 36
Geographic Location 36
Asset Size 37
Balance Sheet Parameters
Introduction 38
Cash and Investments to Assets 39
Mortgage-Backed Securities to Assets 39
One- to Four-Family Loans to Assets 40
Total Net Loans to Assets 40
Total Net Loans and Mortgage-Backed Securities to Assets 40
Borrowed Funds to Assets 41
Equity to Assets 42
Performance Parameters
Introduction 42
TABLE OF CONTENTS (CONT.)
PAGE
III. COMPARABLE GROUP SELECTION (CONT.)
Performance Parameters (cont.)
Return on Average Assets 43
Return on Average Equity 43
Net Interest Margin 44
Operating Expenses to Assets 44
Noninterest Income to Assets 44
Asset Quality Parameters
Introduction 46
Nonperforming Assets to Assets 46
Repossessed Assets to Assets 46
Loan Loss Reserve to Assets 47
The Comparable Group 47
IV. ANALYSIS OF FINANCIAL PERFORMANCE 49
V. MARKET VALUE ADJUSTMENTS
Earnings Performance 52
Market Area 56
Financial Condition 57
Asset, Loan and Deposit Growth 59
Dividend Payments 61
Subscription Interest 62
Liquidity of Stock 63
Management 63
Marketing of the Issue 64
VI. VALUATION METHODS 65
Price to Book Value Method 66
Price to Earnings Method 68
Price to Assets Method 68
Valuation Conclusion 69
LIST OF EXHIBITS
NUMERICAL
EXHIBITS PAGE
1 Consolidated Balance Sheet - At December 31, 2005 70
2 Consolidated Balance Sheets -
At December 31, 2001 through December 31, 2004 71
3 Consolidated Statement of Income for the Year
Ended December 31, 2005 72
4 Consolidated Statements of Income -
For the Years Ended December 31, 2001 through 2004 73
5 Selected Financial Information 74
6 Income and Expense Trends 75
7 Normalized Earnings Trend 76
8 Performance Indicators 77
9 Volume/Rate Analysis 78
10 Yield and Cost Trends 79
11 Net Portfolio Value 80
12 Loan Portfolio Composition 81
13 Loan Maturity Schedule 82
14 Loan Originations and Purchases 83
15 Delinquent Loans 84
16 Nonperforming Assets 85
17 Classified Assets 86
18 Allowance for Loan Losses 87
19 Investment Portfolio Composition 88
20 Mix of Deposits 89
21 Certificates of Deposit by Rate and Maturity 90
22 Deposit Activity 91
23 Borrowed Funds 92
24 Offices of Monadnock Community Bank 93
25 Management of the Bank 94
26 Key Demographic Data and Trends 95
27 Key Housing Data 96
28 Major Sources of Employment 97
29 Unemployment Rates 98
30 Market Share of Deposits 99
31 National Interest Rates by Quarter 100
32 Thrift Stock Prices and Pricing Ratios 101
33 Key Financial Data and Ratios 109
34 Recently Converted Thrift Institutions 117
LIST OF EXHIBITS (CONT.)
NUMERICAL
EXHIBITS PAGE
35 Acquisitions and Pending Acquisitions 119
36 Thrift Stock Prices and Pricing Ratios - Mutual Holding Companies 120
37 Key Financial Data and Ratios - Mutual Holding Companies 122
38 Balance Sheets Parameters - Comparable Group Selection 124
39 Operating Performance and Asset Quality Parameters -
Comparable Group Selection 127
40 Balance Sheet Ratios - Final Comparable Group 130
41 Operating Performance and Asset Quality Ratios
Final Comparable Group 131
42 Balance Sheet Totals - Final Comparable Group 132
43 Balance Sheet - Asset Composition - Most Recent Quarter 133
44 Balance Sheet - Liability and Equity - Most Recent Quarter 134
45 Income and Expense Comparison Trailing Four Quarters 135
46 Income and Expense Comparison as a Percent of
Average Assets - Trailing Four Quarters 136
47 Yields, Costs and Earnings Ratios - Trailing Four Quarters 137
48 Dividends, Reserves and Supplemental Data 138
49 Valuation Analysis and Conclusions 139
50 Comparable Group Market, Pricing and Financial Ratios 140
51 Projected Effects of Conversion Proceeds - Minimum 141
52 Projected Effects of Conversion Proceeds - Midpoint 142
53 Projected Effects of Conversion Proceeds - Maximum 143
54 Projected Effects of Conversion Proceeds - Maximum, as Adjusted 144
55 Summary of Valuation Premium or Discount 145
ALPHABETICAL EXHIBITS
A Background and Qualifications 146
B RB 20 Certification 147
C Affidavit of Independence 148
INTRODUCTION
Keller & Company, Inc. is an independent appraisal firm for financial
institutions, and has prepared this Conversion Appraisal Report ("Report") which
provides the pro forma market value of the to-be-issued common stock of
Monadnock Bancorp, Inc. (the "Corporation"), a Maryland corporation, in
connection with the conversion of Monadnock Mutual Holding Company from the
mutual to the stock form of organization. The shares of common stock to be
issued represent the majority interest in Monadnock Community Bancorp, Inc.,
which was formed in June 2004 as a mid-tier holding company, owned by Monadnock
Mutual Holding Company. Monadnock Community Bank is a subsidiary of Monadnock
Community Bancorp, Inc. Upon completion of the conversion, Monadnock Community
Bancorp, Inc., will cease to exist and will be succeeded by the Corporation.
Under the Plan of Conversion, Monadnock Mutual Holding Company will also cease
to exist, with Monadnock Community Bank becoming a wholly-owned subsidiary of
the Corporation. The existing shares of stock in Monadnock Community Bancorp
will be exchanged for new shares of stock in the Corporation based on their
current appraised value as determined in this Report.
The Application is being filed with the Office of Thrift Supervision
("OTS") of the Department of the Treasury and the Securities and Exchange
Commission ("SEC"). In accordance with the conversion, there will be an issuance
of 54.7 percent of the Corporation's stock representing the ownership of
Monadnock Mutual Holding Company in the Corporation. Such Application for
Conversion has been reviewed by us, including the Prospectus and related
documents, and discussed with the Bank's management and the Bank's conversion
counsel, Luse Gorman Pomerenk & Schick, P.C., Washington, D.C.
This conversion appraisal was prepared based on the guidelines provided by
OTS entitled "Guidelines for Appraisal Reports for the Valuation of Savings
Institutions Converting from the Mutual to Stock Form of Organization", in
accordance with the OTS application requirements of Regulation Section563b and
the OTS's Revised Guidelines for Appraisal Reports, and represents a full
appraisal report. The Report provides detailed exhibits based on the Revised
1
INTRODUCTION (CONT.)
Guidelines and a discussion on each of the fourteen factors that need to be
considered. Our valuation will be updated in accordance with the Revised
Guidelines and will consider any changes in market conditions for thrift
institutions.
The pro forma market value is defined as the price at which the stock of
the Corporation after conversion would change hands between a typical willing
buyer and a typical willing seller when the former is not under any compulsion
to buy and the latter is not under any compulsion to sell, and with both parties
having reasonable knowledge of relevant facts in an arm's-length transaction.
The appraisal assumes the Bank is a going concern and that the shares issued by
the Corporation in the conversion are sold in noncontrol blocks.
In preparing this conversion appraisal, we have reviewed the financial
statements for the five fiscal years ended December 31, 2005, and discussed them
with Monadnock's management and with Monadnock's independent auditors,
Shatswell, MacLeod & Company, P.C., West Peabody, Massachusetts.. We have also
discussed and reviewed with management other financial matters and have reviewed
internal projections. We have reviewed the Corporation's preliminary Form SB-2
and the Bank's preliminary Form AC and discussed them with management and with
the Bank's conversion counsel.
We have visited Monadnock's home office and have traveled the surrounding
area. We have studied the economic and demographic characteristics of the
primary market area, and analyzed the Bank's primary market area relative to New
Hampshire, Massachusetts and the United States. We have also examined the
competitive market within which Monadnock operates, giving consideration to the
area's numerous financial institution offices, mortgage banking offices, and
credit union offices and other key market area characteristics, both positive
and negative.
We have given consideration to the market conditions for securities in
general and for publicly-traded thrift stocks in particular. We have examined
the performance of selected
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INTRODUCTION (CONT.)
publicly-traded thrift institutions and compared the performance of Monadnock to
those selected institutions.
Our valuation is not intended to represent and must not be interpreted to
be a recommendation of any kind as to the desirability of purchasing the
to-be-outstanding shares of common stock of the Corporation. Giving
consideration to the fact that this appraisal is based on numerous factors that
can change over time, we can provide no assurance that any person who purchases
the stock of the Corporation in this mutual-to-stock conversion will
subsequently be able to sell such shares at prices similar to the pro forma
market value of the Corporation as determined in this conversion appraisal.
3
I. DESCRIPTION OF MONADNOCK COMMUNITY BANK
GENERAL
Monadnock Community Bank, Peterborough, New Hampshire, was organized in
1996 as a federally-chartered mutual savings bank with the name Monadnock
Community Bank. In June 2004, the Bank formed its mutual holding company,
Monadnock Mutual Holding Company, and its mid-tier holding company, Monadnock
Bancorp, Inc., becoming the subsidiary of the Corporation and completing a
minority stock offering.
Monadnock conducts its business from its main office in Peterborough and
branch office in Winchenden, Massachusetts in Worchester County. The Bank
currently has no plan to open another branch or a new loan office. The Bank's
primary retail market area is comprised of Hillsborough County, New Hampshire
and Worcester County, Massachusetts, and its extended lending market also
includes Cheshire County, New Hampshire.
Monadnock's deposits are insured up to applicable limits by the Federal
Deposit Insurance Corporation ("FDIC") in the Savings Association Insurance Fund
("SAIF"). The Bank is also subject to certain reserve requirements of the Board
of Governors of the Federal Reserve Bank (the "FRB"). Monadnock is a member of
the Federal Home Loan Bank (the "FHLB") of Boston and is regulated by the OTS
and by the FDIC. As of December 31, 2005, Monadnock had assets of $75,801,000,
deposits of $53,238,000, and equity of $4,954,000.
Monadnock is a community-oriented financial institution which has been
principally engaged in the business of serving the financial needs of the public
in its local communities and throughout its market area. Monadnock has been
actively and consistently involved in the origination of one-to four-family
mortgage loans which represented 52.9 percent of its loan portfolio at December
31, 2005, excluding an additional 13.0 percent of home equity loans, and a
similar 52.7 percent of its loan portfolio at fiscal year end December 31, 2004.
4
GENERAL (CONT.)
At December 31, 2005, 87.2 percent of the Bank's gross loans consisted of
all types of real estate loans, compared to a higher 90.3 percent at December
31, 2004, with the primary sources of funds being retail deposits from residents
in its local communities and moderate levels of FHLB advances. The Bank is also
an originator of commercial real estate loans, multi-family loans, construction
loans, commercial loans, and consumer loans. Consumer loans include loans on
savings accounts, automobile loans, mobile home loans and other secured and
unsecured personal loans.
The Bank had $3.9 million, or 5.2 percent of its assets in cash and
investments excluding FHLB stock and mortgage-backed securities. The Bank had an
additional $1.2 million, or 1.6 percent of its assets in FHLB stock, with the
combined total of investment securities, FHLB stock and cash and cash
equivalents being $5.1 million or 6.7 percent of assets. The Bank had $24.6
million in mortgage-backed securities. Deposits, FHLB advances and equity have
been the primary sources of funds for the Bank's lending and investment
activities.
The Bank's gross amount of stock to be sold in the second stage offering
will be $4,923,000 or 615,375 shares at $8 per share based on the midpoint of
the appraised value of $9.0 million, and representing 54.7 percent of the total
value. The net conversion proceeds will be $4.3 million reflecting conversion
expenses of approximately $670,000. The actual cash proceeds to the Bank of $3.8
million will represent ninety percent of the net conversion proceeds. The ESOP
will represent 6.0 percent of the gross shares issued, or 36,922 shares at $8
per share, representing $295,376. The Bank's net proceeds will be invested in
residential and nonresidential real estate loans and initially invested in short
term investments. The Bank may also use the proceeds to expand services, expand
operations or acquire other financial service organizations, diversification
into other businesses, or for any other purposes authorized by law. The
Corporation will use its proceeds to fund the ESOP, to purchase short- and
intermediate-term government or federal agency securities or to invest in
short-term deposits.
5
GENERAL (CONT.)
Monadnock has seen a modest overall deposit increase over the past year
with deposits increasing 15.5 percent from December 31, 2004, to December 31,
2005. The Bank has focused on increasing its one- to four-family real estate
loan portfolio with a lesser increase in home equity and commercial business
loans, impacted by decreases in construction loans, commercial real estate loans
and multi-family loans during the past year, monitoring its earnings and
nonperforming assets. Equity to assets decreased from 7.37 percent of assets at
December 31, 2004, to 6.54 percent at December 31, 2005.
Monadnock's primary lending strategy has been to focus on the origination
of both adjustable-rate and fixed-rate, one-to four-family loans, commercial
real estate loans, construction loans, multi-family loans, commercial loans, and
the origination of consumer loans and home equity loans.
Monadnock's share of one- to four-family loans has increased slightly from
52.7 percent of gross loans at December 31 2004, to 52.9 percent as of December
31, 2005. Home equity loans increased from 7.7 percent of gross loans at
December 31, 2004, to 13.0 percent at December 31, 2005. Commercial real estate
loans decreased from 26.7 percent to 18.9 percent from December 31, 2004, to
December 31, 2005. Multi-family loans decreased from 1.7 percent at December 31,
2004, to 1.3 percent at December 31, 2005. Construction loans decreased from 1.4
percent at December 31, 2004, to 1.1 percent at December 31, 2005. All types of
mortgage loans as a group decreased modestly from 90.3 percent of gross loans at
December 31, 2004, to 87.2 percent at December 31, 2005. The decrease in
mortgage loans was offset by the Bank's modest increase in consumer and
commercial loans. The Bank's share of consumer and commercial loans witnessed an
increase in their share of loans from 9.7 percent at December 31, 2004, to 12.8
percent at December 31, 2005.
