SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES AND EXCHANGE ACT OF 1934
FOR THE FISCAL YEAR ENDED DECEMBER 31, 2001
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D)
OF THE SECURITIES ACT OF 1934
FOR THE TRANSITION PERIOD FROM TO
COMMISSION FILE NO. 0-17222
WARREN BANCORP, INC.
(Exact Name of registrant as specified in the charter)
MASSACHUSETTS 04-3024165
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
10 MAIN STREET 01960
PEABODY, MASSACHUSETTS (Zip Code)
(Address of principal executive offices)
(978) 531-7400
(Registrant's telephone number, including area code)
SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT:
None
SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT:
Common Stock par value $0.10 per share
Preferred Stock Purchase Rights
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such report(s), and (2) has been subject to such
filing requirement for the past 90 days. Yes [x] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X].
The aggregate market value of the voting stock of the registrant held
by non-affiliates of the registrant based on the closing sale price for the
registrant's common stock on March 4, 2002, as reported by the Nasdaq National
Market was $66,733,211.
The number of shares of the registrant's common stock outstanding as of
March 4, 2002 was 7,392,031.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the Proxy Statement for the Annual Meeting of Stockholders to be
held on May 1, 2002 are incorporated by reference into this Annual Report as
portions of Part III of Form 10-K.
1
SELECTED FINANCIAL DATA
DECEMBER 31,
------------------------------------------------------------
2001 2000 1999 1998 1997
-------- -------- -------- -------- --------
(IN THOUSANDS)
CONSOLIDATED BALANCE SHEET DATA:
Total assets $463,630 $438,122 $402,247 $397,065 $370,993
Investment securities 54,332 54,001 80,314 93,950 83,701
Mortgage-backed securities 10,097 11,813 14,048 20,430 30,579
Net loans 336,666 343,551 286,743 262,452 236,697
Real estate acquired by foreclosure -- -- -- 1,450 2,010
Deposits 398,347 387,047 355,534 347,012 325,293
Borrowed funds 19,082 8,654 7,510 7,674 2,926
Stockholders' equity 42,445 37,682 35,644 39,921 40,028
-------- -------- -------- -------- --------
YEAR ENDED DECEMBER 31,
------------------------------------------------------------------
2001 2000 1999 1998 1997
-------- -------- -------- -------- --------
(DOLLARS IN THOUSANDS, EXCEPT PER-SHARE DATA)
CONSOLIDATED STATEMENT OF OPERATIONS DATA:
Interest and dividend income $ 33,210 $ 33,064 $ 28,987 $ 29,253 $ 28,539
Interest expense 13,489 13,120 11,803 12,060 11,404
-------- -------- -------- -------- --------
Net interest income 19,721 19,944 17,184 17,193 17,135
(Recovery of) provision for loan losses (131) 456 120 (91) (316)
Non-interest income 2,589 2,027 1,297 1,443 3,339
Non-interest expenses 12,019 11,414 10,070 10,099 9,857
-------- -------- -------- -------- --------
Income before income taxes 10,422 10,101 8,291 8,628 10,933
Income tax expense 3,318 3,368 2,827 2,724 3,648
-------- -------- -------- -------- --------
Net income $ 7,104 $ 6,733 $ 5,464 $ 5,904 $ 7,285
======== ======== ======== ======== ========
Basic earnings per share $ 0.97 $ 0.92 $ 0.74 $ 0.75 $ 0.96
======== ======== ======== ======== ========
Diluted earnings per share $ 0.94 $ 0.91 $ 0.72 $ 0.72 $ 0.91
======== ======== ======== ======== ========
Cash dividends paid $ 0.450 $ 0.625 $ 0.630 $ 0.720 $ 0.435
======== ======== ======== ======== ========
OTHER DATA:
Return on average assets 1.57% 1.61% 1.39% 1.57% 2.02%
Return on average stockholders' equity 17.73 18.81 15.26 14.79 19.50
Stockholders' equity to assets at year end 9.15 8.60 8.86 10.05 10.79
Dividend payout ratio 46.64 67.96 85.56 96.04 44.79
Weighted average interest rate spread 4.37 4.74 4.35 4.53 4.80
Net yield on average earning assets 4.57% 4.96% 4.57% 4.79% 5.03%
Number of banking offices 6 6 6 6 6
The consolidated financial data for the Corporation and its subsidiaries
presented above are expanded and explained in more detail by the financial
information contained elsewhere herein. The consolidated financial data were
derived from audited consolidated financial statements of the Corporation and
the Bank at and for the periods shown.
2
LETTER TO SHAREHOLDERS OMITTED FROM THIS ANNUAL REPORT ON FORM 10-K.
3
LETTER TO SHAREHOLDERS OMITTED FROM THIS ANNUAL REPORT ON FORM 10-K.
4
CROSS REFERENCE SHEET OF INFORMATION REQUIRED BY ITEMS IN
FORM 10-K
Page
----
Item 1. Business................................................................................................. 26-32
Item 2. Properties............................................................................................... 17
Item 3. Legal Proceedings........................................................................................ 16
Item 4. Submission of Matters to a Vote of Security Holders...................................................... 33
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.................................... 78
Item 6. Selected Financial Data.................................................................................. 2
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations......................................................................................... 6-26
Item 7A. Quantitative and Qualitative Disclosures about Market Risk............................................... 7-8
Item 8. Financial Statements and Supplementary Data.............................................................. 36-75
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosures........................................................................................... 33
Item 10. Directors and Executive Officers of the Corporation...................................................... 33
Item 11. Executive Compensation................................................................................... 33
Item 12. Security Ownership of Certain Beneficial Owners and Management........................................... 33
Item 13. Certain Relationships and Related Transactions........................................................... 33
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K.......................................... 76
STATISTICAL DISCLOSURE FOR BANK HOLDING COMPANIES
(2) Distribution of Assets, Liabilities and Stockholders' Equity; Interest Rates
and Interest Differential............................................................................. 19-20
(3) Investment Portfolio..................................................................................... 11
(4) Loan Portfolio........................................................................................... 12-13
(5) Summary of Loan Loss Experience.......................................................................... 15
(6) Deposits................................................................................................. 18
(7) Return on Equity and Assets.............................................................................. 2
(8) Short-Term Borrowings ................................................................................... 54
5
MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Certain statements in this Form 10-K constitute "forward-looking
statements" as that term is defined under the Private Securities Litigation
Reform Act of 1995. The words "believe," "expect," "anticipate," "intend,"
"estimate," "plan," "assume" and other similar expressions which are predictions
of or indicate future events and trends identify forward-looking statements.
Reliance should not be placed on forward-looking statements because they involve
known and unknown risks, uncertainties and other factors, which are in some
cases beyond the control of the Corporation and may cause the actual results,
performance or achievements of the Corporation to differ materially from
anticipated future results, performance or achievements expressed or implied by
such forward-looking statements.
Certain factors that might cause such differences include, but are not
limited to, the following: interest rates may increase, adversely affecting the
ability of borrowers to repay adjustable-rate loans and the Corporation's
earnings and income which derive in significant part from loans to borrowers;
unemployment in the Corporation's market area may increase, adversely affecting
the ability of individual borrowers to repay loans; property values may decline,
adversely affecting the ability of borrowers to repay loans and the value of
real estate securing repayment of loans; and general economic and market
conditions in the Corporation's market area may decline, adversely affecting the
ability of borrowers to repay loans, the value of real estate securing repayment
of loans and the Corporation's ability to make profitable loans. Any of the
above may also result in lower interest income, increased loan losses,
additional charge-offs and writedowns and higher operating expenses. These and
other factors that might cause differences between actual and anticipated
results, performance and achievements are discussed in greater detail in this
Annual Report, including the Annual Report on Form 10-K, under "Management's
Discussion and Analysis of Financial Condition and Results of Operations," and
the section entitled "Business."
Management's discussion and analysis of financial condition and results
of operations should be read in conjunction with the audited financial
statements and notes thereto appearing elsewhere in this report.
GENERAL
Warren Bancorp, Inc.'s (the "Corporation") operating results for the
year ended December 31, 2001 (the "2001 period") reflect the operations of its
only subsidiary, Warren Five Cents Savings Bank (the "Bank"). The Bank, which is
wholly owned by the Corporation, operates as a community bank and is in the
business of making individual and commercial loans to customers in its market
area.
The Corporation recorded an increased profit for the 2001 period as
compared to the year ended December 31, 2000 (the "2000 period") primarily due
to increased asset levels, increased gains on sales of mortgage loans, and
receipt of state-tax refunds plus interest for the resolution of certain tax
matters of prior years. During the 2001 period, short-term interest rates have
declined significantly. The yield on the one-year constant maturity index
decreased to 2.17% at December 31, 2001 from 5.32% at December 31, 2000, and
prime rate decreased to 4.75% at December 31, 2001 from 9.50% at December 31,
2000. When general interest rates decrease, the Corporation's weighted average
interest-rate spread and net yield on average earning assets will usually
decrease. This is mainly because certain sources of funds, namely NOW and
regular savings deposits, may not have their rates decrease at the same rate as
the Corporation's assets. Also demand deposits and stockholders' equity have no
interest rate attached to them; therefore, their costs as a funding source do
not decrease. As a result, despite increased asset levels, net interest income
decreased in the 2001 period.
Stockholders' equity increased in 2001 due to increased earnings and an
unrealized gain on securities available for sale net of income taxes. This was
partially offset by the payment of dividends equal to 47% of net income. Future
increases in interest rates could reduce the value of the securities portfolio
and stockholders' equity.
Nonperforming loans and real estate acquired by foreclosure were zero
at December 31, 2001 and December 31, 2000. Management continues to monitor the
loan portfolio closely. If conditions in the Massachusetts real estate market
become unstable and values deteriorate, the amount of nonaccrual loans
6
and real estate acquired by foreclosure would be expected to increase, resulting
in lower interest income and increased loan losses, which could require
additional loan loss provisions to be charged to operating income. Moreover, an
increase in real estate acquired by foreclosure may give rise to additional
charge-offs and writedowns and higher expenses for property taxes and other
carrying costs.
In 2001, the Corporation paid regular quarterly dividends totaling $.45
per share.
ASSET/LIABILITY MANAGEMENT
A primary objective of the Corporation's asset/liability management
policy is to manage the interest-rate risk over time to achieve a prudent level
of net interest income in changing interest-rate environments. Management's
strategies are intended to be responsive to changes in interest rates and to
recognize market demands for particular types of deposit and loan products.
These strategies are overseen by an internal Asset/Liability Management
Committee and by the Bank's Board of Directors, and the risks are managed with
techniques such as simulation analysis, which measures the effect on net
interest income of possible changes in interest rates, and "gap" analysis, using
models similar to the one shown on the following page.
The Corporation uses simulation analysis to measure exposure of net
interest income to changes in interest rates over a one-year period. This period
is measured because the Corporation is most vulnerable to changes in short-term
(one year and under) rates. Simulation analysis involves projecting future
interest income and expense under various rate scenarios. The Corporation's
policy on interest-rate risk specifies that if short-term money market interest
rates were to shift immediately up or down 200 basis points, estimated net
interest income for the next 12 months should decline by less than 15%. Due to
the current interest-rate conditions, the interest-rate indices in the declining
rate simulation could not all be lowered by 200 basis points. Those that could
not be lowered by 200 basis points were lowered as much as was reasonable so as
not to produce distorted rates. The Corporation was in compliance with this
policy at December 31, 2001 and 2000. The following table reflects the
Corporation's estimated exposure as a percentage of estimated net interest
income for the next 12 months, assuming an immediate shift in short-term
interest rates:
Estimated 12--month increase (decrease) in
Rate change (basis points) net interest income from
-------------------------- December 31,
2001 2000
------ ------
+200 2.3% 5.9%
-200 (3.4)% (3.4)%
The result is within the Corporation's policy guidelines.
Simulation analysis depends to a significant extent on a variety of
assumptions and estimates, which may not reflect actual future events. Estimates
of customer behavior to changing interest rates may differ significantly from
actual behavior. Areas of these estimates include loan prepayment speeds, shifts
between adjustable-rate and fixed-rate loans, and activity within different
categories of deposit products. Also, the ability of some borrowers to repay
their adjustable-rate loans may decrease in the event of interest-rate
increases.
The following table summarizes the Corporation's interest-rate
sensitivity position as of December 31, 2001. Assets and liabilities are
classified as interest-rate sensitive if they have a remaining term to maturity
of 0-12 months or are subject to interest-rate adjustments within those time
periods. Adjustable-rate loans and mortgage-backed securities are shown as if
the entire balance came due on the repricing date. Nonaccruing loans are not
included in this analysis due to their status as non-earning assets. Estimates
of fixed-rate loan and fixed-rate mortgage-backed security amortization and
prepayments are included with rate sensitive assets. The following types of
deposit accounts are assumed to have effective maturities as follows based on
their past retention characteristics: NOW accounts-up to five years; cash
manager and passbook plus accounts-up to six months; and regular savings
accounts-up to greater than five years. None of these assets is considered a
trading asset.
7
INTEREST-RATE SENSITIVITY POSITION
DECEMBER 31, 2001
-------------------------------------------------------------------
0-3 3-6 6-12 1-5 OVER 5
MONTHS MONTHS MONTHS YEARS YEARS
------ ------ ------ ----- -----
(Dollars in Thousands)
INTEREST SENSITIVE ASSETS:
Investment securities, including
overnight investments .................. $ 23,187 $ 11,898 $ 3,088 $ 23,891 $ --
Loans held for sale ..................... 13,510 -- -- -- --
Adjustable-rate loans ................... 97,589 18,454 32,393 138,355 --
Fixed-rate loans ........................ 7,235 1,164 3,391 35,119 7,939
Due from mortgage investors ............. 13,003 -- -- -- --
Mortgage-backed securities .............. 842 1,475 5,386 1,972 145
-------- -------- -------- -------- --------
Total interest sensitive assets ...... 155,366 32,991 44,258 199,337 8,084
-------- -------- -------- -------- --------
INTEREST SENSITIVE LIABILITIES:
Cash manager and passbook plus
accounts ............................... 26,862 26,864 -- -- --
Time deposits ........................... 52,870 42,980 31,399 26,384 --
Other deposits(a) ....................... 13,414 13,415 26,848 96,050 10,621
Borrowings .............................. 13,425 -- 3,000 2,019 638
-------- -------- -------- -------- --------
Total interest sensitive liabilities . 106,571 83,259 61,247 124,453 11,259
-------- -------- -------- -------- --------
Excess (deficiency) of interest
sensitive assets over interest
sensitive liabilities .................. $ 48,795 $(50,268) $(16,989) $ 74,884 $ (3,175)
======== ======== ======== ======== ========
Excess (deficiency) of cumulative
interest sensitive assets over cumu-
lative interest sensitive liabilities .. $ 48,795 $ (1,473) $(18,462) $ 56,422 $ 53,247
======== ======== ======== ======== ========
Cumulative interest sensitive assets
as a percentage of cumulative
interest sensitive liabilities ......... 145.8% 99.2% 92.6% 115.0% 113.8%
======== ======== ======== ======== ========
Cumulative excess (deficiency) as a
percentage of total assets ............. 10.5% (.3)% (4.0)% 12.2% 11.5%
======== ======== ======== ======== ========
- ----------
(a) Other deposits consist of regular savings, club and N.O.W. accounts.
Interest-rate sensitivity statistics are static measures that do not
necessarily take into consideration external factors which might affect the
sensitivity of assets and liabilities and consequently cannot be used alone to
predict the operating results of a financial institution in a changing
environment. However, these measurements do reflect major trends and thus the
Corporation's sensitivity to interest rate changes over time.
LIQUIDITY
The Bank seeks to ensure that sufficient liquidity is available to meet
cash requirements while earning a return on liquid assets. The Bank uses its
liquidity primarily to fund loan and investment commitments, to supplement
deposit flows and to meet operating expenses. The primary sources of liquidity
are interest and amortization from loans, mortgage-backed securities and
investments, sales and maturities of investments, loan sales, deposits and
Federal Home Loan Bank of Boston ("FHLBB") advances, which include a $15 million
overnight line of credit. The Bank also has access to the Federal Reserve Bank's
discount window and may
8
borrow from the Depositors Insurance Fund Liquidity Fund. During 2001, the Bank
did not use the Federal Reserve Bank discount window and did not borrow from the
Depositors Insurance Fund Liquidity Fund.
The Bank also uses the longer term borrowing facilities within its
total available credit line with the FHLBB. Advances from the FHLBB, other than
the overnight facility, were $5,657,000 at December 31, 2001 and $2,671,000 at
December 31, 2000. The available borrowing capacity as of December 31, 2001, was
$51.7 million, which includes the aforementioned $15.0 million overnight line of
credit. The borrowing capacity at FHLBB is collateralized by loans secured by
one- to four-family properties. As these loan balances increase or decrease, the
Corporation's borrowing capacity increases or decreases accordingly.
During 2001, the primary sources of liquidity were $96.3 million in
loan sales, loan paydowns and amortization of $164.9 million, $11.3 million in
growth of deposits, proceeds from maturities of investments of $18.9 million and
proceeds from payments of mortgage-backed securities of $3.8 million. Primary
uses of funds were $261.2 million in residential, commercial real estate and
commercial loan originations, $18.1 million to purchase investment securities,
$2.0 million to purchase mortgage-backed securities, and $3.3 million to pay
dividends to shareholders. At December 31, 2001, the Bank had $10.2 million in
money market funds and overnight investments.
The primary source of liquidity for the Corporation is dividends from
the Bank. Dividends paid and stock repurchases by the Corporation are the
primary uses of this liquidity. In 2001, there were no stock repurchases.
From time to time, the Bank obtains time deposits in denominations of
$100,000 and over. The following table summarizes maturities of time deposits of
$100,000 or more outstanding at December 31, 2001:
Within one year: (In thousands)
Less than 3 months ....................... $13,248
3 to 6 months ............................ 7,534
6 to 12 months ........................... 4,374
-------
25,156
More than one year ................................ 6,869
-------
$32,025
=======
CAPITAL ADEQUACY
Total stockholders' equity at December 31, 2001 was $42.4 million, an
increase of $4.7 million from $37.7 million at the end of 2000. Included in
stockholders' equity is an unrealized gain on securities available for sale,
which increased stockholders' equity, of $660,000 as compared to an unrealized
loss at December 31, 2000 of $60,000 which decreased stockholders' equity.
Future interest-rate increases could reduce the fair value of these securities,
which would reduce stockholders' equity. As a percentage of total assets,
stockholders' equity was 9.15% at December 31, 2001 compared to 8.60% at
December 31, 2000.
The Federal Reserve Board's ("FRB") leverage capital-to-assets
guidelines require the strongest and most highly rated bank holding companies to
maintain at least a 3.00% ratio of Tier I capital to average consolidated
assets. All other bank holding companies are required to maintain at least 4.00%
to 5.00%, depending on how the FRB evaluates their condition. The FRB may
require a higher capital ratio. At December 31, 2001, the FRB leverage capital
ratio was 9.02% compared to 8.68% at December 31, 2000.
The FDIC's leverage capital-to-assets ratio guidelines are
substantially similar to those adopted by the FRB and described above. At
December 31, 2001, the Bank's leverage capital ratio, under FDIC guidelines, was
8.66% compared to 8.35% at December 31, 2000.
The FRB and the FDIC have also imposed risk-based capital requirements
on the Corporation and the Bank, respectively, which give different risk
weightings to assets and to off-balance sheet assets such as loan commitments
and loans sold with recourse. Both the FRB and FDIC guidelines require the
Corporation and the Bank to have an 8.00% total risk-based capital ratio. The
Corporation's and the Bank's total risk-based capital ratios were 12.43% and
11.98%, respectively, at December 31, 2001 compared to 11.44% and 11.06%,
respectively, at December 31, 2000, thus exceeding their risk-based capital
requirements.
9
As of December 31, 2001, the Bank's total risk-based capital ratio,
Tier I risk-based capital ratio and leverage capital ratio were 11.98%, 10.73%,
and 8.66%, respectively. Based on these capital ratios, the Bank is considered
to be "well capitalized." (For further discussion on capital adequacy see note 9
in the Notes to Consolidated Financial Statements.)
CRITICAL ACCOUNTING POLICIES
The Corporation's significant accounting policies are described in note
1 in the Notes to Consolidated Financial Statements. The Corporation considers
the following accounting policies to be most critical in their potential effect
on its financial position or results of operations:
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is established though a charge to the
provision for loan losses. The allowance for loan losses is a significant
estimate and is regularly reviewed by the Corporation for adequacy by assessing
such factors as changes in the volume of and risks inherent in the loan
portfolio; trends in portfolio credit quality, including delinquency rates and
loss history; and current economic conditions that may affect a borrower's
ability to repay. The Corporation's methodology with respect to the
determination of the allowance for loan losses is more fully discussed on page
17 of Management's Discussion and Analysis of Financial Condition and Results of
Operations.
INTEREST INCOME RECOGNITION
Interest on loans is included in income as earned based upon interest
rates applied to unpaid principal. Accrual of interest income on loans is
discontinued either when a reasonable doubt exists as to the full, timely
collection of principal or interest or when the loans become contractually past
due by ninety days or more, unless they are adequately secured and are in the
process of collection. When a loan is placed on nonaccrual status, all interest
previously accrued but not collected is reversed against current period interest
income. Income on such loans is recognized to the extent that cash is received
and where the ultimate collection of principal and interest is probable. Loans
are removed from nonaccrual when they become less than ninety days past due and
when concern no longer exists as to the collectibility of principal or interest
or when they are adequately secured and are in the process of collection.
INCOME TAXES
The Corporation must estimate income tax expense for each period for
which a statement of operations is presented. This involves estimating the
Corporation's actual current tax exposure as well as its deferred taxes.
Deferred tax assets and liabilities are recognized for the estimated future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases. Deferred tax assets and liabilities are measured using enacted tax rates
in effect for the year in which those temporary differences are expected to be
recovered or settled. The Corporation must also assess the likelihood that any
deferred tax assets will be recovered from future taxable income and to the
extent that recovery is not likely, a valuation allowance must be established.
Significant management judgment is required in determining income tax expense
and deferred tax assets and liabilities.
FINANCIAL CONDITION
The Corporation's total assets increased to $463.6 million at December
31, 2001 from $438.1 million at December 31, 2000. Increases occurred in cash
and cash equivalents, loans held for sale, and due from mortgage investors which
were partially offset by decreases in loans and investments.
