EXHIBIT 99.1
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CONVERSION VALUATION APPRAISAL REPORT
Prepared for:
NAUGATUCK VALLEY FINANCIAL CORPORATION
NAUGATUCK, CONNECTICUT
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As Of:
May 21, 2004
Prepared By:
KELLER & COMPANY, INC.
555 Metro Place North
Suite 524
Dublin, Ohio 43017
(614) 766-1426
KELLER & COMPANY
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CONVERSION VALUATION APPRAISAL REPORT
Prepared for:
Naugatuck Valley Financial Corporation
Naugatuck, Connecticut
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As Of:
May 21, 2004
TABLE OF CONTENTS
PAGE
INTRODUCTION 1
I. DESCRIPTION OF NAUGATUCK VALLEY SAVINGS AND LOAN
General 4
Performance Overview 8
Income and Expense 10
Yields and Costs 16
Interest Rate Sensitivity 18
Lending Activities 20
Nonperforming Assets 26
Investments 28
Deposit Activities 29
Borrowings 30
Subsidiaries 30
Office Properties 31
Management 31
II. DESCRIPTION OF PRIMARY MARKET AREA 32
III. COMPARABLE GROUP SELECTION
Introduction 39
General Parameters
Merger/Acquisition 40
Mutual Holding Companies 40
Trading Exchange 42
IPO Date 42
Geographic Location 42
Asset Size 43
Balance Sheet Parameters
Introduction 44
Cash and Investments to Assets 45
Mortgage-Backed Securities to Assets 45
One- to Four-Family Loans to Assets 46
Total Net Loans to Assets 46
Total Net Loans and Mortgage-Backed Securities to Assets 46
Borrowed Funds to Assets 47
Equity to Assets 47
Performance Parameters
Introduction 48
TABLE OF CONTENTS (CONT.)
PAGE
III. COMPARABLE GROUP SELECTION (CONT.)
Performance Parameters (cont.)
Return on Average Assets 48
Return on Average Equity 49
Net Interest Margin 49
Operating Expenses to Assets 50
Noninterest Income to Assets 50
Asset Quality Parameters
Introduction 51
Nonperforming Assets to Assets 51
Repossessed Assets to Assets 52
Loan Loss Reserve to Assets 52
The Comparable Group 52
IV. ANALYSIS OF FINANCIAL PERFORMANCE 54
V. MARKET VALUE ADJUSTMENTS
Earnings Performance 57
Market Area 62
Financial Condition 64
Asset, Loan and Deposit Growth 67
Dividend Payments 68
Subscription Interest 69
Liquidity of Stock 70
Management 71
Marketing of the Issue 72
VI. VALUATION METHODS 73
Price to Book Value Method 74
Price to Earnings Method 76
Price to Assets Method 77
Valuation Conclusion 78
LIST OF EXHIBITS
NUMERICAL PAGE
EXHIBITS
1 Consolidated Statements of Financial Condition -
At March 31, 2004, and December 31, 2003 80
2 Consolidated Statements of Financial Condition -
At December 31, 1999 through 2002 81
3 Consolidated Statements of Income - Three months ended
March 31, 2003 and 2004, and
Year Ended December 31, 2003 82
4 Consolidated Statements of Income - Years ended
December 31, 1999 through 2002 83
5 Selected Financial Information 84
6 Income and Expense Trends 85
7 Normalized Earnings Trend 86
8 Performance Indicators 87
9 Volume/Rate Analysis 88
10 Yield and Cost Trends 89
11 Gap Analysis 90
12 Loan Portfolio Composition 91
13 Loan Maturity Schedule 92
14 Loan Originations and Purchases 93
15 Delinquent Loans 94
16 Nonperforming Assets 95
17 Classified Assets 96
18 Allowance for Loan Losses 97
19 Investment Portfolio Composition 98
20 Mix of Deposits 99
21 Certificates of Deposit by Rate and Maturity 100
22 Deposit Activity 101
23 Borrowed Funds Activity 102
24 Offices of Naugatuck Valley Savings and Loan . 103
25 Management of the Bank 104
26 Key Demographic Data and Trends 105
27 Key Housing Data 106
28 Major Sources of Employment 107
29 Unemployment Rates 108
30 Market Share of Deposits 109
31 National Interest Rates by Quarter 110
32 Thrift Stock Prices and Pricing Ratios 111
33 Key Financial Data and Ratios 119
34 Recently Converted Thrift Institutions 128
35 Acquisitions and Pending Acquisitions 129
LIST OF EXHIBITS (CONT.)
NUMERICAL PAGE
EXHIBITS
36 Thrift Stock Prices and Pricing Ratios -
Mutual Holding Companies 130
37 Key Financial Data and Ratios -
Mutual Holding Companies 132
38 Balance Sheets Parameters -
Comparable Group Selection 134
39 Operating Performance and Asset Quality Parameters -
Comparable Group Selection 137
40 Balance Sheet Ratios
Final Comparable Group 141
41 Operating Performance and Asset Quality Ratios
Final Comparable Group 142
42 Balance Sheet Totals - Final Comparable Group 143
43 Balance Sheet - Asset Composition
Most Recent Quarter 144
44 Balance Sheet - Liability and Equity
Most Recent Quarter 145
45 Income and Expense Comparison
Trailing Four Quarters 146
46 Income and Expense Comparison as a Percent of
Average Assets - Trailing Four Quarters 147
47 Yields, Costs and Earnings Ratios
Trailing Four Quarters 148
48 Dividends, Reserves and Supplemental Data 149
49 Valuation Analysis and Conclusions 150
50 Market Pricings and Financial Ratios - Stock Prices
Comparable Group 151
51 Pro Forma Minimum Valuation 152
52 Pro Forma Mid-Point Valuation 153
53 Pro Forma Maximum Valuation 154
54 Pro Forma Superrange Valuation 155
55 Summary of Valuation Premium or Discount 156
ALPHABETICAL EXHIBITS PAGE
A Background and Qualifications 157
B RB 20 Certification 161
C Affidavit of Independence 162
INTRODUCTION
Keller & Company, Inc. is an independent appraisal firm for financial
institutions and has prepared this Conversion Valuation Appraisal Report
("Report") to provide the pro forma market value of the to-be-issued common
stock of Naugatuck Valley Financial Corporation (the "Corporation"), a Delaware
corporation, formed as a mid-tier holding company to own all of the common stock
of Naugatuck Valley Savings and Loan ("Naugatuck Valley" or the "Bank"),
Naugatuck, Connecticut. The Corporation will be majority owned by Naugatuck
Valley Mutual Holding Company, a federally-chartered mutual holding company.
Under the Plan of Conversion, the Corporation will be majority owned by
Naugatuck Valley Mutual Holding Company, which will own 55.0 percent of the
Corporation. The Corporation will sell 43.0 percent on the appraised value of
the Corporation as determined in this Report in a minority stock offering and
will issue the remaining 2.0 percent to a newly formed foundation, the Naugatuck
Valley Charitable Foundation ("Foundation").
The Application is being filed with the Office of Thrift Supervision
("OTS") of the Department of the Treasury and the Securities and Exchange
Commission ("SEC"). Such Application for Conversion has been reviewed by us,
including the Prospectus and related documents, and discussed with the Bank's
management and the Bank's conversion counsel, Muldoon Murphy Faucette & Aguggia
LLP, Washington, D.C.
This conversion appraisal was prepared based on the guidelines provided by
OTS entitled "Guidelines for Appraisal Reports for the Valuation of Savings
Institutions Converting from the Mutual to Stock Form of Organization", in
accordance with the OTS application requirements of Regulation Section 563b and
the OTS's Revised Guidelines for Appraisal Reports, and represents a full
appraisal report. The Report provides detailed exhibits based on the Revised
Guidelines and a discussion on each of the fourteen factors that need to be
considered. Our valuation will be updated in accordance with the Revised
Guidelines and will consider any changes in market conditions for thrift
institutions.
INTRODUCTION (CONT.)
We define the pro forma market value as the price at which the stock of
the Corporation after conversion would change hands between a typical willing
buyer and a typical willing seller when the former is not under any compulsion
to buy and the latter is not under any compulsion to sell, and with both parties
having reasonable knowledge of relevant facts in an arm's-length transaction.
The appraisal assumes the Bank is a going concern and that the shares issued by
the Corporation in the conversion are sold in noncontrol blocks.
As part of our appraisal procedure, we have reviewed the financial
statements for the five fiscal years ended December 31, 1999 through 2003, and
for the three months ended March 31, 2003 and 2004, and discussed them with
Naugatuck Valley's management and with Naugatuck Valley's independent auditors,
Snyder & Haller, P.C., Hartford, Connecticut. We have also discussed and
reviewed with management other financial matters and have reviewed internal
projections. We have reviewed the Corporation's preliminary Form SB-2 and the
Bank's preliminary Form MHC and discussed them with management and with the
Bank's conversion counsel.
To gain insight into the Bank's local market condition, we have visited
Naugatuck Valley's main office and have traveled the surrounding area. We have
studied the economic and demographic characteristics of the primary market area,
and analyzed the Bank's primary market area relative to Connecticut and the
United States. We have also examined the competitive market within which
Naugatuck Valley operates, giving consideration to the area's numerous financial
institution offices, mortgage banking offices, and credit union offices and
other key market area characteristics, both positive and negative.
We have given consideration to the market conditions for securities in
general and for publicly-traded thrift stocks in particular. We have examined
the performance of selected publicly-traded thrift institutions and compared the
performance of Naugatuck Valley to those selected institutions.
INTRODUCTION (CONT.)
Our valuation is not intended to represent and must not be interpreted to
be a recommendation of any kind as to the desirability of purchasing the
to-be-outstanding shares of common stock of the Corporation. Giving
consideration to the fact that this appraisal is based on numerous factors that
can change over time, we can provide no assurance that any person who purchases
the stock of the Corporation in the minority stock offering in this
mutual-to-stock conversion will subsequently be able to sell such shares at
prices similar to the pro forma market value of the Corporation as determined in
this conversion appraisal.
I. DESCRIPTION OF NAUGATUCK VALLEY SAVINGS AND LOAN
GENERAL
Naugatuck Valley was organized in 1922 as a state-chartered mutual savings
and loan with the name Naugatuck Building and Loan and then changed its name to
Savings and Loan Association of Naugatuck, Inc. in 1951. Then in 1974, the Bank
changed its name to Naugatuck Valley Savings And Loan Association, Inc.
Naugatuck Valley converted from a state-chartered savings association to a
state-chartered savings bank in 2003 with the name Naugatuck Valley Savings and
Loan, S.B. and then converted to a federally-chartered stock savings bank in
2004 with the name Naugatuck Valley Savings and Loan. The Bank also formed a
mid-tier stock holding company in 2004 with the name Naugatuck Valley Financial
Corporation, which will own all of the stock of the Bank. The Bank's mutual
holding company Naugatuck Valley Mutual Holding Company, will own 55.0 percent
of Naugatuck Valley Financial Corporation.
Naugatuck Valley conducts its business from its main office in Naugatuck,
Connecticut and its four branch offices in Fairfield and New Haven Counties. The
Bank serves its customers from these five offices. The Bank's primary market
area is focused on New Haven County, where four of its five offices are located.
Naugatuck Valley's deposits are insured up to applicable limits by the
Federal Deposit Insurance Corporation ("FDIC") in the Savings Association
Insurance Fund ("SAIF"). The Bank is also subject to certain reserve
requirements of the Board of Governors of the Federal Reserve Bank (the "FRB").
Naugatuck Valley is a member of the Federal Home Loan Bank (the "FHLB") of
Boston and will be regulated by the OTS and by the FDIC. As of March 31, 2004,
Naugatuck Valley had assets of $242,148,000, deposits of $187,474,000 and equity
of $21,656,000.
Naugatuck Valley has been principally engaged in the business of serving
the financial needs of the public in its local communities and throughout its
primary market area as a community-oriented institution. Naugatuck Valley has
been involved in the origination of residential mortgage loans secured by one-
to four-family dwellings, including construction
GENERAL (CONT.)
loans, which represented 77.3 percent of its loan originations during the fiscal
year ended March 31, 2004. Consumer loan originations represented a moderate
14.2 percent and a strong 26.4 percent of total originations for the same
respective time periods. At March 31, 2004, 69.7 percent of its gross loans
consisted of residential real estate loans on one- to four-family dwellings,
excluding construction and home equity loans, compared to a larger 86.4 percent
at December 31, 1999, with the primary sources of funds being retail deposits
from residents in its local communities and FHLB advances. The Bank is also an
originator of multi-family and commercial real estate loans, construction loans,
consumer loans, and commercial business loans. Consumer loans include home
equity loans and lines of credit, automobile loans, loans on deposit accounts
and other secured and unsecured personal loans.