Management's internal strategy has also included continued emphasis on
maintaining an adequate and appropriate allowance for loan losses relative to
loans and nonperforming assets in recognition of the more stringent requirements
within the industry to establish and
6
GENERAL (CONT.)
maintain a higher level of general valuation allowances and also in recognition
of the Bank's continued increase in lending, particularly one- to four-family
loans, home equity loans, commercial loans and consumer loans. At December 31,
2004, Monadnock had $325,000 in its loan loss allowance or 0.91 percent of gross
loans, which decreased to $311,000 and represented a lesser 0.70 percent of
gross loans at December 31, 2005.
Interest income from loans and investments has been the primary basis of
earnings with the net interest margin being the key determinant of net earnings.
With a dependence on net interest margin for earnings, current management will
focus on strengthening the Bank's net interest margin without undertaking
excessive credit risk and will not pursue any significant change in its interest
rate risk position.
PERFORMANCE OVERVIEW
Monadnock's financial position for the two most recent fiscal years ended
December 31, 2004 and 2005 is highlighted through the use of selected financial
data in Exhibit 5. Monadnock has focused on maintaining a reasonable equity
position, controlling its overhead ratio, increasing its loan and deposit
levels, decreasing its mortgage-backed securities, and striving to control its
net interest margin. Monadnock has experienced a moderate increase in assets
from December 31, 2004 to December 31, 2005, with a similar increase in
deposits, and a decrease in equity over the same period. Such increase in assets
was focused on an increase in mortgage loans. Assets, loans and deposits have
all increased from December 31, 2004, to December 31, 2005.
Monadnock witnessed an increase in assets of $5.0 million or 7.1 percent
for the period of December 31, 2004, to December 31, 2005. The Bank's net loan
portfolio, including mortgage loans and non-mortgage loans, increased from $35.6
million at December 31, 2004, to $49.5 million at December 31, 2005, and
represented a total increase of
7
PERFORMANCE OVERVIEW (CONT.)
$8.9 million, or 25.0 percent. This increase was primarily the result of a
higher level of one- to four-family real estate loans.
Monadnock has pursued obtaining funds through deposits and has also made
moderate use of FHLB advances during the period of December 31, 2004, to
December 31, 2005. The Bank's competitive rates for savings in its local market
in conjunction with its focus on service have been the sources and strategies
for attracting retail deposits. Deposits increased 13.3 percent from December
31, 2004, to December 31, 2005. The Bank's increase in deposits is primarily the
result of Monadnock's more aggressive pricing of deposits. The Bank's level of
FHLB advances has decreased from $19.4 million at December 31, 2004, to $17.5
million at December 31, 2005.
Monadnock has witnessed a decrease in its equity level and ratio from
December 31, 2004, to December 31, 2005. At December 31, 2004, the Bank had
equity of $5.2 million representing a 7.37 percent equity to assets ratio and
then decreasing to $5.0 million by December 31, 2005, and representing a 6.54
percent equity to assets ratio. The modest decrease in the equity to assets
ratio from December 31, 2004, to December 31, 2005, is the result of the Bank's
net loss in 2005 accented by a moderate increase in assets. Equity decreased 5.0
percent from December 31, 2004, to December 31, 2005.
8
INCOME AND EXPENSE
Exhibit 6 presents selected operating data for Monadnock, reflecting the
Bank's income and expense trends. This table provides key income and expense
figures in dollars for the fiscal years of 2004 and 2005.
Monadnock has witnessed an overall increase in its dollar level of
interest income from fiscal year ended December 31, 2004, to December 31, 2005,
due to the Bank's increase in yield on interest-earning assets, as a result of
the rise in interest rates combined with the Bank's growth in loans. Interest
income increased from $2.5 million in 2004 to $3.5 million in 2005. In fiscal
year 2005, interest income increased $965,000 or 38.4 percent to $3.48 million.
The Bank's interest expense experienced a similar trend with an increase
in the fiscal year 2005. Interest expense increased $707,000 or 71.1 percent,
from 2004 to 2005, compared to a larger dollar increase in interest income of
$965,000 or 38.4 percent, for the same time period. Such increase in interest
income, recognizing the increase in interest expense, resulted in a moderate
dollar increase in annual net interest income of $258,000 or 17.0 percent for
the fiscal year ended December 31, 2005, but a decrease in net interest margin
and net interest spread.
The Bank has made provisions for loan losses in one of the past two fiscal
years of 2004 and 2005. The amounts of provisions were determined in recognition
of the Bank's levels of nonperforming assets, charge-offs, repossessed assets,
the Bank's level of lending activity, and industry norms. The loan loss
provisions were zero in 2004 and $16,000 in the year ended December 31, 2005.
The impact of these loan loss provisions has been to provide Monadnock with a
general valuation allowance of $311,000 at December 31, 2005, or 0.70 percent of
gross loans and 88.9 percent of nonperforming loans.
Total other income or noninterest income indicated modest growth from
fiscal year 2004 to 2005 with the increase in 2005 due to a rise in customer
service charges. Noninterest income was $242,000 in fiscal year 2004,
representing 0.34 percent of assets. Noninterest
9
INCOME AND EXPENSE (CONT.)
income for the year ended December 31, 2005, was $257,000 and representing 0.34
percent of assets. Noninterest income consists primarily of service charges,
fees and other income.
The Bank's general and administrative expenses or noninterest expenses
increased from $1,709,000 for the fiscal year of 2004 to $2,109,000 for the
fiscal year ended December 31, 2005. The dollar increase in noninterest expenses
was $400,000 from 2004 to 2005, representing a percentage increase of 23.4
percent. This increase in operating expenses was due primarily to the Bank's
addition of a second office in 2004. On a percent of average assets basis,
operating expenses decreased from 3.02 percent of average assets for the fiscal
year ended December 31, 2004, to 2.78 percent for the fiscal year ended December
31, 2005, which was higher than the current industry average of approximately
2.08 percent.
The net earnings position of Monadnock has indicated modest earnings in
2004 and modest loss in 2005. The annual net income figures for the past two
fiscal years of 2004 and 2005 were $32,000 and a loss of $30,000, representing
returns on average assets of 0.06 percent and (0.04) percent, respectively.
Exhibit 7 provides the Bank's normalized earnings or core earnings for
fiscal year 2005. The Bank's normalized earnings eliminate any nonrecurring
income and expense items. There were no adjustments for fiscal year 2005.
The key performance indicators comprised of selected operating ratios,
asset quality ratios and equity ratios are shown in Exhibit 8 to reflect the
results of performance. The Bank's return on assets decreased from 0.06 percent
in fiscal year 2004, to (0.04) percent in fiscal year 2005.
The Bank's average net interest rate spread decreased from 2.51 percent in
fiscal year 2004 to 2.12 percent in fiscal year 2005, representing a decrease of
39 basis points. The Bank's
10
INCOME AND EXPENSE (CONT.)
net interest margin indicated a similar trend, decreasing from 2.73 percent in
fiscal year 2004 to 2.41 percent in fiscal year 2005, representing a decrease of
32 basis points.
The Bank's return on average equity decreased from 2004 to 2005. The
return on average equity decreased from 0.84 percent in 2004 to (0.59) percent
in fiscal year 2005.
Monadnock's ratio of average interest-earning assets to average
interest-bearing liabilities decreased slightly from 112.48 percent at December
31, 2004, to a lesser 112.17 percent at December 31, 2005.
The Bank's ratio of noninterest expenses to average assets decreased from
3.02 percent in fiscal year 2004, to a moderately lower 2.78 percent in fiscal
year 2005, due to the Bank's larger growth in assets. Another key noninterest
expense ratio reflecting efficiency of operation is the ratio of noninterest
expenses to noninterest income plus net interest income referred to as the
"efficiency ratio". The industry norm is 58.9 percent with the lower the ratio
indicating higher efficiency. The Bank has been characterized with a lower level
of efficiency reflected in its higher efficiency ratio, which increased from
96.92 percent in 2004 to 103.57 percent in 2005.
Earnings performance can be affected by an institution's asset quality
position. The ratio of nonperforming assets to total assets is a key indicator
of asset quality. Monadnock witnessed a modest increase in its nonperforming
asset ratio from fiscal year 2004 to December 31, 2005. Nonperforming assets
consist of loans delinquent 90 days or more, nonaccruing loans and repossessed
assets. The Bank's nonperforming assets were comprised primarily of nonaccrual
loans. The ratio of nonperforming assets to total assets was 0.30 percent at
December 31, 2004, and increased to 0.46 percent at December 31, 2005. The
Bank's allowance for loan losses was December 31, 2005, resulting primarily from
the Bank's increase in loans combined with minimal charge-offs in 2005. As a
percentage of nonperforming loans,
11
INCOME AND EXPENSE (CONT.)
Monadnock's allowance for loan losses decreased from 163.32 percent at December
31, 2004, to 88.86 percent at December 31, 2005.
Exhibit 9 provides the changes in net interest income due to rate and
volume changes for the fiscal year of 2005. In fiscal year 2005, net interest
income increased $258,000, due to an increase in interest income of $965,000
offset by a $707,000 increase in interest expense. The increase in interest
income was due to an increase due to volume of $689,000, accented by an increase
due to rate of $206,000 and an increase due to a combination of rate and volume
of $70,000. The increase in interest expense was due to an increase due to
volume of $440,000 accented by an increase due to a change in rate of $201,000
and an increase due to a combination of rate and volume of $66,000.
12
YIELDS AND COSTS
The overview of yield and cost trends for the years ended December 31,
2004 and 2005, can be seen in Exhibit 10, which offers a summary of key yields
on interest-earning assets and costs of interest-bearing liabilities.
Monadnock's weighted average yield on its loan portfolio increased 24
basis points from fiscal year 2004 to 2005, from 5.64 percent to 5.88 percent
and then increased another 27 basis points at December 31, 2005. The yield on
mortgage-backed securities increased 40 basis points from fiscal year 2004 to
2005 from 2.99 percent to 3.39 percent and increased another 45 basis points at
December 31, 2005 to 3.84 percent. The yield on agency securities was 3.75 for
the year ended December 31, 2005, with no agency securities in 2004. The yield
on agency securities increased 28 basis points or 1.03 percent at December 31,
2005. The yield on interest-earning assets increased 199 basis points from
fiscal year 2004 to 2005, from 1.01 percent to 3.00 percent and then increased
85 basis points at December 31, 2005, to 3.85 percent. The combined weighted
average yield on all interest-earning assets increased 18 basis points to 4.70
percent form 2004 to 2005 and then increased another 56 basis points to 5.26
percent at December 31, 2005.
Monadnock's weighted average cost of interest-bearing liabilities
increased 57 basis points from fiscal year 2004 to 2005, which was greater than
the Bank's 18 basis point increase in yield, resulting in a decrease in the
Bank's interest rate spread of 39 basis points from 2.51 percent to 2.12 percent
from 2004 to 2005. The Bank's average cost of interest-bearing liabilities then
increased 22 basis points to 2.80 percent compared to a 56 basis point increase
in yield on interest-earning assets at December 31, 2006. The result was an
increase in the Bank's interest rate spread of 34 basis points to 2.46 percent
at December 31, 2005. The Bank's net interest margin decreased from 2.73 percent
in fiscal year 2004 to 2.41 percent in fiscal year 2005.
13
INTEREST RATE SENSITIVITY
Monadnock has monitored its interest rate sensitivity position and focused
on maintaining a moderate level of rate sensitive assets by originating a
moderate share of adjustable-rate mortgage loans with a relatively high level of
home equity loans, commercial real estate loans, and adjustable-rate commercial
loans. Monadnock recognizes the thrift industry's historically higher interest
rate risk exposure, which caused a negative impact on earnings and market value
of portfolio equity in the past as a result of significant fluctuations in
interest rates, specifically rising rates in the past. Such exposure was due to
the disparate rate of maturity and/or repricing of assets relative liabilities
commonly referred to as an institution's "gap". The larger an institution's gap,
the greater the risk (interest rate risk) of earnings loss due to a decrease in
net interest margin and a decrease in market value of equity or portfolio loss.
In response to the potential impact of interest rate volatility and negative
earnings impact, many institutions have taken steps to minimize their gap
position. This frequently results in a decline in the institution's net interest
margin and overall earnings performance. Monadnock has responded to the interest
rate sensitivity issue by being a more active originator of adjustable-rate
commercial real estate loans and originating higher levels of adjustable-rate
home equity loans, commercial business loans and adjustable-rate mortgage loans.
The Bank measures its interest rate risk through the use of its net
portfolio value ("NPV") of the expected cash flows from interest-earning assets
and interest-bearing liabilities and any off-balance sheet contracts. The NPV
for the Bank is calculated on a quarterly basis, by the OTS, showing the change
in the NPV for the Bank under rising and falling interest rates. Such changes in
NPV under changing rates is reflective of the Bank's interest rate risk
exposure.
There are numerous factors which have a measurable influence on interest
rate sensitivity in addition to changing interest rates. Such key factors to
consider when analyzing interest rate sensitivity include the loan payoff
schedule, accelerated principal payments, deposit maturities, interest rate caps
on adjustable-rate mortgage loans and deposit withdrawals.
14
INTEREST RATE SENSITIVITY (CONT.)
Exhibit 11 provides the Bank's NPV as of December 31, 2005, based on OTS
calculations and the change in the Bank's NPV under rising and declining
interest rates. The focus of this exposure table is a 200 basis points change in
interest rates either up or down.
The Bank's change in its NPV at December 31, 2005, based on a rise in
interest rates of 100 basis points was a 12.0 percent decrease, representing a
dollar decrease in equity value of $701,000. In contrast, based on a decline in
interest rates of 100 basis points, the Bank's NPV was estimated to increase 5.0
percent or $309,000 at December 31, 2005. The Bank's exposure increases to a
27.0 percent decrease under a 200 basis point rise in rates. The Bank's post
shock NPV ratio is 5.89 percent at December 31, 2005, and the Bank's change in
its NPV ratio is a negative 189 basis points, based on a 200 basis point
increase in interest rates.
The Bank is aware of its higher interest rate risk exposure under rapidly
rising rates and falling rates, impacted by its lower equity to asset ratio of
6.54 percent. Due to Monadnock's recognition of the need to control its interest
rate exposure, the Bank has been a more active originator of adjustable-rate
residential mortgage loans, commercial loans and home equity loans and
adjustable-rate commercial real estate loans and plans to continue this lending
strategy with a continued emphasis on adjustable rate commercial real estate
loans.