DUE FROM MORTGAGE INVESTORS
Due from mortgage investors was $13.0 million at December 31, 2001
compared to zero at December 31, 2000. This represents the amount owed to the
Corporation by mortgage investors for loans sold. During
10
the 2001 period there have been significant delays by mortgage investors in
making payments due to the backlog caused by the volume of mortgage loans sold
into the secondary market nationwide.
INVESTMENTS AND MORTGAGE-BACKED SECURITIES
Investments, consisting of investment and mortgage-backed securities
available for sale, investment securities held to maturity and cost-basis
investments, decreased to $64.4 million at December 31, 2001 from $65.7 million
at December 31, 2000. This was caused by maturities of corporate notes and
paydowns of mortgage-backed securities. Mortgage-backed securities decreased to
$9.8 million at December 31, 2001 from $11.6 million at December 31, 2000 due to
$3.8 million in principal paydowns offset by a $2.0 million purchase. Future
increases in interest rates could reduce the value of these investments.
INVESTMENTS. Certain information regarding the Corporation's
investments as of December 31 is presented below (in thousands):
2001 2000
-------- --------
Amortized Cost:
Investment and mortgage-backed securities available for sale:
U.S. Government and related obligations .................. $ 12,612 7,645
Fixed-income mutual funds ................................ 28,490 28,698
Mortgage-backed securities ............................... 9,820 11,552
Corporate notes .......................................... -- 5,567
Preferred stock .......................................... 5,314 5,314
-------- --------
Total amortized cost ................................ 56,236 58,776
Investment securities held to maturity:
Foreign government bonds ................................. 1,375 1,250
Cost-basis investments
Stock in Federal Home Loan Bank of Boston ................ 4,110 4,110
Stock in Depositors Insurance Fund Liquidity Fund ........ 108 108
Stock in Savings Bank Life Insurance Company of
Massachusetts ......................................... 1,576 1,576
-------- --------
5,794 5,794
-------- --------
Total amortized cost ........................................... 63,405 $ 65,820
Unrealized gain/(loss) on investment securities
available for sale .......................................... 1,024 (80)
-------- --------
Total carrying value ........................................... $ 64,429 $ 65,740
======== ========
Total fair value of investment securities ...................... $ 64,669 $ 65,980
======== ========
11
The following table presents the maturity distribution of debt
securities included in the investment securities portfolio and the weighted
average yield for each type and range of maturity as of December 31, 2001.
Adjustable-rate mortgage-backed securities are shown as if the entire balance
came due on the repricing date. Estimates are made of fixed-rate mortgage-backed
security amortization and prepayments (dollars in thousands):
WITHIN ONE TO FIVE TO OVER
ONE YEAR FIVE YEARS TEN YEARS TEN YEARS TOTAL
-------- ---------- --------- --------- -----
AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD AMOUNT YIELD
---------- ----- ------- ------ ------- ------ ------- ------ -------- -----
U.S. Treasury and agency
obligations available
for sale ................ $ 12,612 2.55% $ -- --% $ -- --% $ -- --% $ 12,612 2.55%
Mortgage-backed securities
available for sale ....... 7,703 6.16 1,972 6.47 145 6.03 -- -- 9,820 6.22
Foreign government bonds
held to maturity ......... -- -- 875 6.97 500 5.63 -- -- 1,375 6.48
---------- ------- ---- ----- --------
$ 20,315 3.92% $ 2,847 6.62% $ 645 5.72% -- --% $ 23,807 4.29%
========== ======= ====== ===== ========
At December 31, 2001, the Corporation did not hold securities of any
single issuer that exceeded ten percent of stockholders' equity.
LOANS AND LOANS HELD FOR SALE
Loans held for sale increased by $8.3 million during the 2001 period to
$13.5 million at December 31, 2001. This increase is due to lower interest rates
in the 2001 period, and customer preference shifting to fixed-rate mortgage
loans. The Corporation sells this production.
Loans decreased by $6.7 million during the 2001 period to $341.6
million at December 31, 2001. This decrease is the result of a decrease in
residential mortgage loans offset by increases in commercial real estate,
commercial and consumer loans. Commercial real estate, commercial construction
and commercial loans typically earn higher yields than residential mortgage
loans, but usually carry higher risk due to loan size.
The following table sets forth the classification of the Corporation's
loans as of December 31 (in thousands):
2001 2000 1999 1998 1997
-------- -------- -------- -------- --------
Residential mortgages ..... $ 48,762 $ 88,517 $ 52,209 $ 45,658 $ 52,707
Commercial real estate .... 200,890 178,666 167,221 163,154 125,832
Commercial construction ... 13,192 14,812 19,590 13,620 19,739
Commercial loans .......... 49,225 41,512 29,446 23,726 22,259
Consumer loans ............ 29,570 24,825 22,548 20,317 20,226
-------- -------- -------- -------- --------
$341,639 $348,332 $291,014 $266,475 $240,763
======== ======== ======== ======== ========
Balances in residential mortgage loans decreased mainly as a result of
decreases in interest rates during the 2001 period. The Bank typically sells all
fixed-rate residential mortgage loans that it originates to the secondary
mortgage market and retains the adjustable-rate loans in its residential
mortgage portfolio. Due to the decrease in interest rates during the 2001
period, the adjustable-rate portfolio has decreased as borrowers preferred
fixed-rate loans to adjustable-rate loans. Balances in commercial real estate
and commercial loans increased mainly due to the Corporation's continued
emphasis on corporate lending. Balances in consumer loans increased based on the
Corporation's focus on equity lines of credit.
12
Residential mortgage loan originations increased during 2001 to $114.7
million from $74.6 million in 2000 due mainly to higher refinancing levels and a
strong market for home purchases, both a result of lower interest rates. The
Corporation originated $103.3 million in fixed-rate loans during 2001 compared
to $22.3 million during 2000. Adjustable-rate loans totaling $11.4 million were
originated during 2001 compared to $52.3 million during 2000. The Corporation
sold loans totaling $109.3 million during 2001 compared to $19.0 million in
2000. At year-end 2001, the Corporation held $13.5 million of fixed-rate
residential mortgage loans for sale compared to $5.2 million at year-end 2000.
The following table sets forth a maturity distribution of the
Corporation's commercial real estate, commercial construction, and commercial
loans as of December 31, 2001. For purposes of compiling this table, fixed rate
loans are treated as if the entire balance were due on the last contractual
payment date. Adjustable-rate loans are shown at the adjustment period date.
Based on experience with such loans, partial or full repayment of a portion of
the Corporation's commercial real estate loans prior to contractual maturity can
be expected.
WITHIN ONE TO OVER TOTAL
ONE YEAR FIVE YEARS FIVE YEARS GROSS LOANS
-------- ---------- ---------- -----------
(IN THOUSANDS)
Commercial real estate ... $ 63,267 $133,368 $ 4,255 $200,890
Commercial construction .. 13,192 -- -- 13,192
Commercial loans ......... 28,935 19,498 792 49,225
-------- -------- -------- --------
Total ............... $105,394 $152,866 $ 5,047 $263,307
======== ======== ======== ========
Loans with adjustable rate $ 95,596 $118,921 $ -- $214,517
Loans with fixed rate .... 9,798 33,945 5,047 48,790
-------- -------- -------- --------
$105,394 $152,866 $ 5,047 $263,307
======== ======== ======== ========
CREDIT QUALITY
IMPAIRED AND NONPERFORMING LOANS
Loans are deemed by the Corporation to be impaired when, based on
current information and events, it is probable that the Corporation will be
unable to collect all amounts due according to the contractual terms of the
original loan agreement. Generally, nonaccruing loans are deemed impaired. Large
groups of homogeneous loans, such as smaller balance residential mortgage and
consumer installment loans, are collectively evaluated for impairment.
Typically, the maximum delay in receiving payments according to the contractual
terms of the loan that can occur before a loan is considered impaired is 90
days. Impaired loans are analyzed and categorized by level of credit risk and
collectibility in order to determine their related allowance for loan losses. At
December 31, 2001, four loans were considered impaired and accruing interest
totaling $1.8 million compared to two loans considered impaired and accruing
interest totaling $991,000 at December 31, 2000.
Loans past due 90 days or more, or past due less than 90 days but in a
nonaccrual status, were zero at December 31, 2001 and December 31, 2000. Accrual
of interest on loans is discontinued either when reasonable doubt exists as to
the full, timely collection of principal or interest or when the loans become
contractually past due by 90 days or more, unless they are adequately secured
and are in the process of collection.
When a loan is placed on nonaccrual status, all interest previously
accrued but not collected is reversed against current period interest income.
Income on such loans is recognized to the extent that cash is received and where
the ultimate collection of principal and interest is probable. Following
collection procedures for loans secured by real estate, the Corporation
generally institutes appropriate action to foreclose the property or acquire it
by deed in lieu of foreclosure.
13
The table below details nonperforming loans at December 31 (dollars in
thousands):
2001 2000 1999 1998 1997
-------- -------- -------- -------- --------
Accruing loans 90 days or more
past due .......................... $ -- $ -- $ 633 $ 163 $ --
Nonaccrual loans .................... -- -- 914 475 347
-------- -------- -------- -------- --------
Total nonperforming loans ........... $ -- $ -- $ 1,547 $ 638 $ 347
======== ======== ======== ======== ========
Percentage of nonperforming loans to:
Total loans ......................... N/A N/A 0.53% 0.24% 0.14%
======== ======== ======== ======== ========
Total assets ........................ N/A N/A 0.38% 0.16% 0.09%
======== ======== ======== ======== ========
In addition, at December 31, 2001 and 2000, the Corporation had
$808,000 and $9,000, respectively, of loans past due 60 to 89 days and still
accruing interest not included above. These loans are closely monitored by
management and they are considered in reviews of the adequacy of the loan loss
reserve.
The Corporation's lending activities are conducted throughout eastern
Massachusetts with emphasis in Essex County, Massachusetts and contiguous
counties, including those in southern New Hampshire, although from time to time
loans will be made outside of this area. The Bank makes single family,
residential construction, condominium and multi-family residential loans;
commercial real estate, commercial construction and commercial loans; and a
variety of consumer loans. Most loans granted by the Bank are collateralized by
real estate. The ability and willingness of the single family residential and
consumer borrowers to honor their repayment commitments is generally dependent
on the level of overall economic activity and real estate values within the
borrower's geographic area. The ability and willingness of commercial real
estate, commercial construction and commercial loan borrowers to honor their
repayment commitments is generally dependent on the health of the real estate
economic sector, the borrower's business/industrial sector and the general
economy in the borrower's geographic area.
REAL ESTATE ACQUIRED BY FORECLOSURE
There was no real estate acquired by foreclosure at December 31, 2001
and December 31, 2000. Real estate acquired by foreclosure is reflected at the
lower of the carrying value of the loan or the net carrying value of the
property less estimated cost of disposition.
The Corporation had a net gain of zero on the sale of real estate
acquired by foreclosure in the 2001, 2000 and 1999 periods.
In summary, nonperforming assets are as follows at December 31, (in
thousands):
2001 2000 1999 1998 1997
------ ------ ------ ------ ------
Nonperforming loans ...... $ -- $ -- $1,547 $ 638 $ 347
Real estate acquired by
foreclosure ............. -- -- -- 1,450 2,010
------ ------ ------ ------ ------
Total nonperforming assets $ -- $ -- $1,547 $2,088 $2,357
====== ====== ====== ====== ======
14
ALLOWANCE FOR LOAN LOSSES
The following table presents the activity in the allowance for loan
losses for the years ended December 31 (dollars in thousands):
2001 2000 1999 1998 1997
------- ------- ------- ------- -------
Balance at beginning of period ..................... $ 4,781 $ 4,271 $ 4,023 $ 4,066 $ 4,533
------- ------- ------- ------- -------
Losses charged to the allowance:
Commercial ..................................... -- -- (4) -- --
Commercial mortgage and
construction ................................ -- -- (49) -- (344)
Residential mortgage ........................... (3) (14) -- -- (241)
Consumer loans ................................. (1) (8) (7) (98) (23)
------- ------- ------- ------- -------
(4) (22) (60) (98) (608)
------- ------- ------- ------- -------
Loan recoveries:
Commercial ..................................... 21 34 100 24 116
Commercial mortgage
and construction ............................ 269 1 34 79 248
Residential mortgage ........................... 26 24 36 23 75
Consumer loans ................................. 11 17 18 20 18
------- ------- ------- ------- -------
327 76 188 146 457
------- ------- ------- ------- -------
Net (charge-offs) recoveries ................... 323 54 128 48 (151)
Provision for (recovery of) loan
losses charged (credited)
to expense ..................................... (131) 456 120 (91) (316)
------- ------- ------- ------- -------
Balance at end of period ........................... $ 4,973 $ 4,781 $ 4,271 $ 4,023 $ 4,066
======= ======= ======= ======= =======
Allowance to total loans
at end of period ............................... 1.46% 1.37% 1.47% 1.50% 1.69%
======= ======= ======= ======= =======
Allowance to nonperforming
loans at end of period ......................... N/A N/A 276.1% 630.6% 1171.18%
======= ======= ======= ======= =======
Net (charge-offs) recoveries to
Average loans outstanding ...................... .09% .02% .04% .02% (.07)%
======= ======= ======= ======= =======
Allocation of ending balance:
Commercial ..................................... $ 752 $ 629 $ 435 $ 298 $ 295
Commercial mortgage and
construction ................................ 3,268 3,094 3,110 2,917 2,752
Residential mortgage ........................... 557 818 512 619 727
Consumer loans ................................. 396 240 214 189 292
------- ------- ------- ------- -------
$ 4,973 $ 4,781 $ 4,271 $ 4,023 $ 4,066
======= ======= ======= ======= =======
Percentage of loans in each category to total loans:
Commercial ..................................... 14.4% 11.9% 10.1% 8.9% 9.2%
Commercial mortgage and
construction ................................. 62.7 55.6 64.2 66.3 60.5
Residential mortgage ........................... 14.3 25.4 17.9 17.1 21.9
Consumer loans ................................. 8.6 7.1 7.8 7.7 8.4
------- ------- ------- ------- -------
100.0% 100.0% 100.0% 100.0% 100.0%
======= ======= ======= ======= =======
Notwithstanding the foregoing allocations, the entire allowance for
loan losses is available to absorb charge-offs in any category of loans. Loan
losses are charged against the allowance when management believes that the
collectibility of the loan principal is doubtful.
15
Balances in the allowance for loan losses are determined on a periodic
basis by management and the Loan Committee of the Board of Directors with
assistance from a third-party credit-review consulting firm. Management uses a
consistent systematic process that takes into consideration specific and general
portfolio risk, economic conditions and the current regulatory environment. For
impaired loans, management quantifies potential losses. For all other loans a
grading system is used based on assessed credit risk, and loss percentages are
applied to these loans. The loss percentages are determined by reviewing
historic loss trends in each grade category and taking into consideration
industry and regulatory norms, current economic conditions, delinquency levels,
experience of staff and other trends.
In addition to the above components, management applies an unallocated
allowance that is not attributable to any specific loan or loan grade. This
allowance is based on various factors. Among the factors are: the risk
characteristics of the loan portfolio generally; general economic trends;
assessment of the current business cycle; credit quality trends in relation to
current economic conditions; trends in the outlook of banking regulators with
respect to allowance for loan losses and supervisory concerns in general; and
industry trends with respect to levels of allowance for loan losses. The amounts
of the unallocated allowance for the years ended December 31, 2001, 2000 and
1999 is as follows: $1,356,000, or 27% of the total allowance at year-end 2001;
$1,538,000, or 32% of the total allowance at year-end 2000; $1,115,000 or 26% of
the total allowance at year-end 1999. For purposes of the table on the preceding
page, the unallocated allowance is reallocated to specific categories on a
"pro-rata" basis. The unallocated allowance decreased in 2001 based mainly on
management's assessment that: the Corporation's customers were favorably
withstanding the economic slowdown projected at the end of 2000 (nonaccruing
loans remained at zero at the end of 2001); reduced interest rates would better
enable customers to pay their debts to the Corporation; and the Corporation's
lending and credit staff was enhanced during the year.
Assessing the adequacy of the allowance for loan losses involves
substantial uncertainties and is based upon management's evaluation of the
amounts required to meet estimated charge-offs in the loan portfolio after
weighting the above factors. Because the allowance for loan losses is based on
various estimates and includes a high degree of judgment, subsequent changes in
general economic conditions and the economic prospects of the borrowers may
require changes in those estimates.
The associated provision for loan losses is the amount required to
bring the allowance for loan losses to the balance considered necessary by
management at the end of the period after accounting for the effect of loan
charge-offs (which decrease the allowance) and loan-loss recoveries (which
increase the allowance). The allowance for loan losses included above
attributable to $1.8 million of impaired loans, all of which is measured using
the fair value method, is $91,000 at December 31, 2001.
LEGAL AND OFF-BALANCE SHEET RISKS
Various legal claims arise from time to time in the course of business
of the Corporation and its subsidiaries. At December 31, 2001 there were no
material legal claims against the Corporation.
The Corporation is party to financial instruments with off-balance
sheet risk in the normal course of business to meet the financial needs of its
customers and to reduce its own exposure to fluctuations of interest rates.
These financial instruments include commitments to originate loans, unused lines
of credit, standby letters of credit, recourse arrangements on sold assets and
forward commitments to sell loans. The financial instruments involve, to varying
degrees, elements of credit, liquidity and interest-rate risk in excess of the
amount recognized in the consolidated balance sheets.
16
Financial instruments with off-balance sheet risk at December 31 are as
follows:
CONTRACT
AMOUNT
------
(IN THOUSANDS)
2001 2000
------- -------
Financial Instruments Whose Contract Amounts Represent
Credit Risk:
Commitments to originate loans .................... $39,183 $37,701
Unused lines of credit ............................ 46,728 48,417
Standby letters of credit ......................... 1,028 3,375
Unadvanced portions of construction loans ......... 21,100 24,710
Loans sold with recourse .......................... 746 899
Financial Instruments Whose Contract Amounts
Exceed the Amount of Credit Risk:
Forward commitments to sell loans ................. $20,200 $ 6,978
For additional information regarding risks associated with these
instruments, see note 12 in the Notes to Consolidated Financial Statements.
PROPERTIES
The Bank operates a main office and three additional banking offices in
Peabody and two banking offices in Beverly. At December 31, 2001, management
believes that the Bank's existing properties are adequate for the conduct of its
business.
The following table sets forth certain information relating to the
Bank's offices as of December 31, 2001:
OWNED
SOLD LEASE LEASE
YEAR OR EXPIRATION RENEWAL
OFFICE LOCATION OPENED LEASED DATE OPTION
--------------- ------ ------ ---------- ------
Peabody Square
10 Main Street .......... 1854 Owned -- --
Northshore Shopping Center 1958 Leased 2005 No
West Peabody
Russell and Lowell Street 1971 Leased 2003 No*
South Peabody
Lynnfield Street ........ 2000 Leased 2009 Yes
Beverly
175 Cabot Street ........ 1867 Owned -- --
North Beverly
55 Dodge Street ......... 1968 Leased 2006 No
* Bank has option to purchase.
OTHER ASSETS
Included in other assets at December 31, 2001 and December 31, 2000 are
$1.0 million and $1.3 million, respectively, of deferred income tax asset.
17
LIABILITIES
Year-end deposit levels increased to $398.3 million at December 31,
2001 from $387.0 million at December 31, 2000. This increase took place
primarily in demand deposits, NOW deposits, and savings deposits and was
partially offset by a decrease in time deposits.
AVERAGE DEPOSITS.
The following table presents the average balance and average cost of
the Corporation's deposits for the years ended December 31 (dollars in
thousands):
2001 2000 1999
----------------- ------------------ ------------------
AMOUNT COST AMOUNT COST AMOUNT COST
--------- ----- --------- ----- --------- -----
Non-interest bearing.......... $ 27,412 --% $ 22,715 --% $ 17,485 --%
NOW accounts.................. 45,932 0.51 40,251 0.52 36,692 0.53
Savings....................... 157,850 2.42 146,573 2.86 137,497 2.46
Time.......................... 154,343 5.47 159,808 5.23 155,621 5.08
--------- --------- ---------
Total deposits.......... $ 385,537 3.24 $ 369,347 3.45 $ 347,295 3.31%
========= ========= =========
Federal Home Loan Bank of Boston advances were $5.7 million at December
31, 2001 and $2.7 million at December 31, 2000. Securities sold under agreement
to repurchase (customer "repos") were $13.4 million at December 31, 2001 and
$6.0 million at December 31, 2000.
Accrued expenses and other liabilities includes a current income tax
payable of $384,000 at December 31, 2001 and $1.1 million at December 31, 2000.
It also includes accrued salaries and benefits payable of $992,000 at December
31, 2001 and $886,000 at December 31, 2000.
18
INCOME YIELD AND COST OF FUNDS ANALYSIS. The table below sets forth
information concerning the Corporation's average balances, interest income and
expense, and yield information for the three years shown. Average loan balances
include nonaccruing loans. The yields on investments and loans are calculated on
a fully taxable-equivalent basis using a federal tax rate of 34%.
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------------------------------------------
2001 2000 1999
--------------------------------- --------------------------------- -------------------------------
AVERAGE YIELD/ AVERAGE YIELD/ AVERAGE YIELD/
BALANCE INTEREST RATE BALANCE INTEREST RATE BALANCE INTEREST RATE
------- -------- ------ -------- -------- ------ -------- -------- -----
(DOLLARS IN THOUSANDS)
Interest-earning assets:
Loans ................. $376,571 $ 29,677 7.94% $317,937 $ 27,452 8.63% $273,376 $ 22,891 8.37%
Investments, including
overnight investments . 51,296 2,766 5.60 74,429 4,682 6.46 89,115 4,969 5.64
Mortgage-backed
securities ........... 10,924 767 7.02 12,795 930 7.27 16,579 1,127 6.80
-------- -------- -------- -------- -------- --------
Total interest-
earning assets ... 438,791 33,210 7.64% 405,161 33,064 8.19% 379,070 28,987 7.66%
Non-interest earning
assets ................ 14,692 12,674 13,692
-------- -------- --------
Total assets ............ $453,483 $417,835 $392,762
======== ======== ========
Interest-bearing
liabilities:
Deposits .............. $358,125 12,492 3.49% $346,632 12,744 3.68% $329,810 $ 11,488 3.48%
Borrowings ............ 26,598 997 3.71 10,591 376 3.55 8,659 315 3.64
-------- -------- -------- -------- -------- --------
Total interest-
bearing liabilities . 384,723 13,489 3.50 357,223 13,120 3.67 338,469 11,803 3.49
Non-interest bearing
deposits .............. 27,412 22,715 17,485
-------- -------- --------
Total deposits and
borrowed funds ........ 412,135 3.27 379,938 3.45 355,954 3.31
Non-interest bearing
liabilities ........... 1,282 2,095 918
Stockholders' equity .... 40,066 35,802 35,890
-------- -------- --------
Total liabilities
and stockholders'
equity ............ $453,483 $417,835 $392,762
======== ======== ========
Net interest income ..... $ 19,721 $ 19,944 $ 17,184
======== ======== ========
Weighted average
rate spread ........... 4.37% 4.74% 4.35%
Net yield on average
earning assets ........ 4.57% 4.96% 4.57%
19
RATE/VOLUME ANALYSIS. The following table sets forth information
concerning the Bank's interest and dividend income, interest expense and net
interest income changes for the years listed.