The Bank had cash and investments of $44.8 million, or a moderate 18.5
percent of its assets, excluding FHLB stock which totaled $1.8 million or 0.7
percent of assets. The Bank had $10.2 million of its investments in
mortgage-backed and related securities representing 4.2 percent of assets,
excluding $4.7 million in collateralized mortgage obligations. Deposits, FHLB
advances and equity have been the primary sources of funds for the Bank's
lending and investment activities.
The total amount of stock to be sold by the Corporation in the minority
stock offering will be $21.5 million or 2,150,000 shares at $10 per share based
on the midpoint of the appraised value of $50.0 million, representing 43.0
percent of the total value, excluding the 2.0 percent to the Foundation. The net
conversion proceeds will be $20.7 million, reflecting conversion expenses of
approximately $795,000. The actual cash proceeds to the Bank of $10.3 million
will represent 50 percent of the net conversion proceeds. The ESOP will
represent 8 percent of the gross shares issued in the minority offering and to
the Foundation, or 180,000 shares at $10 per share, representing $1,800,000. The
Bank's net proceeds will be used to fund new loans, to open new branches and to
invest in securities following their initial deployment to short term
investments. The Bank may also use the proceeds to expand services, expand
operations or acquire other financial service organizations, diversity into
other businesses, or for any other
GENERAL (CONT.)
purposes authorized by law. The Corporation will use its proceeds to fund the
ESOP, to purchase short- and intermediate-term government or federal agency
securities or to invest in short-term deposits and can use the proceeds to pay
dividends and buy back shares of common stock in the future.
The Bank has experienced a moderate deposit increase over the past four
fiscal years with deposits increasing 39.9 percent from December 31, 1999 to
December 31, 2003, or an average of 10.0 percent per year. From December 31,
2003, to March 31, 2004, deposits increased by 2.2 percent or 8.8 percent,
annualized, compared to a 5.9 percent growth rate in fiscal 2003. The Bank has
focused on increasing its residential real estate loan, construction loan,
commercial real estate and multi-family loans, home equity loans and commercial
loan activity during the past five years, monitoring its net interest margin and
earnings and strengthening its equity to assets ratio. Equity to assets
increased from 8.33 percent of assets at December 31, 1999, to 8.70 percent at
December 31, 2003, and then increased slightly to 8.94 percent at March 31,
2004, due to a steady rise in earnings combined with moderate growth in assets.
The primary lending strategy of Naugatuck Valley has been to focus on the
origination of adjustable-rate and fixed-rate one-to four-family loans, the
origination of construction loans, the origination of commercial mortgage and
multi-family loans, and the origination of consumer loans, including home equity
loans.
The Bank's share of one- to four-family mortgage loans has decreased
moderately, from 86.4 percent of gross loans at December 31,1999, to 69.7
percent as of March 31, 2004. Commercial real estate and multi-family loans
increased from 0.6 percent of loans to 8.2 percent from December 31, 1999, to
March 31, 2004, respectively, while construction loans increased from 2.2
percent to 7.9 percent during the same time period. All types of real estate
loans as a group decreased slightly from 89.1 percent of gross loans at December
31, 1999, to 85.8 percent at March 31, 2004. The decrease in real estate loans
was partially offset by the Bank's increases in commercial business loans and
consumer loans. The Bank's share of commercial loans
GENERAL (CONT.)
witnessed an increase in their share of loans from 0.1 percent at December 31,
1999, to 2.3 percent at March 31, 2004, and the dollar level of commercial
business loans increased from $194,000 to $4.2 million. Consumer loans also
witnessed an increase in their share of loans from 10.7 percent at December 31,
1999, to 12.0 percent at March 31, 2004. Management's internal strategy has also
included continued emphasis on maintaining an adequate and appropriate level of
allowance for loan losses relative to loans and nonperforming assets in
recognition of the more stringent requirements within the industry to establish
and maintain a higher level of general valuation allowances and also in
recognition of the Bank's rising level of higher risk loans and higher
charge-offs. At December 31, 1999, Naugatuck Valley had $1,935,000 in its loan
loss allowance or 1.38 percent of gross loans and 103.1 percent of nonperforming
assets, which decreased to $1,811,000 and represented a lower 0.98 percent of
gross loans but a higher 184.8 percent of nonperforming assets at March 31,
2004.
The basis of earnings for the Bank has been interest income from loans and
investments with the net interest margin being the key determinant of net
earnings with a rising emphasis on noninterest income. With a primary dependence
on net interest margin for earnings, current management will focus on continuing
to strengthen the Bank's net interest margin without undertaking excessive
credit risk combined with controlling the Bank's interest risk position and
continuing to strive to increase noninterest income.
PERFORMANCE OVERVIEW
The financial position of Naugatuck Valley at year end December 31, 1999
through December 31, 2003, and at March 31, 2004, is shown in Exhibits 1 through
4. Exhibit 5 provides selected financial data at December 31, 1999, through 2003
and at March 31, 2004. Naugatuck Valley has focused on growing its asset base
combined with strengthening its equity ratio, increasing its loan portfolio and
investment securities, and growing retail deposits. The impact of these trends,
recognizing the change in interest rates, has been a rise in net interest rate
spread from 3.64 percent at December 31, 1999, to 3.77 percent at December 31,
2003, and then a decrease to 3.72 percent for the three months ended March 31,
2004.
With regard to the Bank's financial condition, Naugatuck Valley has
experienced a relatively strong increase in assets from December 31, 1999,
through March 31, 2004, with a similar increase in deposits, a moderate increase
in FHLB advances and a moderate increase in the dollar level of equity over the
past five periods.
The Bank witnessed a total increase in assets of $74.3 million or 43.7
percent for the period of December 31, 1999, to December 31, 2003, representing
an average annual increase in assets of 10.9 percent. For the year ended
December 31, 2003, assets increased $16.0 million or 7.0 percent. For the three
months ended March 31, 2004, the Bank's assets decreased $1.8 million or 0.7
percent. Over the past four fiscal periods, the Bank experienced its largest
dollar rise in assets of $26.9 million in fiscal year 2002, which represented a
strong 13.3 percent increase in assets funded by a rise in deposits of $15.6
million and a rise in FHLB advances of $7.7 million. This increase in assets was
succeeded by a $16.0 million or 7.0 percent increase in assets in fiscal year
2003 and then a $1.8 million decrease or 0.7 percent from December 31, 2003, to
March 31, 2004.
Naugatuck Valley's loan portfolio, which included mortgage loans and
non-mortgage loans, increased from $138.2 million at December 31, 1999, to
$182.3 million at March 31, 2004, and represented a total increase of $44.1
million, or 73.2 percent. The average annual increase during that period was 7.5
percent. For the year ended December 31, 2003, loans
PERFORMANCE OVERVIEW (CONT.)
increased $14.3 million or 8.6 percent. For the three months ended March 31,
2004, net loans increased $1.9 million or 1.1 percent, representing 4.4 percent,
annualized.
Naugatuck Valley has obtained funds through deposits and FHLB advances in
response to the demand for loans and secondary market activity. The Bank's
competitive rates for deposits in its local market in conjunction with its focus
on service and a modest network of offices have been the sources for attracting
retail deposits. Deposits increased $52.3 million or 39.9 percent from 1999 to
2003, with an average annual rate of increase of 10.0 percent. For the three
months ended March 31, 2004, deposits increased by $4.0 million or 2.2 percent,
annualized to 8.8 percent. The Bank's largest fiscal year deposit growth was in
2001, when deposits increased $20.2 million or a relatively strong 14.8 percent.
The Bank's FHLB advances increased from $21.7 million at December 31, 1999, to
$35.0 million at December 31, 2003, and then decreased to $30.1 million at March
31, 2004.
The Bank has been able to increase its equity level each fiscal year from
1999 through 2003 and in the three months ended March 31, 2004. At December 31,
1999, the Bank had equity of $14.1 million, representing a 8.33 percent equity
to assets ratio and then increased to $21.2 million at December 31, 2003,
representing a higher 8.70 percent equity to assets ratio due to the Bank's
higher earnings. At March 31, 2004, equity was a higher $21.7 million and a
higher 8.94 percent of assets due to the Bank's moderate earnings and shrinkage
in assets.
The overall rise in the equity to assets ratio from 1999 to 2003 is the
result of the Bank's overall rising earnings performance impacted by the Bank's
growth in assets. The dollar level of equity increased 50.1 percent from
December 31, 1999, to December 31, 2003, representing an average annual increase
of 12.5 percent and increased 2.1 percent for the three months ended March 31,
2004, or 8.3 percent, annually.
INCOME AND EXPENSE
Exhibit 6 presents selected operating data for Naugatuck Valley,
reflecting the Bank's income and expense trends. This table provides key income
and expense figures in dollars for the fiscal years of 1999 through 2003 and for
the three months ended March 31, 2004.
Naugatuck Valley witnessed an overall increase in its dollar level of
interest income from December 31, 1999, to December 31, 2002, and then a
decrease for the year ended December 31, 2003 and for the three months ended
March 31, 2004, due to the decrease in interest rates in the market and at the
Bank. Interest income was $11.4 million in 1999 and a higher $13.2 million in
2002. This trend was a rising trend that continued each year from 1999 through
2002. For the year ended December 31, 2003, interest income was a lesser $12.6
million, compared to a higher $13.2 million in 2002. For the three months ended
March 31, 2004, interest income was $3.0 million compared to a higher $3.3
million for the three months ended March 31, 2003.
The Bank's interest expense experienced a similar trend with an overall
increase from fiscal year 1999 to 2001, and then decreased in 2002 and 2003.
Interest expense increased $906,000 or 17.2 percent from 1999 to 2001, compared
to a larger dollar increase in interest income of $1.4 million but a smaller
11.2 percent increase for the same time period. Interest expense then decreased
$879,000 or 14.2 percent from 2001 to 2002, compared to an increase in interest
income of $547,000 or 4.3 percent. Such increase in interest income in 2002,
notwithstanding the decrease in interest expense, resulted in a larger dollar
increase in annual net interest income of $1.4 million or 22.1 percent for the
fiscal year ended December 31, 2002, and a moderate increase in net interest
margin. Interest expense decreased $1.1 million or 20.0 percent in 2003,
compared to a smaller $534,000 decrease in interest income with a modest
decrease in net interest margin.
In summary, net interest income increased from $6.1 million in 1999, to
$8.4 million in 2003. Then, for the three months ended March 31, 2004, Naugatuck
Valley's actual net interest income was $2,090,000 or $8.4 million, annualized,
which was similar to the $2,084,000 for the three months ended March 31, 2004,
or $8.3 million, annualized.
INCOME AND EXPENSE (CONT.)
The Bank has made provisions for loan losses in each of the past five
fiscal years of 1999 through 2003 but not in the three months ended March 31,
2004. The amounts of those provisions were determined in recognition of the
Bank's levels of nonperforming assets, charge-offs, repossessed assets, the
Bank's rise in lending activity, and industry norms. The loan loss provisions
were $110,000 in 1999, $73,000 in 2000, $80,000 in 2001, $231,000 in 2002 and
$45,000 in 2003. The higher provision in 2002 was related to the need to
strengthen the allowance for loan losses after higher charge-offs in 1999 and
2000. The impact of these loan loss provisions has been to provide Naugatuck
Valley with a general valuation allowance of $1,811,000 at March 31, 2004, or
0.98 percent of gross loans and 184.8 percent of nonperforming assets.
Total other income or noninterest income indicated a rising trend from
fiscal year 1999 through 2003. The highest level of noninterest income was in
fiscal year 2003 at $1.1 million or 0.46 percent of assets, including only
$14,000 in gains on the sale of loans. The lowest level of noninterest income
was $523,000 in 1999, representing 0.31 percent of assets. The average
noninterest income level for the past five fiscal years was $791,000 or 0.39
percent of average assets. In the three months ended March 31, 2004, noninterest
income was $333,000 or 0.55 percent of assets on an annualized basis.
Noninterest income consists primarily of service charges and loan fees, income
from bank-owned life insurance, income from investment advisory services, and
other income and gains on the sale of loans and investments.