15
LENDING ACTIVITIES
Monadnock has focused its lending activity historically on the origination
of conventional mortgage loans secured by one- to four-family dwellings with an
increasing emphasis on commercial real estate loans. Exhibit 12 provides a
summary of Monadnock's loan portfolio, by loan type, at December 31, 2004 and
2005.
Residential loans secured by one- to four-family dwellings and commercial
real estate loans were the primary loan types representing 84.8 percent of the
Bank's gross loans as of December 31, 2005. This share has seen a modest
decrease from 87.2 percent at December 31, 2004. The largest individual loan
type comprising this category was one- to four-family loans, which represented
52.9 percent of loans at December 31, 2005, decreasing from 52.7 percent at
December 31, 2004. The second largest individual loan category was commercial
real estate loans, which represented 18.9 percent of loans at December 31, 2005,
decreasing from 26.7 percent at December 31, 2004. The third largest loan type
as of December 31, 2005, was home equity loans, which comprised a 13.0 percent
share of gross loans compared to a smaller 7.7 percent as of December 31, 2004.
The multi-family loan category was the fourth largest loan type at December 31,
2005, which represented 1.3 percent of gross loans, compared to a larger 1.7
percent at December 31, 2004. The final real estate loan category was commercial
construction and residential development loans represented a minimal 1.1 percent
of gross loans at December 31, 2005, down from 1.4 percent at December 31, 2004.
These five real estate loan categories represented 87.2 percent of gross loans
at December 31, 2005, compared to a larger 90.3 percent of gross loans at
December 31, 2004.
Commercial loans represent a moderate size loan category for Monadnock
with regard to the amount of loans. Commercial loans totaled $4,340,000 and
represented 9.7 percent of total loans at December 31, 2005, compared to
$3,118,000 and 8.7 percent of total loans at December 31, 2004. Commercial loans
are included in the other loans category.
16
LENDING ACTIVITIES (CONT.)
The consumer loan category was the remaining loan category at December 31,
2005, and represented a modest 3.0 percent of gross loans compared to 0.9
percent at December 31, 2004. The primary types of consumer loans are automobile
loans, savings account loans, recreational vehicle loans and secured and
unsecured personal loans. Consumer loans were the fifth largest overall loan
type, at December 31, 2005, and the smallest loan type at December 31, 2004. The
overall mix of loans has witnessed some moderate changes from the end of fiscal
year 2004 to December 31, 2005, with the Bank having increased its shares of
home equity loans and commercial loans to offset its decrease in commercial real
estate loans.
The emphasis of Monadnock's lending activity is the origination of
conventional mortgage loans secured by one- to four-family residences. Such
residences are located in Monadnock's market area which includes all of
Hillsborough and Cheshire Counties in New Hampshire and Worcester County in
Massachusetts. The Bank also originates interim construction loans on one- to
four-family residences primarily to individual owners and to developers. At
December 31, 2005, 52.9 percent of Monadnock's gross loans consisted of loans
secured by one- to four-family residential properties, excluding construction
loans. Construction loans represented another 1.1 percent of gross loans at
December 31, 2005.
The Bank originates three-year and five-year adjustable-rate mortgage
loans ("ARMs") The initial interest rates on ARMs are indexed to the rate on
one-year and three-year U. S. Treasury securities adjusted to a constant
maturity. Three-year, and five-year ARMs have a maximum rate adjustment of 2.0
percent at each adjustment period and a maximum rate adjustment of 6.0 percent
for the life of the loan, with payments based on up to a 30 year loan term. The
Bank does not use below market interest rates to attract borrowers. The Bank
retains most of the ARMs which it originates.
The majority of ARMs have terms of up to 30 years, and fixed rate loans
have normal terms of 15 to 30 years. The Bank has retained its ARMs and short
term fixed-rate loans. Historically, the majority of Monadnock's one-to
four-family mortgage loan portfolio has been
17
LENDING ACTIVITIES (CONT.)
fixed-rate mortgage loans, which represented 67.2 percent of one-to four-family
mortgage loans at December 31, 2005, with 32.8 percent being ARMs.
The normal loan-to-value ratio for conventional mortgage loans to purchase
or refinance one-to four-family dwellings generally does not exceed 80 percent
at Monadnock, even though the Bank will grant loans with up to a 95 percent loan
to value ratio, but private mortgage insurance is generally required for loans
with a loan-to-value ratio in excess of 80.0 percent. Mortgage loans originated
by the Bank include due-on-sale clauses enabling the Bank to adjust rates on
fixed-rate loans in the event the borrower transfers ownership. The Bank
normally exercises its rights under these clauses.
The Bank uses the services of a mortgage company to originate the majority
of the Bank's one-to four-family mortgage loans in order to be more
cost-effective. The Bank accepts the loan application and then prepares the
material for submission to the mortgage company for underwriting, processing and
closing the loan. These loans are funded by the mortgage company with Monadnock
having an option to purchase the loan. The Bank purchased $5.5 million of the
$6.1 million mortgage loans originated in 2005.
Monadnock originates multi-family loans in its market area. Multi-family
loans totaled $597,000 at December 31, 2005, and represented 1.3 percent of
loans. The Bank originates primarily adjustable-rate multi-family loans with a
maximum loan-to-value ratio of 80.0 percent.
Monadnock has also been a relatively active originator of commercial real
estate loans. The Bank will continue to make commercial real estate loans. The
Bank had a total of $8.4 million in commercial real estate loans at December 31,
2005, or 18.9 percent of gross loans, compared to $9.6 million or 26.7 percent
of gross loans at December 31, 2004. The major portion of commercial real estate
loans are secured by office buildings, retail stores, churches and other
commercial properties and are located in the Bank's primary market area.
18
LENDING ACTIVITIES (CONT.)
The Bank has been relatively active in the origination of home equity
loans, which totaled $5.8 million at December 31, 2005, representing 13.0
percent of loans. The Bank's home equity loans have adjustable rates tied to the
prime rate with a normal loan to value ratio of 80.0 percent, including the
first mortgage. Home equity loans have a maturity period of 20 years with a
10-year draw period.
The Bank also originates commercial loans to area businesses which totaled
$4.3 million and represented 9.7 percent of loans at December 31, 2005. Such
business loans include term loans and lines of credit and are generally secured
by equipment, inventory and accounts receivable. Monadnock has been less active
in consumer lending. Consumer loans originated consist primarily of automobile
loans, secured and unsecured personal loans, and savings account loans and
represented $1.3 million or 3.0 percent of gross loans at December 31, 2005, up
from $336,000 or 0.9 percent of loans at December 31, 2004.
Exhibit 13 provides a loan maturity schedule and breakdown and summary of
Monadnock's fixed-rate and adjustable-rate loans, indicating a majority of
adjustable-rate loans. At December 31, 2005, 44.0 percent of the Bank's total
loans due after December 31, 2006, were fixed-rate and 56.0 percent were
adjustable-rate. The Bank has a modest 14.1 percent of its loans at December 31,
2004, due in 10 years or less and an additional 26.7 percent due in 11 to 15
years.
As indicated in Exhibit 14, Monadnock experienced a significant decrease
in its one- to four-family loan originations and total loan originations from
fiscal year 2004 to 2005. Total loan originations in fiscal year 2004 were $12.3
million compared to a higher $19.7 million in fiscal year 2005, reflective of a
higher level of one- to four-family loans originated, increasing from $4.8
million to $6.9 million. The increase in one- to four-family real estate loan
originations from 2004 to 2005 of $2.1 million represented 28.4 percent of the
$7.4 million aggregate increase in total loan originations from 2004 to 2005,
with home equity loans increasing $3.6 million and representing 49.1 percent of
the total increase in loan originations.
19
LENDING ACTIVITIES (CONT.)
Commercial real estate loans decreased $179,000 from 2004 to 2005, and
commercial loans originated increased $1.2 million. Consumer loans increased
$1.1 million from 2004 to 2005.
20
NONPERFORMING ASSETS
Monadnock understands asset quality risk and the direct relationship of
such risk to delinquent loans and nonperforming assets including real estate
owned. The quality of assets has been a key concern to financial institutions
throughout many regions of the country. A number of financial institutions have
been confronted with recent increases in their levels of nonperforming assets
and have been forced to recognize losses by setting aside higher valuation
allowances. A sharp increase in nonperforming assets has often been related to
specific regions of the country and has frequently been associated with higher
risk loans, including purchased nonresidential real estate loans. Monadnock has
not been faced with higher levels of delinquent loans or nonperforming assets.
On a monthly basis, Monadnock's management reviews all loans delinquent 30
days or more, to assess their collectibility and to initiate any direct contact
with borrowers. When a loan is delinquent, the Bank sends the borrower a late
payment notice within 15 days after the payment is due. The Bank then initiates
both written and oral communication with the borrower if the loan remains
delinquent for 60 days. When the loan becomes delinquent at least 90 days, the
Bank will commence foreclosure proceedings. The Bank does not normally accrue
interest on loans past due 90 days or more. Most loans delinquent 90 days or
more are placed on a nonaccrual status, and at that point in time the Bank
pursues foreclosure procedures or may decide to modify the loan or grant a
limited moratorium to allow the borrower to reorganize his financial affairs.
Exhibit 15 provides a summary of Monadnock's delinquent loans at December
31, 2004, and at December 31, 2005. Delinquent loans include loans 60 to 89 days
past due and loans 90 days or more past due. The Bank had $259,900 in delinquent
loans at December 31, 2004, and increasing slightly to $350,000 at December 31,
2005. The major share of delinquent loans consist of commercial real estate
loans, which represented 61.7 percent of delinquent loans at December 31, 2005,
with the remainder being commercial business loans.
21
NONPERFORMING ASSETS (CONT.)
Exhibit 16 provides a summary of Monadnock's nonperforming assets at
December 31, 2004, at December 31, 2005. Nonperforming assets consist of
nonaccrual loans, loans delinquent 90 days or more and real estate owned
including other repossessed assets. The Bank has historically carried a lower
level of nonperforming assets, and these assets have increased from 2004 to
2005. Monadnock's level of nonperforming assets increased from $212,000 or 0.30
percent of assets at December 31, 2004, to $350,000 or 0.52 percent of assets at
December 31, 2005. At December 31, 2005, Monadnock's nonperforming assets
consisted of $350,000 in nonaccrual loans, with no loans 90 days or more past
due and no real estate owned.
Monadnock's level of nonperforming assets was higher than its level of
classified assets. The Bank's level of classified assets was $97,000 or 0.13
percent of assets at December 31, 2005 (reference Exhibit 17). The Bank's
classified assets consisted of $97,000 in substandard assets, with no assets
classified as doubtful and no assets classified as loss. The Bank had $435,000
in classified assets at December 31, 2004, with all of them classified as
substandard.
Exhibit 18 shows Monadnock's allowance for loan losses for fiscal years
ended December 31, 2004 and 2005, indicating the activity and the resultant
balances. Monadnock has witnessed a slight decrease in its balance of allowance
for loan losses from $325,000 at December 31, 2004, to $311,0000 at December 31,
2005. The balance in allowance for loan losses decreased from December 31, 2004,
to December 31, 2005, due to a credit to loan loss provisions. The Bank's ratio
of allowance for loan losses to gross loans decreased from 0.91 percent at
December 31, 2004, to 0.70 percent at December 31, 2005. The ratio of allowance
for loan losses to nonperforming loans was 163.32 percent at December 31, 2004,
and a lower 88.86 percent at December 31, 2005, reflecting the increase in
nonperforming loans.
22
INVESTMENTS
The investment securities portfolio of Monadnock has been comprised of
U.S. Government and federal agency securities, mortgage-backed securities,
interest-bearing deposits in financial institutions, FHLB stock and other
investments. Exhibit 19 provides a summary of Monadnock's investment securities
at December 31, 2004, and 2005, including FHLB stock. Investment securities,
including available-for-sale and held-to-maturity securities, totaled $32.5
million at December 31, 2004, compared to $29.0 million at December 31, 2005,
including FHLB stock of $1,220,000 at December 31, 2005. The decrease in
investment securities was primarily the result of a decrease in mortgage-backed
securities of $6.1 million from 2004 to 2005. The primary component of
investment securities at December 31, 2005, was mortgage-backed securities,
representing 94.8 percent of investments. The mortgage-backed securities had a
weighted average yield of 3.39 percent for the year ended December 31, 2005. The
Bank also had U.S. government agency securities totaling $3.0 million at
December 31, 2005, with a yield of 3.75 percent of the year ended December 31,
2005.
DEPOSIT ACTIVITIES
The change in the mix of deposits from December 31, 2004, to December 31,
2005, is provided in Exhibit 20. There has been a moderate change in both total
deposits and in the deposit mix during this period. Certificates of deposit
witnessed an increase in their share of total deposits, rising from 50.0 percent
of total deposits at December 31, 2004, to a more normal 58.0 percent of total
deposits at December 31, 2005. This increase is in contrast to the industry norm
of a slight decrease in the share of certificates. The major component of
certificates had rates between 3.01 percent and 4.00 percent and represented
55.9 percent of certificates at December 31, 2005. Regular savings accounts
decreased in dollar amount from $3.3 million to $2.8 million, and their share of
total deposits decreased from 7.2 percent to 5.2 percent from December 31, 2004,
to December 31, 2005. NOW accounts also indicated a decrease from $3.4 million
at December 31, 2004, to $3.2 million at December 31, 2005, and their share of
total deposits decreased from 7.5 percent to 6.0 percent. Noninterest-bearing
23
DEPOSIT ACTIVITIES (CONT.)
checking accounts indicated an increase from $4.4 million at December 31, 2004,
to $5.3 million at December 31, 2005, with their share of deposits increasing
from 9.6 percent in 2004 to 9.9 percent in 2005. Money market accounts had a
decrease in their share of total deposits declining from 25.8 percent to 20.9
percent during the same time period.
Exhibit 21 shows the Bank's breakdown in certificates of deposit by
maturity at December 31, 2005. Monadnock has a strong 75.6 percent of its
certificates of deposit maturing in less than one year and another 16.6 percent
maturing in one to two years. The major share of certificates had interest rates
from 3.01 percent to 4.00 percent responsible for 55.87 percent of certificates
with the second largest category having rates between 2.01 percent and 3.00
percent and representing 29.44 percent of certificates.