YEAR ENDED DECEMBER 31,
---------------------------------------------------------------------------
2001 COMPARED TO 2000 2000 COMPARED TO 1999
INCREASE (DECREASE) INCREASE (DECREASE)
DUE TO DUE TO
------------------------------------ ------------------------------------
AVERAGE AVERAGE
RATE/ RATE/
VOLUME RATE VOLUME TOTAL VOLUME RATE VOLUME TOTAL
------- ------- ------- ------- ------- ------- ------- -------
(IN THOUSANDS)
Interest and dividend income:
Investments, including overnight
investments ................. $(1,496) $ (643) $ 223 $(1,916) $ (828) $ 736 $(195) $ (287)
Mortgage-backed securities ..... (136) (32) 5 (163) (257) 78 (18) (197)
Loans .......................... 5,063 (2,220) (618) 2,225 3,731 714 116 4,561
------- ------- ----- ------- ------- ------- ----- -------
Total interest and dividend
income ................... 3,431 (2,895) (390) 146 2,646 1,528 (97) 4,077
Interest expense:
Deposits:
N.O.W ......................... 30 (5) (1) 24 19 (5) (1) 13
Savings ....................... 322 (632) (49) (359) 224 537 35 796
Time .......................... (286) 382 (13) 83 213 228 6 447
Borrowings ..................... 568 21 32 621 70 (8) (1) 61
------- ------- ----- ------- ------- ------- ----- -------
Total interest expense ..... 634 (234) (31) 369 526 752 39 1,317
------- ------- ----- ------- ------- ------- ----- -------
Net interest income .............. $ 2,797 $(2,661) $(359) $ (223) $ 2,120 $ 776 $(136) $ 2,760
======= ======= ===== ======= ======= ======= ===== =======
BUSINESS SEGMENTS
For internal reporting, planning and business purposes, the Corporation
segments its operations into distinct business groups. An individual business
group's profit contribution to the Corporation as a whole is determined based
upon the Corporation's profitability reporting system which assigns capital and
other balance sheet items and income statement items to each of the business
groups. This segmentation mirrors the Corporation's organizational structure.
Management accounting policies are in place for assigning revenues and expenses
that are not directly incurred by the business groups, such as overhead, the
results of asset allocations, and transfer revenues and expenses. Accordingly,
the Corporation's business-segment operating results will differ with other
similar information published by other financial institutions. In addition,
management accounting concepts are periodically refined and results may change
to reflect these refinements.
For purposes of this disclosure, operating segments are defined as
components of an enterprise that are evaluated regularly by chief operating
decision maker in deciding how to allocate resources and in assessing
performance. The Corporation's chief operating decision maker is the President
and Chief Executive Officer of the Corporation. This disclosure has no effect on
the Corporation's primary financial statements.
In 2001, the Corporation has identified its reportable operating
business segments as the Corporate Banking Business, the Personal Banking
Business and the Residential Mortgage Business. In 2000 and 1999, the
Corporation had identified its reportable business segments as the Corporate
Banking Business and the Personal Banking Business. Although the Corporation's
business segments included the Residential Mortgage Business in 2000 and 1999,
it was not considered a reportable segment. In 2001 the Corporation changed its
method of allocating assets, capital, and funding among the business segments.
The major change is that the residential mortgage loan portfolio became part of
the assets of the Residential Mortgage Business in 2001. In prior periods, the
Residential Mortgage
20
Business sold loans that were to be kept in the Bank's portfolio to the Personal
Banking Business at a specified transfer price. Because of this change in the
mix of assets, capital allocations and funding methods to those two businesses
also changed. Also because of these changes, the Residential Mortgage Business
met certain quantitative thresholds and is now considered a reportable segment.
Due to the complexity of the financial statements, the fact that the
Corporation's new approach encompasses a fundamental change and that change is
more than just a reassignment of profit centers, a restatement of information in
prior periods is impracticable. In addition, for the same reasons, it is
impracticable to restate the current reporting period under the old basis.
Furthermore, management has not restated prior or current business-segment
financial information for internal purposes. A description of each reportable
business segment is discussed below:
CORPORATE BANKING BUSINESS
The Corporate Banking Business provides services to business customers
in the Corporation's market area. These services include, but are not limited
to, commercial real estate and construction loans, asset-based financing and
cash management/deposit services. It services all loans in its business. This
business' segment reporting approach remained the same in the 2001, 2000 and
1999 periods.
RESIDENTIAL MORTGAGE BUSINESS
The Residential Mortgage Business provides services to consumers in the
Corporation's market area. These services include making adjustable-rate and
fixed-rate mortgage loans. This group also services all loans held in its
business and sells fixed-rate loans into the secondary market.
PERSONAL BANKING BUSINESS
The Personal Banking Business provides services to consumers in the
Corporation's market area through its branch and ATM network. These services
include, but are not limited to, home equity loans, installment loans, safe
deposit boxes and an array of deposit services. In the 2000 and 1999 period,
this business purchased adjustable-rate mortgage loans from another business
segment and serviced all loans in its business. In the 2001 period, the
adjustable-rate mortgage loans were transferred to the books of the Residential
Mortgage Business along with the expense of servicing those loans.
NON-REPORTABLE SEGMENTS
Non-reportable operating segments of the Corporation's operations that
do not meet the qualitative and quantitative thresholds requiring disclosure are
included in the Other category in the disclosure of business segments below.
Revenues in these segments consist mainly of interest income on investments and
gains on sales of securities, and in 2000 and 1999 also included gains on sales
of mortgage loans.
21
Specific reportable segment information as of and for the years ended
December 31, 2001, 2000 and 1999 is as follows (in thousands):
YEAR ENDED DECEMBER 31, 2001
CORPORATE RESIDENTIAL PERSONAL WARREN BANCORP
BANKING MORTGAGE BANKING OTHER ELIMINATIONS CONSOLIDATED
- -----------------------------------------------------------------------------------------------------------
Interest income - external $ 22,330 $ 7,422 $ 3,012 $ 446 -- $ 33,210
Interest income - internal -- -- 14,708 -- $(14,708) --
Interest expense-external 2,048 595 10,750 96 -- 13,489
Interest expense-internal 9,821 4,887 -- -- (14,708) --
Fee and other income 238 1,079 1,029 243 -- 2,589
Income tax expense
(benefit) 3,010 838 706 (1,236) -- 3,318
Net income 4,890 1,289 1,187 (262) -- 7,104
Total assets 291,400 81,300 76,500 14,400 -- 463,600
Total loans 263,300 48,700 29,600 -- -- 341,600
Total deposits 64,300 900 328,700 4,400 -- 398,300
YEAR ENDED DECEMBER 31, 2000
CORPORATE PERSONAL WARREN BANCORP
BANKING BANKING OTHER ELIMINATIONS CONSOLIDATED
- ---------------------------------------------------------------------------------------------
Interest income - external $ 21,362 $ 11,412 $ 290 -- $ 33,064
Interest income - internal -- 9,800 111 $(9,911) --
Interest expense - external 2,221 10,805 94 -- 13,120
Interest expense - internal 9,800 -- 111 (9,911) --
Fee and other income 326 904 797 -- 2,027
Income tax expense
(benefit) 2,929 1,655 (1,216) -- 3,368
Net income (loss) 4,435 2,985 (687) -- 6,733
Total assets 262,500 167,500 8,100 -- 438,100
Total loans 235,000 113,300 -- -- 348,300
Total deposits 67,400 317,500 2,100 -- 387,000
22
YEAR ENDED DECEMBER 31, 1999
CORPORATE PERSONAL WARREN BANCORP
BANKING BANKING OTHER ELIMINATIONS CONSOLIDATED
- ---------------------------------------------------------------------------------------------
Interest income - external $ 19,076 $ 9,682 $ 229 -- $ 28,987
Interest income - internal -- 8,963 45 $(9,008) --
Interest expense - external 1,338 10,367 98 -- 11,803
Interest expense - internal 8,963 -- 45 (9,008) --
Fee and other income 168 807 322 -- 1,297
Income tax expense
(benefit) 2,973 1,233 (1,379) -- 2,827
Net income (loss) 4,459 2,512 (1,507) -- 5,464
Total assets 237,600 156,600 8,000 -- 402,200
Total loans 216,200 74,800 -- -- 291,000
Total deposits 39,700 313,700 2,100 -- 355,500
23
RESULTS OF OPERATIONS - 2001 COMPARED TO 2000
GENERAL
The Corporation recorded a profit for the 2001 period of $7.1 million
compared to a profit for the 2000 period of $6.7 million.
Net interest income for the 2001 period was $19.7 million and $19.9
million for the 2000 period. The weighted average interest-rate spread for the
2001 period was 4.37% compared to 4.74% for the 2000 period. The net yield on
average earning assets was 4.57% for the 2001 period and 4.96% for the 2000
period. The return on average assets and the return on average stockholders'
equity were 1.57% and 17.73%, respectively, for the 2001 period compared to
1.61% and 18.81%, respectively, for the 2000 period.
During the 2001 period, short-term interest rates have declined
significantly. The yield on the one-year constant maturity index decreased to
2.17% at December 31, 2001 from 5.32% at December 31, 2000, and prime rate
decreased to 4.75% at December 31, 2001 from 9.50% at December 31, 2000. When
general interest rates decrease, the Corporation's weighted average
interest-rate spread and net yield on average earning assets will usually
decrease. This is mainly because certain sources of funds, namely NOW and
regular savings deposits, may not have their rates decrease at the same rate as
the Corporation's assets. Also demand deposits and stockholders' equity have no
interest rate attached to them; therefore, their costs as a funding source do
not decrease. As a result, despite increased asset levels, net interest income
decreased in the 2001 period.
INTEREST AND DIVIDEND INCOME
Total interest and dividend income increased to $33.2 million for the
2001 period from $33.1 million for the 2000 period. Interest on loans increased
to $29.7 million for the 2001 period from $27.5 million for the 2000 period due
to average loans outstanding increasing in the 2001 period which was offset by a
decrease in the average loan yield to 7.94% for the 2001 period from 8.63% for
the 2000 period. Interest and dividends on investments was $2.8 million for the
2001 period compared to $4.7 million for the 2000 period. This is attributable
to a decrease in the average amount of investments held and a decrease in the
average yield on investments to 5.60% for the 2001 period from 6.46% for the
2000 period. Mortgage-backed securities income decreased to $767,000 in the 2001
period from $930,000 in the 2000 period primarily due to a decrease in the
average amount of mortgage-backed securities held due to paydowns and a decrease
in the average yield to 7.02% for the 2001 period from 7.27% in the 2000 period.
INTEREST EXPENSE
Interest on deposits decreased to $12.5 million for the 2001 period
from $12.7 million for the 2000 period. This decrease was related to a decrease
in the average cost of total deposits to 3.24% for the 2001 period from 3.45%
for the 2000 period despite an increase in average total deposits outstanding.
Interest on borrowed funds and escrow deposits of borrowers increased to
$997,000 in the 2001 period from $376,000 for the 2000 period. This increase is
related to an increase in the average amount of borrowed funds and an increase
in the average cost of borrowings to 3.71% for the 2001 period from 3.55% for
the 2000 period.
NON-INTEREST INCOME
Total non-interest income for the 2001 period was $2.6 million compared
to $2.0 million for the 2000 period. The gain from the sale of mortgage loans
was $1.0 million in the 2001 period compared to $214,000 in the 2000 period.
Because the Corporation sells fixed-rate loans that it originates, and because
more fixed-rate loans were originated in the 2001 period due to low interest
rates, gains on sales of mortgage loans increased. Also included in the 2001
period is $200,000 of interest for the resolution of certain tax matters of
prior years. The gain from the sale of investment securities was
24
zero for the 2001 period compared to $208,000 in the 2000 period. The gain on
sale of securities in the 2000 period was due to a call of a preferred stock.
The other gain included in the 2000 period is a gain on sale of fixed assets of
$376,000 from the sale of the land and building that was the former location of
the Bank's South Peabody branch office (see Note 11 "Related-Party Transaction"
in the notes to consolidated financial statements.)
NON-INTEREST EXPENSE
Total non-interest expense was $12.0 million in the 2001 period
compared to $11.4 million in the 2000 period. Salaries and employee benefits
were $7.4 million in the 2001 period and $7.1 million for the 2000 period.
Salaries and benefits increased due to salaries and benefits increases for
existing staff. Other expenses increased to $2.2 million in the 2001 period from
$2.0 million in the 2000 period due to recruiting costs, the cost of an
additional ATM, and consulting services.
INCOME TAX EXPENSE
Income tax expense for the 2001 period was $3.3 million, or 31.8% of
income before income taxes, compared to $3.4 million, or 33.3% of income before
income taxes, for the 2000 period. Included in income tax expense for the 2001
period is a $176,000 reduction of state tax expense, net of federal tax, due to
resolution of certain tax matters of prior years. The Corporation's tax rate
without this reduction was 33.5%.
RESULTS OF OPERATIONS - 2000 COMPARED TO 1999
GENERAL
The Corporation recorded a profit for the 2000 period of $6.7 million
compared to a profit for the 1999 period of $5.5 million.
Net interest income for the 2000 period was $19.9 million and $17.2
million for the 1999 period. The weighted average interest-rate spread for the
2000 period was 4.74% compared to 4.35% for the 1999 period. The net yield on
average earning assets was 4.96% for the 2000 period and 4.57% for the 1999
period. The return on average assets and the return on average stockholders'
equity were 1.61% and 18.81%, respectively, for the 2000 period compared to
1.39% and 15.26%, respectively, for the 1999 period.
INTEREST AND DIVIDEND INCOME
Total interest and dividend income increased to $33.1 million for the
2000 period from $29.0 million for the 1999 period. Interest on loans increased
to $27.5 million for the 2000 period from $22.9 million for the 1999 period due
to average loans outstanding increasing in the 2000 period as well as an
increase in the average loan yield to 8.63% for the 2000 period compared to
8.37% for the 1999 period. Interest and dividends on investments was $4.7
million for the 2000 period compared to $5.0 million for the 1999 period. This
is attributable to a decrease in the average amount of investments held offset
by an increase in the average yield on investments to 6.46% for the 2000 period
from 5.64% for the 1999 period. Mortgage-backed securities income decreased to
$930,000 in the 2000 period from $1.1 million in the 1999 period primarily due
to a decrease in the average amount of mortgage-backed securities held due to
paydowns offset by an increase in the average yield from 7.27% for the 2000
period compared to 6.80% in the 1999 period.
INTEREST EXPENSE
Interest on deposits increased to $12.7 million for the 2000 period
from $11.5 million for the 1999 period. This increase was related to an increase
in the average cost of total deposits to 3.45% for the 2000 period from 3.31%
for the 1999 period and an increase in average total deposits outstanding.
Interest on borrowed funds and escrow deposits of borrowers increased to
$376,000 in the 2000 period from $315,000 for the 1999 period. This increase is
primarily related to an increase in borrowed funds
25
partially offset by the average cost of borrowings decreasing to 3.55% for the
2000 period from 3.64% for the 1999 period.
NON-INTEREST INCOME
Total non-interest income for the 2000 period was $2.0 million compared
to $1.3 million for the 1999 period. The gain from the sale of mortgage loans
was $214,000 in the 2000 period compared to $232,000 in the 1999 period. The
gain from the sale of investment securities was $208,000 for the 2000 period
compared to $17,000 in the 1999 period. The gain on sale of securities in the
2000 period was due to a call of a preferred stock. The other gain included in
the 2000 period is a gain on sale of fixed assets of $376,000 from the sale of
the land and building that was the former location of the Bank's South Peabody
branch office (see Note 11 "Related-Party Transaction" in the Notes to
Consolidated Financial Statements.)
NON-INTEREST EXPENSE
Total non-interest expense was $11.4 million in the 2000 period
compared to $10.1 million in the 1999 period. The 1999 period included expenses
incurred in the formation of a real estate investment trust ("REIT") subsidiary
for $196,000. Salaries and employee benefits were $7.1 million in the 2000
period and $6.6 million for the 1999 period. Salaries and benefits increased due
to salaries and benefits increases for existing staff and increases in staff.
Occupancy and equipment increased in the 2000 period to $1.2 million in the 2000
period from $1.1 million in the 1999 period due to expenses associated with the
new location of the South Peabody branch. Marketing costs increased with
additional emphasis being given to the Corporation's marketing and sales
efforts.
INCOME TAX EXPENSE
Income tax expense for the 2000 period was $3.4 million, or 33.3% of
income before income taxes, compared to $2.8 million, or 34.1% of income before
income taxes, for the 1999 period. The 2000 period reflects a full year of
operation of Warren Real Estate Investment Corporation, a REIT subsidiary.
BUSINESS
GENERAL
THE CORPORATION. Warren Bancorp, Inc. is a business corporation
organized under the General Laws of the Commonwealth of Massachusetts. The only
office of the Corporation, and its principal place of business, is located at 10
Main Street, Peabody, Massachusetts 01960. The Corporation's telephone number is
(978) 531-7400.
The Corporation is a bank holding company which owns all of the
outstanding common stock of its only subsidiary, Warren Five Cents Savings Bank.
The Corporation charges fees to the Bank for providing certain administrative
services for the Bank. Such fees are charged on a cost basis.
THE BANK. The Bank, a wholly owned subsidiary of the Corporation, is a
Massachusetts-chartered savings bank incorporated in 1854. The Bank conducts its
business from four banking offices in Peabody and two banking offices in Beverly
and over the internet.
The Bank is engaged principally in the business of attracting retail
and wholesale deposits from the general public and investing those deposits in
various types of residential and commercial mortgages, consumer and commercial
loans, and various securities. The Bank offers a wide variety of deposit, loan
and investment products and services to individuals and commercial customers.
The Bank has been a member of the FDIC since 1983. The Bank's deposits
are insured by the FDIC up to FDIC limits (generally $100,000 per depositor) and
by the Depositors Insurance Fund (the
26
"DIF") for the portion of deposits in excess of that insured by the FDIC. The
Bank is also a member of the Federal Home Loan Bank ("FHLB") system.
MARKET AREA
The Corporation's primary business and market area are the same as the
Bank's business and market area. The Bank's primary market area is centered in
Peabody (where its main office is located) and Beverly, Massachusetts, both
approximately 18 miles north of Boston, and includes the other cities and towns
of Essex County, Massachusetts. However, the Bank will make loans and provide
services to customers throughout eastern Massachusetts and parts of southern New
Hampshire. The population of Essex County increased to 723,000 in 2000 from
704,000 in 1999, and median family income in 2000 was $74,300. In addition, the
unemployment rate in December 2001 in the Boston labor market was 4.0% compared
to 4.3% in Massachusetts and 5.7% in the United States. This compares to 2.1%,
2.6% and 4.0% in December 2000 for the Boston labor market, Massachusetts and
the United States, respectively.
COMPETITION
The primary business of the Corporation is currently the ongoing
business of the Bank. Therefore, the competitive conditions faced by the
Corporation are the same as those faced by the Bank.
The Bank faces competition in its market area both in originating loans
and attracting deposits. Competition in originating loans comes primarily from
thrift institutions, commercial banks, mortgage companies and consumer finance
companies. Within the Bank's market area and surrounding communities, there are
many competing commercial banks and thrift institutions. Further, there are
numerous mortgage companies, including nationwide organizations, with offices in
the area or calling officers soliciting in the area. The Bank competes for loans
principally on the basis of interest rates and repricing terms, loan fees, the
types of loans originated and the quality of service provided to borrowers.
Management believes that through the Bank's various loan programs, it can
compete for most types of loans in this market area.
In attracting deposits, the Bank's primary competitors are thrift
institutions, commercial banks, money market funds, credit unions and the
capital markets. Competition for deposits comes not only from local
institutions, but from those located in the Boston metropolitan market, through
branching networks, proximity to the work place and the general reach of the
mass media (particularly newspapers) and nationally with competition created by
the internet. The Bank competes for deposits primarily on the basis of interest
rate paid, scope of services provided, convenience and quality of customer
service. In order to appeal to customers and attract depositors, the Bank plans
to continue to offer a wide range of high quality customer services,
professional staff, and convenient offices and hours, in addition to paying
competitive rates on deposits.
Moreover, under the Gramm-Leach-Bliley Act of 1999 (the "GBLA"),
securities firms, insurance companies and other financial services providers
that elect to become financial holding companies may acquire banks and other
financial institutions. Although to date the impact of the GBLA has not been
substantial in this respect, it may in the future significantly change the
competitive environment in which the Corporation and its subsidiaries conduct
business. See "Regulation and Supervision" below. The financial services
industry is also likely to become more competitive as further technological
advances enable more companies to provide financial services. These
technological advances may diminish the importance of depository institutions
and other financial intermediaries in the transfer of funds between parties.
REGULATION AND SUPERVISION
In addition to the generally applicable state and federal laws
governing businesses and employers, the Corporation and the Bank are further
regulated by federal and state laws and regulations applicable to financial
institutions and their parent companies. Virtually all aspects of our
27
operations are subject to specific requirements or restrictions and general
regulatory oversight. State and federal banking laws have as their principal
objective either the maintenance of the safety and soundness of financial
institutions and the federal deposit insurance system or the protection of
consumers or classes of consumers, rather than the specific protection of
stockholders of a bank or its parent company. To the extent the following
material describes statutory or regulatory provisions, it is qualified in its
entirety by reference to the particular statute or regulation.
THE CORPORATION
GENERAL. As a bank holding company ("BHC"), the Corporation is subject
to regulation and supervision by the FRB. The Corporation is required to file
annually a report of its operations with, and is subject to examination by, the
FRB. The FRB has the authority to issue orders to BHCs to cease and desist from
unsound banking practices and violations of conditions imposed by, or violations
of agreements with, the FRB. The FRB is also empowered to assess civil money
penalties against companies or individuals who violate the BHC Act of 1956, as
amended, (the "BHCA") or orders or regulations thereunder, to order termination
of non-banking activities of non-banking subsidiaries of BHCs, and to order
termination of ownership and control of a non-banking subsidiary by a BHC.
