1 ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED JUNE 30, 1999 OR [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM TO COMMISSION FILE #0-9623 ------------- UST CORP. (Exact Name of Registrant as Specified in its Charter) MASSACHUSETTS 04-2436093 (State or other jurisdiction (I.R.S. Employer of incorporation or organization) Identification No.) 40 COURT STREET 02108 BOSTON, MASSACHUSETTS (Zip Code) (Address of principal executive offices) (617) 726-7000 (Registrant's telephone number, including area code) NO CHANGE (Former name, former address and former fiscal year, if changed since last year.) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes /X/ No / / Indicate the number of shares outstanding of each of the registrant's classes of common stock, as of the latest practicable date. At July 30, 1999, there were 42,757,566 shares of common stock outstanding, par value $.625 per share. ================================================================================ 2 UST CORP. TABLE OF CONTENTS PAGE ---- PART I. FINANCIAL INFORMATION ITEM 1. Financial Statements Consolidated Balance Sheets - June 30, 1999 and December 31, 1998.................................... 3 Consolidated Statements of Income - Three and Six Months Ended June 30, 1999 and 1998................ 4 Consolidated Statements of Changes in Stockholders' Investment - Six Months Ended June 30, 1999 and 1998............................................................................. 5 Consolidated Statements of Cash Flows - Six Months Ended June 30, 1999 and 1998..................... 6 Notes to Consolidated Financial Statements........................................................... 7 ITEM 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.......... 15 ITEM 3. Quantitative and Qualitative Disclosures about Market Risk..................................... 27 PART II. OTHER INFORMATION ITEM 1. Legal Proceedings.............................................................................. 28 ITEM 6. Exhibits and Reports on Form 8-K............................................................... 29 SIGNATURES ............................................................................................. 30 2 3 PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS UST CORP. CONSOLIDATED BALANCE SHEETS (DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS) JUNE 30, DECEMBER 31, 1999 1998 -------- ------------ (UNAUDITED) ASSETS Cash, due from banks and interest-bearing deposits............................. $ 129,580 $ 126,861 Federal funds sold............................................................. 14,540 7,969 Securities: Securities available-for-sale: Mortgage-backed securities .............................................. 977,559 1,077,543 U.S. Treasury and federal agencies, and other securities................. 127,858 136,772 ---------- ---------- Total securities available-for-sale................................. 1,105,417 1,214,315 All other investments, at cost.............................................. 99,355 97,838 ---------- ------------ Total............................................................... 1,204,772 1,312,153 Loans held-for-sale............................................................ 1,350 Loans: Loans - net of unearned discount of $47,318 in 1999 and $42,779 in 1998 (Note 2).................................................. 4,453,060 4,296,103 Reserve for possible loan losses (Note 2) .................................. (63,654) (65,274) ---------- ---------- Total loans, net.................................................... 4,389,406 4,230,829 Premises, furniture and equipment, net......................................... 117,258 90,424 Intangible assets, net......................................................... 77,096 51,959 Other property owned, net ..................................................... 3,148 4,660 Other assets................................................................... 94,429 76,022 ---------- ---------- Total assets........................................................ $6,031,579 $5,900,877 ========== ========== LIABILITIES AND STOCKHOLDERS' INVESTMENT Deposits: Noninterest-bearing......................................................... $ 892,075 $ 847,341 Interest-bearing: NOW...................................................................... 67,812 69,739 Money market............................................................. 959,857 964,705 Regular savings.......................................................... 1,028,173 962,852 Time: Certificates of deposit over $100 thousand............................. 305,806 300,543 Other.................................................................. 987,088 1,088,491 ---------- ---------- Total deposits...................................................... 4,240,811 4,233,671 Short-term borrowings.......................................................... 1,140,184 986,082 Other borrowings............................................................... 50,595 76,043 Other liabilities.............................................................. 64,381 71,536 ---------- ---------- Total liabilities................................................... 5,495,971 5,367,332 Commitments and contingencies (Note 3) Stockholders' investment (Note 4): Preferred stock $1 par value; Authorized - 4,000,000 shares; Outstanding -- none Common stock $.625 par value; Authorized - 75,000,000 shares Issued - 42,728,031 and 42,824,177 shares in 1999 and 1998, respectively... 26,705 26,765 Additional paid-in capital................................................... 201,859 201,936 Retained earnings............................................................ 318,557 300,003 Accumulated other comprehensive income....................................... (11,228) 7,563 Treasury stock, at cost: 3,947 shares and 80,451 shares in 1999 and 1998, respectively............................................................... (91) (1,866) Other........................................................................ (194) (856) ---------- ---------- Total stockholders' investment...................................... 535,608 533,545 ---------- ---------- Total liabilities and stockholders' investment...................... $6,031,579 $5,900,877 ========== ========== The accompanying notes are an integral part of these consolidated financial statements. 3 4 UST CORP. CONSOLIDATED STATEMENTS OF INCOME (DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS) (UNAUDITED) THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, --------------------------- ------------------------- 1999 1998 1999 1998 ---- ---- ---- ---- Interest income: Interest and fees on loans ................................. $ 88,484 $ 87,169 $175,907 $174,296 Interest and dividends on securities: Taxable ................................................. 18,238 17,521 37,421 35,436 Nontaxable and preferential rate income ................. 439 567 863 1,282 Interest on federal funds sold and other short-term investments .............................................. 237 962 1,015 2,113 -------- -------- -------- -------- Total interest income ........................ 107,398 106,219 215,206 213,127 -------- -------- -------- -------- Interest expense: Interest on deposits ....................................... 27,542 32,806 55,644 65,967 Interest on borrowings ..................................... 13,172 11,331 26,326 22,184 -------- -------- -------- -------- Total interest expense ....................... 40,714 44,137 81,970 88,151 -------- -------- -------- -------- Net interest income ........................................ 66,684 62,082 133,236 124,976 Provision for possible loan losses (Note 2) .................. 1,400 (879) 2,600 222 -------- -------- -------- -------- Net interest income after provision for possible loan losses............................................... 65,284 62,961 130,636 124,754 -------- -------- -------- -------- Noninterest income: Asset management fees ...................................... 4,470 3,851 8,576 7,579 Deposit account service charges ............................ 3,913 3,021 7,102 5,839 Corporate services income, net ............................. 1,881 1,513 3,665 2,991 Securities gains, net ...................................... 158 174 312 1,733 Gain on sale of loans ...................................... 106 168 309 319 Other ...................................................... 4,584 2,379 8,555 5,010 -------- -------- -------- -------- Total noninterest income .................... 15,112 11,106 28,519 23,471 -------- -------- -------- -------- Noninterest expense: Salary and employee benefits ............................... 27,827 23,816 54,974 47,865 Occupancy, net ............................................. 4,922 3,933 9,654 8,006 Equipment depreciation and maintenance ..................... 3,607 2,860 7,539 5,491 Data processing services ................................... 1,746 2,384 3,181 4,287 Intangible asset amortization .............................. 1,617 1,827 3,093 3,654 Professional and consulting fees ........................... 1,571 1,484 3,128 2,701 Year 2000 readiness expense ................................ 1,414 845 3,179 1,339 Advertising and promotion .................................. 1,226 1,410 2,678 2,891 Foreclosed asset and workout expense ....................... 350 2,153 556 2,644 Other ...................................................... 7,839 6,494 16,406 13,968 -------- -------- -------- -------- Total noninterest expense .................... 52,119 47,206 104,388 92,846 -------- -------- -------- -------- Income before income taxes ................................... 28,277 26,861 54,767 55,379 Income tax provision ....................................... 10,440 9,410 19,664 19,195 -------- -------- -------- -------- Net income .................................. $ 17,837 $ 17,451 $ 35,103 $ 36,184 ======== ======== ======== ======== Per share data (Note 4): Basic earnings per share ................................... $ 0.42 $ 0.41 $ 0.82 $ 0.86 Diluted earnings per share ................................. $ 0.41 $ 0.40 $ 0.81 $ 0.84 Cash dividends declared per share .......................... $ 0.15 $ 0.15 $ 0.30 $ 0.25 The accompanying notes are an integral part of these consolidated financial statements. 4 5 UST CORP. CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' INVESTMENT (DOLLARS IN THOUSANDS) (UNAUDITED) ACCUMULATED ADDITIONAL OTHER COMPREHENSIVE COMMON PAID-IN RETAINED COMPREHENSIVE TREASURY INCOME (LOSS) STOCK CAPITAL EARNINGS INCOME (LOSS) STOCK OTHER TOTAL ------------- ------ -------- -------- ------------- -------- ----- ----- Balance December 31, 1997, as previously stated in the 1998 Form 10-K................ $ 26,528 $195,047 $268,049 $ 3,164 $ (3,402) $(330) $489,056 Comprehensive income (Note 6): Net income................................ $ 36,184 36,184 36,184 Other: Unrealized securities gains, net of $1,908 tax expense....................... 2,863 Less: Reclassification of securities gains included in net income, net of $719 tax expense................................. 1,014 --------- Total other comprehensive income... 