BORROWINGS
Monadnock has relied on retail deposits as its primary source of funds but
has also made use of FHLB advances. Exhibit 22 shows the Bank's FHLB advances
for the past two fiscal years ended December 31, 2004, and 2005. The Bank had
FHLB advances totaling $19.4 million at December 31, 2004, representing 25.5
percent of assets with such advances having decreased to $17.5 million and
representing 23.0 percent of assets at December 31, 2005. The cost of FHLB
advances has increased from 2.81 percent at December 31, 2004, to 3.26 percent
at December 31, 2005.
SUBSIDIARIES
Monadnock has no active subsidiaries.
24
OFFICE PROPERTIES
Monadnock has two full service offices with its home office located in
Peterborough in Hillsborough County, New Hampshire, and a branch in Winchenden,
Worcester County, Massachusetts (reference Exhibit 22). Monadnock owns its
branch office. The Bank's net investment in its office premises totaled $811,000
or 1.07 percent of assets at December 31, 2005.
MANAGEMENT
The president and chief executive officer of Monadnock is William M.
Pierce, Jr., who is also a director. Mr. Pierce joined the Bank in 1997 and
served the Bank as chief operating officer and vice president until 1999, when
he became president and chief executive officer. Mr. Pierce became a director of
the Bank in 1999. Mr. Pierce has over thirty years of banking experience. Other
senior officers include Karl F. Betz, senior vice president and chief financial
officer; William C. Gilson, senior vice president-senior lending officer; and
Donald R. Blanchette, senior vice president of operations. Mr. Betz has served
in his present position since November 2004. Mr. Betz previously served as the
finance officer and secretary of the board of directors for Ocean National Bank,
Portsmouth, New Hampshire, and as controller and administrative vice president
with the predecessor of Ocean National Bank, Granite Bank. William C. Gilson has
served as senior vice president and senior lending officer since April 2005,
previously holding the position of vice president of commercial lending since
March 2001. Mr. Gilson has over thirty years of commercial lending experience.
Donald R. Blanchette serves the Bank as senior vice president of operations, a
position he has held since 1998. Mr. Blanchette previously served the Bank as
treasurer from 1998 until November 2004.
25
II. DESCRIPTION OF PRIMARY MARKET AREA
Monadnock Community Bank's market area encompasses Hillsborough County,
New Hampshire and Worcester County, Massachusetts, and its extended lending
market also includes Cheshire County, New Hampshire.
Exhibit 26 provides a summary of key demographic data and trends for
Cheshire and Hillsborough Counties in New Hampshire, Worcester County in
Massachusetts, New Hampshire and the United States. From 1990 to 2000,
population increased in the market area counties as well as in New Hampshire and
the United States. The population increased by 5.3 percent in Cheshire County,
increased by 13.3 percent in Hillsborough County and increased by 5.8 percent in
Worcester County. Population increased by 11.4 percent in New Hampshire and 13.2
percent in the United States. The population in 2005 indicated a minimal
decrease in population from 2000 to 2005 in Cheshire County, while Hillsborough
and Worcester Counties indicated increases in population of 6.5 percent and 5.3
percent, respectively, compared to a 6.7 percent increase in New Hampshire and
6.1 percent in the United States. Future population projections indicate that
population will continue to increase in the market area counties from 2005
through the year 2010. The market area counties' population figures are
projected to increase by 12.0 percent in Cheshire County, by 6.4 percent in
Hillsborough County and by 6.0 percent in Worcester County, with the populations
of New Hampshire and the United States both projected to increase by 6.3 percent
..
The market area experienced an increase in households from 1990 to 2000.
During that time period, the number of households increased in Cheshire County
by 9.4 percent, in Hillsborough County by 16.0 percent, in Worcester County by
9.1 percent, in New Hampshire by 15.4 percent and in the United States by 14.7
percent. The trend in household growth from 2000 to 2005 indicates a minimal
increase in the Cheshire County of 2.3 percent, with Hillsborough and Worcester
Counties increasing in households by 7.2 percent and 5.7 percent, respectively.
New Hampshire also indicated an increase of 8.1 percent, higher than the United
States' increase of 6.6 percent. From 2005 through the year 2010, the market
area counties' households are projected to continue to increase by 7.9 percent,
6.9 percent and 6.4
26
DESCRIPTION OF PRIMARY MARKET AREA (CONT.)
percent in Cheshire, Hillsborough and Worcester Counties, respectively, while
the number of households are expected to increase by 7.1 percent in New
Hampshire and by 6.5 percent in the United States.
In 1990, the per capita income in the market area counties had 1990 per
capita income levels of $13,887 in Cheshire County, $17,404 in Hillsborough
County and $15,505 in Worcester County, while New Hampshire and the United
States had 1990 per capita income levels of $15,959 and $14,420, respectively.
From 1990 to 2000, per capita income increased in all areas. The market area
counties' per capita income increased from 1990 to 2000 by 49.0 percent to
$20,685 in Cheshire County, by 44.8 percent to $25,198 in Hillsborough County
and by 48.2 percent to $22,983 in Worcester County. Per capita income increased
by 49.4 percent in New Hampshire to $23,844 and by 49.7 percent to $21,587 in
the United States. From 2000 to 2005, per capita income continued to increase by
25.8 percent, 25.7 percent and 28.1 percent to $26,016 $31,667 and $29,445 in
Cheshire, Hillsborough and Worcester Counties and by 25.8 percent to $29,997 in
New Hampshire and by 21.5 percent to $26,228 in the United States.
The 1990 median household income of $31,648, 40,404 and $35,774, in the
market area counties of Cheshire County, Hillsborough County and Worcester
County, respectively, was higher than the median household income in the United
States at $30,056. From 1990 to 2000, median household income increased in all
areas, with Cheshire County indicating a 33.9 percent increase to $42,382,
Hillsborough County indicating a 32.1 percent in crease to $53,384 and Worcester
County indicating a 33.8 percent increase to $47,874, compared to a 36.2 percent
increase to $49,467 in New Hampshire and a 39.7 percent increase to $41,994 in
the United States. From 2000 to 2005, median household income in the market area
counties was estimated to have increased 19.8 percent 21.2 percent and 6.3
percent to $50,785, $64,728 and $50,888 in Cheshire, Hillsborough and Worcester
Counties.. New Hampshire's median household income grew 20.4 percent to $59,545,
and the United States' increase was 18.5 percent to $49,747 from 2000 to 2005.
From 2005 to 2010, median household income
27
DESCRIPTION OF PRIMARY MARKET AREA (CONT.)
is projected to decrease by 0.8 percent in Cheshire County, but increase by 18.7
percent Hillsborough County, by 40.8 percent in Worcester County, by 20.3
percent in New Hampshire and by 17.4 percent in the United States. Based on
those rates of increase, by 2010, median household income is expected to be
$50,400 in Cheshire County, $76,842 in Hillsborough County, $71,668 in Worcester
County, $71,652 in New Hampshire, and $58,384 in the United States.
Exhibit 27 provides a summary of key housing data for the market area
counties, New Hampshire and the United States. In 1990, Cheshire County had a
rate of owner-occupancy of 70.4 percent, higher than Hillsborough and Worcester
Counties, New Hampshire and the United States at 63.7 percent, 61.4 percent,
68.2 percent and 64.2 percent, respectively. As a result, Cheshire County
supported a lower rate of renter-occupied housing of 29.6 percent, compared to
36.3 percent in Hillsborough County, 38.6 percent in Worcester County, 31.8
percent for New Hampshire and 35.8 percent for the United States. In 2000,
owner-occupied housing increased in all the areas to 70.8 percent, 64.9 percent,
64.1 percent, 69.7 percent and 66.2 percent in Cheshire, Hillsborough and
Worcester Counties, New Hampshire and the United States, respectively.
Conversely, the renter-occupied rates decreased in all areas to levels of 29.3
percent, 35.1 percent, 35.9 percent, 30.3 and 33.8 percent in the market area
counties, New Hampshire and the United States, respectively.
The market area counties' 1990 median housing values were 111,000,
$137,100 and $139,600, higher than the United States' median housing value of
$78,500. The 1990 median rents in the market area counties was $516, $588 and
$522, compared to the median rent of New Hampshire at $549 and the United States
at $447. In 2000, median housing values had increased slightly in the market
area counties, actually decreasing in Cheshire County, while increasing in New
Hampshire and the United States. The market area counties had 2000 median
housing values of $105,300, $139,100 and $146,000 in Cheshire, Hillsborough
Counties with New Hampshire at $133,300 and the United States at $119,600. The
2000
28
DESCRIPTION OF PRIMARY MARKET AREA (CONT.)
median rents were $596, $694 and $580 in the market area counties, and $646 and
$602 in New Hampshire and the United States, respectively.
In 1990, the major source of employment for the market area by industry
group, based on share of employment, was the services industry at an average of
34.2 percent. The services industry was also responsible for the majority of
employment in New Hampshire and the United States with 34.6 percent of jobs in
New Hampshire and 37.5 percent in the United States (reference Exhibit 28). The
manufacturing industry was the second major employer in the market area at 24.3
percent, as was the manufacturing sector the second leading employer at 22.6
percent in New Hampshire. The wholesale/retail trade sector was the second major
employer with 21.2 percent in the United States. The wholesale/retail trade
group was the third major overall employer in the market area at 21.0 percent.
In New Hampshire, the wholesale/retail sector was the third major employer,
responsible for 21.7 percent of employment. The manufacturing group was the
third major employer in the United States at 17.7 percent. The construction
group, finance, insurance and real estate group, transportation/utilities group,
and the agriculture/mining groups combined to provide 20.5 percent of employment
in the market area, 21.1 percent of employment in New Hampshire and 23.6 percent
in the United States.
In 2000, the services industry, manufacturing industry and
wholesale/retail trade industry provided the first, second and third highest
levels of employment, respectively, for the market area and New Hampshire,
unlike the United States where the services industry, wholesale/retail trade and
manufacturing industries provided the first, second and third highest sectors of
employment. The services industry accounted for 41.3 percent, 43.8 percent and
46.7 percent in the market area, New Hampshire and the United States,
respectively. The manufacturing industry provided for 18.9 percent, 18.1 percent
and 14.1 percent in the same respective areas. The wholesale/retail trade group
provided 18.3 percent, 17.3 percent and
29
DESCRIPTION OF PRIMARY MARKET AREA (CONT.)
15.3 percent of employment in the market area, New Hampshire and the United
States, respectively.
Some of the largest employers in the area are listed below.
Number of
Employer Business Employees
- -------------------------------------- ----------------------------- ----------
NH Ball Bearings Precision bearings 450
Monadnock Community
Hospital Health care 400
Peterborough Public
School System Education 266
Eastern Mountain Sports Outdoor equipment 224
Millard Group Inc. Mailing list brokerage 210
Staff Dev. For Educators Educational Seminars 175
Rivermead Retirement community 100
Harborside Health Care Nursing home 90
Unemployment rates are another key economic indicator. Exhibit 29 shows
the unemployment rates in Cheshire, Hillsborough and Worcester Counties, New
Hampshire and the United States in 2001 through December 2005. Cheshire County
has been characterized by the lowest unemployment rates compared to Hillsborough
and Worcester Counties, New Hampshire and the United States. In 2001, Cheshire
County had an unemployment rate of 3.0 percent, compared to unemployment rates
of 3.5 percent in Hillsborough County, 3.9 percent in Worcester County, 3.4
percent in New Hampshire and 4.8 percent in the United States. Unemployment
rates increased in 2002 to 3.6 percent in Cheshire County, compared to 4.9
percent in Hillsborough County, 5.6 percent in Worcester County, 4.5 percent in
New Hampshire and 5.8 percent in the United States. In 2003, the unemployment
rate remained the same in Cheshire County at 3.6 percent. Hillsborough County's
rate decreased slightly to 4.8 percent, Worcester County's rate increased to 6.2
percent, New Hampshire also decreased to 4.4 percent, and the United States
increased to 6.1 percent. In 2004, Cheshire County's unemployment rate decreased
to 3.3 percent. All other areas also decreased in rates of unemployment to 3.9
percent and 5.5 percent in Hillsborough County and Worcester Count compared to
decreases to 3.9 percent in New Hampshire and 6.0 percent in the United States.
30
DESCRIPTION OF PRIMARY MARKET AREA (CONT.)
Through December 2005, all areas had decreases in unemployment rates. The market
area counties' unemployment rates decreased to 2.9 percent, 3.4 percent and 4.7
percent in Cheshire County, Hillsborough County and Worcester County, and the
unemployment rates in New Hampshire and the United States decreased to 3.2
percent and 5.6 percent, respectively.
Exhibit 30 provides deposit data for banks and thrifts in Cheshire,
Hillsborough and Worcester Counties. Monadnock Community Bank's deposit base in
the market area was $53.1 million or a 0.6 percent share of the $9.3 billion
total thrift deposits and only a 0.3 percent share of the total deposits, which
were $17.5 billion as of June 30, 2005. It is evident from the size of the
thrift deposits and bank deposits that the market area has a strong deposit
base, with Monadnock Community Bank having a minimal level of market penetration
for thrift deposits as well as total deposits.
Exhibit 31 provides interest rate data for each quarter for the years 2001
through the fourth quarter of 2005. The interest rates tracked are the Prime
Rate, as well as 90-Day, One-Year and Thirty-Year Treasury Bills. Short term
interest rates experienced a declining trend in 2001 and 2002 and then a
basically flat trend in 2003. This trend indicates some increase in One-Year
Treasury Bills and 30-Year Treasury Notes. Then rates have indicated constant
increases in each quarter in 2005 and continuing at a stronger pace in 2005.
SUMMARY
To summarize, the market area represents an area with growing population
and household trends during the 1990s and early 2000s. Such a pattern is
projected to continue from 2005 through 2010. The market area displayed a higher
per capita income and lower household income than the United States. In 1990,
the median rent level of the market area was, by average, slightly lower than
New Hampshire's median rent. By 2000, the average median rent level of the
market area was still slightly lower than New Hampshire's median
31
SUMMARY (CONT.)
rent. In 1990, the market area's median housing value was also slightly higher
than New Hampshire's and much higher than that of the United States, and in
2000, the market area's median housing value was again higher than New
Hampshire' median housing value and the United States. The market area has had a
similar and fluctuating unemployment rate when compared to that of New Hampshire
and the United States. Finally, the market area is a competitive financial
institution market dominated by thrifts with a total market deposit base for
banks and thrifts in the market area that is $17.5 billion in deposits.