BHCA - ACTIVITIES AND OTHER LIMITATIONS. The BHCA prohibits a BHC from
acquiring substantially all the assets of a bank or acquiring direct or indirect
ownership or control of more than 5% of the voting shares of any bank, or
increasing such ownership or control of any bank, or merging or consolidating
with any BHC without prior approval of the FRB. The Riegle-Neal Interstate
Banking and Branching Efficiency Act of 1994 (the "Interstate Act") generally
authorizes BHCs to acquire banks located in any state, possibly subject to
certain state-imposed age and deposit concentration limits, and also generally
authorizes interstate mergers and to a lesser extent, interstate branching.
Unless a BHC becomes a "financial holding company" ("FHC") under the
GLBA (as discussed below), the BHCA also prohibits a BHC from acquiring a direct
or indirect interest in or control of more than 5% of the voting shares of any
company which is not a bank or BHC and from engaging directly or indirectly in
activities other than those of banking, managing or controlling banks or
furnishing services to its subsidiary banks, except that it may engage in and
may own shares of companies engaged in certain activities the FRB determined to
be so closely related to banking or managing and controlling banks as to be a
proper incident thereto.
The GLBA established a comprehensive framework to permit affiliations
among commercial banks, insurance companies, securities firms, and other
financial service providers by revising and expanding the BHCA framework to
permit BHCs that qualify and elect to be treated as FHCs to engage in a range of
financial activities broader than would be permissible for traditional BHCs,
such as the Corporation, that have not elected to be treated as FHCs. "Financial
activities" is broadly defined to include not only banking, insurance and
securities activities, but also merchant banking and additional activities that
the FRB, in consultation with the Secretary of the Treasury, determines to be
financial in nature, incidental to such financial activities, or complementary
activities that do not pose a substantial risk to the safety and soundness of
depository institutions or the financial system generally.
In order to become an FHC, a BHC must meet certain tests and file an
election form with the FRB. To qualify, all of a BHC's subsidiary banks must be
well-capitalized (as discussed below under "The Bank") and well-managed, as
measured by regulatory guidelines. In addition, to engage in the new activities,
each of the BHC's banks must have been rated "satisfactory" or better in its
most recent federal Community Reinvestment Act ("CRA") evaluation.
A BHC that elects to be treated as an FHC may face significant
consequences if its banks fail to maintain the required capital and management
ratings, including entering into an agreement with the FRB that imposes
limitations on its operations and may even require divestitures. Such possible
ramifications may limit the ability of a bank subsidiary to significantly expand
or acquire less than well-capitalized and well-managed institutions. The
Corporation has not elected to become a FHC.
28
CAPITAL REQUIREMENTS. The FRB has adopted capital adequacy guidelines
pursuant to which it assesses the adequacy of capital in examining and
supervising a BHC and in analyzing applications to it under the BHCA. These
capital adequacy guidelines generally require BHCs to maintain total capital
equal to 8% of total risk-adjusted assets and off-balance sheet items (the
"Total Risk-Based Capital Ratio"), with at least one-half of that amount
consisting of Tier I or core capital and the remaining amount consisting of Tier
II or supplementary capital. Tier I capital for BHCs generally consists of the
sum of common stockholders' equity and perpetual preferred stock (subject in the
case of the latter to limitations on the kind and amount of such stocks which
may be included as Tier I capital), less goodwill and other non-qualifying
intangible assets. Tier II capital generally consists of hybrid capital
instruments; perpetual preferred stock, which is not eligible to be included as
Tier I capital; term subordinated debt and intermediate-term preferred stock;
and, subject to limitations, general allowances for loan losses. Assets are
adjusted under the risk-based guidelines to take into account different risk
characteristics.
In addition to the risk-based capital requirements, the FRB requires
BHCs to maintain a minimum leverage capital ratio of Tier I capital (defined by
reference to the risk-based capital guidelines) to total average assets (the
"Leverage Ratio") of 3.0%. Total average assets for this purpose does not
include goodwill and any other intangible assets and investments that the FRB
determines should be deducted from Tier I capital. The FRB has announced that
the 3.0% Leverage Ratio requirement is the minimum for the top-rated BHCs
without any supervisory, financial or operational weaknesses or deficiencies or
those, which are not experiencing or anticipating significant growth.
The Corporation currently is in compliance with both the Risk Based
Capital Ratio and the Leverage Ratio requirements. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations--Capital
Adequacy." U.S. bank regulatory authorities and international bank supervisory
organizations, principally the Basel Committee on Banking Supervision, currently
are considering changes to the risk-based capital adequacy framework, which
ultimately could affect the appropriate capital guidelines.
LIMITATIONS ON ACQUISITIONS OF COMMON STOCK. The Federal Change in Bank
Control Act prohibits a person or group of persons from acquiring "control" of a
BHC unless the FRB has been given at least 60 days to review the proposal. Under
a rebuttable presumption established by the FRB, the acquisition of 10% or more
of a class of voting stock of a BHC, such as us, with a class of securities
registered under Section 12 of the Securities Exchange Act of 1934, as amended
(the "Exchange Act") would, under the circumstances set forth in the
presumption, constitute the acquisition of control.
In addition, any company, as that term is broadly defined in the
statute, would be required to obtain the approval of the FRB under the BHCA
before acquiring 25% (5% in the case of an acquirer that is a BHC) or more, or
such lesser percentage of our outstanding common stock as the FRB deems to
constitute control over us.
MASSACHUSETTS LAW. As a Massachusetts corporation, the Corporation must
comply with the General Laws of the Commonwealth of Massachusetts and is subject
to corporate regulation by the Massachusetts Secretary of State.
THE BANK
GENERAL. The Bank is subject to extensive regulation and examination by
the Massachusetts Commissioner of Banks (the "Commissioner") and by the FDIC,
which insures its deposits to the maximum extent permitted by law, and to
certain requirements established by the FRB. The federal and state laws and
regulations which are applicable to banks regulate among other things, the scope
of their business, their investments, their reserves against deposits, the
timing of the availability of deposited funds and the nature and amount of and
collateral for certain loans.
FDIC INSURANCE PREMIUMS. The Bank pays deposit insurance premiums to
the FDIC based on an assessment rate established by the FDIC for Bank Insurance
Fund-member institutions. The FDIC has established a risk-based assessment
system under which institutions are classified, and generally pay premiums
according to their perceived risk to the federal deposit insurance funds.
29
CAPITAL REQUIREMENTS. The FDIC has promulgated regulations and adopted
a statement of policy regarding the capital adequacy of state-chartered banks,
which, like the Bank, are not members of the Federal Reserve System. These
requirements are substantially similar to those adopted by the FRB regarding
BHCs, as described above.
Moreover, the federal banking agencies have promulgated substantially
similar regulations to implement the system of prompt corrective action
established by Section 38 of the Federal Deposit Insurance Act (the "FDIA").
Under the regulations, a bank generally shall be deemed to be:
- - "well capitalized" if it has a Total Risk Based Capital Ratio of 10.0% or
more, has a Tier I Risk Based Capital Ratio of 6.0% or more, has a Leverage
Ratio of 5.0% or more and is not subject to any written capital order or
directive;
- - "adequately capitalized" if it has a total Risk Based Capital Ratio of 8.0%
or more, a Tier I Risk Based Capital Ratio of 4.0% or more, and a Leverage
Ratio of 4.0% or more (3.0% under certain circumstances) and does not meet
the definition of "well capitalized,"
- - "undercapitalized" if it has a Total Risk Based Capital Ratio that is less
than 8.0%, a Tier I Risk Based Capital Ratio that is less than 4.0% or a
Leverage Ratio that is less than 4.0% (3.0% under certain circumstances),
- - "significantly undercapitalized" if it has a Total Risk Based Capital Ratio
that is less than 6.0%, a Tier I Risk Based Capital Ratio that is less than
3.0% or a Leverage Ratio that is less than 3.0%, and
- - "critically undercapitalized" if it has a ratio of tangible equity to total
assets that is equal to or less than 2.0%.
An institution generally must file a written capital restoration plan
which meets specified requirements with an appropriate federal banking agency
within 45 days of the date that the institution receives notice or is deemed to
have notice that it is undercapitalized, significantly undercapitalized or
critically undercapitalized. An institution, which is required to submit a
capital restoration plan, must concurrently submit a performance guaranty by
each company that controls the institution. A critically undercapitalized
institution generally is to be placed in conservatorship or receivership within
90 days unless the FDIC formally determines that forbearance from such action
would better protect the deposit insurance fund
Immediately upon becoming undercapitalized, an institution becomes
subject to the provisions of Section 38 of the FDIA (i) restricting payment of
capital distributions and management fees, (ii) requiring that the appropriate
federal banking agency monitor the condition of the institution and its efforts
to restore its capital, (iii) requiring submission of a capital restoration
plan, (iv) restricting the growth of the institution's assets and (v) requiring
prior approval of certain expansion proposals.
At December 31, 2001, the Bank was deemed to be a well capitalized
institution for the above purposes. See "Management's Discussion and Analysis of
Financial Condition and Results of Operation--Capital Adequacy." Bank regulators
may raise capital requirements applicable to banking organizations beyond
current levels. We are unable to predict whether higher capital requirements
will be imposed and, if so, at what levels and on what schedules. Therefore, we
cannot predict what effect such higher requirements may have on us. As is
discussed above, the Bank would be required to remain a well-capitalized
institution at all times if we elected to be treated as an FHC.
BROKERED DEPOSITS. The FDIA restricts the use of brokered deposits by
certain depository institutions. These restrictions have not had a material
impact on the operations of the Bank because the Bank historically has not
relied upon brokered deposits as a source of funding. At December 31, 2001, the
Bank did not have any brokered deposits.
TRANSACTIONS WITH AFFILIATES. The FDIA restricts the range of
permissible transactions between a bank and an affiliated company. The Bank is
subject to certain restrictions on loans to the Corporation, on investment in
the stock or securities thereof, on the taking of such stock or securities
30
as collateral for loans to any borrower, and on the issuance of a guarantee or
letter of credit on the Corporation's behalf. The Bank also is subject to
certain restrictions on most types of transactions with the Corporation,
requiring that the terms of such transactions be substantially equivalent to
terms to similar transactions with non-affiliates. The GLBA requires the FRB to
promulgate rules addressing credit exposure relating to derivatives transactions
between banks and their affiliates. The FRB has adopted interim rules addressing
such transactions, and it has solicited comments on the types of restrictions
that should apply to derivatives transaction between banks and their affiliates.
ACTIVITIES AND INVESTMENTS OF INSURED STATE-CHARTERED BANKS. Section 24
of the FDIA generally limits the activities as principal and equity investments
of FDIC-insured, state-chartered banks to those that are permissible for
national banks. In 1999, the FDIC substantially revised its regulations
implementing Section 24 to ease the ability of state banks to engage in certain
activities not permissible for national banks, and to expedite FDIC review of
bank applications and notice to engage in such activities.
Further, the GLBA permits national banks and state banks, to the extent
permitted under state law, to engage in certain new activities that are
permissible for subsidiaries of an FHC. Further, it expressly preserves the
ability of national banks and state banks to retain all existing subsidiaries.
In order to form a financial subsidiary, a national bank or state bank must be
well-capitalized, and such banks would be subject to certain capital deduction,
risk management and affiliate transaction rules. Also, the FDIC's final rules
governing the establishment of financial subsidiaries adopt the position that
activities that a national bank could only engage in through a financial
subsidiary, such as securities underwriting, only may be conducted in a
financial subsidiary by a state nonmember bank. However, activities that a
national bank could not engage in through a financial subsidiary, such as real
estate development or investment, continue to be governed by the FDIC's standard
activities rules. Moreover, to mirror the FRB's actions with respect to state
member banks, the final rules provide that a state bank subsidiary that engages
only in activities that the bank could engage in directly (regardless of the
nature of the activities) will not be deemed to be a financial subsidiary.
COMMUNITY REINVESTMENT ACT. The CRA requires the FDIC to evaluate the
Bank's performance in helping to meet the credit needs of the community.
Massachusetts has also enacted a similar statute that requires the Commissioner
to evaluate the Bank's performance in helping to meet community credit needs. As
a part of the CRA program, the Bank is subject to periodic examinations by the
FDIC and the Commissioner, and maintains comprehensive records of its CRA
activities for this purpose. Management believes the Bank is currently in
compliance with all CRA requirements.
CUSTOMER INFORMATION SECURITY. The FRB, the FDIC and other bank
regulatory agencies have adopted final guidelines (the "Guidelines") for
safeguarding confidential customer information. The Guidelines require each
financial institution, under the supervision and ongoing oversight of its Board
of Directors, to create a comprehensive written information security program
designed to ensure the security and confidentiality of customer information,
protect against any anticipated threats or hazards to the security or integrity
of such information; and protect against unauthorized access to or use of such
information that could result in substantial harm or inconvenience to any
customer.
PRIVACY. The GLBA requires financial institutions to implement policies
and procedures regarding the disclosure of nonpublic personal information about
consumers to nonaffiliated third parties. In general, the statute requires the
Bank to explain to consumers its policies and procedures regarding the
disclosure of such nonpublic personal information, and, except as otherwise
required by law, the Bank is prohibited from disclosing such information except
as provided in its policies and procedures.
USA PATRIOT ACT. The USA Patriot Act of 2001 (the "Patriot Act"),
designed to deny terrorists and others the ability to obtain anonymous access to
the United States financial system, has significant implications for depository
institutions, brokers, dealers and other businesses involved in the transfer of
money. The Patriot Act mandates or will require financial institutions to
implement additional policies and procedures with respect to, or additional
measures designed to address, any or all of the following matters, among others:
money laundering; suspicious activities and currency transaction reporting; and
currency crimes.
31
MASSACHUSETTS LAW - DIVIDENDS. Under Massachusetts law, stock savings
banks such as the Bank may pay dividends no more often than quarterly, and only
out of "net profits" and to the extent that such payments will not impair the
Bank's capital stock and surplus account. Moreover, prior Commissioner approval
is required if the total dividends for a calendar year would exceed net profits
for that year combined with retained net profits for the previous two years.
These restrictions on the ability of the Bank to pay dividends may restrict the
Corporation's ability to pay dividends to its stockholders.
REGULATORY ENFORCEMENT AUTHORITY. The enforcement powers available to
federal banking regulators include, among other things, the ability to assess
civil money penalties, to issue cease-and-desist or removal orders and to
initiate injunctive actions against banking organizations and
institution-affiliated parties, as defined. In general, these enforcement
actions may be initiated for violations of law and regulations and unsafe or
unsound practices. Other actions or inactions may provide the basis for
enforcement action, including misleading or untimely reports filed with
regulatory authorities. Federal law requires, except under certain
circumstances, public disclosure of final enforcement actions by the federal
banking agencies.
New legislation or regulatory requirements could have a significant
impact on the information reporting requirements applicable to the Bank's
clients and may in the short term adversely affect the Bank's ability to service
those clients at a reasonable cost. Any failure by the Bank to provide such
support could cause the loss of customers and have a material adverse effect on
the Corporation's financial results. Additionally, legislation or regulations
may be proposed or enacted to regulate the Corporation in a manner that may
adversely affect its financial results.
EMPLOYEES
At the present time, the Corporation does not have any employees other
than its officers, who are compensated by the Bank. The Corporation may utilize
the support staff of the Bank from time to time without the payment of any fees
to the Bank. If the Corporation expands the scope or size of its financial
services business, or acquires or pursues other lines of business, it may hire
additional employees.
At December 31, 2001, the Bank had 161 employees, 36 of whom were
part-time. None of the employees of the Bank are represented by a collective
bargaining group, and management considers its relations and communications with
employees to be satisfactory.
BANK SUBSIDIARIES AND OTHER ACTIVITIES
The Bank has six wholly owned subsidiaries. All of these subsidiaries
are fully consolidated in the Corporation's financial statements. Those with
significant activity include:
Northbank Realty, Inc., a Massachusetts corporation incorporated in
1976, owned the Bank's South Peabody branch office and land, which it sold in
2000 (see Note 11 "Related-Party Transaction" in the notes to consolidated
financial statements.)
Warren Securities Corporation II, a Massachusetts corporation
incorporated in 1997, owns investment securities that it receives as equity
contributions from the Bank.
Warren Real Estate Investment Corporation, a Massachusetts corporation
incorporated in 1999, owns real estate loans that it receives as equity
contributions from the Bank.
SAVINGS BANK LIFE INSURANCE
The Bank acts as an issuing agent for Savings Bank Life Insurance
Company of Massachusetts and earns commissions for selling life insurance and
annuities.
32
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL
DISCLOSURES
There were no changes in or disagreements with accountants regarding
accounting principles or financial disclosure.
SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
There were no matters submitted to a vote of security holders during
the fourth quarter of 2001.
DIRECTORS AND EXECUTIVE OFFICERS OF THE CORPORATION
Information pertaining to directors and executive officers is set forth
under "Election of a Class of Directors" and "Executive Officers" in the Proxy
Statement for the Annual Meeting of the Corporation to be held on May 1, 2002
and is incorporated herein by reference.
EXECUTIVE COMPENSATION
Information pertaining to executive compensation is set forth under
"Executive Compensation" in the Proxy Statement for the Annual Meeting of the
Corporation to be held on May 1, 2002 and is incorporated herein by reference.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
Information pertaining to security ownership of management and
beneficial owners of more than five percent of the Corporation's common stock is
set forth under "Beneficial Ownership of Common Stock" in the Proxy Statement
for the Annual Meeting of the Corporation to be held on May 1, 2002 and is
incorporated herein by reference.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
Information pertaining to certain relationships and related
transactions is set forth under "Certain Relationships and Related Transactions"
in the Proxy Statement for the Annual Meeting of the Corporation to be held on
May 1, 2002 and is incorporated herein by reference.
33
INDEX TO FINANCIAL STATEMENTS OF
WARREN BANCORP, INC. AND SUBSIDIARIES
PAGES
-----
Report of Independent Public Accountants.............................................. 35
Consolidated Balance Sheets at December 31, 2001 and December 31, 2000................ 36
Consolidated Statements of Operations for the years ended
December 31, 2001, 2000 and 1999.................................................... 37
Consolidated Statements of Changes in Stockholders' Equity for the years ended
December 31, 2001, 2000 and 1999.................................................... 38
Consolidated Statements of Cash Flows for the years ended
December 31, 2001, 2000 and 1999.................................................... 39
Notes to Consolidated Financial Statements............................................ 40-75
34
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Shareholders and Board of Directors of
Warren Bancorp, Inc.:
We have audited the accompanying consolidated balance sheets of Warren Bancorp,
Inc. and subsidiaries (collectively, the Corporation) as of December 31, 2001
and 2000 and the related consolidated statements of operations, changes in
stockholders' equity and cash flows for each of the three years in the period
ended December 31, 2001. These financial statements are the responsibility of
the Corporation's management. Our responsibility is to express an opinion on
these financial statements based on our audits.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of Warren Bancorp, Inc.
and subsidiaries as of December 31, 2001 and 2000 and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 2001, in conformity with accounting principles generally accepted
in the United States.
ARTHUR ANDERSEN LLP
Boston, Massachusetts
January 15, 2002
35
WARREN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(IN THOUSANDS, EXCEPT SHARE DATA)
DECEMBER 31, DECEMBER 31,
2001 2000
------------ ------------
A S S E T S
Cash and due from banks (non-interest bearing) (note 12) $ 16,834 $ 13,669
Money market funds and overnight investments 10,166 74
--------- ---------
Cash and cash equivalents 27,000 13,743
Due from mortgage investors (note 1) 13,003 --
Investment and mortgage-backed securities available for sale (amortized cost of
$56,236 at December 31, 2001, and $58,776 at December 31, 2000) (notes 2 and 7) 57,260 58,696
Investment securities held to maturity (fair value of $1,375 at December 31, 2001 and
$1,250 at December 31, 2000) (note 2) 1,375 1,250
Cost-basis investments (fair value of $6,034 at December 31, 2001 and
$6,034 at December 31, 2000) (note 2) 5,794 5,794
Loans held for sale (note 3) 13,510 5,180
Loans (notes 3 and 12) 341,639 348,332
Allowance for loan losses (note 3) (4,973) (4,781)
--------- ---------
Net loans 336,666 343,551
Banking premises and equipment, net (note 4) 4,805 5,056
Accrued interest receivable 2,067 2,573
Other assets (note 8) 2,150 2,279
--------- ---------
Total assets $ 463,630 $ 438,122
========= =========
L I A B I L I T I E S A N D S T O C K H O L D E R S' E Q U I T Y
Liabilities:
Deposits (note 6) $ 398,347 $ 387,047
Borrowed funds (note 7) 19,082 8,654
Escrow deposits of borrowers 1,056 1,329
Accrued interest payable 435 550
Accrued expenses and other liabilities (note 8) 2,265 2,860
--------- ---------
Total liabilities 421,185 400,440
--------- ---------
Commitments and contingencies (notes 4 and 12)
Stockholders' equity (notes 9 and 10):
Preferred stock, $.10 par value; Authorized - 10,000,000 shares;
Issued and outstanding - none -- --
Common stock, $.10 par value; Authorized - 20,000,000 shares;
Issued - 8,094,414 shares at December 31, 2001 and December 31, 2000
Outstanding - 7,382,731 shares at December 31, 2001, 7,337,611 shares at
December 31, 2000 809 809
Additional paid-in capital 35,595 35,715
Retained earnings 11,253 7,462
Treasury stock, at cost, 711,683 shares at December 31, 2001, 756,803 shares at
December 31, 2000 (5,872) (6,244)
--------- ---------
41,785 37,742
Accumulated other comprehensive income (note 2) 660 (60)
--------- ---------
Total stockholders' equity 42,445 37,682
--------- ---------
Total liabilities and stockholders' equity $ 463,630 $ 438,122
========= =========
See accompanying notes to consolidated financial statements.