1,849 1,849 1,849 --------- Total comprehensive income......... $ 38,033 ========= Cash dividends declared .................... (10,730) (10,730) Activity related to stock option, restricted stock and stock purchase plans....................................... 101 4,714 4,815 Other stockholders' investment activity..... 374 34 85 493 -------- -------- -------- --------- -------- ----- -------- Balance June 30, 1998 ...................... $ 26,629 $200,135 $293,537 $ 5,013 $ (3,402) $(245) $521,667 ======== ======== ======== ========= ======== ===== ======== Balance December 31, 1998 .................. $ 26,765 $201,936 $300,003 $ 7,563 $ (1,866) $(856) $533,545 Comprehensive income (Note 6): Net income ............................... $ 35,103 35,103 35,103 Other: Unrealized securities losses, net of $13,077 tax benefit................... (18,608) Less: Reclassification of securities gains included in net income, net of $129 tax expense.................. 183 --------- Total other comprehensive loss..... (18,791) (18,791) (18,791) --------- Total comprehensive income......... $ 16,312 ========= Cash dividends declared .................... (12,810) (12,810) Activity related to stock option, restricted stock and stock purchase plans.............................. (60) (77) (3,739) 6,465 2,589 Treasury stock acquired..................... (4,690) (4,690) Other stockholders' investment activity..... 662 662 -------- -------- -------- --------- -------- ----- -------- Balance June 30, 1999....................... $ 26,705 $201,859 $318,557 $ (11,228) $ (91) $(194) $535,608 ======== ======== ======== ========= ======== ===== ======== The accompanying notes are an integral part of these consolidated financial statements. 5 6 UST CORP. CONSOLIDATED STATEMENTS OF CASH FLOWS (DOLLARS IN THOUSANDS) (UNAUDITED) SIX MONTHS ENDED JUNE 30, ------------------------- 1999 1998 ---- ---- Cash flows from operating activities: Net income................................................................... $ 35,103 $ 36,184 Adjustments to reconcile net income to net cash provided by operating activities: Provision for possible loan losses......................................... 2,600 221 Depreciation and amortization.............................................. 10,368 8,626 Accretion of securities discount, net...................................... (1,491) (511) Securities gains, net...................................................... (312) (1,733) Gain on sale of loans held-for-sale........................................ (309) (319) (Increase) decrease in loans held-for-sale................................. (1,350) 1,576 Loss on sale of other property owned....................................... 1,114 1,864 Write-downs of other property owned, net................................... 178 Write-downs of fixed assets................................................ 1,165 670 Deferred income tax benefit................................................ (1,540) (1,765) Net change in other assets and other liabilities........................... (16,654) (3,729) -------- -------- Net cash provided by operating activities............................ 28,872 41,084 Cash flows from investing activities: Proceeds from sales of securities available-for-sale......................... 1,057 149,025 Proceeds from maturities of securities available-for-sale.................... 127,882 170,959 Proceeds from maturities of securities held-to-maturity...................... 56,475 Purchases of securities available-for-sale................................... (50,235) (273,757) Purchases of securities held-to-maturity..................................... (20,808) Purchases of restricted and other nonmarketable securities................... (1,517) (257) Net increase in federal funds sold........................................... (6,571) (18,303) Net increase in loans........................................................ (166,634) (96,404) Proceeds from other property owned........................................... 8,625 3,450 Purchase of insurance agency................................................. (24,497) Purchases of premises and equipment, net..................................... (35,274) (7,248) --------- -------- Net cash used by investing activities................................ (147,164) (36,868) Cash flows from financing activities: Net increase in nontime deposits............................................. 103,280 90,349 Net decrease in certificates of deposit...................................... (96,140) (85,963) Net increase (decrease) in short-term and other borrowings................... 128,654 (8,174) Cash dividends paid.......................................................... (12,820) (9,115) Treasury stock acquired...................................................... (4,690) Issuance of common stock for cash, net....................................... 2,727 2,669 -------- -------- Net cash provided (used) by financing activities..................... 121,011 (10,234) -------- -------- Increase (decrease) in cash and cash equivalents............................. 2,719 (6,018) Cash and cash equivalents at beginning of period............................. 126,861 120,521 -------- -------- Cash and cash equivalents at end of period................................... $129,580 $114,503 ======== ======== Supplemental disclosure of cash flow information: Cash paid during the period for: Interest................................................................... $ 81,255 $ 87,401 ======== ======== Income taxes............................................................... $ 17,450 $ 30,330 ======== ======== Noncash transactions: Transfers from loans to other property owned................................. $ 7,181 $ 6,296 ======== ======== Common stock issuance........................................................ $ 3,601 $ 1,647 ======== ======== The accompanying notes are an integral part of these consolidated financial statements. 6 7 UST CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (1) BASIS OF PRESENTATION The consolidated financial statements of UST Corp. and its subsidiaries (the "Company") included herein have been prepared by the Company, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosure normally included in financial statements prepared in accordance with generally accepted accounting principles have been condensed or omitted pursuant to such rules and regulations. The Company, however, believes that the disclosures are adequate to make the information presented not misleading. All applicable prior period amounts included in this Form 10-Q have been restated to reflect the July 1998 acquisition of Somerset Savings Bank, and the August 1998 acquisition of Affiliated Community Bancorp, Inc., as poolings of interests. Refer to Note 5 for a further discussion of acquisitions. The amounts shown reflect, in the opinion of management, all adjustments necessary for a fair presentation of the financial statements for the periods reported. These financial statements should be read in conjunction with the financial statements and the notes thereto included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1998. Certain prior period amounts have been reclassified to reflect current reporting classifications. The results of operations for the three and six months ended June 30, 1999 and 1998 are not necessarily indicative of the results of operations for the full year or any other interim period. On June 21, 1999, the Company announced the execution of a definitive agreement under which Citizens Financial Group, Inc. ("Citizens"), a wholly-owned subsidiary of The Royal Bank of Scotland, plc., would acquire the Company in a cash transaction for $1.4 billion, or $32 per share. The transaction is subject to regulatory and shareholder approval and is expected to close in January 2000. In connection with the transaction, the Company granted Citizens an option to acquire newly-issued shares equal to 19.9 percent of the Company's outstanding common stock exercisable in certain circumstances, including a third-party's interference with the transaction. The Company is unaware of any event that has occurred that would permit Citizens to exercise or assert rights under this option. (2) RESERVE FOR POSSIBLE LOAN LOSSES Analysis of the reserve for possible loan losses for the six months ended June 30, 1999 and 1998 is as follows: 1999 1998 ---- ---- (DOLLARS IN THOUSANDS) Balance at beginning of period..................... $65,274 $68,539 Charge-offs........................................ 6,549 5,663 Recoveries on loans previously charged-off......... 2,329 5,610 ------- ------- Net charge-offs.................................... 4,220 53 Provision for possible loan losses................. 2,600 222 ------- ------- Balance at end of period........................... $63,654 $68,708 ======= ======= The reserve for possible loan losses is determined based on a consistent, systematic method which analyzes the size and risk of the loan portfolio. See "Credit Quality and Reserve for Possible Loan Losses" in Management's Discussion and Analysis of Financial Condition and Results of Operations herein. 7 8 UST CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (3) COMMITMENTS AND CONTINGENCIES At June 30, 1999, the Company had the following off-balance sheet financial instruments whose contract amounts represent credit risk: CONTRACT OR NOTIONAL AMOUNT --------------------------- (DOLLARS IN THOUSANDS) Commitments to extend credit.................. $1,152,000 Standby letters of credit and financial guarantees written......................... 81,000 When issued securities contracts.............. 80,000 Loans sold with recourse...................... 8,000 Commercial letters of credit.................. 10,000 Foreign exchange contracts.................... 21,000 The Company enters into contractual commitments to sell mortgage loans for the purpose of reducing the market risk associated with originating loans for sale. In order to fulfill a commitment, the Company typically first exchanges current production of loans for cash through the Federal Home Loan Mortgage Corporation or the Federal National Mortgage Association, which loans are then delivered to national securities firms at a future date at prices or yields specified by the contracts. In the event the Company is unable to originate loans to fulfill the contracts, it has the option to purchase securities in the open market to deliver against the contract or settle the contract for cash. At June 30, 1999, the remaining commitments to deliver loans pursuant to master commitments with secondary mortgage market investors amounted to approximately $18 million. Failure to fulfill delivery requirements of commitments may result in payment of certain fees to investors. Individual commitments to sell loans require the Company to make delivery at a specific future date of a specified amount, at a specified price or yield. Loans are generally sold without recourse and, accordingly, risks arise principally from movements in interest rates. 