32
III. COMPARABLE GROUP SELECTION
INTRODUCTION
Integral to the valuation of the Corporation is the selection of an
appropriate group of publicly-traded thrift institutions, hereinafter referred
to as the "comparable group". This section identifies the comparable group and
describes each parameter used in the selection of each institution in the group,
resulting in a comparable group based on such specific and detailed parameters,
current financials and recent trading prices. The various characteristics of the
selected comparable group provide the primary basis for making the necessary
adjustments to the Corporation's pro forma value relative to the comparable
group. There is also a recognition and consideration of financial comparisons
with all publicly-traded, FDIC-insured thrifts in the United States and all
publicly-traded, FDIC-insured thrifts in the New England region and in New
Hampshire.
Exhibits 32 and 33 present Thrift Stock Prices and Pricing Ratios and Key
Financial Data and Ratios, respectively, both individually and in aggregate, for
the universe of 216 publicly-traded, FDIC-insured thrifts in the United States
("all thrifts"), excluding mutual holding companies, used in the selection of
the comparable group and other financial comparisons. Exhibits 32 and 33 also
subclassify all thrifts by region, including the 14 publicly-traded New England
thrifts ("New England thrifts") and the two publicly-traded thrifts in New
Hampshire ("New Hampshire thrifts"), and by trading exchange. Exhibit 34
presents prices, pricing ratios and price trends for all FDIC-insured thrifts
completing their conversions between January 1, 2005, and February 22, 2006.
The selection of the comparable group was based on the establishment of
both general and specific parameters using financial, operating and asset
quality characteristics of Monadnock as determinants for defining those
parameters. The determination of parameters was also based on the uniqueness of
each parameter as a normal indicator of a thrift institution's operating
philosophy and perspective. The parameters established and defined are
considered to be both reasonable and reflective of Monadnock's basic operation.
33
INTRODUCTION (CONT.)
Inasmuch as the comparable group must consist of at least ten
institutions, the parameters relating to asset size and geographic location have
been expanded as necessary in order to fulfill this requirement.
GENERAL PARAMETERS
MERGER/ACQUISITION
The comparable group will not include any institution that is in the
process of a merger or acquisition due to the price impact of such a pending
transaction. The following thrift institutions were potential comparable group
candidates but had to be eliminated due to their involvement in a
merger/acquisition.
Institution State
- --------------------------- --------
Atlantic Liberty Financial New York
Union Community Bancorp Indiana
There is are no pending merger/acquisition transaction involving thrift
institutions in Monadnock's city, county or market area, as indicated in Exhibit
35.
MUTUAL HOLDING COMPANIES
The comparable group will not include any mutual holding companies. The
percentage of public ownership of individual mutual holding companies indicates
a wide range from minimal to 49.0 percent, the largest permissible percentage,
causing them to demonstrate certain varying individual characteristics different
among themselves and from conventional, publicly-traded companies. A further
reason for the elimination of mutual holding companies
34
MUTUAL HOLDING COMPANIES (CONT.)
as potential comparable group candidates relates to the presence of a mid-tier,
publicly-traded holding company in some, but not all, mutual holding company
structures. The presence of mid-tier holding companies can also result in
inconsistent and unreliable comparisons among the relatively small universe of
63 publicly-traded mutual holding companies as well between those 63 entities
and the larger universe of conventional, publicly-traded thrift institutions. As
a result of the foregoing and other factors, mutual holding companies typically
demonstrate higher pricing ratios that relate to their minority ownership
structure and are inconsistent in their derivation with those calculated for
conventionally structured, publicly-traded institutions. In our opinion it is
appropriate to limit individual comparisons to institutions that are 100 percent
publicly owned. Exhibit 35 presents pricing ratios and Exhibit 36 presents key
financial data and ratios for the 63 publicly-traded, FDIC-insured mutual
holding companies in the United States. The following thrift institutions were
potential comparable group candidates, but were not considered due to their
mutual holding company form:
Institution State
- -------------------------------------- -------------
Atlantic Coast Federal, MHC Georgia
Cheviot Financial, MHC Ohio
Pathfinder Bancorp, MHC New York
Jacksonville Savings Bank, MHC Illinois
Greater Delaware Valley, MHC Pennsylvania
Greene County Bancorp, MHC New York
PSB Holdings, Inc, MHC Connecticut
Governeur Bancorp, MHC New York
First Federal Financial Services, MHC Illinois
Naugatuck Valley Financial, MHC Connecticut
Ocean Shore Holding Co, MHC New Jersey
Oneida Financial, MHC New York
SI Financial Group, MHC Connecticut
35
TRADING EXCHANGE
It is necessary that each institution in the comparable group be listed on
one of the three major stock exchanges, the New York Stock Exchange, the
American Stock Exchange, or the National Bank of Securities Dealers Automated
Quotation System (NASDAQ). Such a listing indicates that an institution's stock
has demonstrated trading activity and is responsive to normal market conditions,
which are requirements for listing. Of the 279 publicly-traded, FDIC-insured
institutions, including 63 mutual holding companies, 14 are traded on the New
York Stock Exchange, 7 are traded on the American Stock Exchange and 153 are
listed on NASDAQ, 66 are traded on the OTC Bulletin Board and 39 are listed in
the Pink Sheets.
IPO DATE
Another general parameter for the selection of the comparable group is the
initial public offering ("IPO") date, which must be at least four quarterly
periods prior to the trading date of February 22, 2006, used in this report, in
order to insure at least four consecutive quarters of reported data as a
publicly-traded institution. The resulting parameter is a required IPO date
prior to January 1, 2005.
GEOGRAPHIC LOCATION
The geographic location of an institution is a key parameter due to the
impact of various economic and thrift industry conditions on the performance and
trading prices of thrift institution stocks. Although geographic location and
asset size are the two parameters that have been developed incrementally to
fulfill the comparable group requirements, the geographic location parameter has
nevertheless eliminated regions of the United States distant to Monadnock,
including the western and southwestern states.
36
GEOGRAPHIC LOCATION (CONT.)
The geographic location parameter consists of New England, Mid-Atlantic,
Midwest and Southeast states. To extend the geographic parameter beyond those
states could result in the selection of similar thrift institutions with regard
to financial conditions and operating characteristics, but with different
pricing ratios due to their geographic regions. The result could then be an
unrepresentative comparable group with regard to price relative to the
parameters and, therefore, an inaccurate value.
ASSET SIZE
Asset size was another key parameter used in the selection of the
comparable group. The range of total assets for any potential comparable group
institution was $750 million or less, due to the general similarity of asset mix
and operating strategies of institutions within this asset range, compared to
Monadnock, with assets of approximately $75.8 million. Such an asset size
parameter was necessary to obtain an appropriate comparable group of at least
ten institutions.
In connection with asset size, we did not consider the number of offices
or branches in selecting or eliminating candidates, since that characteristic is
directly related to operating expenses, which are recognized as an operating
performance parameter.
SUMMARY
Exhibits 38 and 39 show the 46 institutions considered as comparable group
candidates after applying the general parameters, with the shaded lines denoting
the institutions ultimately selected for the comparable group using the balance
sheet, performance and asset quality parameters established in this section. It
should be noted that the comparable group candidates may be members of either
the Bank Insurance Fund (BIF) or the Savings Association
37
SUMMARY (CONT.)
Insurance Fund (SAIF), since many members of each fund hold significant balances
of deposits insured by the other fund.
BALANCE SHEET PARAMETERS
INTRODUCTION
The balance sheet parameters focused on seven balance sheet ratios as
determinants for selecting a comparable group, as presented in Exhibit 38. The
balance sheet ratios consist of the following:
1. Cash and investments to assets
2. Mortgage-backed securities to assets
3. One- to four-family loans to assets
4. Total net loans to assets
5. Total net loans and mortgage-backed securities to assets
6. Borrowed funds to assets
7. Equity to assets
The parameters enable the identification and elimination of thrift
institutions that are distinctly and functionally different from Monadnock with
regard to asset mix. The balance sheet parameters also distinguish institutions
with a significantly different capital position from Monadnock. The ratio of
deposits to assets was not used as a parameter as it is directly related to and
affected by an institution's equity and borrowed funds ratios, which are
separate parameters.
38
CASH AND INVESTMENTS TO ASSETS
The Bank's ratio of cash and investments to assets was 5.2 percent at
December 31, 2005, and reflects Monadnock's share of investments moderately
lower than national and regional averages. The Bank's investments have consisted
primarily of federal agency securities and deposits in other financial
institutions. For its most recent three fiscal years, Monadnock's average ratio
of cash and investments to assets was a lesser 4.0 percent, from a high of 5.2
percent in 2005 to a low of 2.7 percent in 2004, with a generally level trend.
It should be noted that, for the purposes of comparable group selection,
Monadnock's $1,220,400 balance of Federal Home Loan Bank stock at December 31,
2005, is included in the other assets category, rather than in cash and
investments, in order to be consistent with reporting requirements and sources
of statistical and comparative analysis related to the universe of comparable
group candidates and the final comparable group.
The parameter range for cash and investments is fairly broad, in spite of
Monadnock's lower balance of cash and investments, related to the general
volatility of this parameter and institutions' varying liquidity options and
approaches, including the purchase of mortgage-backed and mortgage derivative
securities. The range has been defined as 25.0 or less of assets, with a
midpoint of 12.5 percent.
MORTGAGE-BACKED SECURITIES TO ASSETS
At December 31, 2005, Monadnock's ratio of mortgage-backed securities to
assets was a higher 32.4 percent compared to the regional average of 12.2
percent and the national average of 10.2 percent for publicly-traded thrifts.
The Bank's three most recent fiscal year average is 32.9 percent, also higher
than industry averages. Inasmuch as many institutions purchase mortgage-backed
securities as an alternative to both lending, relative to cyclical loan demand
and prevailing interest rates, and other investment vehicles, this parameter is
also fairly broad at 35.0 percent or less of assets and a midpoint of 17.5
percent.
39
ONE- TO FOUR-FAMILY LOANS TO ASSETS
Monadnock's lending activity is focused on the origination of residential
mortgage loans secured by one- to four-family dwellings. One- to four-family
loans, including construction loans, represented 39.4 percent of the Bank's
assets at December 31, 2005, which is lower than the national average of 46.0
percent. The parameter for this characteristic requires any comparable group
institution to have from 20.0 percent to 70.0 percent of its assets in one- to
four-family loans with a midpoint of 45.0 percent.
TOTAL NET LOANS TO ASSETS
At December 31, 2005, Monadnock had a 58.7 percent ratio of total net
loans to assets and a lower three fiscal year average of 59.8 percent, both
being lower than the national average of 71.1 percent and the regional average
of 63.0 percent for publicly-traded thrifts. The Bank's ratio of total net loans
to assets has demonstrated a mild downward trend since fiscal year 2003.
The parameter for the selection of the comparable group is from 40.0
percent to 90.0 percent with a midpoint of 65.0 percent. The wider range is due
to the fact that, as the referenced national and regional averages indicate,
many institutions hold a greater volume of investment securities and/or
mortgage-backed securities as cyclical alternatives to lending, but may
otherwise be similar to Monadnock.
TOTAL NET LOANS AND MORTGAGE-BACKED SECURITIES TO ASSETS
As discussed previously, Monadnock's shares of mortgage-backed securities
to assets and total net loans to assets were 32.4 percent and 58.7 percent,
respectively, for a combined share of 91.1 percent. Recognizing the industry and
regional ratios of 10.2 percent and 12.2 percent, respectively, of
mortgage-backed securities to assets, the parameter range for the
40
TOTAL NET LOANS AND MORTGAGE-BACKED SECURITIES TO ASSETS (CONT.)
comparable group in this category is 60.0 percent to 90.0 percent, with a
midpoint of 75.0 percent.
BORROWED FUNDS TO ASSETS
Monadnock had a $17.5 million balance of borrowed funds at December 31,
2005, consisting of FHLB advances, representing 23.1 percent of assets. At
December 31, 2004, the Bank's borrowed funds were $19.4 million or a higher 27.4
percent of assets, and higher than its $6.7 million balance or 15.4 percent at
December 31, 2003. The use of borrowed funds by some thrift institutions
indicates an alternative to retail deposits and may provide a source of term
funds for lending. The federal insurance premium on deposits has also increased
the attractiveness of borrowed funds.
The use of borrowed funds by some banks indicates an alternative to retail
deposits and may provide a source of longer term funds. The federal insurance
premium on deposits has also increased the attractiveness of borrowed funds. The
institutional demand for borrowed funds had increased, due to the greater
competition for deposits and higher interest rates, resulting in an increase in
borrowed funds by many banks as an alternative to higher cost and/or longer term
certificates. Rising interest rates resulted in some moderation of borrowings in
the banking industry, particularly among nonpublicly-traded banks. The ratio of
borrowed funds to assets, therefore, does not typically indicate higher risk or
more aggressive lending, but primarily an alternative to retail deposits.
The range of borrowed funds to assets is 35.0 percent or less with a
midpoint of 17.5 percent.
41
EQUITY TO ASSETS
Monadnock's equity to assets ratio was 6.5 percent at December 31, 2005,
and 7.4 percent at December 31, 2004. At the end of its two most recent fiscal
years, the Bank's equity to asset ratios were 7.4 percent and 5.7 percent. After
conversion, based on the midpoint value of $9.0 million and a public offering of
$4.9 million, with 71.4 percent of the net proceeds of the public offering going
to the Bank, Monadnock's equity is projected to stabilize in the area of 10.8
percent of assets. Based on that equity ratio, we have defined the equity ratio
parameter to be 6.0 percent to 12.0 percent with a midpoint ratio of 9.0
percent.
PERFORMANCE PARAMETERS
INTRODUCTION
Exhibit 39 presents five parameters identified as key indicators of
Monadnock's earnings performance and the basis for such performance both
historically and during the four quarters ended December 31, 2005. The primary
performance indicator is the Bank's return on average assets (ROAA). The second
performance indicator is the Bank's return on average equity (ROAE). To measure
the Bank's ability to generate net interest income, we have used net interest
margin. The supplemental source of income for the Bank is noninterest income,
and the parameter used to measure this factor is the ratio of noninterest income
to average assets. The final performance indicator is the Bank's ratio of
operating expenses or noninterest expenses to average assets, a key factor in
distinguishing different types of operations, particularly institutions that are
aggressive in secondary market activities, which often results in much higher
operating costs and overhead ratios.