The Bank's general and administrative expenses or noninterest expenses
increased from $4.2 million for the fiscal year of 1999 to $6.8 million for the
fiscal year ended December 31, 2003. The largest dollar increase in noninterest
expenses was $1.0 million from 2002 to 2003. This larger increase in noninterest
expenses was due primarily to the Bank's office expansion and the addition of
new staffing combined with the normal rise in overhead expenses. On a percent of
average assets basis, operating expenses increased from 2.49 percent of average
assets for the fiscal year ended December 31, 1999, to 2.94 percent for the
fiscal year ended December 31,
INCOME AND EXPENSE (CONT.)
2003. For the three months ended March 31, 2004, Naugatuck Valley's ratio of
operating expenses to average assets was a higher 3.16 percent.
The net earnings position of Naugatuck Valley has indicated volatility
from 1999 to 2003, and then a decrease in performance in the three months ended
March 31, 2004. The annual net income figures for the fiscal years of 1999 to
2003 were $829,000, $1,619,000, $1,182,000, $1,920,000 and $1,806,000,
respectively, representing returns on average assets of 0.50 percent, 0.96
percent, 0.65 percent, 0.91 percent and 0.77 percent for fiscal years 1999
through 2003, respectively. For the three months ended March 31, 2004, net
earnings were $378,000, representing an annualized return on average assets of
0.63 percent.
Exhibit 7 provides the Bank's normalized earnings or core earnings for the
twelve months ended March 31, 2004 and the fiscal year 2003. The Bank's
normalized earnings eliminate any nonrecurring income and expense items. There
were two adjustments, one to income to reduce the Bank's gain on sale of
investments and one adjustment to expenses to reduce the credit on the sale of
foreclosed real estate.
The key performance indicators comprised of selected performance ratios,
asset quality ratios and capital ratios are shown in Exhibit 8 to reflect the
results of performance. The Bank's return on assets increased from 0.50 percent
in 1999, to 0.96 percent in fiscal year 2000, then decreased to 0.65 percent in
fiscal year 2001. It then increased to 0.91 percent in 2002 and was a lower 0.77
percent in 2003. It was still lower for the three months ended March 31, 2004,
at 0.63 percent, annualized, due primarily to the Bank's decrease in its net
interest margin and rise in noninterest expenses.
The Bank's net interest rate spread increased from 3.64 percent in 1999 to
3.78 percent in 2000, then decreased to 3.50 percent in 2001 and then rose to
3.77 percent in fiscal year 2002 and remained at 3.77 percent in fiscal 2003.
For the three months ended March 31, 2004, net interest spread decreased to 3.72
percent, annualized. The Bank's net interest margin indicated
INCOME AND EXPENSE (CONT.)
a similar overall trend, increasing from 3.88 percent in 1999 to 3.98 percent in
2000, and then decreased to 3.71 percent in 2001, rising to 3.90 percent in
fiscal year 2002, and then decreasing to 3.85 percent in fiscal year 2003 and
then decreasing further to 3.77 percent for the three months ended March 31,
2004, annualized. Naugatuck Valley's net interest rate spread increased 13 basis
points from 1999 to 2003 to 3.77 percent from 3.64 percent in 1999. The Bank's
net interest margin followed a more stable trend, decreasing 3 basis points to
3.85 percent in 2003 from 3.88 percent in 1999. For the three months ended March
31, 2004, Naugatuck Valley's annualized net interest spread decreased 5 basis
points to 3.72 percent, and its net interest margin decreased 8 basis points to
3.77 percent.
The Bank's return on average equity increased from 1999 to 2003. The
return on average equity increased from 5.98 percent in 1999 to 8.59 percent in
fiscal year 2003. For the three months ended March 31, 2004, return on average
equity was a lesser 6.99 percent, annualized, due to the Bank's lower earnings,
resulting in a lower return on equity.
Naugatuck Valley's ratio of interest-earning assets to interest-bearing
liabilities decreased modestly from 107.34 percent at December 31, 1999, to
103.69 percent at December 31, 2003, and continued to decrease to 102.93 percent
at March 31, 2004. The Bank's decrease in its ratio of interest-earning assets
to interest-bearing liabilities is primarily the result of the Bank's purchase
of $4.7 million in bank-owned life insurance in 2003.
The Bank's ratio of noninterest expenses to average assets increased from
2.49 percent in fiscal year 1999 to a higher 2.94 percent in fiscal year 2003,
due to the Bank's stronger growth in assets combined with moderate increases in
noninterest expenses. For the three months ended March 31, 2004, noninterest
expenses to assets further increased to 3.16 percent related to office expansion
costs. Another key noninterest expense ratio reflecting efficiency of operation
is the ratio of noninterest expenses to noninterest income plus net interest
income referred to as the "efficiency ratio." The industry norm is 57.3 percent
with the lower the ratio indicating higher efficiency. The Bank has been
characterized with a lower level of efficiency historically
INCOME AND EXPENSE (CONT.)
reflected in its higher efficiency ratio, which increased from 62.0 percent in
1999 to 71.62 percent in 2003. The ratio then increased to 77.2 percent for the
three months ended March 31, 2004, due to a rise in noninterest expenses
discussed previously.
Earnings performance can be affected by an institution's asset quality
position. The ratio of nonperforming assets to total assets is a key indicator
of asset quality. Naugatuck Valley witnessed a decrease in its nonperforming
asset ratio from 1999 to 2003, and the ratio was below the industry norm in 2003
and at March 31, 2004. Nonperforming assets consist of loans delinquent 90 days
or more, nonaccruing loans, real estate owned and repossessed assets. Naugatuck
Valley's nonperforming assets consisted of nonaccrual loans and real estate
owned in 1999 through 2003 and at March 31, 2004. The ratio of nonperforming
assets to total assets was 1.11 percent at December 31, 1999, then decreased to
0.46 percent at December 31, 2003. At March 31, 2004, Naugatuck Valley's ratio
of nonperforming assets to total assets decreased slightly to 0.40 percent of
assets.
Two other indicators of asset quality are the Bank's ratios of allowance
for loan losses to total loans and also to nonperforming loans. The Bank's
allowance for loan losses was 1.38 percent of loans at December 31, 1999, and
decreased to 0.99 percent at December 31, 2003, and then decreased to 0.98
percent of loans at March 31, 2004, with the decrease due to the Bank's higher
charge-offs in 2003 combined with growth in loans. As a percentage of
nonperforming loans, Naugatuck Valley's allowance for loan losses was 130.22
percent in 1999 and 199.78 percent in 2003. At March 31, 2004, the ratio was a
higher 213.31 percent.
Exhibit 9 provides the changes in net interest income due to rate and
volume changes for the fiscal years of 2002 and 2003 and for the three months
ended March 31, 2004. In fiscal year 2002, net interest income increased
$1,426,000, due to an increase in interest income of $547,000 accented by a
$879,000 decrease in interest expense. The increase in interest income was due
to an increase due to volume of $1,426,000, reduced by a decrease due to rate of
$879,000.
INCOME AND EXPENSE (CONT.)
For the fiscal year ended December 31, 2003, net interest income increased
$524,000 due to a $1,058,000 decrease in interest expense reduced by a $534,000
decrease in interest income. The decrease in interest income was due to a
$1,120,000 decrease due to rate reduced by a $586,000 increase due to volume.
The decline in interest expense was the result of a decrease due to rate of
$986,000 accented by a decrease due to volume of $72,000.
For the three months ended March 31, 2004, compared to the three months
ended March 31, 2003, net interest income increased $6,000 due to a $236,000
decrease in interest income reduced by a $230,000 decrease in interest expense.
The decrease in interest income was due to a $431,000 decrease due to rate
reduced by a $195,000 increase due to volume. The decline in interest expense
was the result of a decrease due to rate of $457,000 reduced by an increase due
to volume of $227,000.
YIELDS AND COSTS
The overview of yield and cost trends for the years ended December 31,
2001, 2002 and 2003, for the three months ended March 31, 2003 and 2004, and at
March 31, 2004, can be seen in Exhibit 10, which offers a summary of key yields
on interest-earning assets and costs of interest-bearing liabilities.
Naugatuck Valley's weighted average yield on its loan portfolio decreased
113 basis points from fiscal year 2001 to 2003, from 7.56 percent to 6.431
percent, and then decreased 54 basis points to 5.89 percent for the three months
ended March 31, 2004, compared to a higher 6.75 percent for the three months
ended March 31, 2003. The yield on investment securities decreased 134 basis
points from 5.12 percent in 2001 to 3.78 percent in fiscal year 2003 and then
increased 8 basis points to 3.86 percent for the three months ended March 31,
2004, compared to a higher 4.11 percent for the three months ended March 31,
2003. The yield on Fed funds sold decreased 289 basis points from fiscal year
2001 to 2003, from 3.95 percent to 1.06 percent and then decreased another 18
basis points to 0.88 percent for the three months ended March 31, 2004, compared
to a higher 1.10 percent for the three months ended March 31, 2003. The combined
weighted average yield on all interest-earning assets decreased 148 basis points
to 5.79 percent from fiscal year 2001 to 2003, reflecting the Bank's higher
yield on loans. The yield on interest-earning assets for the three months ended
March 31, 2004, was a lower 5.46 percent, compared to a higher 6.12 percent for
the three months ended March 31, 2003.
Naugatuck Valley's weighted average cost of interest-bearing liabilities
decreased 175 basis points to 2.01 percent from fiscal year 2001 to 2003, which
was greater than the Bank's 148 basis point increase in yield, resulting in an
increase in the Bank's interest rate spread of 27 basis points from 3.51 percent
to 3.78 percent from 2001 to 2003. For the three months ended March 31, 2004,
the Bank's cost of funds decreased 27 basis points to 1.74 percent, compared to
a 33 basis point decrease in yield on interest-earning assets, resulting in a
lower net interest rate spread by 6 basis points to 3.72 percent compared to
3.81 percent for the three months ended March 31, 2003. The Bank's net interest
margin increased from 3.71 percent in fiscal year 2001 to 3.90 percent in fiscal
year 2002, and then decreased to 3.85 percent in fiscal year 2003. The
YIELDS AND COSTS (CONT.)
Bank's net interest margin for the three months ended March 31, 2004, decreased
to 3.77 percent compared to a higher 3.92 percent for the three months ended
March 31, 2003. The Bank's yield on earning assets decreased 14 basis points to
5.32 percent at March 31, 2004, compared to 5.46 percent for the three months
ended March 31, 2004. The Bank's cost of funds decreased to 1.71 percent at
March 31, 2004, compared to 1.74 percent for the three months ended March 31,
2003. The resultant net interest rate spread decreased 11 basis points to 3.61
percent at March 31, 2004, compared to 3.72 percent for the three months ended
March 31, 2004.
INTEREST RATE SENSITIVITY
Naugatuck Valley has monitored its interest rate sensitivity position and
focused on maintaining a reasonable level of rate sensitive assets. Naugatuck
Valley has recognized the thrift industry's historically higher interest rate
risk exposure, which caused a negative impact on earnings and market value of
equity as a result of significant fluctuations in interest rates, specifically
rising rates. Such exposure was due to the disparate rate of maturity and/or
repricing of assets relative liabilities commonly referred to as an
institution's "gap." The larger an institution's gap, the greater the risk
(interest rate risk) of earnings loss due to a decrease in net interest margin
and a decrease in market value of equity or portfolio loss.
In response to the potential impact of interest rate volatility and
negative earnings impact, many institutions have taken steps during the past
five years to reduce their gap position. This frequently results in a decline in
the institution's net interest margin and overall earnings performance.
Naugatuck Valley has responded to the interest rate sensitivity issue by
originating more adjustable-rate commercial real estate and multi-family and
residential mortgage loans.
The Bank measures its interest rate risk through the use of the
calculation of its change in annual net interest income under rising and falling
interest rate assumptions and by the determination of its cumulative
interest-rate gap and corresponding ratio of cumulative interest-rate gap as a
percentage of interest-earning assets. The cumulative interest-rate gap for the
Bank is calculated on a quarterly basis by an outside firm. Such cumulative
interest-rate gaps based on different maturities are reflective of the Bank's
interest rate risk exposure.
There are numerous factors which have a measurable influence on interest
rate sensitivity in addition to changing interest rates. Such key factors to
consider when analyzing interest rate sensitivity include the loan payoff
schedule, accelerated principal payments, deposit maturities, interest rate caps
on adjustable-rate loans and deposit withdrawals.