36
WARREN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS
(IN THOUSANDS, EXCEPT PER-SHARE DATA)
YEAR ENDED DECEMBER 31,
--------------------------------
2001 2000 1999
-------- ------- --------
Interest and dividend income:
Interest on loans $ 29,677 $27,452 $ 22,891
Interest and dividends on investments 2,766 4,682 4,969
Interest on mortgage-backed securities 767 930 1,127
-------- ------- --------
Total interest and dividend income 33,210 33,064 28,987
-------- ------- --------
Interest expense:
Interest on deposits 12,492 12,744 11,488
Interest on borrowed funds 997 376 315
-------- ------- --------
Total interest expense 13,489 13,120 11,803
-------- ------- --------
Net interest income 19,721 19,944 17,184
(Recovery of) provision for loan losses (note 3) (131) 456 120
-------- ------- --------
Net interest income after (recovery of) provision for
loan losses 19,852 19,488 17,064
-------- ------- --------
Non-interest income:
Customer service fees 1,309 1,223 964
Gains on sales of investment securities, net (note 2) -- 208 17
Gain on sale of fixed assets (note 11) -- 376 --
Gains on sales of mortgage loans (note 3) 1,032 214 232
Other 248 6 84
-------- ------- --------
Total non-interest income 2,589 2,027 1,297
-------- ------- --------
Income before non-interest expense and income taxes 22,441 21,515 18,361
-------- ------- --------
Non-interest expenses:
Salaries and employee benefits (note 10) 7,430 7,127 6,580
Office occupancy and equipment (note 4) 1,277 1,168 1,054
Professional services 199 186 273
Marketing 309 382 214
Real estate operations income -- -- (510)
Outside data processing expense (note 4) 575 561 480
Other 2,229 1,990 1,783
-------- ------- --------
Subtotal 12,019 11,414 9,874
Expenses for formation of Warren Real Estate Investment
Corporation -- -- 196
-------- ------- --------
Total noninterest expenses 12,019 11,414 10,070
-------- ------- --------
Income before income taxes 10,422 10,101 8,291
Income tax expense (note 8) 3,318 3,368 2,827
-------- ------- --------
Net income $ 7,104 $ 6,733 $ 5,464
======== ======= ========
Basic earnings per share (note 5) $ 0.97 $ 0.92 $ 0.74
======== ======= ========
Diluted earnings per share (note 5) $ 0.94 $ 0.91 $ 0.72
======== ======= ========
See accompanying notes to consolidated financial statements.
37
WARREN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
YEARS ENDED DECEMBER 31, 1999, 2000 AND 2001
(DOLLARS IN THOUSANDS)
ACCUMULATED
ADDITIONAL OTHER
COMPREHENSIVE COMMON PAID-IN RETAINED COMPREHENSIVE TREASURY
INCOME STOCK CAPITAL EARNINGS INCOME STOCK TOTAL
------------- ------ ---------- -------- ------------- -------- --------
Balance at December 31, 1998 $809 $35,710 $4,516 $799 ($1,913) $39,921
Comprehensive income:
Net Income $ 5,464 -- -- 5,464 -- -- 5,464
Other comprehensive income: ---------
Unrealized loss on securities
Available for sale, net of taxes (806)
Less: Reclassification adjustment for
securities gains, net of tax expense
included in net income 0
---------
Total other comprehensive income (806) -- -- -- (806) -- (806)
---------
Comprehensive income $ 4,658
=========
Purchase of treasury stock (523,400 shares) -- -- -- -- (4,634) (4,634)
Dividends paid ($.630 per share) -- -- (4,675) -- -- (4,675)
Tax benefit of stock options exercised -- 246 -- -- -- 246
Issuance of 29,920 common shares
for exercise of options -- (115) -- -- 243 128
---- ------- ------- ---- ------- -------
Balance at December 31, 1999 809 35,841 5,305 (7) (6,304) 35,644
Comprehensive income:
Net Income $ 6,733 -- -- 6,733 -- -- 6,733
Other comprehensive income: ---------
Unrealized gain on securities
available for sale, net of taxes 82
Less: Reclassification adjustment for
securities gains, net of tax
expense of $73, included in net
income (135)
---------
Total other comprehensive income (53) -- -- -- (53) -- (53)
---------
Comprehensive income $ 6,680
=========
Purchase of treasury stock (25,000 shares) -- -- -- -- (183) (183)
Dividends paid ($.625 per share) -- -- (4,576) -- -- (4,576)
Tax benefit of stock options exercised -- 2 -- -- -- 2
Issuance of 29,400 common shares
for exercise of options -- (128) -- -- 243 115
---- ------- ------- ---- ------- -------
Balance at December 31, 2000 809 35,715 7,462 (60) (6,244) 37,682
Comprehensive income:
Net Income $ 7,104 -- -- 7,104 -- -- 7,104
Other comprehensive income: ---------
Unrealized gain on securities
available for sale, net of taxes 720 -- -- -- 720 -- 720
---------
Comprehensive income $ 7,824
=========
Dividends paid ($.450 per share) -- -- (3,313) -- -- (3,313)
Tax benefit of stock options exercised -- 21 -- -- -- 21
Issuance of 45,120 common shares
for exercise of options -- (141) -- -- 372 231
---- ------- ------- ---- ------- -------
Balance at December 31, 2001 $809 $35,595 $11,253 $660 ($5,872) $42,445
==== ======= ======= ==== ======= =======
See accompanying notes to consolidated financial statements.
38
WARREN BANCORP, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(IN THOUSANDS)
YEAR ENDED DECEMBER 31,
----------------------------------
2001 2000 1999
-------- -------- --------
Net income $ 7,104 $ 6,733 $ 5,464
Adjustments to reconcile net income to net cash provided by operating
activities:
(Recovery of) provision for loan losses (131) 456 120
Depreciation and amortization 541 511 488
(Prepaid) deferred income taxes (118) 373 229
(Accretion) amortization of premiums, fees and discounts (98) (12) 604
(Gains) on sale of investment securities -- (208) (17)
(Gains) on sales of mortgage loans (1,032) (214) (232)
(Gains) on sales of fixed assets -- (376) --
(Gains) on sale of real estate acquired by foreclosure -- -- (514)
Loans originated for sale (98,673) (22,348) (23,718)
Proceeds from sales of loans 97,376 19,198 23,326
Decrease in accrued interest receivable 506 40 190
(Increase) in due from mortgage investors 0 -- --
(Increase) decrease in other assets (137) (218) 83
(Decrease) increase in accrued interest payable (115) 38 (77)
(Decrease) increase in other liabilities and escrow deposits (847) 1,144 1,424
-------- -------- --------
Net cash (used in) provided by operating activities 4,376 5,117 7,370
-------- -------- --------
Cash flows from investing activities:
Purchase of investment securities (18,119) (22,925) (18,100)
Purchase of mortgage-backed securities (2,049) -- --
Proceeds from sales of investment securities available for sale -- 2,204 17
Proceeds from maturities of investment securities available for sale 18,903 34,848 37,953
Proceeds from payments of mortgage-backed securities available for sale 3,778 2,434 5,982
Proceeds from sales of real estate acquired by foreclosure -- -- 163
Net decrease (increase) in loans (11,988) (57,264) (22,610)
Proceeds from sales of fixed assets -- 669 --
Purchases of premises and equipment (290) (809) (535)
-------- -------- --------
Net cash provided by (used in) investing activities (9,765) (40,843) 2,870
-------- -------- --------
Cash flows from financing activities:
Net increase in deposits 11,300 31,513 8,522
Proceeds from Federal Home Loan Bank advances 3,000 -- --
Principal payments on Federal Home Loan Bank advances (14) -- --
Net increase (decrease) in other borrowed funds 7,442 1,144 (164)
Dividends paid (3,313) (4,576) (4,675)
Purchases of treasury stock -- (183) (4,634)
Stock options exercised 231 115 128
-------- -------- --------
Net cash provided by (used in) financing activities 18,646 28,013 (823)
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 13,257 (7,713) 9,417
Cash and cash equivalents at beginning of year 13,743 21,456 12,039
-------- -------- --------
Cash and cash equivalents at end of year $ 27,000 $ 13,743 $ 21,456
======== ======== ========
Cash paid during the year for:
Interest $ 13,604 $ 13,082 $ 11,880
Income taxes $ 4,367 $ 2,535 $ 2,245
Supplemental noncash activities:
Foreclosures on real estate $ -- $ -- $ 101
Mortgage loans converted from adjustable-rate portfolio loans
to fixed-rate loans held for sale or loans sold $ 19,004 -- --
See accompanying notes to consolidated financial statements.
39
WARREN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Years ended December 31, 2001, 2000 and 1999
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS AND BASIS OF PRESENTATION
Warren Bancorp, Inc. (the "Corporation") is a bank-holding company that
wholly owns Warren Five Cents Savings Bank (the "Bank"). The Bank operates a
main office and three additional banking offices in Peabody and two banking
offices in Beverly and also operates a website with online banking capabilities.
The Bank operates as a community bank with a primary service area centered in
the cities of Peabody and Beverly, Massachusetts. This service area also
encompasses other cities and towns in eastern Massachusetts as well as southern
New Hampshire. It is in the business of making individual and commercial loans
as well as offering an array of deposit products to customers in its market
area.
The consolidated financial statements include the accounts of the
Corporation, the Bank, and the Bank's wholly owned subsidiaries, Warren Real
Estate Investment Corporation, Northbank Realty, Inc., Northbank Financial
Corporation, Hannah Investments, Inc., Warren Securities Corporation II and
Peabody Development Corporation. All significant intercompany accounts and
transactions have been eliminated in consolidation.
USE OF ESTIMATES IN THE PREPARATION OF FINANCIAL STATEMENTS
The accounting and reporting policies of the Corporation conform to
generally accepted accounting principles and to general practices within the
banking industry. In preparing the financial statements, management is required
to make estimates and assumptions that affect the reported amounts of assets and
liabilities as of the dates of the balance sheets and income and expense for the
periods. Actual results could differ from those estimates.
Material estimates that are susceptible to change relate to the
determination of the allowance for loan losses and the realizability of the
deferred tax asset. In connection with the determination of the allowance for
loan losses management obtains independent appraisals for significant properties
as deemed necessary.
A substantial portion of the Corporation's loans are secured by real
estate in markets primarily in Massachusetts. Accordingly, the ultimate
collectibility of a substantial portion of the Corporation's loan portfolio is
susceptible to changing conditions in these markets.
SIGNIFICANT GROUP CONCENTRATIONS OF CREDIT RISK
Most of the Corporation's business is with customers in Massachusetts
and southern New Hampshire. The types of securities in which the Corporation
invests are disclosed in Note 2. Note 3 discloses the types of lending in which
the Corporation is engaged. The Corporation does not have any significant
concentrations in any one industry or customer.
40
WARREN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
The following is a summary of the more significant accounting
policies.
CASH AND CASH EQUIVALENTS
For purposes of the consolidated statement of cash flows, cash and
cash equivalents include cash and balances due from banks and overnight deposits
and investments with remaining maturities of three months or less.
DUE FROM MORTGAGE INVESTORS
This represents the amount owed to the Corporation by mortgage
investors for loans sold. During the 2001 period there have been significant
delays by mortgage investors in making payments due to the backlog caused by the
volume of mortgage loans sold into the secondary market nationwide.
INVESTMENT AND MORTGAGE-BACKED SECURITIES
Debt securities that the Corporation has the positive intent and
ability to hold to maturity are classified as held-to-maturity investments and
non-marketable equity securities are generally classified as cost-basis
investments. Both classifications are reported at amortized cost. Debt and
equity securities that are bought and held principally for the purpose of
selling in the near term are classified as trading investments and reported at
fair value, with unrealized gains and losses included in earnings. Debt and
equity securities not classified as held to maturity, cost basis or trading are
classified as available-for-sale investments and reported at fair value, with
unrealized gains and losses excluded from earnings and reported as a separate
component of stockholders' equity, net of income taxes. The Corporation
classifies its investments and mortgage-backed securities into three categories:
available-for-sale, held-to-maturity and cost-basis investments; the Corporation
has no securities held for trading.
Premium and discounts on investment and mortgage-backed securities
are amortized or accreted into income by use of the effective interest method.
If a decline in fair value below the amortized cost basis of an investment or
mortgage-backed security is judged to be other than temporary, the cost basis of
the investment is written down to fair value as a new cost basis and the amount
of the write-down is included as a charge against earnings. Gains and losses on
the sale of investment and mortgage-backed securities are recognized at the time
of sale on a specific identification basis.
LOANS HELD FOR SALE AND SALES OF LOANS
Prior to the adoption of SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, loans held for sale are stated at the lower
of aggregate cost or fair value. The fair value of loans held for sale is
estimated based on outstanding investor commitments or, in the absence of such
commitments, current investor yield requirements. Net unrealized losses, if any,
are provided for in a valuation allowance by charges to operations.
41
WARREN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
In addition, the Corporation had entered into commitments to fund
residential mortgage loans with the intention of selling them in the secondary
markets. The Corporation had also entered into forward sales agreements for
certain funded loans and loan commitments. The Corporation recorded unfunded
commitments based upon their fair value as a charge through earnings. The
Corporation also records the undesignated forward sales agreements at fair value
with charges to earnings. When a commitment is funded, the Corporation
designates the forward sale agreement as a hedge of the loan held for sale and
records both instruments at fair value with changes recorded in earnings.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is available for future credit losses
inherent in the loan portfolio. Additions to the allowance are charged to
earnings. Loan losses are charged against the allowance when management believes
that the collectibility of the loan principal is doubtful. Recoveries on loans
previously charged off are credited to the allowance.
The allowance is an amount management believes will be adequate to
absorb loan losses based on evaluations of known and inherent risks in the
portfolio, changes in the nature of the loan portfolio, overall portfolio
quality, specific problem loans, prior loss experience and economic trends that
may affect the borrowers' ability to pay. It consists of three components: an
allowance specific to impaired loans; a general allowance on loans graded
according to assessed credit risk; and an unallocated allowance that is not
attributable to any specific loan or loan grade and that is based on
consideration such as general risk characteristics in the loan portfolio,
general economic trends in assessment of the current business cycle and trends
and concerns of banking regulators.
Management believes that the allowance for loan losses is adequate,
and it is assisted by a third-party credit-review consulting firm in making that
determination. Loan loss allocations are based on the conditions of each loan,
whether performing or nonperforming, including collectibility, collateral
adequacy and the general condition of the borrowers, economic conditions,
delinquency statistics, market area activity, the risk factors associated with
each of the various loan categories and the borrower's adherence to the original
terms of the loan.
The associated provision for loan losses is the amount required to
bring the allowance for loan losses to the balance considered necessary by
management at the end of the period after accounting for the effect of loan
charge-offs (which decrease the allowance) and loan-loss recoveries (which
increase the allowance) during the period. In addition, various regulatory
agencies, as part of their examination process, periodically review the
Corporation's allowance for loan losses. Such agencies may require the
Corporation to recognize additions to the allowance based on their judgments
about information available to them at the time of their examination.
42
WARREN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
IMPAIRED AND NONACCRUAL LOANS
The Corporation accounts for impaired loans at the present value of
the expected future cash flows discounted at the loans' effective interest rates
or the fair value of collateral for collateral-dependent loans. When the measure
of the impaired loan is less than the recorded investment in the loan, the
impairment is recorded through the allowance for loan losses. Loans are deemed
by the Corporation to be impaired when, based on current information and events,
it is probable that the Corporation will be unable to collect all amounts due
according to the contractual terms of the original loan agreement. Generally,
nonaccruing loans are deemed impaired. Large groups of homogeneous loans, such
as smaller balance residential mortgage and consumer installment loans, are
collectively evaluated for impairment. Typically, the maximum delay in receiving
payments according to the contractual terms of the loan that can occur before a
loan is considered impaired is ninety days.
Nonaccrual loans, which may include impaired loans, are loans on
which the accrual of interest has been discontinued. Accrual of interest income
on loans is discontinued either when a reasonable doubt exists as to the full,
timely collection of principal or interest or when the loans become
contractually past due by ninety days or more, unless they are adequately
secured and are in the process of collection. When a loan is placed on
nonaccrual status, all interest previously accrued but not collected is reversed
against current period interest income. Income on such loans is recognized to
the extent that cash is received and where the ultimate collection of principal
and interest is probable. Loans are removed from nonaccrual when they become
less than ninety days past due and when concern no longer exists as to the
collectibility of principal or interest or when they are adequately secured and
are in the process of collection.
LOAN FEES AND COSTS
Loan origination fees and certain direct incremental loan origination
costs are deferred and amortized over the life of the related loans as yield
adjustments using primarily the effective interest method. When the loans are
sold or paid off, the unamortized fees and costs are recognized as income or
expense.
BANKING PREMISES AND EQUIPMENT
Banking premises, equipment and leasehold improvements are stated at
cost, less accumulated depreciation and amortization. Depreciation and
amortization are computed principally on the straight-line method over the
estimated useful lives of the assets or the terms of leases, if shorter. Any
repairs and maintenance are expensed. The Corporation periodically assesses the
realizability of its long-lived assets in accordance with Statement of Financial
Accounting Standards ("SFAS") No. 121, Accounting for the Impairment or Disposal
of Long-Lived Assets and for Long-Lived Assets to be Disposed of. Based on its
review, the Corporation does not believe that any material impairment of its
long-lived assets has occurred.
REAL ESTATE ACQUIRED BY FORECLOSURE
Real estate acquired by foreclosure is comprised of properties
acquired through foreclosure proceedings, acceptance of a deed in lieu of
foreclosure or by taking possession of collateral and is
43
WARREN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
recorded and subsequently carried at the lower of the carrying value of the loan
or the fair value of the property received, less estimated costs of disposition.
Losses arising from the acquisition of such properties are charged against the
allowance for loan losses. Operating expenses and any subsequent write-downs are
charged to real estate operations.
INCOME TAXES
Deferred tax assets and liabilities are recognized for the estimated
future tax consequences attributable to differences between the financial
statement carrying amounts of existing assets and liabilities and their
respective tax bases. Deferred tax assets and liabilities are measured using
enacted tax rates in effect for the year in which those temporary differences
are expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period that
includes the enactment date.
RECENT ACCOUNTING DEVELOPMENTS
The Corporation adopted SFAS No. 133, Accounting for Derivative
Instruments and Hedging Activities, as amended on January 1, 2001. This
statement establishes accounting and reporting standards requiring that every
derivative instrument (including certain derivative instruments embedded in
other contracts) be recorded on the balance sheet as either an asset or
liability measured at its fair value. The statement requires that changes in the
derivative's fair value be recorded currently in income unless specific hedge
accounting criteria are met. Special accounting for qualifying hedges allows a
derivative's gains or losses to offset related results of the hedged item in the
statement of income and requires that a company formally document, designate and
assess the effectiveness of transactions that receive hedge accounting. SFAS No.
133, as amended by SFAS No. 137, Deferral of the Effective Date of FASB
Statement No. 133, and FASB No. 138, An Amendment of Statement 133, was adopted
on January 1, 2001 and there was no effect on the results of operations.
As of December 31, 2001, the Corporation had commitments outstanding
to fund mortgage loans, which will be sold to third parties subsequent to
origination as required under contracts. These commitments to fund mortgage
loans and the agreements to subsequently sell such loans to third parties
qualify as derivative instruments under SFAS No. 133. However, recognition of
these derivative instruments upon the adoption of SFAS No. 133 did not have a
material impact on the Corporation's financial position or results of
operations.
The Financial Accounting Standards Board ("FASB") has issued SFAS No.
140, Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities. This Statement replaces SFAS No. 125, Accounting
for Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities, and rescinds SFAS Statement No. 127, "Deferral of the Effective
Date of Certain Provisions of FASB Statement No. 125." SFAS No. 140 provides
accounting and reporting standards for transfers and servicing of financial
assets and extinguishments of liabilities. This statement provides consistent
standards for distinguishing transfers of financial assets that are sales from
transfers that are secured borrowings. This statement is effective for transfers
and servicing of financial assets and extinguishments of liabilities occurring
after March 31, 2001; however, the disclosure provisions are effective for
fiscal years ending after December 15, 2000. The adoption of this statement did
not have a material impact on the Corporation's financial position or results of
operations.
44
WARREN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - (CONTINUED)
In July 2001, FASB issued SFAS No. 141, Business Combinations ("SFAS
141"), and SFAS No. 142, Goodwill and Other Intangible Assets ("SFAS 142"). SFAS
141 addresses the accounting for acquisitions of businesses and is effective for
acquisitions occurring on or after July 1, 2001. SFAS 142 addresses the method
of identifying and measuring goodwill and other intangible assets acquired in a
business combination, eliminates further amortization of goodwill, and requires
periodic evaluations of impairment of goodwill balances. SFAS 142 is effective
for fiscal years beginning after December 15, 2001. Based on the Corporation's
balance sheet at December 31, 2001, there would be no impact from the adoption
of SFAS 141 and SFAS 142 because the Corporation does not have goodwill on its
balance sheet.
In August 2001, the FASB issued SFAS No. 144, Accounting for the
Impairment or Disposal of Long-Lived Assets, which supersedes SFAS No. 121 and
portions of APB Opinion No. 30. This statement addresses the recognition of an
impairment loss for long-lived assets to be held and used, or disposed of by
sale or otherwise. This statement is effective for financial statements issued
for fiscal years beginning after December 15, 2001, and interim periods within
those fiscal years. The adoption of this statement is not expected to have a
material effect on the Corporation's financial condition.
45
WARREN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(2) INVESTMENT AND MORTGAGE-BACKED SECURITIES
Investment and mortgage-backed securities at December 31, 2001 and
2000 are as follows:
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
--------- ---------- ---------- ----
(IN THOUSANDS)
2001
AVAILABLE FOR SALE
Fixed income mutual funds .......... $ 28,490 $ 764 $ (8) $ 29,246
FNMA mortgage-backed securities .... 7,324 243 -- 7,567
GNMA mortgage-backed securities .... 2,496 34 -- 2,530
U.S. Government and related
obligations ....................... 12,612 26 (4) 12,634
Preferred stock .................... 5,314 106 (137) 5,283
-------- -------- -------- --------
56,236 1,173 (149) 57,260
-------- -------- -------- --------
HELD TO MATURITY
Foreign government bonds ........... 1,375 -- -- 1,375
-------- -------- -------- --------
COST BASIS
Stock in Federal Home Loan Bank
of Boston ........................ 4,110 -- -- 4,110
Stock in Depositors Insurance Fund
Liquidity Fund ................... 108 -- -- 108
Stock in Savings Bank Life Insurance
Company of Massachusetts ......... 1,576 240 -- 1,816
-------- -------- -------- --------
5,794 240 -- 6,034
-------- -------- -------- --------
$ 63,405 $ 1,413 $ (149) $ 64,669
======== ======== ======== ========
46
WARREN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(2) INVESTMENT AND MORTGAGE-BACKED SECURITIES - (CONTINUED)
GROSS GROSS
AMORTIZED UNREALIZED UNREALIZED FAIR
COST GAINS LOSSES VALUE
-------- -------- -------- --------
(IN THOUSANDS)
2000
AVAILABLE FOR SALE
Fixed income mutual funds .......... $ 28,698 $ 252 $ (38) $ 28,912
FNMA mortgage-backed securities .... 8,044 289 -- 8,333
GNMA mortgage-backed securities .... 3,508 -- (28) 3,480
U.S. Government and related
obligations ....................... 7,645 28 -- 7,673
Corporate notes .................... 5,567 2 (4) 5,565
Preferred stock .................... 5,314 -- (581) 4,733
-------- -------- -------- --------
58,776 571 (651) 58,696
-------- -------- -------- --------
HELD TO MATURITY
Foreign government bonds ........... 1,250 -- -- 1,250
-------- -------- -------- --------
COST BASIS
Stock in Federal Home Loan Bank
of Boston ........................ 4,110 -- -- 4,110
Stock in Depositors Insurance Fund
Liquidity Fund ................... 108 -- -- 108
Stock in Savings Bank Life Insurance
Company of Massachusetts ......... 1,576 240 -- 1,816
-------- -------- -------- --------
5,794 240 -- 6,034
-------- -------- -------- --------
$ 65,820 $ 811 $ (651) $ 65,980
======== ======== ======== ========
There were no sales of mortgage-backed securities in 2001, 2000 and
1999, and there were no sales of other types of debt securities in 2001, 2000
and 1999.