42
RETURN ON AVERAGE ASSETS
The key performance parameter is the ROAA. For the twelve months ended
December 31, 2005, Monadnock's ROAA was a negative 0.04 percent based on
identical net and core earnings after taxes of a negative $30,000, as detailed
in Item I of this report. The Bank's ROAA over its most recent two fiscal years,
based on net earnings, was 0.06 percent in fiscal year 2003 and 0.06 percent in
fiscal year 2004 .
Considering the historical and current earnings performance of Monadnock,
the range for the ROAA parameter based on core income has been defined as 0.25
percent to a high of 0.80 percent with a midpoint of 0.53 percent.
RETURN ON AVERAGE EQUITY
The ROAE has been used as a secondary parameter to eliminate any
institutions with an unusually high or low ROAE that is inconsistent with the
Bank's position. This parameter does not provide as much meaning for a recently
converted thrift institution as it does for established stock institutions, due
to the unseasoned nature of the capital structure of the recently converted
thrift and the inability to accurately reflect a mature ROAE for the recently
converted thrift relative to other stock institutions.
Prior to the second stage offering, the Bank's ROAE for the twelve months
ended December 31, 2005, was a negative 0.59 percent based on identical net and
core income. The parameter range for the comparable group, based on core income,
is from 2.0 percent to 12.0 percent with a midpoint of 7.0 percent.
43
NET INTEREST MARGIN
Monadnock had a net interest margin of 2.50 percent for the twelve months
ended December 31, 2005, representing net interest income as a percentage of
average interest-earning assets. The Bank's net interest margins in fiscal years
2003 and 2004 were 2.72 percent and 2.73 percent, respectively, with a three
calendar year average of 2.78 percent.
The parameter range for the selection of the comparable group is from a
low of 2.00 percent to a high of 3.75 percent with a midpoint of 2.88 percent.
OPERATING EXPENSES TO ASSETS
For the twelve months ended December 31, 2005, Monadnock had a 2.88
percent ratio of operating expense to average assets. In fiscal year 2003, the
Bank's expense ratio was a higher 3.24 percent, decreasing to 3.02 percent in
fiscal year 2004. For its five most recent calendar years ended December 31,
2005, Monadnock's operating expense ratio averaged 3.07 percent. It should be
noted, however, that the Bank's current operating expense ratio remains higher
than the averages of 2.09 percent for New England savings institutions and 2.07
percent for all publicly-traded savings institutions.
The operating expense to assets parameter for the selection of the
comparable group is from a low of 1.75 percent to a high of 3.75 percent with a
midpoint of 2.75 percent.
NONINTEREST INCOME TO ASSETS
Compared to publicly-traded thrifts, Monadnock has historically
experienced a considerably lower than average dependence on noninterest income
as a source of additional income. The Bank's noninterest income was $258,000 or
0.35 percent of assets for the twelve
44
NONINTEREST INCOME TO ASSETS (CONT.)
months ended December 31, 2005, which is much lower than the 1.26 percent
average for publicly-traded thrift institutions during that period.
The range for this parameter for the selection of the comparable group is
1.00 percent of average assets or less, with a midpoint of 0.50 percent.
45
ASSET QUALITY PARAMETERS
INTRODUCTION
The final set of financial parameters used in the selection of the
comparable group are asset quality parameters, also shown in Exhibit 39. The
purpose of these parameters is to insure that any thrift institution in the
comparable group has an asset quality position similar to that of Monadnock. The
three defined asset quality parameters are the ratios of nonperforming assets to
total assets, repossessed assets to total assets and loan loss reserves to total
assets at the end of the most recent period.
NONPERFORMING ASSETS TO ASSETS
Monadnock's ratio of nonperforming assets to assets was 0.46 percent at
December 31, 2005, which was lower than the national average of 0.69 percent for
publicly-traded thrifts, but higher than the New England regional average of
0.20 percent. The Bank's ratio was a modestly lower 0.30 percent at December 31,
2004, following a higher ratio of 0.39 percent at December 31, 2003. For its
five most recent calendar years ended December 31, 2005, the Bank's ratio of
nonperforming assets to total assets averaged 0.36 percent, ranging from a low
of 0.29 percent in 2002 to a high of 0.46 percent in 2005.
The parameter range for nonperforming assets to assets has been defined as
1.00 percent of assets or less with a midpoint of 0.50 percent.
REPOSSESSED ASSETS TO ASSETS
Monadnock had no repossessed assets at December 31, 2005. The Bank's
balance of repossessed assets was$12,500 or 0.02 percent of total assets at
December 31, 2004, and 0.03
46
REPOSSESSED ASSETS TO ASSETS (CONT.)
percent of assets at December 31, 2003. National and regional averages were 0.10
percent and 0.01 percent, respectively, for publicly-traded thrift institutions
at December 31, 2005.
The range for the repossessed assets to total assets parameter is 0.50
percent of assets or less with a midpoint of 0.25 percent.
LOANS LOSS RESERVES TO ASSETS
Monadnock had an allowance for loan losses of $311,000, representing a
loan loss allowance to total assets ratio of 0.41 percent at December 31, 2005,
which is slightly lower than its 0.46 percent ratio at December 31, 2004, and
lower than its 0.73 percent ratio at December 31, 2003. For the five fiscal
years of 2001 to 2005, the Bank's loan loss reserve averaged 0.63 percent of
assets with a moderate decrease due to growth, from a high of 0.90 percent in
2002 to a low of 0.41 percent in 2005.
The loan loss allowance to assets parameter range used for the selection
of the comparable group required a minimum ratio of 0.25 percent of assets.
THE COMPARABLE GROUP
With the application of the parameters previously identified and applied,
the final comparable group represents ten institutions identified in Exhibits
40, 41 and 42. The comparable group institutions range in size from $149.6
million to $536.9 million with an average asset size of $352.1 million and have
an average of 7.5 offices per institution. One of the comparable group
institutions was converted in 1985, two in 1986, three in 1987, one in 1988, one
in 1996, one in 1999 and one in 2003. All ten of the comparable group
institutions are traded on NASDAQ and all are SAIF members. The comparable group
47
THE COMPARABLE GROUP (CONT.)
institutions as a unit have a ratio of equity to assets of 8.66 percent, which
is 15.7 percent lower than all publicly-traded thrift institutions in the United
States but 10.2 percent higher than publicly-traded thrift institutions in New
Hampshire, and for the most recent four quarters indicated a core return on
average assets of 0.51 percent, lower than all publicly-traded thrifts at 1.03
percent and lower than publicly-traded New Hampshire thrifts at 0.80 percent.
48
IV. ANALYSIS OF FINANCIAL PERFORMANCE
This section reviews and compares the financial performance of Monadnock
to all publicly-traded thrifts, to publicly-traded thrifts in the New England
region and to New Hampshire thrifts, as well as to the ten institutions
constituting Monadnock's comparable group, as selected and described in the
previous section. The comparative analysis focuses on financial condition,
earning performance and pertinent ratios as presented in Exhibits 43 through 48.
As presented in Exhibits 43 and 44, at December 31, 2005, Monadnock's
total equity of 6.54 percent of assets was lower than the 8.66 percent for the
comparable group, the 10.27 percent for all thrifts, the 12.90 percent for New
England thrifts and the 7.86 percent ratio for the two New Hampshire thrifts.
The Bank had a 58.68 percent share of net loans in its asset mix, modestly lower
than the comparable group at 64.22 percent, and more notably lower than all
thrifts at 71.14 percent, New England thrifts at 62.96 percent and New Hampshire
thrifts at 78.51 percent. Monadnock's share of net loans, lower than industry
averages, is primarily the result of its higher 32.39 percent share of
mortgage-backed securities reduced by its lower than average 5.17 percent share
of cash and investments. The comparable group had a moderately higher 17.83
percent share of cash and investments and a lower 13.34 percent share of
mortgage-backed securities. All thrifts had 10.17 percent of assets in
mortgage-backed securities and 13.74 percent in cash and investments.
Monadnock's 70.23 percent share of deposits was lower than the comparable group
and New Hampshire thrifts, but higher than all thrifts and New England thrifts,
reflecting the Bank's higher than average 23.06 percent ratio of borrowed funds
to assets. The comparable group had deposits of 72.56 percent and borrowings of
17.71 percent. All thrifts averaged a 55.25 percent share of deposits and 32.70
percent of borrowed funds, while New England thrifts had a 62.68 percent share
of deposits and a 19.76 percent share of borrowed funds. New Hampshire thrifts
averaged a 72.17 percent share of deposits and a 17.68 percent share of borrowed
funds. Monadnock had intangible assets of 0.34 percent at December 31, 2005,
comprised of goodwill, compared to 0.31 percent for the comparable group, 0.81
percent for all thrifts, 1.65 percent for New England thrifts and 0.93 percent
for New Hampshire thrifts.
49
ANALYSIS OF FINANCIAL PERFORMANCE (CONT.)
Operating performance indicators are summarized in Exhibits 45 and 46 and
provide a synopsis of key sources of income and key expense items for Monadnock
in comparison to the comparable group, all thrifts, and regional thrifts for the
trailing four quarters.
As shown in Exhibit 47, for the twelve months ended December 31, 2005,
Monadnock had a yield on average interest-earning assets lower than the
comparable group, New England thrifts, New Hampshire thrifts and all thrifts.
The Bank's yield on interest-earning assets was 4.88 percent compared to the
comparable group at 5.28 percent, all thrifts at 5.60 percent, New England
thrifts at 5.26 percent and New Hampshire thrifts at 5.73 percent.
The Bank's cost of funds for the twelve months ended December 31, 2005,
was lower than all thrifts and lower than the comparable group, but higher than
New England thrifts and New Hampshire thrifts. Monadnock had an average cost of
interest-bearing liabilities of 2.50 percent compared to 2.55 percent for the
comparable group, 2.56 percent for all thrifts, 2.13 percent for New England
thrifts and 1.65 percent for New Hampshire thrifts. The Bank's lower yield on
interest-earning assets and lower interest cost resulted in a net interest
spread of 2.38 percent, which was lower than the comparable group at 2.73
percent, lower than all thrifts at 3.04 percent, lower than New England thrifts
at 3.14 percent and New Hampshire thrifts at 4.08 percent. Monadnock generated a
net interest margin of 2.50 percent for the twelve months ended December 31,
2005, based on its ratio of net interest income to average interest-earning
assets, which was moderately lower than the comparable group ratio of 2.94
percent. All thrifts averaged a higher 3.24 percent net interest margin for the
trailing four quarters, with New England thrifts at 3.31 percent and New
Hampshire thrifts at 4.06 percent.
Monadnock's major source of earnings is interest income, as indicated by
the operations ratios presented in Exhibit 46. The Bank had a $16,000 recovery
of provision for loan losses during the twelve months ended December 31, 2005,
equal to 0.02 percent of average assets. The comparable group indicated a
provision representing 0.01 percent of assets, with all thrifts
50
ANALYSIS OF FINANCIAL PERFORMANCE (CONT.)
at 0.08 percent, New England thrifts at 0.04 percent and New Hampshire thrifts
at 0.02 percent.
The Bank's noninterest income was $257,000 or 0.35 percent of average
assets for the twelve months ended December 31, 2005, including $64,000 in gains
on the sale of loans and securities. Such a ratio of noninterest income to
average assets was lower than the comparable group at 0.45 percent, and
significantly lower than all thrifts at 1.26 percent and modestly lower than New
England thrifts at 0.53 percent and New Hampshire thrifts at 0.62 percent. For
the twelve months ended December 31, 2005, Monadnock's operating expense ratio
was 2.88 percent of average assets, which was higher than the comparable group
at 2.49 percent and higher than all thrifts at 2.07 percent, New England thrifts
at 2.09 percent and New Hampshire thrifts at 2.58 percent.
The overall impact of Monadnock's income and expense ratios is reflected
in the Bank's net income and return on assets. For the twelve months ended
December 31, 2005, the Bank had an identical net and core ROAA of a negative
0.04 percent. For its most recent four quarters, the comparable group had a
higher net ROAA of 0.57 percent and a modestly lower core ROAA of 0.51 percent.
All publicly-traded thrifts averaged a higher 1.03 percent core ROAA, as did New
England thrifts at 0.80 percent, with New Hampshire thrifts at a higher 0.84
percent.
51
V. MARKET VALUE ADJUSTMENTS
This is a conclusive section where adjustments are made to determine the
pro forma market value or appraised value of the Corporation based on a
comparison of Monadnock with the comparable group. These adjustments will take
into consideration such key items as earnings performance and growth potential,
market area, financial condition, asset and deposit growth, dividend payments,
subscription interest, liquidity of the stock to be issued, management, and
market conditions or marketing of the issue. It must be noted, however, that all
of the institutions in the comparable group have their differences among
themselves and from the Bank, and as a result, such adjustments become
necessary.
EARNINGS PERFORMANCE
In analyzing earnings performance, consideration was given to net interest
income, the amount and volatility of interest income and interest expense
relative to changes in market area conditions and to changes in overall interest
rates, the quality of assets as it relates to the presence of problem assets
which may result in adjustments to earnings, the level of current and historical
classified assets and real estate owned, the balance of valuation allowances to
support any problem assets or nonperforming assets, the amount and volatility of
non-interest income, and the level of non-interest expenses.
As discussed earlier, the Bank's historical business model has focused on
increasing its net interest income and net income; maintaining a reasonable
ratio of nonperforming assets; monitoring and strengthening its ratio of
interest sensitive assets relative to interest sensitive liabilities, thereby
improving its sensitivity measure and its overall interest rate risk;
maintaining adequate allowances for loan losses to reduce the impact of any
unforeseen charge-offs, and striving to control its overhead expenses and
improve its efficiency ratio. In the future, following its second stage
conversion, it will be the continuing objective of the Bank to increase its net
interest spread and margin, increase its non-interest income, increase
52
EARNINGS PERFORMANCE (CONT.)
the amount and consistency of its net income, increase its return on assets and
return on equity, and and work toward reducing its overhead expenses.
Earnings are generally related to an institution's ability to generate
loans and/or to increase its loan portfolio through loan purchases and
participations at favorable rates. The Bank was an active originator of mortgage
and a modest originator of non-mortgage loans in 2004 and 2005 and also
purchased nonresidential mortgage loans in 2004 and residential and
nonresidential mortgage loans, as well as nonmortgage loans, in 2005.