8 9 UST CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (4) EARNINGS PER SHARE CALCULATION The Company computes earnings per share in accordance with SFAS No. 128, "Earnings Per Share." The Company's common stock equivalents consist primarily of dilutive outstanding stock options computed under the treasury stock method. Basic and Diluted EPS computations for the three and six months ended June 30, 1999 and 1998 are as follows: THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, --------------------------- ------------------------- 1999 1998 1999 1998 ---- ---- ---- ---- (IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) Basic earnings per share computation: Numerator: Net income..................................... $ 17,837 $17,451 $ 35,103 $36,184 Denominator: Weighted average shares outstanding............ 42,704 42,283 42,683 42,164 Basic earnings per share............................. $ 0.42 $ 0.41 $ 0.82 $ 0.86 Diluted earnings per share computation: Numerator: Net income..................................... $ 17,837 $17,451 $ 35,103 $36,184 Denominator: Weighted average shares outstanding............ 42,704 42,283 42,683 42,164 Dilutive stock options......................... 613 1,066 597 1,094 -------- ------- -------- ------- Weighted average diluted shares outstanding.. 43,317 43,349 43,280 43,258 ======== ======= ======== ======= Diluted earnings per share........................... $ 0.41 $ 0.40 $ 0.81 $ 0.84 (5) ACQUISITIONS Somerset Savings Bank On July 20, 1998, the Company completed its acquisition of Somerset Savings Bank ("Somerset"), a Massachusetts savings bank headquartered in Somerville. The transaction was accounted for as a pooling of interests and was structured as a tax-free exchange of 0.19 shares of the Company's common stock for each share of Somerset common stock. The Company's outstanding stock increased by 3,203,373 shares to a total of 33,100,551 shares on the date of acquisition. Based on the closing price of the Company's stock as of July 20, 1998, the market value of the shares exchanged totaled $88.9 million. Somerset operated six branches in Middlesex County. At the date of acquisition, Somerset was merged with and into USTrust, a principal subsidiary bank of the Company. 9 10 UST CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Affiliated Community Bancorp, Inc. On August 7, 1998, the Company completed its acquisition of Affiliated Community Bancorp, Inc. ("Affiliated"), a $1.1 billion multi-bank holding company headquartered in Waltham, Massachusetts. The transaction was accounted for as a pooling of interests and was structured as a tax-free exchange of 1.41 shares of the Company's common stock for each share of Affiliated common stock. The Company's outstanding stock increased by 9,439,735 shares to a total of 42,542,386 shares on the date of acquisition. Based on the closing price of the Company's stock as of August 7, 1998, the market value of the shares exchanged was $225 million. Affiliated's three subsidiary banks, The Federal Savings Bank ("Federal"), Lexington Savings Bank ("Lexington") and Middlesex Bank & Trust Company ("Middlesex"), operated a total of thirteen branch offices in Middlesex County. In the fourth quarter of 1998, Federal and Lexington were merged with and into USTrust. As contemplated by the terms of the agreement under which the Affiliated acquisition was consummated, Middlesex Bank & Trust Company, a $28 million bank, was sold in August 1998 for $8.24 million to a private investor unaffiliated with the Company. The following presentation reflects key line items on a historical basis for Somerset, Affiliated and UST Corp. and on a pro forma combined basis assuming the mergers were in effect for the period presented: UST CORP., AS SOMERSET, AS AFFILIATED, AS UST CORP., ORIGINALLY REPORTED ORIGINALLY REPORTED ORIGINALLY REPORTED RESTATED ------------------- ------------------- ------------------- ---------- (DOLLARS IN THOUSANDS, EXCEPT SHARE AMOUNTS) SIX MONTHS ENDED JUNE 30, 1998 Net interest income................ $ 95,731 $ 10,975 $ 18,270 $ 124,976 Net income......................... 25,390 4,376 6,418 36,184 Net income per diluted share....... 0.83 0.26 0.94 0.84 Total assets....................... 3,915,358 524,149 1,122,980 5,562,487 Total deposits..................... 2,991,896 444,182 733,848 4,169,926 Total shareholders' investment..... 362,099 40,485 119,083 521,667 THREE MONTHS ENDED JUNE 30, 1998 Net interest income................ 48,103 5,200 8,779 62,082 Net income......................... 12,534 1,711 3,206 17,451 Net income per diluted share....... 0.41 0.10 0.47 0.40 Brewer & Lord LLP On June 1, 1999, the Company announced that USTrust completed its acquisition of Brewer & Lord LLP, an independent insurance agency headquartered in Norwell, Massachusetts. The purchase of Brewer & Lord was structured as an all-cash transaction. Through its nine offices, Brewer & Lord specializes in providing personal, commercial and employee benefit-related insurance products to consumers and medium-size and large businesses located primarily in eastern Massachusetts. The Brewer & Lord agency operates as a limited liability corporation and as a wholly-owned subsidiary of USTrust. 10 11 UST CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Restructuring, Acquisition and Merger-related Reserves Reserves associated with restructuring and merger-related charges are included in other liabilities and totaled $1.7 million at December 31, 1998 and zero at March 31 and June 30, 1999. During the first quarter 1999, merger-related cash expenditures and write-offs of $1.7 million were charged against the reserves, while there were no additions to the reserves. There was no activity in these accounts during the current quarter. For a further discussion of restructuring charges, acquisition and merger-related expense, refer to Note 14 to the Notes to Consolidated Financial Statements of the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1998. (6) COMPREHENSIVE INCOME On January 1, 1998, the Company adopted Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" ("SFAS No. 130"), which requires companies to report all changes in stockholders' investment during a period, except those resulting from investment by owners and distribution to owners, in a financial statement for the period in which they are recognized. The Company has chosen, as allowed by SFAS No. 130, to disclose Comprehensive Income, which encompasses net income and unrealized gains or losses on securities available-for-sale, in the Consolidated Statements of Changes in Stockholders' Investment. The impact of this Statement for the six months ended June 30, 1998 was to increase reported net income of $36.2 million to a total comprehensive net income of $38.0 million. The impact for the six months ended June 30, 1999 was to decrease reported net income of $35.1 million to a total comprehensive net income of $16.3 million. (7) BUSINESS SEGMENTS The Company provides a broad range of financial services to individuals and small- and medium-sized companies. It services a single geographic area, the New England region with its principal customer base in eastern Massachusetts. The Company's current operations include five reportable "operating segments," Regional Banking, Residential Mortgage, Consumer Lending, Nonregional Commercial Banking and Treasury. Regional Banking consists of sales and customer service groups providing the Company's complete line of retail and commercial loan, deposit and other services. Regional Banking, which includes the Company's 87 banking branches, is divided into six geographic sales and service regions in eastern Massachusetts. It is presented herein as a single operating segment since its products, services, processes and distribution channels are the same among the regions. The Residential Mortgage group provides residential mortgage loan origination sales and servicing. The Consumer Lending group provides direct and indirect consumer loan and lease products. Nonregional Commercial Banking provides specialized commercial services, including real estate financing, construction lending, cash management services, equipment financing, asset-based lending, merchant services, international trade services, and government banking. The Treasury group is charged with asset/liability risk management of the Company, including the securities portfolio and interest-bearing liabilities. The information presented herein includes allocations of interest income or expense on a segment's excess funds used or provided at a rate reflecting the value of the net funds each segment provides from, or uses in, its operations. The rate is applied without regard to differences in the market risk profile of the operating segments. A provision for possible loan losses is assigned to units involved in credit extension based upon management's expectation of normalized losses. Operating expenses of the Company's support groups, including Data Processing, Finance, Legal, Human Resources, among others, are charged to business segments based on allocation criteria determined by the Company. Federal and state income taxes are applied using the Company's consolidated effective tax rate. Assets of business segments that are net fund providers reflect the excess funds sold in their respective asset balances while net funds users reflect excess funds purchased as a part of liability balances. Expenditures for 11 12 UST CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS additions to long-lived assets by operating segments are not material. No one customer is responsible for more than 10 percent of revenues. Operating segment interest income is reported net of interest expense consistent with Company methodology. Presented in the table below is selected financial information by operating segment and a reconciliation of the reportable segment data to the Company's consolidated total for the three and six months ended June 30, 1999 under its new regional organization structure effective January 1, 1999. NONREGIONAL REGIONAL RESIDENTIAL CONSUMER COMMERCIAL RECONCILIATION UST CORP. BANKING MORTGAGE LENDING BANKING TREASURY ALL OTHER(1) COLUMN(2) CONSOLIDATED --------- ----------- ----------- ----------- -------- ------------ -------------- ------------ (DOLLARS IN THOUSANDS) THREE MONTHS ENDED JUNE 30, 1999 Net interest income- external sources....... $ (8,718) $ 18,148 $ 24,078 $ 21,557 $ 9,749 $ 705 $ 1,165 $ 66,684 Interest on funds (used)/provided- internal transactions... 41,773 (11,639) (14,777) (7,139) (6,344) 858 (2,732) ---------- --------- ---------- ---------- ---------- -------- ----------- ---------- Total net interest income...... 33,055 6,509 9,301 14,418 3,405 1,563 (1,567) 66,684 Noninterest income....... 6,232 438 84 2,044 29 6,083 202 15,112 Net income............... 3,594 2,781 2,113 5,612 1,999 1,350 388 17,837 Total assets............. 4,183,899 961,748 1,264,965 1,306,847 1,184,392 132,866 (3,003,138) 6,031,579 NONREGIONAL REGIONAL RESIDENTIAL CONSUMER COMMERCIAL RECONCILIATION UST CORP. BANKING MORTGAGE LENDING BANKING TREASURY ALL OTHER(1) COLUMN(2) CONSOLIDATED --------- ----------- ----------- ----------- -------- ------------ -------------- ------------ (DOLLARS IN THOUSANDS) SIX MONTHS ENDED JUNE 30, 1999 Net interest income- external sources....... $ (18,177) $ 37,792 $ 46,757 $ 41,904 $ 20,814 $ 1,236 $ 2,910 $ 133,236 Interest on funds (used)/provided- internal transactions... 82,068 (23,474) (28,247) (13,497) (13,661) 1,756 (4,945) ---------- --------- ---------- ---------- --------- --------- ---------- ---------- Total net interest income..... 