Proceeds from the sales of equity securities were $2,204,000 in 2000
and, there were not any sales in 2001 and 1999. Realized gains on sales of
equity securities were $208,000 in 2000. However in 1999, the Corporation
received a settlement in the amount of $17,000 for an investment which was sold
in 1994.
There were no realized losses on sales of equity securities in 2001,
2000 or 1999.
47
WARREN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(2) INVESTMENT AND MORTGAGE-BACKED SECURITIES - (CONTINUED)
U.S. Government and related obligations and mortgage-backed
securities with an amortized cost and fair value of $16,175,000 and $16,298,000,
respectively, at December 31, 2001 were pledged to secure securities sold under
agreements to repurchase. These securities were classified as available for
sale.
The following table presents a maturity distribution of the amortized
cost and fair value of the debt securities portfolio as of December 31, 2001.
Adjustable-rate mortgage-backed securities are shown as if the entire balance
came due on the repricing date. Estimates are made of fixed-rate,
mortgage-backed security amortization and prepayments.
AFTER AFTER
ONE FIVE
BUT BUT
WITHIN WITHIN WITHIN AFTER
ONE FIVE TEN TEN
YEAR YEARS YEARS YEARS TOTAL
---- ----- ----- ----- -----
(IN THOUSANDS)
AVAILABLE FOR SALE
Amortized cost ... $20,315 $ 1,972 $ 145 $ -- $22,432
======= ======= ======= ======== =======
Fair value ....... $20,582 $ 2,002 $ 147 $ -- $22,731
======= ======= ======= ======== =======
HELD TO MATURITY
Amortized cost ... $ -- $ 875 $ 500 $ -- $ 1,375
======= ======= ======= ======== =======
Fair value ....... $ -- $ 875 $ 500 $ -- $ 1,375
======= ======= ======= ======== =======
The Bank, as a member of the Federal Home Loan Bank of Boston
("FHLBB"), is required to invest in $100 par value stock in the amount of one
percent of its outstanding home loans or 1/20th of its outstanding advances from
the FHLBB, whichever is higher. As and when such stock is redeemed, the Bank
would receive from the FHLBB an amount equal to the par value of the stock.
48
WARREN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(3) LOANS
Loans at December 31 are summarized as follows:
2001 2000
---- ----
(IN THOUSANDS)
Residential mortgage:
Adjustable-rate ..... $ 45,511 $ 85,391
Fixed-rate .......... 3,251 3,126
--------- ---------
48,762 88,517
--------- ---------
Commercial mortgage:
Adjustable-rate ..... 175,740 150,295
Fixed-rate .......... 25,150 28,371
Construction ........ 13,192 14,812
--------- ---------
214,082 193,478
--------- ---------
Commercial loans ........ 49,225 41,512
--------- ---------
Consumer loans:
Home equity ......... 26,763 22,442
Other ............... 2,807 2,383
--------- ---------
29,570 24,825
--------- ---------
Total loans ......... 341,639 348,332
Allowance for loan losses (4,973) (4,781)
--------- ---------
Net loans ..... $ 336,666 $ 343,551
========= =========
Changes in the allowance for loan losses for the years ended December
31 are as follows:
2001 2000 1999
---- ---- ----
(IN THOUSANDS)
Balance at beginning of year ................... $ 4,781 $ 4,271 $ 4,023
(Recovery of) provision for loan losses charged
(credited) to expense ......................... (131) 456 120
Loans charged off .............................. (4) (22) (60)
Loan recoveries ................................ 327 76 188
------- ------- -------
Balance at end of year ......................... $ 4,973 $ 4,781 $ 4,271
======= ======= =======
49
WARREN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(3) LOANS - (CONTINUED)
At December 31, 2001 the Corporation had net deferred origination
costs of $330,000, reflected as an addition to the appropriate loan categories,
and at December 31, 2000 had $514,000 net deferred origination costs, reflected
as an addition to the appropriate loan categories.
At December 31, 2001, 2000 and 1999 the Corporation serviced
residential loans for investors of approximately $3,692,000, $3,770,000 and
$3,737,000, respectively, which are not reflected in the accompanying
consolidated financial statements because they are not assets of the
Corporation. At December 31, 2001 no formal recourse provisions exist in
connection with such servicing. At December 31, 2001 and 2000, the Corporation
did not have servicing assets. All loans sold in 2001 were sold on a servicing
released basis. Gains on sales of mortgage loans of $1.0 million and $214,000
were realized during the 2001 and 2000 periods, respectively, from the sale of
$109.3 million and $19.0 million of residential mortgage loans.
Nonaccruing loans amounted to zero at December 31, 2001 and 2000 and
$914,000 at December 31, 1999. Interest income of approximately $47,000 would
have been recorded in 1999 on these nonaccrual loans if these loans had been on
a current basis in accordance with their original terms. Interest income
actually recorded on these nonaccrual loans amounted to $26,000 in 1999.
At December 31, 2001 and 2000, there were $1.8 million and $991,000
of loans considered impaired and performing, respectively. The Corporation would
have recorded no additional interest income had these loans performed under
their original terms. Interest income on these loans amounted to $147,000 in
2001 and $112,000 in 2000.
During 2001 and 2000, the average recorded investment in impaired
loans was $1,117,000 and $887,000, respectively.
The allowance for loan losses at December 31, 2001 attributable to
$1.8 million of impaired loans, all of which is measured using the fair value of
collateral method, is $91,000 (of the $1.8 million of impaired loans, $1.7
million had zero allowance for loan losses). The allowance for loan losses at
December 31, 2000 attributable to $991,000 of impaired loans, all of which is
measured using the fair value of collateral method, was $56,000 (all impaired
loans had an allowance for loan losses).
The Corporation's lending activities are conducted throughout eastern
Massachusetts with emphasis in Essex County, Massachusetts and contiguous
counties, including those in southern New Hampshire. From time to time loans
will be made outside of this area. The Bank makes single family, condominium and
multi-family residential loans; commercial real estate, commercial construction
and commercial loans; and a variety of consumer loans. Most loans made by the
Bank are collateralized by real estate. The ability and willingness of the
single family residential and consumer borrowers to honor their repayment
commitments is generally dependent on the level of overall economic activity and
real estate values within the borrower's geographic area. The ability and
willingness of commercial real estate and commercial borrowers to honor their
repayment commitments is generally dependent on the health of the real estate
economic sector and the general economy in the borrower's geographic area.
50
WARREN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(3) LOANS - (CONTINUED)
In the ordinary course of business, the Bank has made loans to
executive officers and directors of the Corporation and its subsidiaries and to
affiliates of the executive officers and directors at substantially the same
terms, including interest and collateral, as those prevailing at the time for
comparable transactions with unrelated borrowers. The aggregate amount of these
loans at December 31, 2001 was $4,250,000. In addition to this balance, the Bank
has commitments to extend an additional $463,000. Activity in these loans during
the year ended December 31, 2001 included loan additions of $557,000 and loan
repayments of $536,000 and one director resigned with outstanding balances as of
December 31, 2000 of $4,621,000. The balance of these loans at December 31, 2000
was $8,850,000.
(4) BANKING PREMISES AND EQUIPMENT
Banking premises and equipment at December 31 are as follows:
ESTIMATED
USEFUL LIVES 2001 2000
------------ ---- ----
(IN THOUSANDS)
Land........................................................ $ 969 $ 969
Buildings................................................... 3-40 Years 4,681 4,681
Furniture, fixtures and equipment........................... 3-38 Years 4,712 4,490
Leasehold improvements...................................... 5-20 Years 1,584 1,552
------- -----
11,946 11,692
Accumulated depreciation and amortization................... (7,141) (6,636)
------- -----
$ 4,805 5,056
======= =====
Depreciation and amortization expense related to the Corporation's
premises and equipment were $541,000, $511,000 and $488,000 in 2001, 2000 and
1999, respectively.
At December 31, 2001, the Bank is obligated under noncancelable
operating leases for premises and outside data processing for minimum payments
in future periods as follows:
YEAR ENDED DECEMBER 31, MINIMUM PAYMENTS
- ----------------------- ----------------
(IN THOUSANDS)
2002................................................................. $663
2003................................................................. 572
2004................................................................. 196
2005................................................................. 162
2006................................................................. 151
Thereafter........................................................... 228
------
$1,972
======
Rent expense for the years ended December 31, 2001, 2000 and 1999
amounted to approximately $206,000, $200,000 and $125,000, respectively. Outside
data processing expense for the years ended December 31, 2001, 2000 and 1999
amounted to $575,000, $561,000 and $480,000, respectively. In September 2000,
the Corporation sold a parcel of land and building, which was the
51
WARREN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(4) BANKING PREMISES AND EQUIPMENT - (CONTINUED)
former location of the Bank's South Peabody branch office (see Note 11
"Related-Party Transaction" below).
(5) EARNINGS PER SHARE
The components of basic and diluted EPS for the years ended 2001,
2000 and 1999 are as follows:
NET INCOME WEIGHTED AVERAGE SHARES NET INCOME PER SHARE
-------------------------------------------------------------------------------------------------
2001 2000 1999 2001 2000 1999 2001 2000 1999
-------------------------------------------------------------------------------------------------
(IN THOUSANDS, EXCEPT SHARE DATA)
Basic EPS ........ $7,104 $6,733 $5,464 7,360 7,323 7,419 $ 0.97 $ 0.92 $ 0.74
Effect of dilutive
stock options . -- -- -- 190 108 195 0.03 0.01 0.02
------ ------ ------ ----- ----- ----- -------- -------- --------
Diluted EPS ...... $7,104 $6,733 $5,464 7,550 7,431 7,614 $ 0.94 $ 0.91 $ 0.72
====== ====== ====== ===== ===== ===== ======== ======== ========
The following table summarizes options that could potentially dilute
earnings per share in the future. These options were not included in the
computation of the common stock equivalents because the impact would have been
antidilutive:
2001 2000 1999
---- ---- ----
Anti-dilutive options ...................................................... 359,900 527,180 229,100
Weighted average exercise price ............................................ $ 10.89 $ 9.64 $ 12.01
52
WARREN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(6) DEPOSITS
Deposits at December 31 are summarized as follows:
2001 2000
-------- --------
(IN THOUSANDS)
Non-interest bearing ...................... $ 30,640 $ 26,641
-------- --------
Savings deposits:
Regular savings and club accounts ..... 106,319 98,276
NOW accounts .......................... 54,029 47,491
Cash Manager and Passbook Plus accounts 53,726 57,385
-------- --------
Total savings deposits ............... 214,074 203,152
Time deposits ............................. 153,633 157,254
-------- --------
Total deposits ....................... $398,347 $387,047
======== ========
Contractual maturities of time deposits at December 31, 2001 are as
follows:
(IN THOUSANDS)
Within one year....................................................... $ 127,249
From one to two years................................................. 14,490
From two to five years................................................ 11,894
After five years...................................................... 0
------------
$ 153,633
============
The aggregate amount of individual time deposits with a minimum
denomination of $100,000 or more was $32,025,000 and $28,766,000 at December 31,
2001 and 2000, respectively. Interest expense related to such deposits was
approximately $1,646,000 in 2001, $1,572,000 in 2000 and $1,392,000 in 1999.
53
WARREN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(7) BORROWED FUNDS
Borrowed funds at December 31 are summarized as follows:
2001 2000
------------------------------- ------------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
AMOUNT RATE AMOUNT RATE
------ ---- ------ ----
(DOLLARS IN THOUSANDS)
Securities sold under agreements
to repurchase maturing in January,
2002 and January, 2001, at December
31, 2001 and 2000, respectively ... $13,425 1.26% $ 5,983 3.00%
Federal Home Loan Bank advances:
Maturing April 25, 2001 @ 3.78% ... $ -- $ 14
Maturing September 16, 2002 @ 4.88% 3,000 --
Maturing January 31, 2003 @ 3.07% . 19 19
Maturing May 2, 2005 @ 6.03% ...... 2,000 2,000
Maturing November 10, 2009 @ 6.00% 450 450
Maturing May 2, 2011@ 5.54% ....... 188 188
------- -------
Subtotal ....................... 5,657 5.39 2,671 5.96
------- -------
Total borrowed funds .......... $19,082 2.48% $ 8,654 3.91%
======= =======
All Federal Home Loan Bank advances listed above are subject to
prepayment penalties.
In addition to the advances above, the Corporation has an overnight
line of credit with the Federal Home Loan Bank of Boston in the amount of $15
million, none of which was used at December 31, 2001.
54
WARREN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(8) INCOME TAXES
The components of income tax expense for the years ended December 31
were as follows:
2001 2000 1999
---- ---- ----
(IN THOUSANDS)
Current:
Federal ............................................ $ 3,380 $ 2,754 $ 2,349
State .............................................. 56 241 249
------- ------- -------
3,436 2,995 2,598
------- ------- -------
Deferred (prepaid):
Federal ............................................ (90) 318 167
State .............................................. (33) 58 69
Increase (decrease) in beginning-of-the-year balance
of valuation allowance for deferred tax assets . 5 (3) (7)
------- ------- -------
(118) 373 229
------- ------- -------
$ 3,318 $ 3,368 $ 2,827
======= ======= =======
A reconciliation of income tax expense attributable to operations
with Federal income taxes at the statutory rate of 34% for the years ended
December 31, 2001, 2000 and 1999 follows:
2001 2000 1999
---- ---- ----
(IN THOUSANDS)
Computed "expected" tax expense at
statutory rate ................................... $ 3,543 $ 3,434 $ 2,819
Items affecting income tax expense:
Change in the beginning-of-the-year
balance of the valuation allowance
for deferred tax assets allocated to
income tax expense ............................ 5 (3) (7)
Dividends received deduction .................... (82) (107) (107)
State income taxes, net of Federal income
tax benefit, before change in valuation
allowance ...................................... 191 195 204
Resolution of state-tax matters from prior years,
net of federal tax ............................ (176) -- --
Interest on municipal bonds ..................... (138) (45) --
Other ........................................... (25) (106) (82)
------- ------- -------
Income tax expense .......................... $ 3,318 $ 3,368 $ 2,827
======= ======= =======
55
WARREN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(8) INCOME TAXES - (CONTINUED)
The tax effects of temporary differences that give rise to
significant portions of the deferred tax assets and deferred tax liabilities at
December 31, 2001 and 2000 are presented below:
2001 2000
---- ----
(IN THOUSANDS)
Deferred tax assets:
Allowance for loan losses ............................... $ 2,036 $ 1,906
Valuation adjustments on securities ..................... 427 354
Deferred compensation ................................... 117 132
Cash versus accrual adjustments ......................... 176 187
Depreciation of banking premises and equipment .......... 142 235
Unrealized losses on debt and equity securities available
for sale ............................................ -- 20
Other ................................................... 23 30
------- -------
Total gross deferred tax assets ...................... 2,921 2,864
Less valuation allowance .......................... (47) (42)
------- -------
Net deferred tax assets .......................... 2,874 2,822
------- -------
Deferred tax liabilities:
Deferred loan costs ..................................... 86 185
Purchase accounting adjustments ......................... 627 639
Accounting for partnership interests .................... 509 509
Deferred transfer of taxable dividends .................. 252 194
Unrealized gains on debt and equity securities
available for sale ................................... 364 --
Other .................................................. 40 33
------- -------
Total gross deferred tax liabilities ............. 1,878 1,560
------- -------
Net deferred tax asset ........................... $ 996 $ 1,262
======= =======
A valuation allowance is provided when it is more likely than not
that some portion of the gross deferred tax asset will not be realized.
Management has established a valuation allowance principally for the state tax
effects of the valuation adjustments on securities.
The Corporation has certain tax bad debt reserves which will not be
subject to recapture as long as the institution continues to carry on the
business of banking. In addition, the balance of the tax bad debt reserves
continues to be subject to a provision of the current law that requires
recapture
56
WARREN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(8) INCOME TAXES - (CONTINUED)
in the case of certain excess distributions to shareholders. The tax effect of
the tax bad debt reserves subject to recapture in the case of certain excess
distributions is approximately $885,000.
(9) STOCKHOLDERS' EQUITY
CAPITAL ADEQUACY
The Corporation and the Bank are subject to various regulatory
capital requirements administered by federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory and possibly
additional discretionary actions by regulators that, if undertaken, could have a
direct material effect on the Corporation's business and financial statements.
Under capital adequacy guidelines and the regulatory framework for prompt
corrective action, the Corporation must meet specific capital guidelines that
involve quantitative measures of the Corporation's assets, liabilities, and
certain off-balance-sheet items as calculated under regulatory accounting
practices. The Corporation's capital amounts and classification are also subject
to qualitative judgments by the regulators about components, risk weightings,
and other factors.
The Federal Reserve Board's ("FRB") leverage capital-to-assets
guidelines require the strongest and most highly rated bank holding companies to
maintain a 3.00% ratio of Tier I capital to average consolidated assets. All
other bank holding companies are required to maintain at least 4.00% to 5.00%
depending on how the FRB evaluates their condition. The FRB may require a higher
capital ratio. The FDIC's leverage capital-to-assets ratio guidelines on the
Bank are substantively similar to those adopted by the FRB described above.
The FRB and the FDIC have also imposed risk-based capital
requirements on the Corporation and the Bank, respectively, which give different
risk weightings to assets and to off-balance sheet assets such as loan
commitments and loans sold with recourse. Both the FRB and FDIC guidelines
require the Corporation and the Bank to have a 4.00% Tier I risk-based capital
ratio and an 8.00% total risk-based capital ratio.
As of December 31, 2001, the most recent notification from the FDIC
categorized the Bank as "well capitalized" under the regulatory framework for
prompt corrective action. To be categorized as well-capitalized, the Bank must
maintain minimum total risk-based, Tier I risk-based and Tier I leverage ratios
as set forth in the following table. There are no conditions or events since
that notification that management believes would cause a change in the Bank's
categorization.
57
WARREN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(9) STOCKHOLDERS' EQUITY - (CONTINUED)
The Corporation's and the Bank's actual regulatory capital amounts
(for purposes of computing the ratios) and ratios at December 31, 2001 and 2000
are presented in the following table (dollars in thousands):
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY ACTION PROVISIONS
------------------------- ------------------- ---------------------------
REGULATORY CAPITAL REGULATORY CAPITAL REGULATORY CAPITAL
CAPITAL RATIO CAPITAL RATIO CAPITAL RATIO
- -------------------------------------------------------------------------------------------------------------------
2001
WARREN BANCORP, INC.
Leverage capital $41,785 9.02% $13,903 3.0% N/A N/A
Tier I risk-based capital 41,785 11.18% 14,950 4.0% N/A N/A
Total risk-based capital 46,461 12.43% 29,900 8.0% N/A N/A
WARREN FIVE CENTS SAVINGS BANK
Leverage capital 40,118 8.66% 13,903 3.0% $ 23,172 5.0%
Tier I risk-based capital 40,118 10.73% 14,960 4.0% 22,440 6.0%
Total risk-based capital 44,797 11.98% 29,920 8.0% 37,400 10.0%
TO BE WELL
CAPITALIZED UNDER
FOR CAPITAL PROMPT CORRECTIVE
ACTUAL ADEQUACY ACTION PROVISIONS
------------------------- ------------------- ---------------------------
REGULATORY CAPITAL REGULATORY CAPITAL REGULATORY CAPITAL
CAPITAL RATIO CAPITAL RATIO CAPITAL RATIO
- ------------------------------------------------------------------------------------------------------------------------------
2000
WARREN BANCORP, INC.
Leverage capital $37,503 8.68% $12,966 3.0% N/A N/A
Tier I risk-based capital 37,503 10.19% 14,716 4.0% N/A N/A
Total risk-based capital 42,104 11.44% 29,432 8.0% N/A N/A
WARREN FIVE CENTS SAVINGS BANK
Leverage capital 36,102 8.35% 12,966 3.0% $ 21,611 5.0%
Tier I risk-based capital 36,102 9.81% 14,726 4.0% 22,089 6.0%
Total risk-based capital 40,706 11.06% 29,453 8.0% 36,816 10.0%
58
WARREN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(9) STOCKHOLDERS' EQUITY - (CONTINUED)
PREFERRED STOCK PURCHASE RIGHTS
In April 1999, the Board of Directors declared a dividend
distribution of one Preferred Stock Purchase Right for each outstanding share of
the Corporation's common stock. These rights, which expire in 2009, entitle
their holders to purchase from the Corporation one one-thousandth of a share (a
"unit") of Series B Junior Participating Cumulative Preferred Stock, par value
$0.10 per share, ("preferred stock") at a cash exercise price of $35 per unit,
subject to adjustment. The rights will trade separately from the common stock
and will become exercisable only when a person or group has acquired 15% or more
of the outstanding common stock, upon the commencement by a person or group of a
tender offer that would result in such person or group acquiring 15% or more of
the outstanding common stock, or upon the declaration by the Board of Directors
that any person holding 10% or more of the outstanding stock is an "adverse
person."
In the event a person or group acquires 15% or more of the
outstanding common stock or the Board of Directors declares a person to be an
"adverse person," each holder of a right (except for any such person or group)
would be entitled to receive upon exercise sufficient units of preferred stock
to equal a value of two times the exercise price of the purchase right. In the
event the Corporation is acquired in a merger or other business combination
transaction or if 50% or more of the Corporation's assets or earning power is
sold, each holder of a right (except for any such person or group described
above) would receive upon exercise common stock of the acquiring company with a
value equal to two times the exercise price of the right.