Exhibit 11 provides the Bank's cumulative interest-rate gap as of March
31, 2004, and the ratio of cumulative interest rate sensitivity gap to total
assets. Such calculations are prepared by
INTEREST RATE SENSITIVITY (CONT.)
an outside firm, and the focus of this exposure table is the cumulative one-year
and three-year interest rate gap levels for the Bank.
The Bank's one-year cumulative interest rate gap at March 31, 2004, was a
negative 11.71 percent, representing a cumulative dollar negative gap of
$28,363,000. The Bank's three-year cumulative interest rate gap ratio at March
31, 2004, was a negative 13.24 percent, representing a dollar negative gap of a
larger $32,056,000. In both calculations, all of the Bank=s $25.0 million in
money market deposit accounts was categorized as maturing in one year or less in
contrast to many other calculations by outside firms that prepare interest rate
risk reports which assume only a portion of these accounts mature in one year or
less. Such variance in assumption could reduce the Bank=s negative one-year,
cumulative gap ratio, due to the fact that the Bank has $25.0 million in this
category. However, all of the Bank's savings and NOW accounts, which totaled
$76.0 million, were categorized in the over ten year maturity in contrast to
many other reports which spread these accounts over the ten year period with
regard to maturity.
The Bank is aware of its moderate interest rate risk position. Due to
Naugatuck Valley's recognition of the need to control its interest rate risk,
the Bank has focused on being more active in the origination of adjustable-rate
commercial real estate and multi-family loans, adjustable-rate residential
mortgage loans and shorter term consumer loans, construction loans and
commercial business loans and plans to continue this lending strategy combined
with selling a portion of its fixed-rate, residential mortgage loans in the
future.
LENDING ACTIVITIES
Naugatuck Valley has focused its lending activity on the origination of
conventional mortgage loans secured by one- to four-family dwellings, commercial
real estate loans, including multi-family loans, construction loans, commercial
business loans and consumer loans. Exhibit 12 provides a summary of Naugatuck
Valley's loan portfolio, by loan type, at December 31, 1999 through 2003, and at
March 31, 2004.
The primary loan type for Naugatuck Valley has been residential loans
secured by one- to four-family dwellings, representing 69.7 percent of the
Bank's gross loans as of March 31, 2004. This share of these loans has seen a
moderate decrease from 86.4 percent at December 31, 1999. The second largest
real estate loan type as of March 31, 2004, was commercial real estate loans,
including multi-family loans, which comprised a modest 8.2 percent of gross
loans compared to 0.6 percent as of December 31, 1999. The third key real estate
loan type was construction loans, which represented 7.9 percent of gross loans
as of March 31, 2004, compared to a lower 2.2 percent at December 31, 1999.
These three real estate loan categories represented a strong 85.8 percent of
gross loans at March 31, 2004, compared to a larger 89.1 percent of gross loans
at December 31, 1999.
Commercial business loans represent a smaller size loan category for
Naugatuck Valley. Commercial business loans totaled $4.2 million and represented
2.3 percent of gross loans at March 31, 2004, compared to a lesser 0.1 percent
at December 31, 1999.
The consumer loan category was the other key loan category at March 31,
2004, and represented a moderate 12.0 percent of gross loans compared to 10.7
percent at December 31, 1999. Consumer loans were the second largest overall
loan type at March 31, 2004, and also at December 31, 1999, surpassing
construction loans and commercial real estate and multi-family loans. The Bank's
consumer loans include home equity loans, home equity lines of credit,
automobile loans, savings account loans and secured and unsecured personal
loans. The overall mix of loans has witnessed modest changes from fiscal
year-end 1999 to March 31, 2004, with the Bank having decreased its share of
residential mortgage loans to offset its increases in
LENDING ACTIVITIES (CONT.)
construction loans, commercial real estate and multi-family loans, commercial
business loans and consumer loans, primarily comprised of home equity loans.
The emphasis of Naugatuck Valley's lending activity is the origination of
conventional mortgage loans secured by one- to four-family residences. Such
residences are located in Naugatuck Valley's primary market area, which includes
Fairfield and New Haven Counties. At March 31, 2004, 69.7 percent of Naugatuck
Valley's gross loans consisted of loans secured by one- to four-family
residential properties.
The Bank offers several types of adjustable-rate mortgage loans, ("ARMs")
with adjustment periods of one year, three years, five years and seven years.
The interest rates on ARMs are generally indexed to the one-year Treasury
constant maturity index. ARMs have a maximum rate adjustment of 2.0 percent at
each adjustment period and 6.0 percent for the life of the loan. Rate
adjustments are computed by adding a stated margin to the index, generally 2.75
percent. The Bank retains all ARMs which it originates. The majority of ARMs
have terms of 15 to 20 years with a maximum term of 30 years.
The Bank periodically offers adjustable-rate mortgage loans with
discounted or teaser rates at rates below those which would prevail under normal
computations based upon a determination of market factors and competitive rates
in the market. On such discounted loans, the borrower is qualified at both the
initial rate and the fully-indexed rate.
The Bank's one- to four-family mortgage loans remain outstanding for
shorter periods than their contractual terms, because borrowers have the right
to refinance or prepay. These mortgage loans contain "due on sale" clauses which
permit the Bank to accelerate the indebtedness of the loan upon transfer of
ownership of the mortgage property.
The Bank's other key mortgage loan product is a fixed-rate mortgage loan
with a share of Naugatuck Valley's new fixed-rate mortgage loans being sold in
the secondary market. The
LENDING ACTIVITIES (CONT.)
Bank has historically retained most of its fixed-rate mortgage loans. Fixed-rate
mortgage loans have a maximum term of 30 years. The Bank's fixed-rate mortgage
loans conform to FHLMC underwriting standards.
The normal loan-to-value ratio for conventional mortgage loans to purchase
or refinance one-to four-family dwellings generally does not exceed 80 percent
at Naugatuck Valley, even though the Bank is permitted to make loans up to a 97
percent loan-to-value ratio. While the Bank does make loans up to 97 percent of
loan-to-value, the Bank generally requires private mortgage insurance or
additional collateral for the amount in excess of the 80.0 percent loan-to-value
ratio. Mortgage loans originated by the Bank include due-on-sale clauses
enabling the Bank to adjust rates on fixed-rate loans in the event the borrower
transfers ownership.
Naugatuck Valley has also been an originator of adjustable-rate and
fixed-rate commercial real estate loans and multi-family loans in the past and
will continue to make multi-family and commercial real estate loans. The Bank
had a total of $15.3 million in commercial real estate and multi-family loans at
March 31, 2004, or 8.2 percent of gross loans, compared to only $773,000 or 0.6
percent of gross loans at December 31, 1999.
The major portion of commercial real estate and multi-family loans are
secured by condominiums, apartment buildings, small retail establishments and
office buildings and other owner-occupied properties used for business. Most of
the multi-family and commercial real estate loans are fully amortizing with a
term of up to 20 years for adjustable-rate loans with one-year, three-year or
five-year adjustment periods. There are no interest rate caps. The maximum
loan-to-value ratio is normally 80 percent.
The Bank also originates construction loans to individuals and to a lesser
extent to builders for the construction of residential projects, including
condominiums, apartments, and single-family subdivisions as well as
owner-occupied properties used for business. The Bank had $14.8 million or 7.9
percent of gross loans in construction loans. Construction loans
LENDING ACTIVITIES (CONT.)
normally have a term of nine months for the construction period with a fixed
interest rate for the term of the loan and a loan-to-value ratio of no more than
80.0 percent. The construction loan normally converts to a permanent loan at the
end of the construction period. The Bank will originate commercial construction
loans for a loan-to-value ratio of up to 75.0 percent with a term of nine months
to two years. The Bank also originates land loans to individuals, area
homebuilders and developers. Land loans normally have rates tied to the one-year
constant maturity Treasury index with a margin of 3.75 percent with terms of up
to twenty years. The maximum loan-to-value ratio is 75.0 percent. Land loan
rates adjust annually after a five-year initial period.
Naugatuck Valley is an originator of commercial business loans with these
loans totaling $4.2 million at March 31, 2004, and representing 2.3 percent of
gross loans. Commercial business loans are normally secured by business assets
such as inventory or business equipment. These loans have a maximum
loan-to-value ratio of 75.0 percent of the personal property. These loans have
terms of one to seven years.
Naugatuck Valley has also been involved in consumer lending. Consumer
loans originated consist primarily of home equity loans and lines of credit,
which represented a total of $21.5 million or 96.0 percent of consumer loans at
March 31, 2004, up from $13.7 million or 90.0 percent of consumer loans at
December 31, 1999. Total consumer loans were $22.4 million or 12.0 percent of
gross loans at March 31, 2004, and a lesser $15.2 million or 10.7 percent of
gross loans at December 31, 1999. Naugatuck Valley offers home equity loans and
lines of credit with a maximum loan-to-value ratio of 80.0 percent. These loans
have a term of up to ten years with rates generally tied to the current prime
rate.
Exhibit 13 provides a loan maturity schedule and breakdown and summary of
Naugatuck Valley's fixed- and adjustable-rate loans, indicating a majority of
fixed-rate loans. At March 31, 2004, 16.9 percent of the Bank's loans due after
March 31, 2005, were adjustable-rate and 83.1
LENDING ACTIVITIES (CONT.)
percent were fixed-rate. The Bank has a moderate 25.2 percent of its loans at
March 31, 2004, due in one year or less with another 9.6 percent due in one to
five years.
As indicated in Exhibit 14, Naugatuck Valley experienced a significant
increase in its one-to four-family loan originations and total loan originations
from fiscal year 2001 to 2003. Total loan originations in fiscal year 2001 were
$62.6 million compared to $101.0 million in fiscal year 2003, reflective of a
higher level of real estate loans accented by higher levels of construction
loans and consumer loans. The increase in one- to four-family real estate loan
originations from 2001 to 2003 of $29.6 million constituted 77.2 percent of the
$38.4 million aggregate increase in total loan originations from 2001 to 2003,
with construction loans increasing $5.8 million, representing 15.0 percent of
the total increase in loan originations. Consumer loans increased $3.7 million
from 2001 to 2003.
Loan originations for the three months ended March 31, 2004, were $13.7
million, representing a lesser $54.8 million on an annualized basis, indicating
a significant decrease in loan origination activity. Loan originations on
residential real estate loans represented 56.0 percent of total loan
originations in fiscal year 2001, and 64.0 percent in fiscal year 2003.
Residential real estate loan originations decreased to 41.6 percent of total
loan originations for the three months ended March 31, 2004. Consumer loans
represented 17.0 percent of total loan originations in 2001 and a lesser 14.2
percent in 2003. For the three months ended March 31, 2004, these loans
represented a larger 26.4 percent of total originations. Construction loans
represented a moderate 12.3 percent of total loan originations in 2001 and a
similar 13.3 percent in 2003. For the three months ended March 31, 2004,
construction loans represented a larger 20.5 percent of total loan originations.
The Bank had no loan purchases from December 31, 2001, through March 31, 2004.
Overall, loan originations and purchases exceeded principal payments,
loans sales, loan repayments and other deductions in each of the periods. In
fiscal 2001, loan originations exceeded reductions by $12.6 million, increasing
to $15.3 million in 2003. For the three months
LENDING ACTIVITIES (CONT.)
ended March 31, 2004, loan originations were greater than total reductions by
$1.7 million with total loan sales representing $1.9 million.
NONPERFORMING ASSETS
Naugatuck Valley understands asset quality risk and the direct
relationship of such risk to delinquent loans and nonperforming assets,
including real estate owned. The quality of assets has been a key concern to
financial institutions throughout many regions of the country. A number of
financial institutions have been confronted with rapid increases in their levels
of nonperforming assets and have been forced to recognize significant losses,
setting aside major valuation allowances.
A sharp increase in nonperforming assets has often been related to
specific regions of the country and has frequently been associated with higher
risk loans, including purchased commercial real estate loans and multi-family
loans. Naugatuck Valley has not been faced with such problems in the past and
has made a concerted effort to control its nonperforming assets, recognizing the
depressed nature of its local economy, and has been successful.
Exhibit 15 provides a summary of Naugatuck Valley's delinquent loans at
December 31, 2001 through 2003, and at March 31, 2004, indicating an overall
increase in delinquent loans from December 31, 2001, to December 31, 2003, and
then a decrease by March 31, 2004. The Bank had $845,000 in loans delinquent 60
to 89 days at March 31, 2004. Loans delinquent 30 to 59 days totaled $797,000 at
March 31, 2004, with these two categories representing 0.88 percent of gross
loans with most of them real estate loans. At December 31, 2003, delinquent
loans of 30 to 89 days totaled $2,159,000 or 1.17 percent of gross loans
compared to a lesser $1,549,000 or 0.98 percent of gross loans at December 31,
2001.