63,891 14,318 18,510 28,407 7,153 2,992 (2,035) 133,236 Noninterest income....... 11,404 1,005 122 5,085 161 10,534 208 28,519 Net income............... 6,577 6,578 4,350 11,780 4,254 2,407 (843) 35,103 Total assets............. 4,183,899 961,748 1,264,965 1,306,847 1,184,392 132,866 (3,003,138) 6,031,579 - ------------ (1) Includes five segments, asset management, insurance agency, nonperforming asset workout group, private banking and mutual funds. None of these segments meet the quantitative thresholds for determining reportable segments or aggregation criteria under Statement of Financial Accounting Standards No. 131, "Disclosures About Segments of an Enterprise and Related Information," ("SFAS No. 131"). (2) Reflects the elimination of interdepartmental charges and credits as well as certain unallocated corporate expenses, Year 2000 readiness expense and certain other unallocated expenses and assets. 12 13 UST CORP. NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Presented in the table below is selected financial information by operating segment and a reconciliation of the reportable segment data to the Company's consolidated total for the three and six months ended June 30, 1999 and 1998. This table is presented for comparability purposes under the organizational structure which was in existence prior to January 1, 1999. The 1999 data presented below includes certain reclassifications and approximations. The historical financial results prior to merger and/or system conversions of acquired institutions accounted for as poolings of interest are not combined with the Company's operating segment results. Such segment information is not readily determinable. Therefore, the operating segment financial information presented is not indicative of segment results for a full year or any interim period. RETAIL COMMERCIAL RECONCILIATION UST CORP. BANKING BANKING TREASURY ALL OTHER(1) COLUMN(2) ACQUISITIONS(3) CONSOLIDATED ------- ---------- -------- ------------ -------------- --------------- ------------ (DOLLARS IN THOUSANDS) THREE MONTHS ENDED JUNE 30, 1999 Net interest income- external sources............ $ 11,298 $ 41,498 $ 9,749 $ 2,974 $ 1,165 $ 66,684 Interest on funds (used)/provided- internal transactions....... 25,767 (16,482) (6,344) (209) (2,732) --------- --------- --------- --------- --------- --------- Total net interest income......... 37,065 25,016 3,405 2,765 (1,567) 66,684 Noninterest income............ 6,481 2,627 29 5,773 202 15,112 Net income.................... 6,676 6,866 1,999 1,908 388 17,837 Total assets.................. 3,792,221 2,098,087 1,184,392 141,424 (1,184,545) 6,031,579 THREE MONTHS ENDED JUNE 30, 1998 Net interest income- external sources............ $ 11,391 $ 24,213 $ 9,079 $ 2,287 $ 1,133 $ 13,979 $ 62,082 Interest on funds (used)/provided- internal transactions....... 15,851 (4,796) (8,324) (128) (2,603) --------- --------- --------- --------- --------- ---------- --------- Total net interest income......... 27,242 19,417 755 2,159 (1,470) 13,979 62,082 Noninterest income............ 3,970 2,104 (315) 4,075 260 1,012 11,106 Net income.................... 4,867 5,373 150 1,271 917 4,873 17,451 Total assets.................. 2,713,029 1,377,443 754,527 120,964 (1,050,605) 1,647,129 5,562,487 13 14 RETAIL COMMERCIAL RECONCILIATION UST CORP. BANKING BANKING TREASURY ALL OTHER(1) COLUMN(2) ACQUISITIONS(3) CONSOLIDATED ------- ---------- -------- ------------ -------------- --------------- ------------ (DOLLARS IN THOUSANDS) SIX MONTHS ENDED JUNE 30, 1999 Net interest income- external sources.......... $ 22,936 $ 80,912 $ 20,814 $ 5,664 $ 2,910 $ 133,236 Interest on funds (used)/provided- internal transactions...... 49,907 (30,990) (13,661) (311) (4,945) -------- -------- -------- ------- ------- --------- Total net interest income........ 72,843 49,922 7,153 5,353 (2,035) 133,236 Noninterest income.......... 11,896 6,267 161 9,987 208 28,519 Net income.................. 12,789 15,445 4,254 3,458 (843) 35,103 Total assets................ 3,792,221 2,098,087 1,184,392 141,424 (1,184,545) 6,031,579 SIX MONTHS ENDED JUNE 30, 1998 Net interest income- external sources.......... $ 22,020 $ 47,771 $ 19,484 $ 4,674 $ 1,782 $ 29,245 $ 124,976 Interest on funds (used)/provided- internal transactions...... 31,146 (8,603) (17,427) (383) (4,733) -------- -------- -------- ------- ------- ----------- ---------- Total net interest income........ 53,166 39,168 2,057 4,291 (2,951) 29,245 124,976 Noninterest income.......... 7,735 4,198 (372) 9,481 373 2,056 23,471 Net income.................. 10,481 11,600 819 3,300 (766) 10,750 36,184 Total assets................ 2,713,029 1,377,443 754,527 120,964 (1,050,605) 1,647,129 5,562,487 - ---------------- (1) Includes four operating segments, equipment financing, asset management, insurance agency and the nonperforming asset workout group. None of these segments meet the quantitative thresholds for determining reportable segments or aggregation criteria under SFAS No. 131. (2) Reflects the elimination of interdepartmental charges and credits as well as certain unallocated corporate expenses, Year 2000 readiness expense and certain other unallocated expenses and certain unallocated assets. (3) The Acquisitions column includes historical financial results of acquired institutions accounted for as poolings of interests. The three and six months ended June 30, 1998, represent the historical results of Somerset and Affiliated. 14 15 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion should be read in conjunction with the financial statements, notes, and tables included in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1998. The discussion contains certain forward-looking statements regarding the future performance of the Company. All forward-looking information is inherently uncertain and actual results may differ materially from the assumptions, estimates or expectations reflected or contained in the forward-looking information. Please refer to "Cautionary Statement Regarding Forward-looking Information" of this Form 10-Q for a further discussion. All applicable prior period financial data included in this discussion has been restated to reflect the 1998 acquisitions of Somerset Savings Bank ("Somerset") and Affiliated Community Bancorp, Inc. ("Affiliated") as poolings of interests. On June 21, 1999, the Company announced the execution of a definitive agreement under which Citizens Financial Group, Inc. ("Citizens"), a wholly-owned subsidiary of The Royal Bank of Scotland, plc., would acquire the Company in a cash transaction for $1.4 billion, or $32 per share. The transaction is subject to regulatory and shareholder approval and is expected to be closed in January 2000. News of the Company's pending sale may affect its ability to attract and retain loan and deposit customers, particularly commercial customers. The result may be a decrease in noninterest income derived from fee-based services, a decrease in earning assets, primarily loans, and a reduced ability to attract low-cost deposits which would negatively affect net interest margin. In addition, the Company has placed on hold the introduction of new services and other sources of fee income and postponed the implementation of certain operating cost reduction initiatives. Such initiatives are under review to determine their compatibility with the objectives of a combined UST Corp. and Citizens entity. These factors could individually or collectively negatively affect the Company's operating results for the second half of this year. HIGHLIGHTS Net income for the quarter ended June 30, 1999 was $17.8 million, or $0.41 per diluted share, compared with $17.5 million, or $0.40 per diluted share, for the same period last year. This period's earnings results were a continuation of the growth and revenue improvements experienced over the past several quarters. Net interest income increased 7 percent, or $4.6 million, over the second quarter of 1998. Noninterest income improved 36 percent, or $4.0 million, due to growth in fee-based services income, including asset management fees, deposit account service charges, corporate services income, mutual fund fees, and insurance commission income resulting from the Company's June 1999 acquisition of an insurance agency. The provision of possible loan losses was $1.4 million this quarter while the three months ended June 30, 1998 included a credit provision to the reserve of $1.7 million recorded by Somerset. Noninterest expense increased $4.9 million over last quarter. Personnel costs represented the largest portion of the increase reflecting staff additions to support the transfer of outsourced data processing to the Company's in-house operating system, and to support growth and new business activities. For the six months ended June 30, 1999, net income was $35.1 million, or $0.81 per diluted share, compared with $36.2 million, or $0.84 per diluted share, for the first half of 1998, which included nonrecurring tax credits of $1.8 million and Year 2000 readiness expense of $1.3 million compared with $3.2 million in 1999. The higher level of average equity due to retained earnings and growth in average assets since last year, combined with a modest increase in earnings this quarter resulted in a slight decrease in return on average equity and return on average assets from 13.65 percent and 1.27 percent, respectively, for the second quarter of 1998 to 13.49 percent and 1.20 percent, respectively, this quarter. 15 16 NET INTEREST INCOME ANALYSIS Net interest income on a fully taxable equivalent basis was $66.9 million for the quarter ended June 30, 1999, compared with $62.4 million for the same period a year ago. For the first six months of 1999, net interest income on a fully taxable equivalent basis was $133.7 million compared with $125.7 million for the first half of 1998. The increase in both comparisons was the result of growth in average interest earning assets, primarily loans, favorable changes in deposit mix and lower deposit and borrowing costs. The following table attributes changes in interest income and interest expense to changes in interest rates and changes in the volume of interest-earning assets and interest-bearing liabilities for the three- and six-month periods ended June 30, 1999, when compared with the three- and six-month periods ended June 30, 1998. Changes attributable to both rate and volume are allocated on a weighted basis. THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30, 1999 COMPARED WITH 1998 1999 COMPARED WITH 1998 INCREASE (DECREASE) DUE TO CHANGE IN: INCREASE (DECREASE) DUE TO CHANGE IN: ------------------------------------- ------------------------------------- AVERAGE AVERAGE AVERAGE AVERAGE VOLUME RATE TOTAL VOLUME RATE TOTAL ------- ------- ----- ------- ------- ----- (DOLLARS IN THOUSANDS) Interest income: Interest and fees on loans*................... $ 7,554 $(6,270) $ 1,284 $15,491 $(13,904) $ 1,587 Interest and dividends on securities: Taxable................................... 1,395 (678) 717 3,294 (1,309) 1,985 Nontaxable and preferential rate income*.. (106) (51) (157) (304) (303) (607) Interest on federal funds sold and other...... (931) 206 (725) (2,697) 1,599 (1,098) ------- ------- ------- ------- ------- ------- Total interest income*.................. 