The rights are redeemable by the Board of Directors at a price of
$.01 per right any time before a person or group acquires 15% or more of the
outstanding common stock or the Board of Directors declares a person holding 10%
or more of the outstanding common stock to be an "adverse person."
RETAINED EARNINGS
At the time of the Bank's conversion from mutual to stock form of ownership
in 1986, the Bank established a liquidation account for the benefit of eligible
account holders who continue to maintain their accounts in the Bank after the
conversion. Liquidation subaccounts totaling $12,340,000 were established for
each such eligible account holder equal to such holder's proportionate share of
total qualifying deposits on February 28, 1986. After the acquisition of Beverly
Savings Bank ("Beverly"), the Bank established a separate liquidation account
for the benefit of eligible account holders of Beverly who continue to maintain
their account after Beverly's conversion from mutual to stock form of ownership
and the subsequent Beverly acquisition, and subaccounts for each such holder
based on such holder's proportionate share of Beverly's total qualifying assets
on April 30, 1986. The balance in the two liquidation accounts at December 31,
2001, the latest measurement date, was $1,186,000 (unaudited). Both liquidation
accounts will be reduced to the extent that eligible account holders have
59
WARREN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - (CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(9) STOCKHOLDERS' EQUITY - (CONTINUED)
reduced their qualifying deposits. Subsequent increases will not restore an
eligible account holder's interest in his liquidation subaccount. In the event
of a complete liquidation of the Bank, and in only such event, each eligible
account holder will be entitled to receive a distribution from the liquidation
accounts equal to the current adjusted qualifying balance of his or her
subaccount, to the extent of the Bank's assets remaining after payment of all
prior claims.
The Bank may not declare or pay a dividend to the holding company if
the effect thereof would reduce capital below regulatory minimums or otherwise
violate banking regulations.
(10) EMPLOYEE BENEFITS
401(K) SAVINGS PLAN
The Bank provides a 401(k) Savings Plan for the benefit of its
employees. Under this defined-contribution plan, the Corporation contributes 3%
of each eligible employee's W-2 compensation to his or her 401(k) account. In
addition, the Corporation matches employee contributions, up to 8% of the
employee's compensation, at a rate of 25%. The Corporation may also make a
profit-sharing distribution to employees' 401(k) accounts. The plan is
administered by a third party. Contribution rates are subject to change.
The Corporation's contributions to the plan charged to operations
were as follows (in thousands):
2001 2000 1999
---- ---- ----
Employer contribution ..... $157 $142 $128
Employer match ............ 58 60 59
Profit sharing distribution 310 313 55
---- ---- ----
$525 $515 $242
==== ==== ====
One of the investment alternatives for the plan's participants is
Warren Bancorp, Inc. common stock. In that regard, the Corporation reserved
270,000 shares of authorized but unissued shares for issuance thereunder.
Employees do not have restrictions on sales of shares within their 401(k)
accounts.
TERMINATION OF PENSION PLAN
As of October 1, 1997, the Bank terminated its defined-benefit,
non-contributory pension plan administered by the Savings Bank Employees
Retirement Association ("SBERA") . To terminate the plan, SBERA made
distributions to participants computed using interest-rate and actuarial
assumptions prescribed by the Pension Benefit Guarantee Corporation. Net
proceeds to the Corporation after distributions to participants were $2,547,000.
The Corporation set aside 25% of these proceeds, or $637,000, into the 401(k)
plan for the benefit of current employees to be distributed into employees'
individual 401(k) accounts in January of 1998, 1999 and 2000 (for the fiscal
years 1997, 1998 and 1999, respectively) as a special profit-sharing
distribution.
60
WARREN BANCORP, INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(10) EMPLOYEE BENEFITS - (CONTINUED)
SUPPLEMENTAL RETIREMENT ARRANGEMENT
Effective July 1, 1995, the Bank established a supplemental retirement
benefit arrangement for the former Chief Executive Officer, who currently serves
as a director of the Corporation and had entered into a consulting agreement
with the Corporation. The expense to maintain that arrangement was zero in 2001,
$61,000 in 2000, and $121,000 in 1999. The cost of this arrangement was being
expensed over the term of the consulting agreement, which ended in May 2000.
Included in the accompanying balance sheets are accrued expenses payable of
$94,000, and $156,000 at December 31, 2001 and 2000, respectively. The
arrangement is being partially funded by a life insurance policy. At December
31, 2001 and 2000, the cash surrender value of the policy, which is included in
other assets, is $582,000 and $480,000, respectively.
DIRECTORS' DEFERRED COMPENSATION PLAN
The Corporation has established an unfunded deferred compensation plan
for its directors who are non-employees of the Corporation. Any non-employee
director may elect to defer earned fees to future years and earn interest on the
unfunded balance which is based on a comparable investment term and rate of
interest. This election may be terminated at the written request of the director
at any time. The deferred compensation expense attributed to the directors for
the years ended December 31, 2001, 2000 and 1999 totaled $21,000, $35,000 and
$32,000, respectively, and the accrued expense payable included in the
accompanying balance sheets for December 31, 2001 and 2000 were $193,000 and
$166,000, respectively.
STOCK OPTION PLANS
The Corporation has adopted four stock option plans, one each in 1986,
1991, 1995 and 1998 (the "Option Plans"), for the benefit of officers and
directors, and reserved 600,000 shares (adjusted for two-for-one common stock
split) of authorized but unissued common stock for each plan for issuance
thereunder. The terms of the Option Plans are similar and provide for options to
be granted at the fair market value of the common stock on the date of grant.
Options granted expire from seven to ten years after the date of grant.
As permitted under SFAS No. 123, the Corporation continues to apply APB
Opinion No. 25 and related interpretations in accounting for the Option Plans;
therefore, no compensation cost has been recognized.
61
WARREN BANCORP, INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(10) EMPLOYEE BENEFITS - (CONTINUED)
Under SFAS No. 123, the Corporation's net income and earnings per share would
have been reduced to the pro-forma amounts indicated below:
2001 2000 1999
------------- ------------- -------------
Net income:
As reported $7,104,000 $6,733,000 $5,464,000
Pro-forma $6,803,000 $6,509,000 $5,106,000
Basic earnings per share:
As reported $0.97 $0.92 $0.74
Pro-forma $0.92 $0.89 $0.69
Diluted earnings per share:
As reported $0.94 $0.91 $0.72
Pro-forma $0.90 $0.88 $0.67
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option pricing model with the following weighted-average
assumptions used for grants in 2001, 2000 and 1999, respectively: dividend yield
of 3.80%, 6.18% and 4.88%; expected volatility of 36%, 46% and 59%; risk-free
interest rates of 4.8%, 6.3% and 5.7%; and expected lives of five years for
2001, 2000 and 1999. The weighted average grant-date fair value per share of
stock options issued in 2001, 2000 and 1999 were $2.72, $2.11 and $3.39,
respectively.
Changes in options outstanding during 2001, 2000 and 1999 were as
follows:
AVERAGE
EXERCISE
EXERCISE PRICE PRICE PER
SHARES RANGE PER SHARE SHARE
------ --------------- -----
Outstanding, December 31, 1998 788,250 $1.8125 to $14.375 $7.50
(427,670 shares exercisable)
Granted during 1999 179,000 $8.000 to $9.000 $8.21
Exercised during 1999 (29,920) $3.3125 to $7.875 $4.25
Canceled during 1999 (28,560) $4.00 to $12.375 $9.00
---------
Outstanding, December 31, 1999 908,770 $1.8125 to $14.375 $7.70
(558,410 shares exercisable)
Granted during 2000 179,500 $7.125 $7.13
Exercised during 2000 (29,400) $1.8125 to $6.1875 $4.00
Canceled during 2000 (28,520) $4.00 to $12.375 $8.19
---------
Outstanding, December 31, 2000 1,030,350 $1.8125 to $14.375 $8.09
(680,230 shares exercisable)
Granted during 2001 187,000 $9.07 to $9.17 $9.15
Exercised during 2001 (45,120) $1.8125 to $7.875 $5.13
Canceled during 2001 (48,320) $4.00 to $14.375 $7.84
---------
Outstanding, December 31, 2001 1,123,910 $1.8125 to $14.375 $8.04
=========
(779,030 shares exercisable)
62
WARREN BANCORP, INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(10) EMPLOYEE BENEFITS - (CONTINUED)
A total of 86,320 shares of common stock have been reserved and are
available for future grants under the Corporation's various stock option plans.
The following table summarizes information about the options
outstanding at December 31, 2001:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE
------------------------- -------------------
WEIGHTED
AVERAGE WEIGHTED WEIGHTED
RANGE OF REMAINING AVERAGE AVERAGE
EXERCISE CONTRACTUAL EXERCISE EXERCISE
PRICES NUMBER LIFE PRICE NUMBER PRICE
------ ------ ---- ----- ------ -----
$0-$5 151,970 2.42 years $3.93 151,970 $3.93
5-10 802,440 5.40 7.80 490,740 7.49
10-15 169,500 4.10 12.85 136,320 12.86
--------- ---------
Total 1,123,910 4.80 8.04 779,030 7.73
========= =========
(11) RELATED-PARTY TRANSACTION
During the 2000 period, the Corporation sold a parcel of land and
building, which was the former location of the Bank's South Peabody branch
office, to a director of the Corporation. The cash sales price of $675,000
resulted in a gain of $376,000. The transaction was completed and transfer of
title occurred in September 2000. See "Non-Interest Income" under "Results of
Operations - 2000 Compared to 1999" and Note 4 "Banking Premises and Equipment"
above.
(12) FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK, COMMITMENTS, AND
CONTINGENT LIABILITIES
The Corporation is party to financial instruments with off-balance
sheet risk in the normal course of business to meet the financial needs of its
customers and to reduce its own exposure to fluctuations of interest rates.
These financial instruments include commitments to originate loans, unused lines
of credit, standby letters of credit, recourse arrangements on sold assets and
forward commitments to sell loans. The financial instruments involve, to varying
degrees, elements of credit and interest-rate risk in excess of the amount
recognized in the consolidated balance sheets. The contract or notional amounts
of these instruments reflect the extent of involvement the Corporation has in
particular classes of financial instruments.
The Corporation's exposure to credit loss in the event of
nonperformance by the other party to the financial instrument for loan
commitments, standby letters of credit and recourse arrangements is represented
by the contractual amount of these instruments. The Corporation uses the same
credit policies in making commitments and conditional obligations as it does for
on-balance sheet instruments. For forward commitments to sell loans, the
contract or notional amounts do not represent exposure to credit loss. The
Corporation controls the credit risk on its forward commitments through credit
approvals, limits and monitoring procedures.
63
WARREN BANCORP, INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(12) FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK, COMMITMENTS, AND
CONTINGENT LIABILITIES - (CONTINUED)
Financial instruments with off-balance sheet risk at December 31 are as
follows:
CONTRACT
AMOUNT
(IN THOUSANDS)
2001 2000
------- -------
Financial Instruments Whose Contract Amounts Represent
Credit Risk:
Commitments to originate loans .................... $39,183 $37,701
Unused lines of credit ............................ 46,728 48,417
Standby letters of credit ......................... 1,028 3,375
Unadvanced portions of construction loans ......... 21,100 24,710
Loans sold with recourse .......................... 746 899
Financial Instruments Whose Contract Amounts
Exceed the Amount of Credit Risk:
Forward commitments to sell loans ................. $20,200 $6,978
Commitments to originate loans, unused lines of credit, and unadvanced
portions of construction loans are agreements to lend to a customer provided
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since some of the commitments may expire without being
drawn upon, the total commitment amounts do not necessarily represent future
cash requirements. The Bank evaluates each customer's creditworthiness on a
case-by-case basis. The amount of collateral obtained, if deemed necessary by
the Bank upon extension of credit, is based on management's credit evaluation of
the borrower. Collateral held varies but may include single family houses,
inventory, property, plant and equipment, and income-producing properties.
Standby letters of credit are conditional commitments issued by the
Bank to guarantee the performance by a customer to a third party. These
guarantees are primarily issued to support public and private borrowing
arrangements, bond financing, and similar transactions. The credit risk involved
in issuing letters of credit is essentially the same as that in extending loan
facilities to customers.
Forward commitments to sell loans are contracts which the Corporation
enters into for the purpose of reducing the interest rate risk associated with
originating loans for sale. In order to fulfill a forward commitment, the
Corporation typically receives cash to be exchanged for the loans at a specified
price at a future date agreed to by both parties. Risk may arise from the
possible inability of the Corporation to deliver the loans specified on the
commitment.
64
WARREN BANCORP, INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(12) FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK, COMMITMENTS, AND
CONTINGENT LIABILITIES - (CONTINUED)
As a nonmember of the Federal Reserve System, the Corporation is
required to maintain certain reserves of vault cash and/or deposits with the
Federal Reserve Bank of Boston. The amount of this reserve requirement included
in cash and due from banks was $4.9 million at December 31, 2001.
There were no material legal claims against the Corporation at December
31, 2001.
(13) WARREN BANCORP, INC. (PARENT COMPANY ONLY)
The condensed information of Warren Bancorp, Inc. is as follows:
BALANCE SHEETS: AT DECEMBER 31,
--------------------
2001 2000
---- ----
(IN THOUSANDS)
ASSETS
Cash ............................................ $1,698 $1,443
Investment in subsidiary ........................ 40,778 36,281
------- -------
Total assets ............................... $42,476 $37,724
======= =======
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accrued expenses ............................. $31 $42
------- -------
Total liabilities ........................ 31 42
Stockholders' equity ............................ 42,445 37,682
------- -------
Total liabilities and stockholders' equity $42,476 $37,724
======= =======
65
WARREN BANCORP, INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(13) WARREN BANCORP, INC. (PARENT COMPANY ONLY) - (CONTINUED)
STATEMENTS OF OPERATIONS: YEAR ENDED DECEMBER 31,
-----------------------
2001 2000 1999
------- ------- -------
(IN THOUSANDS)
Income:
Dividend income from subsidiary ...................... $3,308 $4,570 $7,066
Interest ............................................. 70 92 105
Management fees ...................................... 96 86 111
------- ------- -------
Total operating income ........................ 3,474 4,748 7,282
Expenses:
Other expenses ...................................... (96) (86) (111)
Income tax expense .................................. (31) (42) (52)
Equity in undistributed net income (losses) of subsidiary 3,757 2,113 (1,655)
------- ------- -------
Net income .............................................. $7,104 $6,733 $5,464
======= ======= =======
The parent-company-only statements of changes in stockholders' equity
are identical to the consolidated statement of changes in stockholders' equity
for the three-year period ended December 31, 2001 and therefore are not
reprinted here.
STATEMENTS OF CASH FLOWS YEAR ENDED DECEMBER 31,
-----------------------
2001 2000 1999
------- ------- -------
(IN THOUSANDS)
Cash flows from operating activities:
Net income ........................................... $7,104 $6,733 $5,464
Adjustments to reconcile net income to net cash
provided by operating activities:
Equity in undistributed net income (losses) of Bank
subsidiary ..................................... (3,757) (2,113) 1,655
(Decrease) in liabilities ......................... (10) (8) (62)
------- ------- -------
Net cash provided by operating activities ...... 3,337 4,612 7,057
------- ------- -------
Cash flows from financing activities:
Dividends paid ....................................... (3,313) (4,576) (4,675)
Purchase of treasury stock ........................... -- (183) (4,634)
Stock options exercised .............................. 231 115 128
------- ------- -------
Net cash (used in) financing activities ....... (3,082) (4,644) (9,181)
------- ------- -------
Increase (decrease) in cash and cash equivalents ........ 255 (32) (2,124)
Cash and cash equivalents at beginning of year .......... 1,443 1,475 3,599
------- ------- -------
Cash and cash equivalents at end of year ................ $1,698 $1,443 $1,475
======= ======= =======
66
WARREN BANCORP, INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(14) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED 2001
-----------------------
DECEMBER 31 SEPTEMBER 30 JUNE 30 MARCH 31
----------- ------------- -------- --------
(TABLE IN THOUSANDS, EXCEPT PER-SHARE DATA)
Interest and dividend income ........... $7,803 $8,424 $8,522 $8,461
Interest expense ....................... 2,988 3,492 3,497 3,512
----------- ----------- ----------- -----------
Net interest income ................. 4,815 4,932 5,025 4,949
(Recovery of ) provision for loan losses (178) 38 (29) 38
----------- ----------- ----------- -----------
Net interest income after provision
for loan losses ................... 4,993 4,894 5,054 4,911
Non-interest income (1) ................ 740 628 703 518
Non-interest expense ................... 3,300 2,992 2,957 2,770
----------- ----------- ----------- -----------
Income before income taxes .......... 2,433 2,530 2,800 2,659
Income tax expense (2) ................. 794 844 762 918
----------- ----------- ----------- -----------
Net income ................... $1,639 $1,686 $2,038 $1,741
=========== =========== =========== ===========
Basic earnings per share: .............. $0.22 $0.23 $0.28 $0.24
=========== =========== =========== ===========
Diluted earnings per share: ............ $0.22 $0.22 $0.27 $0.23
=========== =========== =========== ===========
(1) Includes $200,000 of pre-tax interest for resolution of certain tax
matters of prior years in the three months ended June 30, 2001.
(2) Includes a $176,000 reduction of state tax expense, net of federal tax,
due to resolution of certain tax matters of prior years in the three
months ended June 30, 2001.
67
WARREN BANCORP, INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(14) QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
THREE MONTHS ENDED 2000
-----------------------
DECEMBER 31 SEPTEMBER 30 JUNE 30 MARCH 31
----------- ------------- -------- --------
(TABLE IN THOUSANDS, EXCEPT PER-SHARE DATA)
Interest and dividend income ......... $8,675 $8,399 $8,195 $7,795
Interest expense ..................... 3,559 3,353 3,135 3,073
----------- ----------- ----------- -----------
Net interest income ............... 5,116 5,046 5,060 4,722
Provision for loan losses ............ 114 114 114 114
----------- ----------- ----------- -----------
Net interest income after provision
for loan losses ................. 5,002 4,932 4,946 4,608
Non-interest income (1) ............. 371 991 367 298
Non-interest expense ................. 3,018 2,801 2,857 2,738
----------- ----------- ----------- -----------
Income before income taxes ........ 2,355 3,122 2,456 2,168
Income tax expense ................... 790 1,081 805 692
----------- ----------- ----------- -----------
Net income ................. $1,565 $2,041 $1,651 $1,476
=========== =========== =========== ===========
Basic earnings per share: ............ $0.21 $0.28 $0.23 $0.20
=========== =========== =========== ===========
Diluted earnings per share: .......... $0.21 $0.27 $0.22 $0.20
=========== =========== =========== ===========
(1) Includes gain on sale of investment security of $208,000 and gain on
sale of fixed assets (see Note 11 "Related-Party Transaction") of
$376,000 in the three months ended September 30, 2000.
Basic and diluted earnings per share may not aggregate to annual
amounts due to changes in average common shares and common-equivalent shares
outstanding during the year and rounding.
(15) FAIR VALUE OF FINANCIAL INSTRUMENTS
The Corporation estimates the fair value of its financial instruments
at a discrete point in time based on relevant market information and information
about the financial instruments. Because no active market exists for a portion
of those financial instruments, fair value estimates are based on judgment
regarding future expected loss experience, current economic conditions, risk
characteristics of various financial instruments, and other factors. These
estimates are subjective in nature and involve uncertainties and matters of
significant judgment and therefore cannot be determined with precision. Changes
in assumptions could significantly affect the estimates.
Fair value estimates are based on existing on- and off-balance sheet
financial instruments without attempting to estimate the value of anticipated
future business and the value of assets and liabilities that are not considered
financial instruments. In addition, the tax ramifications related to the
realization of unrealized gains and losses can have a significant effect on fair
value estimates and have not been considered in the estimates.
68
WARREN BANCORP, INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(15) FAIR VALUE OF FINANCIAL INSTRUMENTS - (CONTINUED)
CASH AND DUE FROM BANKS, ACCRUED INTEREST RECEIVABLE, ACCRUED INTEREST PAYABLE
AND OTHER BORROWED FUNDS
Cash and due from banks, accrued interest receivable, accrued interest
payable, and other borrowed funds are short-term in nature and are not subject
to material interest rate changes which would result in a material difference
between fair value and book value. In addition, an adjustment to fair value for
credit risk is not considered necessary because of the current financial status
of the various counterparties. The book value of these financial instruments is
representative of their fair value.
INVESTMENT SECURITIES
U.S. Treasury and Government Agency securities, mortgage-backed
securities, money market funds and overnight investments, fixed income mutual
funds and common and preferred stock are actively traded in a secondary market.
Published investment securities market values are used as fair value for most of
these securities. Refer to Note 2 for the fair value of these securities. Stock
in the Federal Home Loan Bank and the Depositors Insurance Fund Liquidity Fund
are not traded in a secondary market. Based upon the characteristics of these
securities, however, book value is a reasonable estimate of fair value.
LOANS
Fair value of loans is estimated for portfolios of loans with similar
financial characteristics. Loans are segregated by type such as residential
mortgage, commercial real estate, commercial, and consumer.
The fair value of fixed-rate residential mortgage loans is primarily
based upon secondary market rates for mortgage-backed securities consisting of
mortgages similar in nature to the loans included in the Bank's residential
mortgage loan portfolio. The fair value of all other types of loans is estimated
by discounting contractual cash flows using estimated market discount rates
which reflect the interest rate and credit risk inherent in the loans. The
discount rate used in the fair value estimation reflects rates that are
available to customers who meet the Bank's underwriting standards.
Management has made estimates of fair value of loans that it believes
are reasonable. However, because there is no market for many of the types of
loans, management has no basis to determine whether the fair value presented
would be indicative of the value negotiated in an actual sale.
DUE FROM MORTGAGE INVESTORS
The book value is representative of the loans' fair value.
DEPOSIT LIABILITIES AND ESCROW DEPOSITS OF BORROWERS
The fair value of deposits with no stated maturity such as savings
deposits, non-interest deposits and escrow deposits of borrowers is equal to the
book value of these accounts. The fair value
69
WARREN BANCORP, INC AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(15) FAIR VALUE OF FINANCIAL INSTRUMENTS - (CONTINUED)
of time deposits (including retirement time deposits) is based upon the
discounted value of contractual cash flows. The discount rate has been estimated
using the rates offered for deposits of a similar remaining maturity as of
December 31, 2001 and 2000. Early withdrawal assumptions, based on the Bank's
experience, do not materially affect the estimation of fair value.