It is normal procedure for Naugatuck Valley's board to review most loans
delinquent 30 days or more on a monthly basis, to assess their collectibility
and to initiate any direct contact with borrowers. When a loan is delinquent 15
days, the Bank sends the borrower a late payment notice. The Bank then initiates
both written and oral communication with the borrower if the loan remains
delinquent and sends additional notices after 30 days and 60 days of
delinquency. When the loan becomes delinquent at least 90 days, the Bank will
normally commence foreclosure proceedings. The Bank does not normally accrue
interest on loans past due 90 days
NONPERFORMING ASSETS (CONT.)
or more unless the loan is adequately collateralized and in the process of
collection. Most loans delinquent 90 days or more are placed on a nonaccrual
status, and at that point in time the Bank pursues foreclosure procedures.
Exhibit 16 provides a summary of Naugatuck Valley's nonperforming assets
at March 31, 2004, and at December 31, 1999 through 2003. Nonperforming assets
normally consist of loans 90 days or more past due, nonaccruing loans and
repossessed assets. The Bank had no loans 90 days or more past due during these
periods. The Bank has normally carried a moderate level of nonperforming assets.
Naugatuck Valley's level of nonperforming assets ranged from a high dollar
amount of $1,877,000 or 1.11 percent of total assets at December 31, 1999, to a
low dollar amount of $1,114,000 or 0.46 percent of assets at December 31, 2003.
The Bank's nonperforming assets totaled $1,332,000 at December 31, 2002,
representing 0.58 percent of assets and have decreased to $980,000 at March 31,
2004, representing 0.40 percent of assets.
Naugatuck Valley's level of nonperforming assets was less than its level
of classified assets. The Bank's level of classified assets was $2,618,000 or
1.08 percent of assets at March 31, 2004 (reference Exhibit 17). The Bank's
classified assets consisted of $2,595,000 in substandard assets, $21,000 in
assets classified as doubtful and $2,000 classified as loss.
Exhibit 18 shows Naugatuck Valley's allowance for loan losses at March 31,
2003 and 2004, and for fiscal years ended 1999 through 2003, indicating the
activity and the resultant balances. Naugatuck Valley has witnessed a modest
decrease in its balance of allowance for loan losses from $1,935,000 at December
31, 1999 to $1,810,000 at December 31, 2003. The balance in allowance for loan
losses then increased slightly to $1,811,000 at March 31, 2004, with provisions
of $110,000 in 1999, $72,000 in 2000, $80,000 in 2001, $231,000 in 2002, $45,000
in fiscal 2003, with no provisions in the first three months ended March 31,
2004.
The Bank had net charge-offs of $451,000 in fiscal 1999, $258,000 in
fiscal 2000, $93,000 in 2002 and $229,000 in 2003 with net recoveries of $27,000
in 2001 and $1,000 for
NONPERFORMING ASSETS (CONT.)
the three months ended March 31, 2004. The Bank's ratio of allowance for loan
losses to gross loans was 1.38 percent at December 31, 1999, and a lower 0.99
percent at December 31, 2003, due to higher net charge-offs. The allowance for
loan losses to gross loans decreased to 0.98 percent of loans at March 31, 2004,
due to no provisions and modest loan growth. Allowance for loan losses to
nonperforming assets was 103.1 percent at December 31, 1999, and a larger 162.5
percent at December 31, 2003. The ratio of allowance for loan losses to
nonperforming assets was a modestly higher 184.8 percent at March 31, 2004.
INVESTMENTS
The investment and securities portfolio, excluding interest-bearing
deposits, has been comprised of U.S. government and federal agency obligations,
mortgage-backed securities, Fed funds, and collateralized mortgage obligations.
Exhibit 19 provides a summary of Naugatuck Valley's investment portfolio at
December 31, 2001, 2002 and 2003 and at March 31, 2004, excluding FHLB stock.
The exhibit also includes a summary of the Bank's mortgage-backed securities.
Investment securities totaled $32.9 million at March 31, 2004, compared to $38.7
million at December 31, 2003, and $21.0 million at December 31, 2001. Included
in these totals are $2.5 million in interest-bearing and U.S. government
securities that are held-to-maturity at March 31, 2004, a lesser $1.6 million at
December 31, 2003, and a lesser $596,000 at December 31, 2001.
The primary component of investment securities at March 31, 2004, was U.S.
government and federal agency obligations, representing 47.1 percent of total
investments, excluding FHLB stock compared to a larger 82.7 percent at December
31, 2001. The Bank also had interest-bearing deposits totaling $11.9 million at
March 31, 2004, and a greater $12.6 million at December 31, 2001. The Bank had
$1,757,000 in FHLB stock at March 31, 2004. The weighted average yield on
investment securities was 3.91 percent at March 31, 2004.
DEPOSIT ACTIVITIES
The mix of deposits by amount from December 31, 2001, to March 31, 2004,
is provided in Exhibit 20. There has been a moderate change in both total
deposits and in the deposit mix during this period. Total deposits have
increased from $156.7 million at December 31, 2001, to $187.5 million at March
31, 2004, representing an increase of $30.8 million or 19.7 percent.
Certificates of deposit have decreased from $89.7 million at December 31, 2001,
to $86.4 million at March 31, 2004, representing a decrease of $3.3 million or
3.6 percent, while savings, NOW, MMDA and noninterest-bearing accounts have
increased $34.1 million from $67.0 million at December 31, 2001, to $101.0
million at March 31, 2004 or 50.9 percent.
The Bank's share of certificates of deposit witnessed a decrease since
2001, declining from a moderate 57.3 percent of deposits at December 31, 2001,
to a lower 46.1 percent of deposits at March 31, 2004. The major component of
certificates at March 31, 2004, had rates between 1.00 percent and 1.99 percent
and represented 37.8 percent of certificates. At December 31, 2001, the major
component of certificates was the 4.00 percent to 4.99 percent category with a
lesser 29.4 percent of certificates. The category witnessing the strongest
growth from December 31, 2001, to March 31, 2004, was certificates with rates
between 1.00 percent and 1.99 percent, which increased $32.7 million during this
time period. The category witnessing the largest decrease from December 31,
2001, to March 31, 2004, was certificates with rates between 4.00 percent and
4.99 percent, which declined $18.5 million.
Exhibit 21 provides a breakdown of certificates by maturity as of March
31, 2004. A strong 60.8 percent of the Bank's certificates of deposit mature in
one year or less. The largest category of certificates based on interest rate
was certificates with rates from 1.00 percent to 1.99 percent, totaling $32.7
million, representing 37.8 percent of certificates.
Exhibit 22 shows the Bank's deposit activity for the three years ended
December 31, 2001, 2002 and 2003, and for the three months ended March 31, 2003
and 2004. Excluding interest credited, Naugatuck Valley experienced net
increases in deposits in each fiscal year and for the three months ended March
31, 2003 and 2004. In fiscal year 2001, there was a net increase in
DEPOSIT ACTIVITY (CONT.)
deposits of $15.1 million, then a lesser $7.4 million in 2003 and $3.4 million
for the three months ended March 31, 2004. Including interest credited, there
was a larger net increase in deposits. In fiscal year 2001, there was a net
increase in deposits of $20.2 million resulting in a 14.8 percent increase in
deposits, including interest credited; and in 2003, there was a net increase in
deposits of $10.2 million or 5.9 percent. For the three months ended March 31,
2004, a net increase in deposits of $4.0 million produced a net rise in deposits
of 2.2 percent, or 8.8 percent, annualized.
BORROWINGS
Naugatuck Valley has made regular use of FHLB advances from December 31,
1999, to March 31, 2004. The Bank had $30.1 million in FHLB advances at March
31, 2004, with an average rate of 4.78 percent compared to a lesser $23.4
million at December 31, 2001, with an average rate of 6.51 percent (reference
Exhibit 23).
SUBSIDIARIES
Naugatuck Valley had one wholly-owned subsidiary at March 31, 2004,
Naugatuck Valley Mortgage Servicing Corporation. Naugatuck Valley Mortgage
Servicing Corporation was established in 1999 to service mortgage loans
originated by the Bank, and at March 31, 2004, the Mortgage Servicing
Corporation had $152.2 million in assets. Naugatuck Valley Mortgage Servicing
Corporation qualifies as a "passive investment company," which exempts it from
Connecticut income tax.
OFFICE PROPERTIES
Naugatuck Valley had five offices at March 31, 2004, located in New Haven
and Fairfield Counties (reference Exhibit 24). Naugatuck Valley owns three
offices and leases two offices. The Bank's net investment in its office premises
totaled $4.7 million or 1.93 percent of assets at March 31, 2004, and the Bank's
investment in fixed assets was $6.2 million or 2.56 percent of assets at March
31, 2004.
MANAGEMENT
The president and chief executive officer of Naugatuck Valley is John C.
Roman, who is also a director. Mr. Roman joined the Bank to serve as vice
president and chief lending officer. He was then appointed president and chief
executive officer in 1999 and was also appointed a director. Prior to joining
Naugatuck Valley, Mr. Roman was vice president of MidConn Bank, Kensington,
Connecticut, from 1994 to 1998 and served as assistant vice president of Eagle
Bank, Bristol, Connecticut, the successor to MidConn Bank as the result of a
merger. Dominic J. Alegi, Jr. is executive vice president in charge of retail
banking. He joined the Bank in 1970. Mr. Alegi is also executive vice president
of Naugatuck Valley Financial and Naugatuck Valley Mutual Holding Company. Mr.
Alegi became executive vice president in 1989, previously serving the Bank as
senior vice president. Jane H. Walsh is senior vice president and also a
director. She joined the Bank in 1974 and is responsible for operations. Mr.
William C. Nimons is senior vice president and joined the Bank in 2001. Mr. Lee
R. Schlesinger is vice president and controller of the Bank. He joined the Bank
in 1983 and has served in his present position since 2003.
II. DESCRIPTION OF PRIMARY MARKET AREA
Naugatuck Valley's retail market area encompasses all of Fairfield and New
Haven Counties, Connecticut ("market area") where the Bank's offices are
located, with the two largest offices located in Naugatuck in New Haven County.
The Bank has five offices, one in Fairfield County and four in New Haven County
with New Haven County being the core of the Bank's market area.
Exhibit 26 provides a summary of key demographic data and trends for
Naugatuck and Fairfield and New Haven Counties, Connecticut and the United
States. Overall, from 1990 to 2000, population increased in all areas. The
population increased by only 1.2 percent in Naugatuck, 2.5 percent in New Haven
County, 6.6 percent in Fairfield County, 3.6 percent in Connecticut and 13.2
percent in the United States. Future population projections indicate that
population will continue to increase in all areas from 2000 through the year
2008. Naugatuck's population is projected to increase by 3.7 percent with the
populations of Fairfield and New Haven Counties, Connecticut and the United
States projected to increase by 4.3 percent, 2.5 percent, 3.6 percent and 9.9
percent, respectively. New Haven County is projected to have the smallest
population increase.
Consistent with its slightly rising trend in population, Naugatuck
witnessed a smaller increase in households (families) of 4.4 percent from 1990
to 2000. During that same time period, the number of households increased in New
Haven County by 4.9 percent, in Fairfield County by 6.2 percent, in Connecticut
by 5.8 percent and in the United States by 14.7 percent. From 2000 through 2008,
Naugatuck's households are projected to continue to increase by 5.4 percent,
while the number of households are expected to increase by 5.5 percent in
Fairfield County, 4.7 percent in New Haven County, 5.7 percent in Connecticut
and by 11.0 percent in the United States. New Haven County indicates the
smallest projected growth in households.
In 1990, the per capita income in Naugatuck and New Haven County were
lower than Connecticut, but higher than the United States. Naugatuck had a 1990
per capita
DESCRIPTION OF PRIMARY MARKET AREA (CONT.)
income of $16,691, New Haven County had a per capita income level of $17,666;
while Fairfield County, Connecticut and the United States had 1990 per capita
income levels of $26,161, $20,189 and $14,420, respectively. From 1990 to 2000,
per capita income increased in all areas, with the United States having the
greatest percent increase of 49.7 percent to $21,587. Naugatuck's per capita
income increased from 1990 to 2000 by 36.3 percent to $22.757. Per capita income
increased by 46.6 percent in Fairfield County to $38,350, by 38.3 percent in New
Haven County to $24,439 and by 42.5 percent in Connecticut to $28,766.