7,912 (6,793) 1,119 15,784 (13,917) 1,867 ------- ------- ------- ------- ------- ------- Interest expense: Interest on regular savings, NOW and money market deposits....................... 1,206 (1,241) (35) 2,431 (2,696) (265) Interest on time deposits..................... (2,661) (2,568) (5,229) (5,727) (4,331) (10,058) Interest on borrowings........................ 3,605 (1,764) 1,841 7,600 (3,458) 4,142 ------- ------- ------- ------- ------- ------- Total interest expense.................. 2,150 (5,573) (3,423) 4,304 (10,485) (6,181) ------- ------- ------- ------- ------- ------- Net interest income............................. $ 5,762 $(1,220) $ 4,542 $11,480 $(3,432) $ 8,048 ======= ======= ======= ======= ======= ======= - ------------- * Fully taxable equivalent at the federal income tax rate of 35 percent and includes applicable state taxes, net of federal benefit. The tax equivalent adjustments were $35 and $111 thousand on loans and $230 and $373 thousand on nontaxable and preferential rate taxable securities for the three and six months ended June 30, 1999, respectively. Average loans increased 9 percent in both the three- and six-month periods, or $364 million and $370 million, respectively, while average securities increased over 7 percent in both periods, or $82 million and $96 million, respectively. These volume increases in earning assets were the largest contributors to the net interest margin improvements. The deposit mix change was favorable as average noninterest-bearing deposits increased $131 million and $122 million for the three- and six-month periods, respectively, and lower cost savings, including NOW and money market, increased $200 million in both comparisons. Higher cost certificates of deposit decreased $206 million and $222 million, respectively, for the three and six months ended June 30, 1999, compared with last year. Average low-cost borrowings increased $299 million and $316 million for the three- and six-month periods, respectively, this year compared with a year ago to provide additional funding for the loan and securities growth. The effect on net interest income from these favorable changes in volume of interest-earning assets and interest-bearing liabilities was an increase of $5.8 million and $11.5 million for the three- and six-month periods ended June 30, 1999, respectively, compared with the same periods last year. 16 17 Yields on earning assets and cost of interest-bearing liabilities largely reflect a decline in interest rates that occurred in the second half of 1998 and the resulting lower interest rate environment this year. Yield on earning assets was 7.25 percent and 7.34 percent for the three- and six-month periods, a decline of 51 and 53 basis points, respectively, from last year. Yield on securities decreased 25 basis points to 6.19 percent and yield on loans declined 60 basis points to 8.07 percent compared with the same quarter last year. The cost of interest-bearing liabilities decreased 47 basis points and 45 basis points for the three- and six-month periods to 2.74 percent and 2.79 percent, respectively, this year. In response to lower market rates, the Company lowered rates on new or rolled over certificates of deposit and certain savings products. The average cost of interest-bearing deposits this quarter was 3.30 percent, a decline of 62 basis points from the same period a year ago. The Company also shortened the average life of its borrowings which reduced borrowing costs by 76 basis points for both the three- and six-month periods to under 4.66 percent. The net effect of rate changes on net interest income for the three and six months ended June 30, 1999, compared with the same periods last year, was a decrease of $1.2 million and $3.4 million, respectively. The interest rate margin and spread were 4.76 percent and 4.03 percent this quarter, very close to last year's levels of 4.78 percent and 3.94 percent, respectively. The effect of favorable changes in earning assets and deposit mix and lower liabilities costs were approximately offset by lower earning asset yields. For the first half of this year, interest rate margin and spread were 4.80 percent and 4.05 percent, respectively, compared with 4.86 percent and 4.03 percent in the first half of last year. The lower interest rate environment experienced over the last year appears to have bottomed out. On July 1, 1999, the Federal Reserve Board announced an increase in the rate charged to member banks for borrowings from the Federal Reserve. Following the announcement, the Company's subsidiary banks, consistent with most banks across the country, increased the prime lending rate by 25 basis points. If a rising interest rate or inflationary environment does develop in the second half of this year, the Company believes the effect on its net interest margin and spread could be neutralized in the short term. NONINTEREST INCOME Total noninterest income increased $4.0 million to $15.1 million for the three months ended June 30, 1999, compared with the same period last year. Deposit account service charges experienced the largest increase, $.9 million due mostly to an increase in nonsufficient fund ("NSF") fees from customer account growth and an increase in the NSF charge rate during the quarter. Also higher were asset management fees $.6 million, corporate services income $.4 million, mutual fund fees $.4 million, and insurance commission income $1.0 million due to the June 1999 purchase of the Brewer & Lord LLP insurance agency. Refer to Note 5 to the Notes to Consolidated Financial Statement for a discussion of acquisitions. For the six months ended June 30, 1999, noninterest income increased $5.0 million to $28.5 million compared with the first half of 1998. Growth in fee-based businesses including asset management, deposit account services charges, corporate services income and mutual funds, contributed to the increase. This year's noninterest income included $1.2 million in residual income on terminated equipment leases, while 1998 included $1.7 million in realized securities gains on mostly venture capital investments compared with $.3 million in realized gains this year. NONINTEREST EXPENSE Total noninterest expense was $52.1 million, $4.9 million higher than the same quarter a year ago. Salary and employee benefits increased $4.0 million consistent with the expanding operations of the Company, additional staffing related to the transfer of outsourced data processing of the acquired banks to the Company's in-house operating systems, and the additional salaries and commissions related to insurance agency activities. Occupancy expense increased $1.0 million, reflective of expanded activities, including two new banking branches. Equipment depreciation and maintenance increased $.7 million due to the recent installation of a new mainframe computer and continued investment in other computer hardware and software systems. Year 2000 readiness expense was $1.4 million this 17 18 quarter, $.6 million higher than a year ago and $.9 million lower than the peak of $2.3 million in the fourth quarter of 1998. The Company expects this expense to continue to decrease as the Company's Year 2000 Readiness Program nears completion. The increase in other noninterest expense was due mostly to increases in communication expense, primarily telephone and postage, as part of expanding operations. Partially offsetting these expense increases was lower outsourced data processing expense of $.6 million and lower foreclosed asset and workout expense of $1.8 million compared to the same quarter last year which included a $1.7 million write-down on other real estate owned by the former Somerset Savings Bank. For the six months ended June 30, 1998, noninterest expense was $104.4 million, an increase of $11.5 million over the first half of 1998. The increase reflects the effect of expanded operations and the move to bring in-house the Company's operating systems. Salary and employee benefits increased $7.1 million, occupancy was up $1.6 million, computer equipment expense increased $2.0 million, and communications expense increased $1.0 million. Year 2000 readiness expense totaled $3.2 million in the first half of this year, an increase of $1.8 million over last year. The 1999 expenses also included a $1.2 million write-down of impaired leasehold improvement at the Company's operations facility in connection with an announced move to a larger owned data processing center, while the first half of 1998 included a $.7 million write-down to market value of a branch held for sale. Partially offsetting these expense increases was $1.1 million reduction in outsourced data processing and the absence of the aforementioned 1998 $1.7 million other real estate owned write-down. The second quarter 1999 operating efficiency ratio, which excludes realized gains/losses on sales of securities and loans, merger-related restructuring charges, and foreclosed asset and workout expense was 63.5 percent. This compares with 61.8 percent for the same quarter a year ago and reflects an improvement over the 65.4 percent reported in the first quarter of this year. Year 2000 The Year 2000 issue, which is common to most corporations, concerns the potential inability of computer-based systems, including among others, computer hardware, embedded chips, and computer software programs, to recognize properly and process date-sensitive information involving 20th and 21st century dates. For a comprehensive discussion of the Company's Year 2000 Readiness Program for addressing Year 2000 issues and contingency plans, refer to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1998. During 1998, the Awareness, Assessment, and Project Planning phases of the Company's Year 2000 Readiness Program were completed and Unit Test Plans for mission critical systems were also completed. Mission critical systems are defined by the Company as those vital to the successful continuance of core business activities. During the first half of 1999, the Company continued to develop Test Plans for noncritical applications which are now substantially complete. The Remediation Phase, wherein software and hardware are either modified or replaced is complete for mission critical applications. Progress on the Remediation phase for nonmission critical applications continued during the second quarter and is presently scheduled to be completed by September 30, 1999. Unit Testing of individual mission critical systems was completed during the second quarter. Unit Testing for nonmission critical systems is well under way and is expected to be substantially completed by September 30, 1999. Integration Testing for mission critical systems is complete, while the completion date for nonmission critical systems is early fourth quarter of 1999. Integration testing involves the testing of applications on an integrated basis, with systems interacting or exchanging data in a future date environment. As of June 30, 1999, the mission critical System Implementation phase, wherein systems are placed into production and used in the normal course of operations, was substantially complete with all but two of the remediated systems now in use. These two systems, installment loan and installment loan origination, are scheduled to be placed into production by August 31, 1999. 