From December 31, 2004, to December 31, 2005, loans receivable increased
by $4.0 million from $4.9 million to $8.8 million. During that period, the
largest loan category increase was one- to four-family residential real estate
loans, followed by home equity loans and commercial business loans. All other
categories indicated modest to moderate decreases during those periods, with the
exception of commercial real estate, development and land loans, which indicated
a modest decrease.
The impact of Monadnock's primary lending efforts has been to generate a
yield on average interest-earning assets of 4.88 percent for the twelve months
ended December 31, 2005, compared to a higher 5.28 percent for the comparable
group, 5.60 percent for all thrifts and 5.26 percent for New England thrifts.
The Bank's ratio of interest income to average assets was 5.60 percent for the
twelve months ended December 31, 2003, which was slightly lower than the
comparable group at 5.68 percent, but all thrifts at 5.02 percent and New
England thrifts at 5.39 percent.
Monadnock's 2.50 percent cost of interest-bearing liabilities for the
twelve months ended December 31, 2005, was similar to the comparable group at
2.55 percent and all thrifts at 2.56 percent, but higher than New England
thrifts at 3.13 percent. The Bank's resulting net interest spread of 2.38
percent for the twelve months ended December 31, 2005, was lower than the
comparable group at 2.73 percent, all thrifts at 3.04 percent and New England
thrifts at 3.14
53
EARNINGS PERFORMANCE (CONT.)
percent. The Bank's net interest margin of 2.50 percent, based on average
interest-earning assets for the twelve months ended December 31, 2005, was
significantly lower than the comparable group at 2.94 percent, all thrifts at
3.24 percent and New England thrifts at 3.31 percent.
Including its small gain on the sale of loans, the Bank's ratio of
noninterest income to assets was 0.35 percent for the twelve months ended
December 31, 2004, decreasing to 0.26 percent net of those gains. That 0.35
percent ratio of noninterest income to assets was moderately lower than the
comparable group at 0.45 percent and New England thrifts at 0.53 percent, but
significantly lower than all thrifts at 1.26 percent. The Bank's operating
expenses were moderately higher than the comparable group and significantly
higher than all thrifts and New England thrifts. For the twelve months ended
December 31, 2005, Monadnock had an operating expenses to assets ratio of 2.88
percent compared to 2.49 percent for the comparable group, 2.07 percent for all
thrifts and 2.09 percent for New England thrifts.
For the twelve months ended December 31, 2005, Monadnock generated lower
noninterest income, higher noninterest expenses and a lower net interest margin
relative to its comparable group. As a result, the Bank's had negative net and
core earnings for the year ended December 31, 2005. Based on identical net and
core earnings, the Bank had a negative return on average assets of (0.04)
percent in 2005, following a small positive ROAA of 0.06 in 2004. For the twelve
months ended December 31, 2005, the comparable group had a higher core ROAA of
0.51 percent, while all thrifts indicated a higher 1.03 percent. The comparable
group had a net ROAA of 0.57 percent for the twelve months ended December 31,
2005, with all thrifts at 1.06 percent and New England thrifts at 0.73 percent.
The earnings stream and net earnings of Monadnock will continue to be
dependent on both the overall trends in interest rates and also on the
consistency, reliability and variation of its noninterest income and overhead
expenses. Net of gains and losses, noninterest income indicated relatively mild
fluctuation from December 31, 2003, through December 31, 2005, and
54
EARNINGS PERFORMANCE (CONT.)
overhead expenses decreased modestly. The Bank's net interest margin, lower than
the comparable group, has been the result of its lower yield on assets, offset
somewhat by its generally average cost of funds. Monadnock's cost of
interest-bearing liabilities is likely to experience modest increases during the
next few years, as short term rates continue to increase from their record lows
in 2003 and 2004. Some upward pressure on lending rates is also anticipated.
Monadnock's composite yield on interest-earning assets is likely to increase
modestly to moderately, based on the mix and repricing interval of the Bank's
loan portfolio, although the Bank's considerable share of fixed-rate loans will
limit the potential for increase. Adjustable-rate loans will likely be
originated and reprice at higher rates, however, as will fixed-rate loans
compared to their current portfolio yield, and investments should experience a
modestly higher yield. In spite of the Bank's favorable market area, it is also
likely that competition from both financial institutions and mortgage companies
will limit the Bank's ability to significantly increase rates on individual
mortgage and non-mortgage loan products. Monadnock's success in achieving its
objective to increase its overall net interest spread and net interest margin
will relate to its ability to increase its lower cost savings and checking
accounts and higher yielding nonresidential mortgage loans, rather than by
significant rate changes on its loan and savings products. During the next few
years, a possible modest to moderate increase in the Bank's net interest spread
and net interest margin will be dependent on Monadnock's marketing and
cross-selling capability, as well as the demographic and economic
characteristics and trends in its market area.
It is also recognized that Monadnock's current negative ROAA, much less
favorable than that of its comparable group, has deteriorated slightly December
31, 2003, as have its net interest margin and net interest spread. Following
conversion, it is anticipated that the Bank's higher equity to assets ratio will
result in decreases in ROAE until conversion proceeds can be deployed into
higher yielding loans.
55
EARNINGS PERFORMANCE (CONT.)
In recognition of the foregoing earnings related factors, with
consideration to Monadnock's current performance measures, a significant
downward has been made to Monadnock's pro forma market value for earnings
performance.
MARKET AREA
As previously indicated in Section II, the Bank's primary market area
encompasses Hillsborough County, New Hampshire and Worcester County,
Massachusetts, and its extended lending market includes Cheshire County, New
Hampshire. Since 1990, this primary market area has experienced similar
population increases than the comparable group markets, New Hampshire and the
United States, and an unemployment rate lower than in the United States and
generally similar to the rate in New Hampshire. The unemployment rates in the
Hillsborough and Worcester Counties were 3.5 percent and 3.9 percent,
respectively, in 2002, compared to 3.4 percent in New Hampshire and a higher 4.8
percent in the United States. By December, 2005, the unemployment rates had
increased to 3.9 percent in Hillsborough County and 5.5 percent in Worcester
County, with New Hampshire and the United States at 3.9 percent and 6.0 percent,
respectively. Per capita income and median household income in Monadnock's
market area have historically been and remain generally similar to state and
national averages and modestly higher than the comparable group, reflecting the
market area's lower unemployment rate. The median housing value in the Bank's
primary market area is modestly higher than New Hampshire, moderately higher
than the comparable group and significantly higher than the median national
value.
Monadnock's market area is both suburban and rural, with the services
sector representing the primary source of employment in both primary market area
counties, followed closely by the wholesale/retail and manufacturing sectors.
The level of financial competition Monadnock's market area is strong, with
commercial banks holding a majority of deposits. The Bank has a low penetration
of both bank and thrift deposits in its two primary market area
56
MARKET AREA (CONT.)
counties. Monadnock nevertheless experienced net increases in deposits in each
of its most recent three fiscal years, including an increasing deposit base in
its Winchendon, Massachusetts, branch, opened in 2004. Overall, the Bank's
average annual deposit growth rate of was considerably higher than the
comparable group.
In recognition of the foregoing factors, including deposit potential in a
growing market, we believe that a small upward adjustment is warranted for the
Bank's market area.
FINANCIAL CONDITION
The financial condition of Monadnock is discussed in Section I and shown
in the related exhibits and is compared to the comparable group in Exhibits 42,
43 and 44. The Bank's ratio of total equity to total assets was 6.54 percent at
December 31, 2005, which was moderately lower than the comparable group at 8.66
percent, and considerably lower than all thrifts at 10.27 percent and New
England thrifts at 12.90 percent. With a conversion at the midpoint, the
Corporation's pro forma equity to assets ratio will increase to approximately
11.0 percent, and the Bank's pro forma equity to assets ratio will increase to
approximately 10.0 percent, based on the Bank receiving at least 85 percent of
the net proceeds from the conversion.
The Bank's mix of assets and liabilities indicates some areas of notable
variation from its comparable group. The Bank's 70.23 percent ratio of deposits
to total assets was slightly lower than the comparable group at 72.56 percent,
but higher than all thrifts at 55.25 percent and New England thrifts at 62.68
percent. Those variations are directly related to Monadnock's 23.06 percent
ratio of borrowed funds to assets, which was higher than the comparable group at
17.71 percent and New England thrifts at 19.76 percent, but lower than all
thrifts at 32.70 percent.
57
FINANCIAL CONDITION (CONT.)
Monadnock had a lower 58.68 percent ratio of net loans to total assets at
December 31, 2005, compared to the comparable group at 64.22, all thrifts at
71.14 percent and New England thrifts at 62.96 percent. The Bank's 5.17 percent
share of cash and investments was much smaller than the comparable group at
17.83 percent, all thrifts at 13.74 percent and New England thrifts at 19.44
percent; but Monadnock's 32.39 percent ratio of mortgage-backed securities to
total assets was significantly higher than the comparable group at 13.34
percent, all thrifts at 11.17 percent and New England thrifts at 12.20 percent.
The Bank's larger combined share of cash and investments and mortgage-backed
securities, resulting in its smaller share of loans, is part of the basis of its
lower yield on interest-earning assets.
Monadnock had intangible assets of $236,000 or 0.34 percent of total
assets, comprised of goodwill and core deposit intangible, compared to a similar
0.31 percent for the comparable group and a higher , 0.81 percent for all
thrifts and 1.65 for New England thrifts. The Bank had was absent repossessed
assets at December 31, 2005, and had nominal repossessed assets of $13,000 at
both December 31, 2004 and 2004, compared to the comparable group at 0.04
percent, while all thrifts and New England thrifts had ratios of 0.10 percent
and 0.01 percent, respectively. The financial condition of Monadnock is
influenced by its nonperforming assets of $350,000 or 0.46 percent of assets at
December 31, 2004, compared to a modestly lower 0.32 percent for the comparable
group, a higher 0.69 percent for all thrifts and a lower 0.12 percent for New
England thrifts. It should be recognized that the Bank's ratio of nonperforming
assets to total assets decreased from 0.55 percent of assets at December 31,
2002. On a calendar year basis, Monadnock's ratio of nonperforming assets to
total assets was 0.55 percent, 0.61 percent and 0.30 percent at December 31,
2002, 2003 and 2004, respectively.
The Bank had a lower 11.75 percent ratio of high risk real estate loans to
assets compared to 20.16 percent for the comparable group, and the Bank's share
was also lower than all thrifts at 24.23 percent. The regulatory definition of
high risk real estate loans is all mortgage loans other than those secured by
one- to four-family residential properties.
58
FINANCIAL CONDITION (CONT.)
At December 31, 2005, Monadnock had $311,000 of allowances for loan
losses, which represented 0.41 percent of assets and 0.69 percent of total
loans. Those ratios are lower than the comparable group, which indicated
allowances equal to 0.61 percent of assets and 0.98 percent of total loans. More
significant, however, is an institution's ratio of allowances for loan losses to
nonperforming assets, since a considerable portion of nonperforming assets might
eventually be charged off. Monadnock's $311,000 of allowances for loan losses,
represented a significantly lower 88.86 percent of nonperforming assets at
December 31, 2005, compared to the comparable group's 173.84 percent, with all
thrifts at 190.17 percent and New England thrifts at 338.77 percent. Monadnock's
ratio of net charge-offs to average total loans was zero for the twelve months
ended December 31, 2005, compared to ratios of (0.09) percent for the comparable
group, 0.16 percent for all thrifts and 0.01 percent for New England thrifts.
Historically, Monadnock has experienced very moderate levels of interest
rate risk, as reflected by the exposure of its net portfolio value to negative
changes under conditions of rising interest rates, and in recent periods, the
Bank's overall interest rate risk has been consistent and is currently
classified as minimal.
Overall, with particular consideration to the Bank's asset quality,
reserves, coverage, interest rate risk and shares of loans and deposits relative
to the comparable group, we believe that no adjustment is warranted for
Monadnock's current financial condition.
ASSET, LOAN AND DEPOSIT GROWTH
During its most recent five calendar years, Monadnock has been
characterized by higher than average rates of growth in assets, loans and
deposits. The Bank's average annual asset growth rate from 2001 to 2005 was 19.3
percent, compared to a much lower 5.2 percent for the comparable group, 11.0
percent for all thrifts and 10.4 percent for New England thrifts. The Bank's
higher asset growth rate is reflective primarily of its large average increase
in loans
59
ASSET, LOAN AND DEPOSIT GROWTH (CONT.)
during that five year period . The Bank's loan portfolio indicates an average
annual increase of 26.1 percent from 2001 to 2005, compared to average growth
rates of 3.4 percent for the comparable group, and 11.4 percent for all thrifts
and New England thrifts.
Monadnock's deposits indicate an average annual increase of 12.2 percent
from December 31, 2001, to December 31, 2005. Annual deposit changes have been
from a decrease of 4.2 percent in 2001 to an increase of 35.0 percent in 2004,
compared to average growth rates of 5.9 percent for the comparable group, 11.4
percent for all thrifts and 8.0 percent for New England thrifts. Consistent with
its lower rate of deposit growth compared to loan growth, the Bank increased its
ratio of borrowed funds to assets from 15.6 percent at December 31, 2001, to
23.1 percent at December 31, 2005, with the increase occurring in 2004, the year
the Bank acquired and opened its branch in Massachusetts. Monadnock's share of
borrowed funds were higher than the comparable group at 17.7 percent at December
31, 2005.
The Bank's ability to maintain its asset base and deposits in the future
is, to a great extent, dependent on its being able to competitively price its
loan and savings products, to maintain a high quality of service to its
customers, to increase its market share and to continue its loan origination
activity. Monadnock's primary market area experienced increases in population
and households between 1990 and 2000 and those increases are projected to
continue at rates similar to state and national increases rates through 2010.
The Bank's primary market area also indicated 2000 per capita income similar to
New Hampshire and the United States, combined with similar comparative median
household income. In 2000, housing values in Monadnock's market area were
similar to New Hampshire but higher than the United States.
The Bank's historical dependence on its current primary market area could
result in lower asset growth in the future as a result of its competitive
operating environment, notwithstanding strong growth in population and
households projected for the future in the primary market area. It should be
noted that the Bank's deposit market shares at June 30, 2005, were 0.69 percent
in Hillsborough County, New Hampshire, the location of its home office, and a
nominal 0.09
60
ASSET, LOAN AND DEPOSIT GROWTH (CONT.)
percent in Worcester County, Massachusetts, the location of the branch office
purchased in 2004. That share in Worcester County was the lowest share of any
institution in the county, with an average branch size of $42.2 million compared
to Monadnock's $8.7 million branch. Monadnock's competitive operating
environment, notwithstanding its anticipated increased capital, will likely
result in rates of asset, load and deposit growth lower than during the past few
years. Considering the positive demographics of the Bank's market area, however,
even such slower growth will probably exceed that of the comparable group, as
well as national and regional averages.