The 1990 median household income of $39,902 in Naugatuck was lower than
the median household income in Connecticut at $41,721. New Haven County's median
household income was $38,471 in 1990, which was also lower than Connecticut.
Fairfield County had a 1990 median household income of $49,891, which was higher
than all other median household income levels in Exhibit 26. From 1990 to 2000,
median household income increased in all areas, with the United States
indicating the highest rate of increase and New Haven County the lowest. Median
household income increased by 28.4 percent to $51,247 in Naugatuck, by 26.9
percent to $48,834 in New Haven County, by 30.8 percent to $65,249 in Fairfield
County, compared to a 29.3 percent increase to $53,935 in Connecticut and a 39.7
percent increase to $41,994 in the United States. From 2000 to 2008, median
household income is projected to increase by 22.2 percent in Naugatuck, by 26.3
percent in New Haven County, by 37.5 percent in Fairfield County, while
increasing by 27.4 percent in Connecticut and 29.3 percent in the United States.
Based on those rates of increase, by 2008, median household income is expected
to be $62,608 in Naugatuck , $61,659 in New Haven County, $89,694 in Fairfield
County, $68,740 in Connecticut, and $54,319 in the United States. Naugatuck and
New Haven County continue to indicate the lowest median household income levels.
Exhibit 27 provides a summary of key housing data for Naugatuck, Fairfield
County, New Haven County, Connecticut and the United States. In 1990, Naugatuck
had a rate of owner-occupancy of 67.1 percent, higher than Connecticut at 65.6
percent and higher than the United
DESCRIPTION OF PRIMARY MARKET AREA (CONT.)
States at 64.2 percent, with New Haven County at 62.9 percent and Fairfield
County at 68.2 percent. As a result, Naugatuck indicated a rate of
renter-occupied housing of 32.9 percent, compared to 37.1 percent for New Haven
County, 31.8 percent for Fairfield County, 34.4 percent for Connecticut and 35.8
percent for the United States. In 2000, owner- occupied housing increased in all
the areas except Naugatuck. The owner-occupancy rates in 2000 rose to 69.2
percent, 63.1 percent, 66.8 percent and 66.2 percent in Fairfield County, New
Haven County, Connecticut and the United States, respectively. Naugatuck's
owner-occupancy rate decreased to 66.5 percent. Conversely, the renter-occupancy
rates decreased in to levels of 30.8 percent, 39.6 percent, 33.2 percent and
33.8 percent in Fairfield County, New Haven County, Connecticut and the United
States, respectively, while Naugatuck's renter-occupancy rate increased to 33.5
percent. New Haven County continued to indicate the lowest owner-occupancy rate
and the highest renter-occupancy rate.
Naugatuck's 1990 median housing value was $142,000, lower than
Connecticut's median housing value of $176,700. New Haven County had a median
housing value of a lower $164,400, much lower than Fairfield County's $248,300.
The 1990 average median rent of Naugatuck was $578. Fairfield and New Haven
Counties had median rent of $709 and $585, while Connecticut had a median rent
of $598 and the United States had a lower median rent level of $374. In 2000,
median housing value had decreased in Naugatuck, New Haven County and
Connecticut. Naugatuck had a 2000 median housing value of $133,000 with New
Haven County at a higher $151,900, Fairfield County at $288,900, Connecticut at
$166,900 and the United States having risen to $119,600. In contrast, median
rent levels had risen from 1990 to 2000 in all areas, with Fairfield County
continuing to have the highest level at $838. The other 2000 median rent levels
were $631, $666, $681 and $602 in Naugatuck, New Haven County, Connecticut and
the United States, respectively.
In 1990, the major source of employment for Naugatuck by industry group,
based on share of employment, was the services industry at 30.6 percent with the
manufacturing group a close second at 29.2 percent and the wholesale/retail
sales group at 20.2 percent. The services industry
DESCRIPTION OF PRIMARY MARKET AREA (CONT.)
was responsible for 36.1 percent of jobs in Fairfield County, 37.8 percent in
New Haven County, 36.4 percent in Connecticut and 34.0 percent in the United
States (reference Exhibit 28). The manufacturing industry was also the second
major employer in both counties and Connecticut at 20.4 percent, 21.1 percent
and 20.5 percent, respectively. In the United States, the wholesale/retail trade
group was the second largest employer at 27.5 percent. The wholesale/retail
trade group was the third major overall employer in Fairfield and New Haven
Counties and in Connecticut at 20.2 percent, 20.2 percent and 19.6 percent,
respectively, while manufacturing was the third largest group in the United
States at 19.2 percent. The construction group, finance, insurance and real
estate group, transportation/utilities group, and the agriculture/mining group
combined to provide 20.3 percent of employment in Naugatuck , 23.3 percent of
employment in Fairfield County, 20.9 percent in New Haven County, 23.5 percent
of employment in Connecticut and 19.3 percent in the United States.
In 2000, the services industry, manufacturing industry and
wholesale/retail trade industry provided the first, second and third highest
levels of employment, respectively, for Naugatuck, New Haven County and
Connecticut but not Fairfield County or the United States where the services
industry, wholesale/retail trade and manufacturing industries provided the
first, second and third highest levels of employment. The services industry
accounted for 42.4 percent, 46.1 percent, 49.0 percent, 47.3 percent and 46.7
percent in Naugatuck, Fairfield and New Haven Counties, Connecticut and the
United States, respectively. The manufacturing industry provided for 23.6
percent, 13.2 percent, 15.9 percent, 14.8 percent and 14.1 percent in the same
respective areas. The wholesale/retail trade group provided 15.3 percent, 14.3
percent, 14.7 percent, 14.4 percent and 15.3 percent of employment in Naugatuck,
Fairfield and New Haven Counties, Connecticut and the United States,
respectively.
DESCRIPTION OF PRIMARY MARKET AREA (CONT.)
Naugatuck's major employer is the Peter Paul Division of Hershey with 282
persons employed. Some of the other large employers in the nearby areas of
Waterbury, Southbury, Cheshire and Watertown are listed below.
Employer Number of Employees
- -------- -------------------
Webster Bank (Corporate) 2,200
IBM 1,825
St. Mary's Hospital 1,825
The Waterbury Hospital 1,325
Bozzuto's 1,000
Pratt & Whitney Eagle Service 800
The Siemon Company 700
Webster Bank (Regional) 635
Connecticut Light & Power 595
Cheshire Direct 575
United Parcel Service 550
The Torrington Company 550
VNA Health Care 500
Crompton Corporation 500
SBC/SNET - Regional 500
Quassy Amusement Park 400
First Union National Bank (Regional) 350
New Opportunities for Waterbury 335
Filene's 330
Bristol Babcock, Inc. 325
Eyelematic Manufacturing Co. 300
Republican-American 300
Timex Corporation 300
Naugatuck Valley Community 290
The unemployment rate is another key economic indicator. Exhibit 29 shows
the unemployment rates in Fairfield and New Haven Counties, Connecticut and the
United States in 2000 through March 2004. New Haven County has been
characterized by higher unemployment rates than Connecticut and similar to the
United States. New Haven County's unemployment has been above Connecticut's and
lower than the United States' until 2003. In 2000, Fairfield County had an
unemployment rate of 1.9 percent, compared to unemployment
DESCRIPTION OF PRIMARY MARKET AREA (CONT.)
rates of 2.5 percent , 2.2 percent and 4.0 percent in New Haven County,
Connecticut and the United States, respectively. Fairfield County's unemployment
rate increased in 2001 to 3.1 percent, compared to 2.5 percent in New Haven
County, 3.3 percent in Connecticut and a higher 4.8 percent in the United
States. In 2002, Fairfield County again increased its rate of unemployment to
4.0 percent. New Haven County and Connecticut also increased to 4.8 percent and
4.3 percent, and the United States increased to 5.8 percent. In 2003, all areas
had increases in their unemployment rates. Fairfield County's unemployment rate
increased to 4.8 percent, and the unemployment rates in New Haven County,
Connecticut and the United States increased to 6.0 percent, 5.5 percent and 6.0
percent, respectively. By March 2004, the unemployment rate decreased to 4.4
percent in Fairfield County, decreased to 5.6 percent in New Haven County,
decreased to 5.2 percent in Connecticut and decreased to 5.4 percent in the
United States.
Exhibit 30 provides deposit data for banks and thrifts in Naugatuck
Valley's two market area counties of Fairfield and New Haven Counties. Naugatuck
Valley's deposit base was $188.8 million or a 1.0 percent share of the $18.6
billion total thrift deposits but only a 0.5 percent share of the total
deposits, which were $36.4 billion as of June 30, 2003. It is evident from the
size of the thrift deposits and bank deposits that Naugatuck Valley has a small
deposit share, with the Bank having a minimal level of market penetration for
thrift deposits and also for total deposits.
Exhibit 31 provides interest rate data for each quarter for the years 2001
through 2003 and for the first quarter of 2004. The interest rates tracked are
the Prime Rate, as well as 90-Day, One-Year and Thirty-Year Treasury Bills.
Short term interest rates experienced a declining trend in 2001 and 2002 and
then a flat trend in 2003. This trend indicates some increase in One-Year
Treasury Bills and 30-Year Treasury Notes in the first quarter of 2004.
SUMMARY
To summarize, Naugatuck represents an area with slightly rising population
and household trends during the 1990s and early 2000s. Such growth is projected
to continue through 2008. Naugatuck displayed a lower per capita income and
lower household income than Connecticut. In 1990, the median rent level of
Naugatuck was lower than Connecticut's median rent. By 2000, the median rent
level of Naugatuck was still lower than Connecticut's median rent. In 1990,
Naugatuck's median housing value was also lower than Connecticut's but higher
than in the United States, and in 2000, Naugatuck's median housing value was
again lower than Connecticut's median housing value. The market area counties
have had similar unemployment rates to Connecticut's. Finally, Naugatuck Valley
is in a very competitive financial institution market slightly dominated by
savings institutions and a total market deposit base for banks and thrifts in
the market area counties that is $36.4 billion in deposits.
III. COMPARABLE GROUP SELECTION
INTRODUCTION
Integral to the valuation of the Corporation is the selection of an
appropriate group of publicly-traded thrift institutions, hereinafter referred
to as the "comparable group". This section identifies the comparable group and
describes each parameter used in the selection of each institution in the group,
resulting in a comparable group based on such specific and detailed parameters,
current financials and recent trading prices. The various characteristics of the
selected comparable group provide the primary basis for making the necessary
adjustments to the Corporation's pro forma value relative to the comparable
group. There is also a recognition and consideration of financial comparisons
with all publicly-traded, FDIC-insured thrifts in the United States and all
publicly-traded, FDIC-insured thrifts in the New England region and in
Connecticut.
Exhibits 32 and 33 present Thrift Stock Prices and Pricing Ratios and Key
Financial Data and Ratios, respectively, both individually and in aggregate, for
the universe of 233 publicly-traded, FDIC-insured thrifts in the United States
("all thrifts"), excluding mutual holding companies, used in the selection of
the comparable group and other financial comparisons. Exhibits 32 and 33 also
subclassify all thrifts by region, including the 16 publicly-traded New England
thrifts ("New England thrifts") and the 2 publicly-traded thrifts in Connecticut
("Connecticut thrifts"), and by trading exchange. Exhibit 34 presents prices,
pricing ratios and price trends for all FDIC-insured thrifts completing their
conversions between January 1, 2003, and May 21, 2004.
The selection of the comparable group was based on the establishment of
both general and specific parameters using financial, operating and asset
quality characteristics of Naugatuck Valley as determinants for defining those
parameters. The determination of parameters was also based on the uniqueness of
each parameter as a normal indicator of a thrift institution's operating
philosophy and perspective. The parameters established and defined are
considered to be both reasonable and reflective of Naugatuck Valley's basic
operation.
INTRODUCTION (CONT.)
Inasmuch as the comparable group must consist of at least ten
institutions, the parameters relating to asset size and geographic location have
been expanded as necessary in order to fulfill this requirement.
GENERAL PARAMETERS
MERGER/ACQUISITION
The comparable group will not include any institution that is in the
process of a merger or acquisition due to the price impact of such a pending
transaction. The following thrift institutions were potential comparable group
candidates but had to be eliminated due to their involvement in a
merger/acquisition.