18 19 The Company has in place a substantial program for evaluating potential credit risk that might arise should any of its large commercial customers experience their own Year 2000 issues. The initial portion of the Commercial Phase, which included the evaluation of credit risk stemming from problems borrowers may have in resolving their own Year 2000 issues, has been completed. Monitoring the remediation efforts of high risk customers is ongoing. During the monitoring stage the Company has implemented a course of action and procedures designed to reduce any increased potential credit risk as a result of a borrower's Year 2000 issues. The Company is communicating with its major borrowing relationships on a regular basis and evaluated credit risk related to Year 2000 issues based on responses from these customers. Risk mitigation plans have been developed for those customers whose Year 2000 credit risk remains high. Such plans utilize the normal process that the Company employs to manage credit risk, including appropriate rating under the Company's existing credit risk rating profile. Refer to the caption, "Credit Quality and Reserve for Possible Loan Losses," in this Form 10-Q for a discussion. The Company will continue to closely monitor these high risk customers. During the second quarter of 1999, the Company updated Business Continuation Plans and developed Year 2000 contingency addendum for 12 area that the Company identified as its core business processes. Validation tests of all 12 plans were conducted during the quarter. The processes involved with the Company's data center and check processing were tested at the Company's off-site disaster recovery locations. For the other 11 areas, testing consisted of the performance of a structured walk-through of each Business Continuation Plan and its Year 2000 addendum. Additionally, the Company has developed a contingency plan that addresses potential liquidity and cash needs for year-end 1999. During the third quarter the Company will further refine its liquidity and cash contingency plans and will update Business Continuation Plans for other business processes. The Company continues to place the resolution of Year 2000 issues as a top priority, and continues to commit substantial financial, technical and management resources to the project. It believes that it will be able to modify or replace any affected systems in time to minimize any detrimental effects on its operations. However, if the Company's Year 2000 Readiness Program were unsuccessful or if commercial borrowers whose operations depend on automated systems experience Year 2000 compliance problems affecting their ability to repay or if basic services such as telecommunications, electric power, and services provided by other financial institutions and governmental agencies were disrupted, it could have a material adverse effect on its future operating results and the financial condition of the Company. For a complete discussion of the risks of Year 2000 issues, please refer to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1998. At June 30, 1999, Year 2000 external readiness expense totaled $8.7 million, $3.2 million in the first six months of this year, $5.4 million in 1998, and $.1 million in 1997. Although total external costs for the entire project have yet to be determined, the Company expects to incur, as current operating expense (including the above $8.7 million), costs in the range of $10 million to assure Year 2000 readiness. These costs and estimates do not include internal costs incurred for Year 2000 matters. Such internal costs, which are not separately tracked by the Company, consist principally of payroll costs of its information systems group. Capital expenditures for new equipment and software purchases are expected to total an additional $1 million. This estimate does not include the cost of a number of system installations previously planned by the Company in the normal course of business. Costs of the Year 2000 project are based on current estimates and actual results could vary significantly from such estimates. INCOME TAXES The Company recorded income taxes in the second quarter of this year of $10.4 million which resulted in an effective tax rate of 36.9 percent compared with $9.4 million at an effective tax rate of 35.0 percent for the same period last year. The 1998 quarter benefited from a nonrecurring tax credit of approximately $.7 million recorded by the former Somerset Savings Bank. The tax credit recorded by Somerset amounted to $1.8 million for the six months ended June 30, 1998. Included in other assets as of June 30, 1999 was a deferred tax asset of approximately $26 million. The Company believes that it is more likely than not that the benefit of this deferred asset will be realized in future periods. 19 20 ASSETS Total assets at June 30, 1999 were $6.032 billion, an increase of $131 million since the beginning of the year. Net loan growth of $157 million to $4.453 billion and increases in federal funds sold and cash was partially offset by a $107 million decrease in securities. Other investments of $99 million at June 30, 1999, included restricted stock of the Federal Home Loan Bank of Boston ("FHLB") of $69 million and certain other nonmarketable investments. Net intangible assets increased $25 million due to the purchase of Brewer & Lord LLP and the resulting goodwill. The completed purchase of a new operations center was the largest contributor to the $27 million increase in premises, furniture and equipment. The following table presents the composition of the loan portfolio: JUNE 30, MARCH 31, DECEMBER 31, JUNE 30, 1999 1999 1998 1998 ---------- ---------- ------------ -------- Commercial: Commercial and financial....................... $1,457,279 $1,371,187 $1,360,274 $1,134,797 Real estate.................................... 585,113 596,201 551,734 530,353 Lease financing................................ 74,643 74,491 76,053 65,366 Construction................................... 62,539 70,462 55,989 103,162 Consumer: Residential mortgage........................... 990,803 1,019,045 1,085,353 1,240,197 Indirect automobile installment................ 999,105 947,866 909,605 753,362 Indirect automobile lease financing ........... 135,272 117,023 98,363 62,119 Home equity.................................... 109,861 111,631 120,020 129,365 Other consumer................................. 38,445 37,539 38,712 41,715 ---------- ---------- ---------- ---------- Total loans.............................. $4,453,060 $4,345,445 $4,296,103 $4,060,436 ========== ========== ========== ========== The Company's commercial loan portfolios listed above totaled $2.180 billion at June 30, 1999, reflecting a net increase of $136 million since year end and $346 million from a year ago, as new loan originations and advances exceeded normal amortization and payoffs. Residential loans decreased $95 million during the first six months to $991 million due to high levels of prepayment and normal amortization. The low interest rate environment has accelerated prepayment rates in this portfolio, however, the recent rise in market interest rates for mortgages may reduce the prepayment rate in future periods. The indirect automobile loan portfolio grew 10 percent, or $90 million, in the first six months of this year to $999 million compared with 33 percent, or $246 million over the prior year. Management expects growth in this portfolio to continue at a more moderate pace. These loans are subjected to the Company's credit quality standards and are not what is referred to in the industry as "subprime" automobile loans. Indirect automobile lease financing, a product the Company initiated through existing client automobile dealers in 1997, totaled $135 million at June 30, 1999, compared with $98 million at year end and $62 million a year ago. LIQUIDITY AND FUNDING Liquidity involves the Company's ability to raise or gain access to funds in order to fulfill its existing and anticipated financial obligations. It may be provided through amortization, maturity or sale of assets such as loans and securities, liability sources such as increased deposits, utilization of a FHLB credit facility, borrowings from the Federal Reserve Bank of Boston, purchased or other borrowed funds, and access to the capital markets. The Company's securities portfolio, except for $99 million in restricted and nonmarketable investments, is classified entirely as available-for-sale, which provides the flexibility to sell securities, based upon changes in economic or market conditions, interest rate risk and the Company's financial position and liquidity. At June 30, 1999, liquidity, which includes excess cash, funds sold and unpledged securities, totaled approximately $722 million, or 12 percent of total assets. 20 21 The funds needed to support the Company's loan and securities portfolios are provided through a combination of commercial and retail deposits and short-term and other borrowings. Total deposits increased $7 million since year-end 1998 to $4.241 billion. Noninterest-bearing deposits increased $45 million. Savings deposits increased $58 million while certificates of deposit decreased $96 million. Short-term and other borrowings, which consist principally of borrowings from the FHLB and securities sold under agreement to repurchase, increased $129 million to $1.191 billion. As shown in the Consolidated Statements of Cash Flows, cash and cash equivalents increased $3 million during the six-month period ended June 30, 1999. Cash provided by operations resulted largely from net income earned during the period. Cash used by investing activities was due to net new loan fundings and an increase in federal funds sold and the purchase of Brewer & Lord LLP insurance agency, partially offset by net maturities of securities available-for-sale. Net cash provided by financing activities was primarily due to an increase in nontime deposits and short-term and other borrowings, partially offset by a decrease in certificates of deposit. At June 30, 1999, the parent company had $4 million in cash and $15 million in repurchase agreements compared with $5 million in cash and $15 million in repurchase agreements at year end. The decrease in cash was primarily due to $13 million in dividends paid to shareholders and $5 million in stock repurchase transactions, net of $19 million in dividends received from subsidiaries. INTEREST RATE RISK Volatility in interest rates requires the Company to manage interest rate risk which arises from differences in the timing of repricing of assets and liabilities. Management monitors and adjusts the difference between interest-sensitive assets and interest-sensitive liabilities ("GAP" position) within various time frames. Within GAP limits established by the Board of Directors, the Company seeks to balance the objective of insulating the net interest margin from rate exposure with that of taking advantage of anticipated changes in rates in order to enhance income. The Company's policy is to limit its one-year cumulative GAP position to 2.5 times equity, presently equal to approximately 22 percent of total assets. The Company manages its interest rate GAP primarily by lengthening or shortening the maturity structure of its securities and borrowing portfolios. The Company's GAP presentation may not reflect the degrees to which interest-earning assets and core deposit costs respond to changes in market interest rates. The Company's rate-sensitive assets consist primarily of loans tied to the prime rate, U.S. Treasuries or the London Interbank Offered Rate ("LIBOR"). 