FEDERAL HOME LOAN BANK ADVANCES
The fair value of Federal Home Loan Bank advances is based upon the
discounted value of contractual cash flows. The discount rate is estimated using
the rates for advances of a similar remaining maturity as of December 31, 2001
and 2000.
OFF-BALANCE SHEET FINANCIAL INSTRUMENTS
The fair value of the Corporation's commitments to extend credit is
estimated using fees currently charged to enter into similar agreements, taking
into account the remaining terms of the agreements and the counterparties'
credit standing. The fair value of the Corporation's commitments to sell loans
is based on current market prices. At December 31, 2001 and 2000, management has
estimated the fair values of these financial instruments to be immaterial.
The estimated fair values of the Corporation's financial instruments at
December 31 are as follows (in thousands):
2001 2000
---- ----
BOOK ESTIMATED BOOK ESTIMATED
VALUE FAIR VALUE VALUE FAIR VALUE
----- ---------- ----- ----------
Financial assets:
Cash and due from banks ................ $16,834 $16,834 $13,669 $13,669
Money market funds and overnight
investments ......................... 10,166 10,166 74 74
Investment securities available for sale 57,260 57,260 58,696 58,696
Loans held for sale .................... 13,510 13,510 5,180 5,219
Loans, net ............................. 341,639 346,817 343,551 342,126
Investment securities held to maturity . 1,375 1,375 1,250 1,250
Cost-basis investments ................. 5,794 6,034 5,794 6,034
Due from mortgage investors ............ 13,003 13,003 -- --
Financial liabilities:
Non-time deposits ...................... 244,714 244,714 229,793 229,793
Time deposits .......................... 153,633 155,282 157,254 156,880
FHLB borrowings ........................ 5,657 5,741 2,671 2,658
Repurchase agreements .................. 13,425 13,425 5,983 5,983
70
WARREN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(16) BUSINESS SEGMENTS
For internal reporting, planning and business purposes, the Corporation
segments its operations into distinct business groups. An individual business
group's profit contribution to the Corporation as a whole is determined based
upon the Corporation's profitability reporting system which assigns capital and
other balance sheet items and income statement items to each of the business
groups. This segmentation mirrors the Corporation's organizational structure.
Management accounting policies are in place for assigning revenues and expenses
that are not directly incurred by the business groups, such as overhead, the
results of asset allocations, and transfer revenues and expenses. Accordingly,
the Corporation's business-segment operating results will differ with other
similar information published by other financial institutions. In addition,
management accounting concepts are periodically refined and results may change
to reflect these refinements.
SFAS No. 131, Disclosures about Segments of an Enterprise and Related
Information, establishes standards for reporting operating segments of a
business enterprise. The rules establish standards for public companies relating
to the reporting of financial and descriptive information about their operating
segments in financial statements. Operating segments are components of an
enterprise which are evaluated regularly by the chief operating decision maker
in deciding how to allocate resources and in assessing performance. The
Corporation's chief operating decision maker is the President and Chief
Executive Officer of the Corporation. SFAS No. 131 has no effect on the
Corporation's primary financial statements, but does result in the disclosure of
segment information contained herein.
In 2001, the Corporation has identified its reportable operating
business segments as the Corporate Banking Business, the Personal Banking
Business and the Residential Mortgage Business.
In 2000 and 1999, the Corporation had identified its reportable
business segments as the Corporate Banking Business and the Personal Banking
Business. Although the Corporation's business segments included the Residential
Mortgage Business in 2000 and 1999, it was not considered a reportable segment.
In 2001 the Corporation changed its method of allocating assets, capital, and
funding among the business segments. The major change is that the residential
mortgage loan portfolio became part of the assets of the Residential Mortgage
Business in 2001. In prior periods, the Residential Mortgage Business sold loans
that were to be kept in the Bank's portfolio to the Personal Banking Business at
a specified transfer price. Because of this change in the mix of assets, capital
allocations and funding methods to those two businesses also changed. Also
because of these changes, the Residential Mortgage Business met certain
quantitative thresholds and is now considered a reportable segment. Due to the
complexity of the financial statements, the fact that the Corporation's new
approach encompasses a fundamental change and that change is more than just a
reassignment of profit centers, a restatement of information for prior periods
is impracticable. In addition, for the same reasons, it is impracticable to
restate the current reporting period under the old basis. Furthermore,
management has not restated prior or current business-segment financial
information for internal purposes. A description of each reportable business
segment is discussed below:
CORPORATE BANKING BUSINESS
The Corporate Banking Business provides services to business customers
in the Corporation's market area. These services include, but are not limited
to, commercial real estate and construction loans, asset-based financing and
cash management/deposit services. It services all loans in its
71
WARREN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(16) BUSINESS SEGMENTS - (CONTINUED)
business. This business' segment reporting approach remained the same in the
2001, 2000 and 1999 periods.
RESIDENTIAL MORTGAGE BUSINESS
The Residential Mortgage Business provides services to consumers in the
Corporation's market area. These services include making adjustable-rate and
fixed-rate mortgage loans. This group also services all loans held in its
business and sells fixed-rate loans into the secondary market.
PERSONAL BANKING BUSINESS
The Personal Banking Business provides services to consumers in the
Corporation's market area through its branch and ATM network. These services
include, but are not limited to, home equity loans, installment loans, safe
deposit boxes and an array of deposit services. In the 2000 and 1999 periods,
this business purchased adjustable-rate mortgage loans from another business
segment and serviced all loans in its business. In the 2001 period, the
adjustable-rate mortgage loans were transferred to the books of the Residential
Mortgage Business along with the expense of servicing those loans.
NON-REPORTABLE SEGMENTS
Non-reportable operating segments of the Corporation's operations that
do not meet the qualitative and quantitative thresholds requiring disclosure are
included in the Other category in the disclosure of business segments below.
Revenues in these segments consist mainly of interest income on investments and
gains on sales of securities, and in 2000 and 1999 also included gains on sales
of mortgage loans.
72
WARREN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(16) BUSINESS SEGMENTS - (CONTINUED)
Specific reportable segment information as of and for the years ended
December 31, 2001, 2000 and 1999 is as follows (in thousands):
YEAR ENDED DECEMBER 31, 2001
----------------------------
CORPORATE RESIDENTIAL PERSONAL WARREN BANCORP
BANKING MORTGAGE BANKING OTHER ELIMINATIONS CONSOLIDATED .
------- -------- ------- ----- ------------ --------------
Interest income - external $22,330 $7,422 $3,012 $446 -- $33,210
Interest income - internal -- -- 14,708 -- $(14,708) --
Interest expense-external 2,048 595 10,750 96 -- 13,489
Interest expense-internal 9,821 4,887 -- -- (14,708) --
Fee and other income 238 1,079 1,029 243 -- 2,589
Income tax expense
(benefit) 3,010 838 706 (1,236) -- 3,318
Net income 4,890 1,289 1,187 (262) -- 7,104
Total assets 291,400 81,300 76,500 14,400 -- 463,600
Total loans 263,300 48,700 29,600 -- -- 341,600
Total deposits 64,300 900 328,700 4,400 -- 398,300
73
WARREN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(16) BUSINESS SEGMENTS - (CONTINUED)
YEAR ENDED DECEMBER 31, 2000
CORPORATE PERSONAL WARREN BANCORP
BANKING BANKING OTHER ELIMINATIONS CONSOLIDATED
-------- -------- -------- ------------ ------------
Interest income - external $21,362 $11,412 $290 -- $33,064
Interest income - internal -- 9,800 111 $(9,911) --
Interest expense - external 2,221 10,805 94 -- 13,120
Interest expense - internal 9,800 -- 111 (9,911) --
Fee and other income 326 904 797 -- 2,027
Income tax expense
(benefit) 2,929 1,655 (1,216) -- 3,368
Net income (loss) 4,435 2,985 (687) -- 6,733
Total assets 262,500 167,500 8,100 -- 438,100
Total loans 235,000 113,300 -- -- 348,300
Total deposits 67,400 317,500 2,100 -- 387,000
74
WARREN BANCORP, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS-(CONTINUED)
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
(16) BUSINESS SEGMENTS - (CONTINUED)
YEAR ENDED DECEMBER 31, 1999
CORPORATE PERSONAL WARREN BANCORP
BANKING BANKING OTHER ELIMINATIONS CONSOLIDATED
------- ------- ----- ------------ ------------
Interest income - external $19,076 $9,682 $229 -- $28,987
Interest income - internal -- 8,963 45 $(9,008) --
Interest expense - external 1,338 10,367 98 -- 11,803
Interest expense - internal 8,963 -- 45 (9,008) --
Fee and other income 168 807 322 -- 1,297
Income tax expense
(benefit) 2,973 1,233 (1,379) -- 2,827
Net income (loss) 4,459 2,512 (1,507) -- 5,464
Total assets 237,600 156,600 8,000 -- 402,200
Total loans 216,200 74,800 -- -- 291,000
Total deposits 39,700 313,700 2,100 -- 355,500
75
EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) Financial Statements. Included in Item 8.
(a) (2) Exhibits
3.(i) (A)-- Articles of Organization of Warren Bancorp, Inc. (7)
3.(i) (B)-- Articles of Merger of Warren Bancorp, Inc. (7)
3.(i) (C)-- Certificate of Vote of Directors Establishing a Class of Stock of Warren Bancorp, Inc. classifying
and designating the Series B Junior Participating Cumulative Preferred Stock. (5)
3.(ii) -- By-laws of Warren Bancorp, Inc., (7)
4.1 -- Form of Stock Certificate of Warren Bancorp, Inc. (9)
4.2 -- Shareholder Rights Agreement, dated as of April 21, 1999, between Warren Bancorp, Inc. and
Registrar and Transfer Company, as Rights Agent (5)
10.1 -- Warren Bancorp, Inc. 1986 Incentive and Nonqualified Stock Option Plan, as amended. (8) *
10.2 -- Special Termination Agreement among Warren Bancorp, Inc., Warren Five Cents Savings
Bank and Paul M. Peduto. (9) *
10.3 -- Special Termination Agreement among Warren Bancorp, Inc., Warren Five Cents Savings
Bank and Leo C. Donahue. (9) *
10.4 -- Split-Dollar Agreement between Warren Five Cents Savings Bank and Paul M. Peduto. (6) *
10.5 -- Split-Dollar Agreement between Warren Five Cents Savings Bank and Leo C. Donahue, Jr. (6) *
10.6 -- Special Termination Agreement among Warren Bancorp, Inc., Warren Five Cents Savings
Bank and John R. Putney. (9) *
10.7 -- Split-Dollar Agreement between Warren Five Cents Savings Bank and John R. Putney. (6) *
10.8 -- Warren Bancorp, Inc. 1991 Incentive and Nonqualified Stock Option Plan, as amended. (1) *
10.9 -- Split-Dollar Agreement between Warren Five Cents Savings Bank and Mark J. Terry (6) *
10.10 -- Special Termination Agreement among Warren Bancorp, Inc., Warren Five Cents Savings
Bank and Mark J. Terry. (9) *
10.11 -- Warren Bancorp, Inc. 1995 Incentive and Nonqualified Stock Option Plan (2) *
10.12 -- Executive Supplemental Retirement Agreement among Warren Bancorp, Inc.,
Warren Five Cents Savings Bank and George W. Phillips. (9) *
10.13 -- Split-Dollar Agreement between Warren Five Cents Savings Bank and George W. Phillips (9) *
10.14 -- Employment Agreement between Warren Five Cents Savings Bank and John R. Putney (3) *
10.15 -- Omitted.
10.16 -- Warren Bancorp, Inc. 1998 Incentive and Nonqualified Stock Option Plan (4) *
21.1 -- List of Subsidiaries of Warren Bancorp, Inc. (9)
23.1 -- Consent of Independent Public Accountants. (9)
99.1 -- Letter to Securities and Exchange Commission regarding representations made by
Arthur Andersen LLP. (9)
(b) Reports on Form 8-K. None.
(1) Previously filed as an exhibit to the Corporation's Registration
Statement on Form S-8 filed with the Securities and Exchange Commission
on June 13, 1995 and incorporated herein by reference.
(2) Previously filed as an exhibit to the Registration Statement on Form
S-8 filed with the Securities and Exchange Commission on May 3, 1995
and incorporated herein by reference.
(3) Previously filed as an exhibit to the Corporation's Annual Report on
Form 10-K filed with the Securities and Exchange Commission on March
31, 1998 and incorporated herein by reference.
(4) Previously filed as an exhibit to the Corporation's Registration
Statement on Form S-8 filed with the Securities and Exchange Commission
on June 11, 1998 and incorporated herein by reference.
(5) Previously filed as an exhibit to the Corporation's Current Report on
Form 8-K filed with the Securities and Exchange Commission on April 26,
1999 and incorporated herein by reference.
(6) Previously filed as an exhibit to the Corporation's Annual Report on
Form 10-K filed with the Securities and Exchange Commission on March
29, 2000 and incorporated herein by reference.
(7) Previously filed as an exhibit to the Corporation's Annual Report on
Form 10-K filed with the Securities and Exchange Commission on March
27, 2001 and incorporated herein by reference.
(8) Previously filed as an exhibit to the Registration Statement on Form
S-4 filed with the Securities and Exchange Commission on May 15, 1988
and incorporated herein by reference.
(9) Filed herewith.
* Management contract or compensatory plan or arrangement required to be
filed or incorporated by reference as an exhibit to this Form 10-K pursuant to
Item 14(c) of Form 10-K
76
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities
Exchange Act of 1934, the Corporation has duly created this report to be signed
on its behalf by the undersigned, thereunto duly authorized, in the City of
Peabody, Commonwealth of Massachusetts, on March 20, 2002.
WARREN BANCORP, INC.
By: /s/ Stephen G. Kasnet
-----------------------------------
STEPHEN G. KASNET
CHAIRMAN OF THE BOARD
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
Corporation and in the capacities and on the dates indicated:
<Table>
<Caption>
NAME TITLE DATE
---- ----- ----
/s/John R. Putney President and Chief Executive Officer, March 20, 2002
- -------------------------------- Director (Principal Executive Officer)
JOHN R. PUTNEY
/s/Paul M. Peduto Treasurer; Director (Principal Financial March 20, 2002
- -------------------------------- Officer and Principal Accounting Officer)
PAUL M. PEDUTO
/s/Peter V. Bent Director March 20, 2002
- --------------------------------
PETER V. BENT
/s/Stephen J. Connolly, IV Director March 15, 2002
- --------------------------------
STEPHEN J. CONNOLLY, IV
/s/Francis L. Conway Director March 20, 2002
- --------------------------------
FRANCIS L. CONWAY
Director March , 2002
- --------------------------------
ROBERT F. FANNING, JR.
/s/Arthur E. Holden Director March 18, 2002
- --------------------------------
ARTHUR E. HOLDEN
/s/Stephen R. Howe Director March 20, 2002
- --------------------------------
STEPHEN R. HOWE
/s/Stephen G. Kasnet Director March 20, 2002
- --------------------------------
STEPHEN G. KASNET
/s/Linda Lerner Director March 20, 2002
- --------------------------------
LINDA LERNER
/s/Arthur E. McCarthy Director March 20, 2002
- --------------------------------
ARTHUR E. MCCARTHY
/s/George W. Phillips Director March 20, 2002
- --------------------------------
GEORGE W. PHILLIPS
/s/William F. Scanlon, Jr. Director March 20, 2002
- --------------------------------
WILLIAM F. SCANLON, JR.
/s/John D. Smidt Director March 20, 2002
- --------------------------------
JOHN D. SMIDT
/s/John H. Womack Director March 20, 2002
- --------------------------------
JOHN H. WOMACK
</Table>
77
SHAREHOLDER INFORMATION
ANNUAL MEETING
The Annual Meeting of Shareholders of Warren Bancorp, Inc. will be held at the
Peabody Marriott, 8A Centennial Drive, Peabody, Massachusetts, on Wednesday, May
1, 2002, at 10:00 a.m. A formal notice of the meeting, together with a proxy
statement and proxy form, is being mailed to shareholders with this annual
report.
FORM 10-K AND OTHER REPORTS
Additional copies of this Annual Report to Shareholders, which contains the
Corporation's annual report to the Securities and Exchange Commission on Form
10-K (without exhibits), a copy of the exhibits to the Annual Report on Form
10-K and copies of quarterly reports may be obtained without charge by writing:
Warren Bancorp, Inc., Shareholder Relations, 10 Main Street, Post Office Box
6159, Peabody, Massachusetts 01960.
SHAREHOLDER INFORMATION
INDEPENDENT PUBLIC
SHAREHOLDER RELATIONS TRANSFER AGENT & REGISTRAR ACCOUNTANTS
Paul M. Peduto, Treasurer Registrar and Transfer Company Arthur Andersen LLP
Warren Bancorp, Inc. 10 Commerce Drive 225 Franklin Street
10 Main Street Cranford, NJ 07016-3572 Boston, MA 02110-2812
Post Office Box 6159
Peabody, MA 01960
(978) 531-7400
MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
The Corporation's common stock is traded over the counter and is quoted by the
Nasdaq National Market under the symbol WRNB. The following table sets forth the
high and low closing prices for the common stock of the Corporation during the
two-year period ended December 31, 2001. All prices set forth below are based
upon information provided by the Nasdaq National Market.
COMMON STOCK
------------
HIGH LOW
---- ---
2001 4th Quarter.......................................... $9.55 $8.92
3rd Quarter.......................................... 10.23 8.58
2nd Quarter.......................................... 9.50 8.56
1st Quarter.......................................... 9.38 7.94
2000 4th Quarter.......................................... $8.00 $7.00
3rd Quarter.......................................... 8.34 6.75
2nd Quarter.......................................... 7.75 6.44
1st Quarter.......................................... 7.75 6.25
As of March 1, 2002, the Corporation had approximately 575 stockholders of
record who held 7,392,031 shares of common stock. The number of shareholders
indicated does not reflect the number of persons or entities who hold their
common stock in nominee names through various brokerage firms or other entities.
78
SHAREHOLDER INFORMATION - (CONTINUED)
The declaration of future dividends to the Corporation's stockholders
is subject to future operating results, financial conditions, tax and legal
considerations and other factors, such as the Bank's ability to declare and pay
dividends to the Corporation. As the principal asset of the Corporation, the
Bank currently provides the only source of payment of dividends by the
Corporation. The Federal Deposit Insurance Corporation Improvement Act limits
the ability of undercapitalized insured banks to pay dividends. Moreover, under
Massachusetts law, a stock-form savings bank may pay dividends no more
frequently than quarterly only out of its net profits and only to the extent
such dividends do not impair the Bank's capital stock, as defined; and the
Commissioner's approval may be required under certain circumstances. Under
Federal Reserve Board and FDIC regulations, the Corporation and the Bank would
be prohibited from declaring dividends if, among other things, they were not in
compliance with applicable regulatory capital requirements. Funds held by the
Corporation are available for various corporate uses, including the payment of
future dividends.
Dividends were paid by the Corporation during 2001 and 2000 as follows:
PAYMENT DIVIDEND
DATE PER SHARE
---- ---------
2001 4th Quarter........................ November 13, 2001 $.115
3rd Quarter................................. August 13, 2001 .115
2nd Quarter........................ May 14, 2001 .115
1st Quarter................................. February 12, 2001 .105
2000 4th Quarter........................ November 13, 2000 $.105
3rd Quarter................................. August 14, 2000 .105
2nd Quarter (1).................... May 15, 2000 .315
1st Quarter................................. February 14, 2000 .100
(1) Includes special dividend of $.21 per share.
79
CORPORATE INFORMATION
WARREN BANCORP, INC. AND WARREN FIVE CENTS SAVINGS BANK
AS OF MARCH 20, 2002
- --------------------------------------------------------------------------------
DIRECTORS PRINCIPAL OFFICERS
- --------- ------------------
PETER V. BENT (2)(4) ARTHUR E. MCCARTHY (1)(3) WARREN BANCORP, INC.
Owner/Manager, Vice President &
Brown's Yacht Yard Managing Director, STEPHEN G. KASNET
Tucker Anthony, Inc. Chairman of the Board
STEPHEN J. CONNOLLY, IV (3)(4)
President, PAUL M. PEDUTO JOHN R. PUTNEY
Connolly Brothers, Inc. Treasurer, President and
Construction Company Warren Bancorp, Inc., and Chief Executive Officer
Executive Vice President,
FRANCIS L. CONWAY (2) Chief Financial Officer and PAUL M. PEDUTO
Chairman Treasurer, Treasurer
Conway, Cahill-Brodeur Warren Five Cents Savings
Funeral Home, LLC Bank
GEORGE W. PHILLIPS (5)(6) CYNTHIA J. HICKEY
Retired Assistant Treasurer
ROBERT R. FANNING, JR.
(1)(2)(3)(6)
President Emeritus, JOHN R. PUTNEY SUSAN G. OUELLETTE
Northeast Health President & Clerk
Systems, Inc. Chief Executive Officer,
Warren Bancorp, Inc. and WARREN FIVE CENTS SAVINGS BANK
Warren Five Cents Savings
ARTHUR E. HOLDEN (1)(3)(4) Bank
Vice President, STEPHEN G. KASNET
Holden Oil, Inc. WILLIAM F. SCANLON, JR. Chairman of the Board
(2)(6)
Associate Visiting Professor
STEPHEN R. HOWE (2)(4)(6) Endicott College JOHN R. PUTNEY
Consultant President and
JOHN D. SMIDT (4) Chief Executive officer
STEPHEN G. KASNET (1)(3)(4) President & Treasurer,
President & John Smidt Co., Inc. PAUL M. PEDUTO
Chief Executive Officer, Executive Vice President,
Harbor Global Co., Ltd. Chief Financial Officer and
Chairman of the Board, JOHN H. WOMACK (2)(6) Treasurer
Warren Bancorp, Inc. and President &
Warren Five Cents Savings Bank Chief Executive Officer, MARK J. TERRY
TJM Enterprise, Inc. Executive Vice President for
LINDA LERNER (2)(4)(6) Corporate Banking and
Retired Senior Lending Officer
LEO C. DONAHUE
Senior Vice President for
Personal Banking
SUSAN G. OUELLETTE
Clerk
(1) Executive Committee
(2) Finance, Audit and Compliance Committee
(3) Nominating Committee
(4) Loan Committee (Warren Five Cents Savings Bank)
(5) Director of Warren Bancorp, Inc. only
(6) Strategic Planning Committee
80