Based on the foregoing factors, we have concluded that an upward
adjustment to the Bank's pro forma value is warranted.
DIVIDEND PAYMENTS
The Corporation has not committed to pay dividends following the
completion of its second stage stock conversion. The Bank has not paid dividends
to its minority shareholders since its mutual holding company reorganization in
2004. Any payment of cash dividends by the Corporation in future years will be
dependent upon such factors as earnings performance, capital position, growth,
and regulatory limitations.
Each of the ten institutions in the comparable group pays cash dividends
for an average dividend yield of 3.16 percent and a payout ratio of 67.80
percent. It should be noted that one of the comparable group institutions, Wayne
Savings Bancshares, paid dividends well in excess of its earnings per share in
2005, resulting in a payout ratio increased from 61.11 percent in 2004.
In our opinion, no adjustment to the pro forma market value of the
Corporation is warranted at this time related to dividend payments.
61
SUBSCRIPTION INTEREST
In 2005, investors' interest in new issues was limited and subscription
levels were consistently low to moderate, although a few issues received
stronger response from the marketplace. New issues also attracted less interest
from investors in 2005 and to date in 2006, and aftermarket price increases have
been lower than in previous years. Overall, the recent and current reaction of
IPO investors appears generally related to a number of analytical factors,
including the financial performance and condition of the converting thrift
institution, the strength of the local economy, general market conditions,
aftermarket price trends and the anticipation of continuing merger/acquisition
activity in the thrift industry. Although the number of recent offerings has
been small relative to the 1990s, there nevertheless appears not to be an
unsatisfied demand for new financial institution issues. Even some issues
attracting considerable interest have experienced smaller than expected price
increases and, in some cases, price decreases in the aftermarket.
The Corporation will direct its offering to depositors of the Bank and, if
there is a community offering, to the general public with a preference to
residents of Hillsborough and Cheshire Counties, New Hampshire, and Worcester
County, Massachusetts. The board of directors and officers anticipate purchasing
approximately $350,000 of the conversion stock or 35,000 shares, which
represents less than 6 percent of the stock offered to the public based on the
appraised midpoint valuation. It should be noted that in its initial mutual
holding company reorganization in June, 2004, the final subscription level was
between the midpoint and the maximum of the valuation range.
The Corporation has secured the services of Ryan Beck & Co. to assist in
the marketing and sale of the conversion stock.
Based on the size of the offering, recent market movement and current
market conditions, local market interest, the terms of the offering and recent
subscription levels for initial offerings, we believe that a downward adjustment
is warranted for the Corporation's anticipated subscription interest.
62
LIQUIDITY OF THE STOCK
The Corporation's total public offering is considerably smaller in size
relative to the average market value of the comparable group and New England
thrifts. The comparable group has an average market value of $36.2 million for
the stock outstanding compared to a midpoint public offering of $4.9 million for
the Corporation, which will increase its total market value to $9.0 million at
the midpoint. Of the ten institutions in the comparable group, all are traded on
NASDAQ, indicating an average daily trading volume of 1,451 shares during the
last four quarters compared to the Bank's average trading volume of a lower 678
shares. With 900,000 shares to be outstanding at the midpoint of the offering
range, the Corporation will have fewer shares outstanding than the comparable
group with an average of 2.2 million shares.
Based on the average market capitalization, shares outstanding and daily
trading volume of the comparable group, as well as the relative trading volume
of publicly-traded mutual holding companies, we have concluded that no
adjustment to the Corporation's pro forma market value is warranted relative to
the anticipated liquidity of its stock.
MANAGEMENT
As previously discussed, Manadnock's senior management include its
president and chief executive officer, William M. Pierce, Jr., its senior vice
president and chief financial officer, Karl F. Betz, its senior vice
president-senior lending officer; William C. Gilson, and its senior vice
president of operations, Donald R. Blanchette.
Over the past several years, the management of Monadnock have been
successful in significantly increasing the Bank's assets, its loan portfolio,
its deposit base and its ratio of loans to deposits, significantly exceeding
comparable group and industry averages. Open for less than two years, the Bank's
Winchendon branch has experienced consistent deposit growth. Nonperforming
assets are lower than industry averages and have decreased in recent years.
63
MANAGEMENT (CONT.)
Monadnock's operating expenses, however, have been and continue to be higher
than than the comparable group and industry averages, as has been the Bank's
efficiency ratio. Net interest margin and earnings have been well below
comparable group and industry averages, but the Bank's business plan indicates
increased earnings following its stock conversion
Overall, we believe the Bank to be professionally, knowledgeably and
efficiently managed, as are the comparable group institutions. It is our opinion
that no adjustment to the pro forma market value of the Corporation is warranted
for management.
MARKETING OF THE ISSUE
The necessity to build a new issue discount into the stock price of a
converting thrift institution continues to be a closely examined issue in
recognition of uncertainty among investors as a result of the thrift industry's
dependence on interest rate trends, recent volatility in the stock market and
reduced interest in conversion offerings. Increased merger/acquisition activity,
as well as the presence of new competitors in the financial institution
industry, such as de novo institutions, investment firms, insurance companies
and mortgage companies, have resulted in increased pressure on an individual
institution's ability to attract retail deposits at normal rates rather than
premium rates and to deploy new funds in a timely and profitable manner.
Although we believe that a new issue discount applied to the price to book
valuation approach is appropriate and necessary in some public offerings, in our
opinion, various characteristics of the Corporation's transaction, as well as
recent market trends, cause us to conclude that such a discount is not warranted
in the case of this particular offering. Consequently, at this time we have made
no adjustment to the Corporation's pro forma market value related to a new issue
discount.
64
VI. VALUATION METHODS
INTRODUCTION
Historically, the most frequently used method for determining the pro
forma market value of common stock for thrift institutions by this firm has been
the price to book value ratio method, due to the volatility of earnings in the
thrift industry in the early to mid-1990s. As earnings in the thrift industry
stabilized and improved in the late 1990s, more emphasis was placed on the price
to earnings method, particularly considering increases in stock prices during
those years. During the past two years, however, as rising interest rates have
had varying effects on individual institutions, depending on the nature of their
operations, the price to book value method has again become pertinent and
meaningful in the objective of discerning commonality and comparability among
institutions. In determining the pro forma market value of Monadnock Bancorp,
Inc., primary emphasis has been placed on the price to book value method, due to
the Corporation's negative earnings in 2005, with additional analytical and
correlative attention to the price to earnings methods.
In recognition of the volatility and variance in earnings due to
fluctuations in interest rates, the continued differences in asset and liability
repricing and the frequent disparity in value between the price to book approach
and the price to earnings approach, a third valuation method, the price to net
assets method, has also been used. The price to assets method is used less often
for valuing ongoing institutions, but becomes more useful in valuing converting
institutions when the equity position and earnings performance of the
institutions under consideration are different.
In addition to the pro forma market value, we have defined a valuation
range with the minimum of the range being 85.0 percent of the pro forma market
value, the maximum of the range being 115.0 percent of the pro forma market
value, and a super maximum being 115.0 percent of the maximum. The pro forma
market value or appraised value will also be referred to as the "midpoint
value".
65
VALUATION METHODS (CONT.)
In applying each of the valuation methods, consideration was given to the
adjustments to the Bank's pro forma market value discussed in Section V.
Downward adjustments were made for earnings performance, subscription interest
and the liquidity of the stock. Upward adjustments were made for the Bank's
market area and its asset, loan and deposit growth. No adjustments were made for
the Bank's dividend payments, financial condition, marketing of the issue and
management.
PRICE TO BOOK VALUE METHOD
In the valuation of thrift institutions, the price to book value method
focuses on an institution's financial condition, and does not give as much
consideration to the institution's long term performance and value as measured
by earnings. Due to the earnings volatility of many thrift stocks, including
Monadnock, the price to book value method is frequently used by investors who
rely on an institution's financial condition rather than earnings performance.
Although this method is, under certain circumstances, considered somewhat less
meaningful for institutions that provide a consistent earnings trend, it remains
significant and reliable when an institution's performance or general economic
conditions are experiencing volatile or uncustomary trends related to internal
or external factors, and serves as a complementary and correlative analysis to
the price to earnings and price to assets approaches.
It should be noted that the prescribed formulary computation of value
using the pro forma price to book value method returns a price to book value
ratio below market value on a fully converting institution. In the case of a
second stage conversion such as Monadnock, however, the application of the
prescribed formulary computation to a sale of less than all the shares based on
the full valuation of the institution might return a value in excess of the book
value of the institution. In most instances, nevertheless, such a value remains
below current comparable market values.
66
PRICE TO BOOK VALUE METHOD (CONT.)
Exhibit 50 shows the average and median price to book value ratios for the
comparable group which were 126.39 percent and 125.41 percent, respectively. The
full comparable group indicated a moderately wide range, from a low of 96.70
percent (Home City Financial Corp.) to a high of 149.79 percent (Laurel Capital
Group, Inc.). The comparable group had modestly higher average and median price
to tangible book value ratios of 131.45 percent and 129.64 percent,
respectively, with the range of 98.51 percent to a higher 169.02 percent.
Excluding the low and the high in the group, the comparable group's price to
book value range narrowed modestly from a low of 107.82 percent to a high of
149.27; and the comparable group's price to tangible book value range also
narrowed modestly from a low of 107.82 percent to a high of 152.89 percent, with
the same institutions representing the limits of both ranges.
Considering the foregoing factors in conjunction with the adjustments made
in Section V, we have determined a pro forma price to book value ratio of 102.85
percent and a price to tangible book value ratio of 104.43 percent at the
midpoint. The price to book value ratio increases from 94.44 percent at the
minimum to 116.76 percent at the super maximum, while the price to tangible book
value ratio increases from 96.01 percent at the minimum to 118.30 percent at the
super maximum.
The Corporation's pro forma price to book value and price to tangible book
value ratios of 102.85 percent and 104.43 percent, respectively, as calculated
using the prescribed formulary computation indicated in Exhibit 49, are
influenced by the Bank's capitalization, local market and percentage of public
ownership, as well as subscription interest in thrift stocks and overall market
and economic conditions. Further, the Corporation's ratio of equity to assets
after conversion at the midpoint of the valuation range will be approximately
11.01 percent compared to 8.66 percent for the comparable group. Based on the
price to book value ratio and the Bank's total equity of $4,954,000 at December
31, 2005, the indicated pro forma market value of the Bank using this approach
is $9,026,095 at the midpoint (reference Exhibit 49).
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PRICE TO EARNINGS METHOD
The basis of the price to earnings method is the determination of the
earnings base to be used, followed by the determination of an appropriate price
to earnings multiple. As indicated in Exhibit 3, Monadnock's after tax net
earnings for the twelve months ended December 31, 2005, was a loss of $30,000,
which also represents the Bank's core earnings for that period. Due to the fact
that Manodnock indicated negative earnings, the price to earnings method was not
meaningful.
PRICE TO ASSETS METHOD
The final valuation method is the price to assets method. This method is
not frequently used, since the calculation incorporates neither an institution's
equity position nor its earnings base. Additionally, the prescribed formulary
computation of value using the pro forma price to net assets method does not
recognize the runoff of deposits concurrently allocated to the purchase of
conversion stock, returning a pro forma price to net assets ratio below its true
level following conversion. Exhibit 49 indicates that the average price to
assets ratio for the comparable group was 10.95 percent and the median was 10.43
percent. The range in the price to assets ratios for the comparable group varied
from a low of 8.51 percent (Central Bancorp, Inc.) to a high of 14.98 percent
(LSB Corp.). The range narrows modestly with the elimination of the two extremes
in the group to a low of 8.67 percent and a high of 14.98 percent.
Based on the previously noted adjustments, it is our opinion that an
appropriate price to assets ratio for the Corporation is 11.32 percent at the
midpoint, which ranges from a low of 9.69 percent at the minimum to 14.69
percent at the super maximum.
Based on the Bank's December 31, 2005, asset base of $75,801,000, the
indicated pro forma market value of the Corporation using the price to assets
method is $9,017,125 at the midpoint (reference Exhibit 49).
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VALUATION CONCLUSION
Exhibit 55 provides a summary of the valuation premium or discount for
each of the valuation ranges when compared to the comparable group based on each
of the valuation approaches. At the midpoint value, the price to book value
ratio of 102.85 percent for the Corporation represents a discount of 18.62
percent relative to the comparable group and decreases to 7.62 percent at the
super maximum. The price to assets ratio at the midpoint represents a premium of
3.47 percent, increasing to a premium of 34.18 percent at the maximum, as
adjusted.
It is our opinion that as of February 22, 2006, the pro forma market value
of the Corporation, is $9,000,000 at the midpoint, representing 1,125,000 shares
at $8.00 per share. The pro forma valuation range of the Corporation is from a
minimum of $7,650,000 or 956,250 shares at $8.00 per share to a maximum of
$10,350,000 or 1,293,750 shares at $8.00 per share, with such range being
defined as 15 percent below the appraised value to 15 percent above the
appraised value. The maximum, as adjusted, defined as 15 percent above the
maximum of the range, is $11,902,500 or 1,487,813 shares at $8.00 per share.
Our valuation assumptions, process and conclusions recognize that minority
public shareholders collectively own 45.3 percent of the Bank's outstanding
shares, and that the current offering contemplates the sale of the 54.7 percent
of the outstanding shares currently owned by Monadnock Community Bancorp, Inc.,
the Bank's mid-tier holding company. The holding company's name will be changed
to Monadnock Bancorp, Inc., in conjunction with the completion of the second
stage offering. As indicated in Exhibit 49, in the conversion, each minority
share will be exchanged for 1.1912 shares of the Corporation at the midpoint of
the offering range, with that exchange ratio being 1.0125 shares, 1.3699 shares
and 1.5753 shares at the minimum, maximum and adjusted maximum of the offering
range, respectively.
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VALUATION CONCLUSION (cont.)
The appraised value of Monadnock Bancorp, Inc., as of February 22, 2006,
is $9,000,000 at the midpoint.
70