21 22 The following table summarizes the Company's GAP position at June 30, 1999: INTEREST SENSITIVE PERIODS ------------------------------------------------------------ 0-30 DAYS 31-91 DAYS 91-365 DAYS OVER 1 YEAR TOTAL --------- ---------- ----------- ----------- ----- (DOLLARS IN MILLIONS) Loans, net of reserve.................. $ 1,165 $ 261 $ 875 $2,088 $4,389 Federal funds sold and other........... 15 15 Securities............................. 61 85 149 910 1,205 Other assets........................... 29 394 423 ------- ----- ------ ------ ------ Total assets................... $ 1,270 $ 346 $1,024 $3,392 $6,032 ------- ----- ------ ------ ====== Interest-bearing deposits.............. $ 898 $ 241 $ 604 $1,606 $3,349 Borrowed funds......................... 1,161 10 3 17 1,191 Noninterest-bearing deposits........... 188 704 892 Other liabilities and stockholders' equity.............................. 600 600 ------- ----- ------ ------ ------ Total liabilities and equity... $ 2,247 $ 251 $ 607 $2,927 $6,032 ------- ----- ------ ------ ====== GAP for period......................... $ (977) $ 95 $ 417 $ 465 ------- ----- ------ ------ Cumulative GAP......................... $ (977) $(882) $ (465) $ 0 ======= ===== ====== ====== As a percent of total assets........... (16.20)% (14.62)% (7.71)% The majority of loans are included in 0-30 days as they reprice in response to changes in the interest rate environment. Interest-bearing deposits are classified according to their expected interest rate sensitivity. Actual sensitivity of these deposits is reviewed periodically and adjustments are made in the Company's GAP analysis that management deems appropriate. Securities and noninterest-bearing deposits are categorized according to their expected lives based on published industry prepayment estimates in the case of securities and current management estimates for noninterest-bearing deposits. Securities are evaluated in conjunction with the Company's asset/liability management strategy and may be purchased or sold in response to expected or actual changes in interest rates, credit risk, prepayment risk, loan growth and similar factors. The reserve for possible loan losses is included in the "Over 1 Year" category of loans. At June 30, 1999, the one-year cumulative GAP position was negative at $465 million, or approximately 8 percent of total assets. The average life of earning assets has been extended through the purchase of longer-term securities lessening the economic risk from accelerated prepayment. In addition, the average life of interest-bearing liabilities has been shortened as long-term borrowings at maturity have been replaced with short-term and overnight borrowings. 22 23 CREDIT QUALITY AND RESERVE FOR POSSIBLE LOAN LOSSES At June 30, 1999, substandard loans were $46.7 million compared with $43.6 million at March 31, 1999. Loans reported as substandard include loans classified as Substandard or Doubtful as determined by the Company in its internal credit risk rating profile. Under the Company's definition, Substandard loans, which include those on nonaccrual, are characterized by the distinct possibility that some loss will be sustained if the credit deficiencies are not corrected. The Substandard classification, however, does not necessarily imply ultimate loss for each individual loan so classified. Loans classified as Doubtful have all the weaknesses inherent in Substandard loans with the added characteristic that the weaknesses make collection of 100 percent of the assets questionable and improbable. At June 30, 1999, approximately 29 percent of loans classified as Substandard or Doubtful were collateralized by real estate and the remainder by accounts receivable, inventory, equipment and other business assets. Also, at June 30, 1999, loans rated Special Mention in the Company's internal risk rating profile amounted to $45.9 million, all of which were current. Special Mention loans, as defined by the Company, have potential weaknesses that deserve management's close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the assets. The following table displays the Company's total nonperforming assets and measures performance regarding certain key indicators of asset quality: JUNE 30, MARCH 31, DECEMBER 31, JUNE 30, 1999 1999 1998 1998 -------- --------- ------------ -------- (DOLLARS IN THOUSANDS) Nonperforming assets: Nonaccrual loans......................... $25,476 $23,970 $23,967 $27,854 Accruing loans 90 days or more past due.. 1,470 2,998 2,423 1,252 Other property owned ("OPO"), net*....... 3,148 4,542 4,660 3,756 Restructured loans....................... 141 12,879 ------- ------- ------- ------- Total nonperforming assets.................. $30,094 $31,510 $31,191 $45,741 ======= ======= ======= ======= Reserve for possible loan losses............ $63,654 $63,840 $65,274 $68,708 Net chargeoffs for the quarter.............. 1,586 2,634 5,451 71 OPO reserve................................. 2,886 5,677 5,657 5,604 Ratios: Reserve to nonaccrual loans.............. 249.9% 266.3% 272.3% 246.7% Reserve to total of nonaccrual loans, accruing loans 90 days or more past due, and restructured loans.................. 236.2% 236.7% 246.0% 163.6% Reserve to period-end loans.............. 1.4% 1.5% 1.5% 1.7% Nonaccrual loans and accruing loans over 90 days past due to period-end loans... 0.6% 0.6% 0.6% 0.7% Nonperforming assets to period-end loans and OPO.......................... 0.7% 0.7% 0.7% 1.0% Annualized net charge-offs (recoveries) to average loans....................... 0.2% 0.2% 0.5% 0.0% OPO reserve to OPO....................... 47.8% 55.6% 54.8% 59.9% - ------------ * Included in other property owned ("OPO") are other real estate, automobiles and equipment acquired through foreclosure or in settlement of loans and leases. 23 24 As shown in the table above, total nonperforming assets were $30.1 million, a decrease of $1.4 million from March 31. The reduction in nonperforming assets from a year ago of $15.6 million was due mostly to the sale in the latter half of 1998 of $21 million in substandard commercial and residential loans acquired in that year's bank acquisitions. The quarter-to-date net charge-offs of $1.7 million and provision for possible loan losses this quarter of $1.4 million resulted in a reserve of $63.7 million at June 30. The reserve to nonaccrual loan ratio was 250 percent at June 30, 1999. Reserve to total loans decreased slightly to 1.4 percent from 1.5 percent at March 31. The Company's consumer loan delinquency rates (greater than 30 days past due including nonaccruals) continue to remain at favorable levels. The delinquency rate for the indirect automobile loans, the second largest component of the Company's consumer loan portfolio, was 2.16 percent at June 30, 1999, down from 2.25 percent at year end. It is possible that the combination of a reduction in growth rate of the indirect automobile loans and the eventual maturity of the existing portfolio, may result in an increase in the delinquency rate and subsequent level of chargeoffs in future periods. At June 30, 1999, total impaired loans were $17.3 million, comprised of $3.3 million that required a reserve for possible loan losses of $850 thousand and $14.0 million that did not require a related reserve. Impaired loans, as defined in Statement of Financial Accounting Standards No. 114 ("SFAS No. 114") are commercial and commercial real estate loans recognized by the Company as nonaccrual and restructured. The Company maintains a reserve for possible loan losses to absorb future chargeoffs of loans and leases in the existing portfolio. The reserve is increased when a loan loss provision is recorded in the income statement. When a loan, or portion thereof, is considered uncollectible, it is charged against the reserve. Recoveries on amounts previously charged off are added to the reserve when collected. Adequacy of the reserve for possible loan losses is evaluated using consistent, systematic methodologies which analyze the size and risk of the loan and lease portfolio. Factors in this analysis include historical loss experience and asset quality, as reflected by delinquency trends, nonaccrual and restructured loans and the Company's credit risk rating profile. Consideration is also given to the current and expected economic conditions and, in particular, how such conditions affect the types of credits in the portfolio and the market area in general. No portion of the reserve is restricted to any loan or group of loans, and the entire reserve is available to absorb future realized losses. The amount and timing of realized losses and future reserve allocations may vary from current estimates. An allocation of the reserve for possible loan losses to each category of loans is presented below: JUNE 30, MARCH 31, DECEMBER 31, JUNE 30, 1999 1999 1998 1998 -------- --------- ------------ -------- (DOLLARS IN THOUSANDS) Reserve for possible loan losses allocation to loans outstanding: Commercial: Commercial and financial............ $ 22,902 $ 20,891 $20,938 $ 17,897 Real estate......................... 9,195 9,083 8,492 8,839 Lease financing..................... 1,586 1,644 1,685 1,202 Construction........................ 983 1,074 862 1,605 Consumer*............................. 28,988 29,027 30,152 28,225 Unallocated........................... 2,121 3,145 10,940 -------- -------- ------ -------- Total loan loss reserve............ $ 63,654 $ 63,840 $65,274 $ 68,708 ======== ======== ======= ======== - ---------- * Consumer loans include indirect automobile installment loans and leases, residential mortgages, home equity lines of credit, credit cards, check credit and other consumer loans. 24 25 CAPITAL AND DIVIDENDS The Company and its banking subsidiaries are subject to various regulatory capital requirements administered by the 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 Company's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and its subsidiary banks must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and its banking subsidiaries to maintain minimum amounts and ratios (set forth in the table below) of Total and Tier I capital to risk-weighted assets, and of Tier I capital to average assets (all as defined in the regulations). Management believes, as of June 30, 1999, that the Company and its subsidiary banks meet all of their respective capital adequacy requirements. The actual capital amounts and ratios of the Company and its banking subsidiaries as of June 30, 1999 are presented in the following summary: AMOUNT PERCENT ---------------------------------------- ----------------------------------------- ADEQUATELY WELL ADEQUATELY WELL CAPITALIZED CAPITALIZED CAPITALIZED CAPITALIZED ACTUAL MINIMUMS MINIMUMS ACTUAL MINIMUMS MINIMUMS ------ ----------- ----------- ------ ----------- ------------ (DOLLARS IN MILLIONS) UST Corp. Consolidated: Tier 1 leverage capital..... $470.5 $ 235.6 * 7.99% 4.00% * Tier 1 capital.............. 470.5 199.7 * 9.42% 4.00% * Total (Tier 1 and Tier 2) capital .................. 533.4 399.3 * 10.69% 8.00% * USTrust: Tier 1 leverage capital..... 