Institution State
- ----------- -----
Falmouth Bancorp, Inc. Massachusetts
First Security Fed Financial Illinois
GA Financial, Inc. Pennsylvania
Warwick Community Bancorp New York
There are no pending merger/acquisition transactions involving thrift
institutions in Naugatuck Valley's city, county or market area, as indicated in
Exhibit 35.
MUTUAL HOLDING COMPANIES
The comparable group will not include any mutual holding companies. The
percentage of public ownership of individual mutual holding companies indicates
a wide range from minimal to 49.0 percent, the largest permissible percentage,
causing them to demonstrate certain
MUTUAL HOLDING COMPANIES (CONT.)
varying individual characteristics different among themselves and from
conventional, publicly-traded companies. A further reason for the elimination of
mutual holding companies as potential comparable group candidates relates to the
presence of a mid-tier, publicly-traded holding company in some, but not all,
mutual holding company structures. The presence of mid-tier holding companies
can also result in inconsistent and unreliable comparisons among the relatively
small universe of 38 publicly-traded mutual holding companies as well between
those 38 entities and the larger universe of conventional, publicly-traded
thrift institutions. As a result of the foregoing and other factors, mutual
holding companies typically demonstrate higher pricing ratios that relate to
their minority ownership structure and are inconsistent in their derivation with
those calculated for conventionally structured, publicly-traded institutions. In
our opinion, it is appropriate to limit individual comparisons to institutions
that are 100 percent publicly owned. Exhibit 37 presents pricing ratios and
Exhibit 38 presents key financial data and ratios for the 38 publicly-traded,
FDIC-insured mutual holding companies in the United States. The following thrift
institutions were potential comparable group candidates, but were not considered
due to their mutual holding company form:
Institution State
- ------------ ------
AJS Bancorp Inc., MHC Illinois
BCSB BankcorpInc., MHC Maryland
Eureka Financial Corp, MHC Pennsylvania
Greater Delaware Valley, MHC Pennsylvania
Greene County Bancorp, Inc., MHC New York
Governeur Bancorp, MHC New York
Jacksonville Bancorp, MHC Illinois
Mid-Southern Savings Bank, MHC Indiana
New England Bancshares, MHC Connecticut
Oneida Financial Corp., MHC New York
Pathfinder Bancorp, Inc., MHC New York
Roebling Financial Corp, MHC New Jersey
Rome Bancorp Inc., MHC New York
Service Bancorp, Inc. MHC Massachusetts
Westborough Financial Services, MHC Massachusetts
Westfield Financial Inc., MHC Massachusetts
TRADING EXCHANGE
It is necessary that each institution in the comparable group be listed on
one of the three major stock exchanges, the New York Stock Exchange, the
American Stock Exchange, or the National Association of Securities Dealers
Automated Quotation System (NASDAQ). Such a listing indicates that an
institution's stock has demonstrated trading activity and is responsive to
normal market conditions, which are requirements for listing. Of the 271
publicly-traded, FDIC-insured savings institutions, including the 38 mutual
holding companies, 17 are traded on the New York Stock Exchange, 18 are traded
on the American Stock Exchange and 180 are traded on NASDAQ. There were an
additional 48 institutions traded on the OTC Bulletin Board and 8 listed in the
Pink Sheets, but they were not considered for the comparable group selection.
IPO DATE
Another general parameter for the selection of the comparable group is the
initial public offering ("IPO") date, which must be at least four quarterly
periods prior to the trading date of May 21, 2004, used in this report, in order
to insure at least four consecutive quarters of reported data as a
publicly-traded institution. The resulting parameter is a required IPO date
prior to March 31, 2003.
GEOGRAPHIC LOCATION
The geographic location of an institution is a key parameter due to the
impact of various economic and thrift industry conditions on the performance and
trading prices of thrift institution stocks. Although geographic location and
asset size are the two parameters that have been developed incrementally to
fulfill the comparable group requirements, the geographic location parameter has
nevertheless eliminated regions of the United States distant to Naugatuck
Valley, including the western, southwestern and southeastern states.
GEOGRAPHIC LOCATION (CONT.)
The geographic location parameter consists of Connecticut and its
surrounding states of Massachusetts, Rhode Island and New York, as well as the
states of Delaware, Indiana, Illinois, Kentucky, Maryland, Maine, New Hampshire,
New Jersey, Ohio, Pennsylvania and West Virginia for a total of sixteen states.
To extend the geographic parameter beyond those states could result in the
selection of similar thrift institutions with regard to financial conditions and
operating characteristics, but with different pricing ratios due to their
geographic regions. The result could then be an unrepresentative comparable
group with regard to price relative to the parameters and, therefore, an
inaccurate value.
ASSET SIZE
Asset size was another key parameter used in the selection of the
comparable group. The range of total assets for any potential comparable group
institution was $100 million to $1.0 billion, due to the general similarity of
asset mix and operating strategies of institutions within this asset range,
compared to Naugatuck Valley, with assets of approximately $242 million. Such an
asset size parameter was necessary to obtain an appropriate comparable group of
at least ten institutions.
In connection with asset size, we did not consider the number of offices
or branches in selecting or eliminating candidates, since that characteristic is
directly related to operating expenses, which are recognized as an operating
performance parameter.
SUMMARY
Exhibits 38 and 39 show the 58 institutions considered as comparable group
candidates after applying the general parameters, with the shaded lines denoting
the institutions ultimately selected for the comparable group using the balance
sheet, performance and asset quality
SUMMARY (CONT.)
parameters established in this section. It should be noted that the comparable
group candidates may be members of either the Bank Insurance Fund (BIF) or the
Savings Association Insurance Fund (SAIF), since many members of each fund hold
significant balances of deposits insured by the other fund.
BALANCE SHEET PARAMETERS
INTRODUCTION
The balance sheet parameters focused on seven balance sheet ratios as
determinants for selecting a comparable group, as presented in Exhibit 38. The
balance sheet ratios consist of the following:
1. Cash and investments to assets
2. Mortgage-backed securities to assets
3. One- to four-family loans to assets
4. Total net loans to assets
5. Total net loans and mortgage-backed securities to assets
6. Borrowed funds to assets
7. Equity to assets
The parameters enable the identification and elimination of thrift
institutions that are distinctly and functionally different from Naugatuck
Valley with regard to asset mix. The balance sheet parameters also distinguish
institutions with a significantly different capital position from Naugatuck
Valley. The ratio of deposits to assets was not used as a parameter as it is
directly related to and affected by an institution's equity and borrowed funds
ratios, which are separate parameters.
CASH AND INVESTMENTS TO ASSETS
The Bank's ratio of cash and investments to asset, excluding
mortgage-backed securities, was 12.4 percent at March 31, 2004, and reflects
Naugatuck Valley's share of investments modestly lower than national and
regional averages. The Bank's investments have consisted primarily of U.S.
government and federal agency securities, state and municipal obligations, debt
securities, equity securities and federal funds sold. For its three most recent
calendar years ended December 31, 2003, Naugatuck Valley's average ratio of cash
and investments to assets was a similar 11.3 percent, ranging from a high of
18.9 percent in 2002 to a low of 10.4 percent in 2003, with modest change. It
should be noted that, for the purposes of comparable group selection, Naugatuck
Valley's $1.8 million balance of Federal Home Loan Bank stock at March 31, 2004,
is included in the other assets category, rather than in cash and investments,
in order to be consistent with reporting requirements and sources of statistical
and comparative analysis related to the universe of comparable group candidates
and the final comparable group.
The parameter range for cash and investments is fairly broad, in spite of
Naugatuck Valley's modestly higher balance of cash and investments, related to
the general volatility of this parameter and institutions' varying liquidity
options and approaches, including the purchase of mortgage-backed and mortgage
derivative securities. The range has been defined as 25.0 percent or less of
assets, with a midpoint of 13.0 percent.
MORTGAGE-BACKED SECURITIES TO ASSETS
At March 31, 2004, Naugatuck Valley's ratio of mortgage-backed securities
to assets was a lower 6.2 percent compared to the regional average of 11.5
percent and the national average of 12.5 percent for publicly-traded thrifts.
The Bank's three most recent calendar year average is 5.6 percent, also lower
than industry averages. Inasmuch as many institutions purchase mortgage-backed
securities as an alternative to both lending, relative to cyclical loan demand
and prevailing interest rates, and other investment vehicles, this parameter is
also fairly broad at 25.0 percent or less of assets and a midpoint of 13.0
percent.
ONE- TO FOUR-FAMILY LOANS TO ASSETS
Naugatuck Valley's lending activity is focused on the origination of
residential mortgage loans secured by one- to four-family dwellings. One- to
four-family loans, including construction loans, represented 54.65 percent of
the Bank's assets at March 31, 2004, which is modestly higher than the national
average of 46.0 percent. The parameter for this characteristic requires any
comparable group institution to have from 30.0 percent to 70.0 percent of its
assets in one- to four-family loans with a midpoint of 50.0 percent.
TOTAL NET LOANS TO ASSETS
At March 31, 2004, Naugatuck Valley had a 75.3 percent ratio of total net
loans to assets and a similar three calendar year average of 75.2 percent, both
being higher than the national average of 67.6 percent and the regional average
of 61.5 percent for publicly-traded thrifts. The Bank's ratio of total net loans
to assets has decreased since 2001. The parameter for the selection of the
comparable group is from 50.0 percent to 90.0 percent with a midpoint of 70.0
percent. The lower end of the parameter range relates to the fact that, as the
referenced national and regional averages indicate, many institutions hold
greater volumes of investment securities and/or mortgage-backed securities as
cyclical alternatives to lending, but may otherwise be similar to Naugatuck
Valley.
TOTAL NET LOANS AND MORTGAGE-BACKED SECURITIES TO ASSETS
As discussed previously, Naugatuck Valley's shares of mortgage-backed
securities to assets and total net loans to assets were 6.1 percent and 75.3
percent, respectively, for a combined share of 81.4 percent. Recognizing the
industry and regional ratios of 12.5 percent and 11.5 percent, respectively, of
mortgage-backed securities to assets, the parameter range for the comparable
group in this category is 70.0 percent to 95.0 percent, with a midpoint of 83.0
percent.
BORROWED FUNDS TO ASSETS
Naugatuck Valley had a $30.1 million balance of borrowed funds at March
31, 2004, consisting of FHLB advances, representing 12.5 percent of assets. The
average ratio of borrowed funds to assets for the past three years was 13.2
percent. The use of borrowed funds by some thrift institutions indicates an
alternative to retail deposits and may provide a source of term funds for
lending. The federal insurance premium on deposits has also increased the
attractiveness of borrowed funds.
The use of borrowed funds by some institutions indicates an alternative to
retail deposits and may provide a source of longer term funds. The federal
insurance premium on deposits has also increased the attractiveness of borrowed
funds. The institutional demand for borrowed funds increased overall from 1997
through 2003 and then subsiding in early 2004. The rise was due to the greater
competition for deposits and lower cost funds, resulting in an increase in
borrowed funds by many institutions as an alternative to higher cost and/or
longer term certificates. In 2002 and 2003, however, lower interest rates
resulted in some moderation of borrowings by financial institutions,
particularly among nonpublicly-traded institutions. The ratio of borrowed funds
to assets, therefore, does not typically indicate higher risk or more aggressive
lending, but primarily an alternative to retail deposits.
The range of borrowed funds to assets is 40.0 percent or less with a
midpoint of 20.0 percent.
EQUITY TO ASSETS
Naugatuck Valley's equity to assets ratio was 8.9 percent at March 31,
2004, and 8.7 percent at December 31, 2003, averaging 8.7 percent for the three
calendar years ended December 31, 2003. After conversion, based on the midpoint
value of $50.0 million and a 43 percent minority public offering of $21.5
million, with 50.0 percent of the net proceeds of the public offering going to
the Bank, Naugatuck Valley's equity is projected to stabilize in the
EQUITY TO ASSETS (CONT.)
area of 12.5 percent of assets. Based on those equity ratios, we have defined
the equity ratio parameter to be 6.0 percent to 18.0 percent with a midpoint
ratio of 12.0 percent.
PERFORMANCE PARAMETERS
INTRODUCTION
Exhibit 39 presents five parameters identified as key indicators of
Naugatuck Valley's earnings performance and the basis for such performance both
historically and during the four quarters ended March 31, 2004. The primary
performance indicator is the Bank's core return on average assets (ROAA). The
second performance indicator is the Bank's core return on average equity (ROAE).