436.7 236.2 $ 295.5 7.40% 4.00% 5.00% Tier 1 capital.............. 436.7 198.6 298.1 8.79% 4.00% 6.00% Total (Tier 1 and Tier 2) capital .................. 499.0 397.2 496.5 10.05% 8.00% 10.00% United States Trust Company: Tier 1 leverage capital..... 6.1 1.1 1.4 22.05% 4.00% 5.00% Tier 1 capital.............. 6.1 0.6 0.9 42.83% 4.00% 6.00% Total (Tier 1 and Tier 2) capital .................. 6.1 1.1 1.4 42.89% 8.00% 10.00% - ------------ * Not applicable 25 26 On June 15, 1999, a regular quarterly dividend to stockholders was declared of $0.15 per share for a total of $6.4 million payable on July 26, 1999. This quarter's dividend was consistent with last quarter and the same quarter last year. In November 1998, the Company announced that its Board of Directors approved a stock repurchase program. Under the program, the Company is authorized to repurchase up to 310,000 shares which constitutes less than 1 percent of the Company's common stock outstanding. The repurchase program will not affect the Company's use of the pooling of interests method of accounting to record the earlier acquisitions by the Company of Affiliated and Somerset. The program authorized the Company to buy back common stock from time to time, subject to prevailing market conditions, in the open market or in privately negotiated transactions. As of June 30, 1999, all of the authorized 310,000 shares had been repurchased under this program, 306,053 shares were reissued and 3,947 shares remained in treasury. In connection with the transaction with Citizens, the Company granted to Citizens an option to acquire newly-issued shares equal to 19.9 percent of the Company's outstanding common stock exercisable in certain circumstances, including a third-party's interference with the transaction. The Company is unaware of any event that has occurred that would permit Citizens to exercise or assert rights under this option. RECENT ACCOUNTING DEVELOPMENTS On January 1, 1999, the Company adopted Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" ("SOP 98-1") and SOP 98-5, "Reporting on the Costs of Start-up Activities," both issued by the American Institute of Certified Public Accountants. SOP 98-1 requires that computer software costs associated with internal use software be expensed as incurred until certain capitalization criteria are met. SOP 98-5 requires all costs associated with pre-opening, pre-operating and organization activities be expensed as incurred. The adoption of these SOP's did not have a material impact on the Company's financial position or results of operations. Also on January 1, 1999, the Company adopted Statement of Financial Accounting Standards No. 134, "Accounting for Mortgage-Backed Securities Retained After the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise ("SFAS No. 134") issued by the Financial Accounting Standards Board ("FASB"). This Statement further amends SFAS No. 65, "Accounting for Certain Mortgage Banking Activities," as amended by SFAS No. 115 and SFAS No. 125. This Statement requires that after the securitization of mortgage loans held for sale, an entity engaged in mortgage banking activities classify the resulting mortgage-backed securities or other retained interests based on its ability and intent to sell or hold those investments. The adoption of this Statement did not have a material impact on the Company's financial position or results of operations. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This Statement establishes accounting and reporting standards for derivative instruments and hedging activities. The Statement, as amended by SFAS No. 137, is effective for all fiscal quarters of fiscal years beginning after June 15, 2000. The Company does not expect that the adoption of this Statement will have a material impact on the Company's financial position or results of operations. 26 27 CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION The preceding Management's discussion and Notes to Consolidated Financial Statements of this Form 10-Q contain certain forward-looking statements as that term is defined in the Private Securities Litigation Reform Act of 1995, including without limitation statements regarding (i) rates of loan growth and amortization; (ii) the rate of loan delinquencies and amounts of chargeoffs; (iii) the level of reserve for possible loan losses; (iv) the amount and timing of future period cost savings and operating efficiencies; (v) the Company's ability to minimize any detrimental effects of the Year 2000 problem and estimates of associated expense; (vi) expectations regarding the Company's earning asset and cost of interest-bearing liabilities rates as well as the effects on operating results from changes in market interest rates; (vii) utilization of deferred tax assets; and (viii) expectations as to the timing and effect of the Citizens transaction. Moreover, the Company may from time to time, in both written reports and oral statements by Company management, express its expectations regarding future performance of the Company and estimates of the effects of its past acquisition activities. These forward-looking statements are inherently uncertain, and actual results may differ from Company expectations. Risk factors that could impact current and future performance include but are not limited to: (i) adverse changes in asset quality and resulting credit risk-related losses and expenses; (ii) adverse changes in the economy of the New England region, the Company's primary market, which could further accentuate credit-related losses and expenses; (iii) adverse changes in the local real estate market can also negatively affect credit risk as most of the Company's loans are concentrated in Eastern Massachusetts and a substantial portion of these loans have real estate as primary and secondary collateral; (iv) the consequences of continued bank acquisitions and mergers in the Company's market, resulting in fewer but much larger and financially stronger competitors which could increase competition for financial services to the Company's detriment; (v) fluctuations in market rates and prices can negatively affect net interest margin, asset valuations and expense expectations; (vi) the various risk factors discussed under the caption "Year 2000" of this Form 10-Q; (vii) changes in the regulatory requirements of federal and state agencies applicable to bank holding companies and banks, such as the Company and its Subsidiary Banks, which could have a materially adverse effect on the Company's future operating results; and (viii) receipt of regulatory and shareholder approval of the Citizens transaction. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK There have been no material changes in market risk exposures that affect the quantitative or qualitative disclosures presented in the Company's Annual Report on Form 10-K for the year ended December 31, 1998. 27 28 PART II. OTHER INFORMATION For the quarter ended June 30, 1999, Items 2, 3, and 5 of Part II are either inapplicable or would elicit a response of "None" and, therefore, no reference thereto has been made herein. ITEM 1. LEGAL PROCEEDINGS. In the ordinary course of operations, the Company and its subsidiaries become defendants in a variety of judicial and administrative proceedings. In the opinion of management, however, there is no proceeding pending, or to the knowledge of management threatened, which, in the event of an adverse decision, would be likely to result in a material adverse change in the financial condition or results of operations of the Company and its subsidiaries. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS ANNUAL MEETING OF STOCKHOLDERS The Annual Meeting of Stockholders of the Company was held on May 18, 1999, at which time the election of each of the following seven (7) Directors of the Company, each of whom will serve for a three-year term was submitted to a vote of the Stockholders of the Company: Timothy J. Hansberry Gerald M. Ridge Brian W. Hotarek William Schwartz James E. McCobb, Jr. Michael J. Verrochi, Jr. Vikki L. Pryor The following votes were cast with respect to the election of Directors: WITHHOLD FOR AUTHORITY ABSTAIN NONVOTING --- --------- ------- --------- Timothy J. Hansberry 32,330,509 0 389,126 0 Brian W. Hotarek 32,336,374 0 383,261 0 James E. McCobb, Jr. 32,334,398 0 385,237 0 Vikki L. Pryor 32,331,073 0 388,562 0 Gerald M. Ridge 32,323,187 0 396,448 0 William Schwartz 32,328,067 0 392,568 0 Michael J. Verrochi, Jr. 32,331,344 0 388,291 0 One (1) vacancy was retained for this year's class of Directors. The members of this class of Directors were elected to serve three-year terms ending at the 2002 Annual Meeting of Stockholders. 28 29 The following is a list of the sixteen (16) additional Directors of the Company whose terms of office as Directors continued after the meeting: Chester G. Atkins Neal F. Finnegan David E. Bradbury Edward S. Heald Kendrick G. Bushnell Francis X. Messina Robert M. Coard Sydney L. Miller Robert L. Culver Barbara C. Sidell Alan K. DerKazarian James V. Sidell Donald C. Dolben Paul D. Slater James F. Drew G. Robert Tod In accordance with the Company's mandatory retirement policy for Directors, three Directors, Messrs. Jack E. Chappell, Edward J. Sullivan and Gordon M. Weiner retired from the Board of the Company on May 18, 1999, the date of the Annual Meeting. The proposal to amend the Company's Bylaws so that the date of the Annual Meeting of Stockholders would be changed from the third Tuesday in May to the third Tuesday in April was also submitted to a vote of the Stockholders of the Company at the Annual Meeting of Stockholders held on May 18, 1999. The Proposal had previously been approved by the Company's Board of Directors. The following votes were cast with respect to the proposed amendment to the Company's Bylaws: IN FAVOR AGAINST ABSTAIN DELIVERED NOT VOTED -------- ------- ------- ------------------- 32,214,076 157,510 347,708 342 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K. (a) Exhibits. The Notice of the Annual Meeting of Stockholders dated April 14, 1999 and related proxy card for the Annual Meeting of Stockholders to be held on May 18, 1999 was previously filed with the Securities and Exchange Commission on April 14, 1999 in hard copy and EDGAR electronic formats. 27.1 Article 9 Summary Financial Information for the six months ended June 30, 1999. 27.2 Article 9 Restated Summary Financial Information for the six months ended June 30, 1998. (b) Reports on Form 8-K. Current Report on Form 8-K filed by the Company on July 2, 1999 (Reporting the Company's entry into an Agreement and Plan of Merger, dated as of June 21, 1999, with Citizens pursuant to the terms of which the Company will be acquired by Citizens). 29 30 In accordance with the requirements of the Securities Exchange Act of 1934, the Company has caused this report to be signed on its behalf by the undersigned duly authorized officers of the Company. Date: August 13, 1999 By: /s/ Neal F. Finnegan --------------------------------------- Neal F. Finnegan, President and Chief Executive Officer Date: August 13, 1999 By: /s/ James K. Hunt --------------------------------------- James K. Hunt, Executive Vice President, Treasurer and Chief Financial Officer (Principal Financial Officer and Principal Accounting Officer) 30