To measure the Bank's ability to generate net interest income, we have used net
interest margin. The supplemental source of income for the Bank is noninterest
income, and the parameter used to measure this factor is the ratio of
noninterest income to average assets. The final performance indicator is the
Bank's ratio of operating expenses or noninterest expenses to average assets, a
key factor in distinguishing different types of operations, particularly
institutions that are aggressive in secondary market activities, which often
results in much higher operating costs and overhead ratios.
RETURN ON AVERAGE ASSETS
The key performance parameter is the core ROAA. For the twelve months
ended March 31, 2004, Naugatuck Valley's core ROAA was 0.72 percent based on
adjusted core earnings after taxes of $1,697,000, as detailed in Item I of this
Report. The Bank's average ROAA over its most recent five calendar years of 1999
to 2003, based on net earnings, was a higher 0.91 percent, ranging from a low of
0.50 percent in 1999 to a high of 0.96 percent in 2000.
RETURN ON AVERAGE ASSETS (CONT.)
Considering the historical and current earnings performance of Naugatuck
Valley, the range for the ROAA parameter based on core income has been defined
as 0.60 percent to a high of 1.10 percent with a midpoint of 0.85 percent.
RETURN ON AVERAGE EQUITY
The ROAE has been used as a secondary parameter to eliminate any
institutions with an unusually high or low ROAE that is inconsistent with the
Bank's position. This parameter does not provide as much meaning for a newly
converted thrift institution as it does for established stock institutions, due
to the unseasoned nature of the capital structure of the newly converted thrift
and the inability to accurately reflect a mature ROAE for the newly converted
thrift relative to other stock institutions.
Prior to conversion, the Bank's core ROAE for the twelve months ended
March 31, 2004, was 8.11 percent based on adjusted core income. In its most
recent five calendar years, the Bank's average ROAE, based on net earnings, was
a lower 8.49 percent, ranging from a low of 5.98 percent in 1999 to a high of
10.71 percent in 2000.
The parameter range for ROAE for the comparable group, based on core
income, is from 4.0 percent to 12.0 percent with a midpoint of 8.0 percent.
NET INTEREST MARGIN
Naugatuck Valley had a net interest margin of 3.69 percent for the twelve
months ended March 31, 2004, representing net interest income as a percentage of
average interest-earning assets. The Bank's net interest margin in calendar
years 1999 through 2003 averaged 3.86
NET INTEREST MARGIN (CONT.)
percent, indicating a volatile trend from 1999 to 2003, reaching 3.98 percent in
2000 and dropping to 3.71 percent in 2001.
The parameter range for the selection of the comparable group is from a
low of 2.75 percent to a high of 4.50 percent with a midpoint of 3.63 percent.
OPERATING EXPENSES TO ASSETS
For the twelve months ended March 31, 2004, Naugatuck Valley had a higher
than average 2.99 percent ratio of operating expense to average assets. In
fiscal year 2003, the Bank's expense ratio was 2.94 percent, representing
increases from 2.75 percent in 2002, 2.96 percent in 2001, 2.68 percent in 2000
and 2.49 percent in 1999. For its five most recent calendar years ended December
31, 2003, Naugatuck Valley's operating expense ratio averaged 2.76 percent. It
should be noted that the Bank's operating expense ratio in 2003 was higher than
the averages of 2.38 percent for all FDIC-insured savings institutions and 2.29
percent for all publicly-traded savings institutions.
The operating expense to assets parameter for the selection of the
comparable group is from a low of 2.00 percent to a high of 4.00 percent with a
midpoint of 3.00 percent.
NONINTEREST INCOME TO ASSETS
Compared to publicly-traded thrifts, Naugatuck Valley has historically
experienced a lower but increasing average dependence on noninterest income as a
source of additional income. Naugatuck Valley's ratio of noninterest income to
average assets was 0.31 percent in 1999, 0.34 percent in 2000, 0.37 percent in
2001, 0.43 percent in 2002 and 0.46 percent in 2003, all of
NONINTEREST INCOME TO ASSETS (CONT.)
which are much lower than the 1.36 percent average for publicly-traded thrift
institutions for the most recent four quarters.
The range for this parameter for the selection of the comparable group is
1.25 percent of average assets or less, with a midpoint of 0.63 percent.
ASSET QUALITY PARAMETERS
INTRODUCTION
The final set of financial parameters used in the selection of the
comparable group are asset quality parameters, also shown in Exhibit 39. The
purpose of these parameters is to insure that any thrift institution in the
comparable group has an asset quality position similar to that of Naugatuck
Valley. The three defined asset quality parameters are the ratios of
nonperforming assets to total assets, repossessed assets to total assets and
loan loss reserves to total assets at the end of the most recent period.
NONPERFORMING ASSETS TO ASSETS
Naugatuck Valley's ratio of nonperforming assets to assets was 0.40
percent at March 31, 2004, which was much lower than the national average of
0.73 percent for publicly-traded thrifts but higher than the 0.10 percent for
New England thrifts. Consistently lower than national averages, the Bank's ratio
of nonperforming assets to total assets was 1.11 percent in 1999, 0.65 percent
in 2000, 0.72 percent in 2001, 0.58 percent in 2002 and 0.46 percent in 2003,
averaging 0.70 percent for its five most recent calendar years ended December
31, 2003.
REPOSSESSED ASSETS TO ASSETS
The parameter range for nonperforming assets to assets has been defined as
1.00 percent of assets or less with a midpoint of 0.50 percent.
Naugatuck Valley had $131,000 in repossessed assets, representing 0.05
percent of assets. National and regional averages were 0.13 percent and 0.01
percent, respectively, for publicly-traded thrift institutions at March 31,
2004.
The range for the repossessed assets to total assets parameter is 0.20
percent of assets or less with a midpoint of 0.10 percent.
LOANS LOSS RESERVES TO ASSETS
Naugatuck Valley had an allowance for loan losses of $1,811,000,
representing a loan loss allowance to total assets ratio of 0.75 percent at
March 31, 2004, which was slightly higher than its 0.74 percent ratio at
December 31, 2003. For the five calendar years of 1999 to 2003, the Bank's loan
loss reserve averaged 0.93 percent of assets with a downward trend from a high
of 1.14 percent in 1999 to a low of 0.74 percent in 2003.
The loan loss allowance to assets parameter range used for the selection
of the comparable group required a minimum ratio of 0.20 percent of assets.
THE COMPARABLE GROUP
With the application of the parameters previously identified and applied,
the final comparable group represents ten institutions identified in Exhibits
40, 41 and 42. The comparable group institutions range in size from $151.7
million to $917.6 million with an average asset size of $463.0 million and have
an average of 7.3 offices per institution. One of
THE COMPARABLE GROUP (CONT.)
the comparable group institutions was converted in 1993, one in 1995, two in
1996, two in 1998, three in 1999 and one in 2002. Eight of the ten of the
comparable group institutions are traded on NASDAQ, with two traded on the
American Stock Exchange. The comparable group institutions as a unit have a
ratio of equity to assets of 8.9 percent, which is 7.3 percent higher than all
publicly-traded thrift institutions in the United States but 5.4 percent lower
than publicly-traded thrift institutions in Connecticut; and for the most recent
four quarters indicated a core return on average assets of 0.80 percent, lower
than all publicly-traded thrifts at 1.07 percent and lower than publicly-traded
Connecticut thrifts at 0.82 percent.
IV. ANALYSIS OF FINANCIAL PERFORMANCE
This section reviews and compares the financial performance of Naugatuck
Valley to all publicly-traded thrifts, to publicly-traded thrifts in the New
England region and to Connecticut thrifts, as well as to the ten institutions
constituting Naugatuck Valley's comparable group, as selected and described in
the previous section. The comparative analysis focuses on financial condition,
earning performance and pertinent ratios as presented in Exhibits 43 through 48.
As presented in Exhibits 43 and 44, at March 31, 2004, Naugatuck Valley's
total equity of 8.94 percent of assets was lower than the 11.52 percent for the
comparable group, the 8.33 percent for all thrifts, the 11.33 percent for New
England thrifts and the 9.45 percent ratio for Connecticut thrifts. The Bank had
a 75.29 percent share of net loans in its asset mix, slightly higher than the
comparable group at 72.56 percent, all thrifts at 67.63 percent, New England
thrifts at 61.49 percent and Connecticut thrifts at 47.22 percent. Naugatuck
Valley's share of net loans, higher than industry averages, is primarily the
result of its slightly lower 12.36 percent share of cash and investments and
significantly lower than average 6.15 percent share of mortgage-backed
securities. The comparable group had a modestly lower 10.56 percent share of
cash and investments and a higher 11.48 percent share of mortgage-backed
securities. All thrifts had 12.54 percent of assets in mortgage-backed
securities and 15.38 percent in cash and investments. Naugatuck Valley's 77.42
percent share of deposits was higher than the comparable group, all thrifts and
New England thrifts but lower than Connecticut thrifts, reflecting the Bank's
lower than average 12.45 percent ratio of borrowed funds to assets. The
comparable group had deposits of 66.16 percent and borrowings of 20.92 percent.
All thrifts averaged a 56.66 percent share of deposits and 33.16 percent of
borrowed funds, while New England thrifts had a 69.14 percent share of deposits
and a 18.57 percent share of borrowed funds. Connecticut thrifts averaged an
80.44 percent share of deposits and an 8.93 percent share of borrowed funds.
Naugatuck Valley had 0.01 percent in intangible assets at March 31, 2004,
compared to 0.17 percent for the comparable group, 0.50 percent for all thrifts,
0.56 percent for New England thrifts and 0.61 percent for Connecticut thrifts.
ANALYSIS OF FINANCIAL PERFORMANCE (CONT.)
Operating performance indicators are summarized in Exhibits 45, 46 and 47
and provide a synopsis of key sources of income and key expense items for
Naugatuck Valley in comparison to the comparable group, all thrifts, and
regional thrifts for the trailing four quarters.
As shown in Exhibit 47, for the twelve months ended March 31, 2004,
Naugatuck Valley had a yield on average interest-earning assets slightly below
the comparable group but higher than all thrifts, New England thrifts and
Connecticut thrifts. The Bank's yield on interest-earning assets was 5.44
percent compared to the comparable group at 5.73 percent, all thrifts at 5.09
percent, New England thrifts at 5.07 percent and Connecticut thrifts at 4.90
percent.
The Bank's cost of funds for the twelve months ended March 31, 2004, was
lower than the comparable group, all thrifts and Connecticut thrifts, but higher
than Connecticut thrifts. Naugatuck Valley had an average cost of
interest-bearing liabilities of 1.87 percent compared to 2.73 percent for the
comparable group, 2.31 percent for all thrifts, 2.36 percent for New England
thrifts and 1.72 percent for Connecticut thrifts. The Bank's similar yield on
interest-earning assets and slightly lower interest cost resulted in a net
interest spread of 3.57 percent, which was higher than the comparable group at
3.00 percent, moderately higher than all thrifts at 2.91 percent, higher than
New England thrifts at 2.70 percent and Connecticut thrifts at 3.18 percent.
Naugatuck Valley generated a net interest margin of 3.69 percent for the twelve
months ended March 31, 2004, based on its ratio of net interest income to
average interest-earning assets, which was moderately higher than the comparable
group ratio of 3.32 percent. All thrifts averaged a lower 3.14 percent net
interest margin for the trailing four quarters, as did New England thrifts at
3.19 percent and Connecticut thrifts at a higher 3.48 percent.
Naugatuck Valley's major source of earnings is interest income, as
indicated by the operations ratios presented in Exhibit 46. The Bank made no
provision for loan losses during the twelve months ended March 31, 2004. The
comparable group indicated a provision representing 0.11 percent of assets, with
all thrifts at 0.10 percent, New England thrifts at 0.09 percent and Connecticut
thrifts at 0.01 percent.
ANALYSIS OF FINANCIAL PERFORMANCE (CONT.)
The Bank's noninterest income was $1.2 million or 0.50 percent of average
assets for the twelve months ended March 31, 2004, including only $27,000 in
gains on the sale of assets. Such a ratio of noninterest income to average
assets was lower than the comparable group, which had a ratio of 0.72 percent,
with all thrifts at 1.36 percent, New England thrifts at 0.56 percent and
Connecticut thrifts at 0.61 percent. For the twelve months ended March 31, 2004,
Naugatuck Valley's operating expense ratio was 2.99 percent of average assets,
which was higher than the comparable group at 2.49 percent and higher than all
thrifts at 2.29 percent, New England thrifts at 2.27 percent and Connecticut
thrifts at 2.43 percent.
The overall impact of Naugatuck Valley's income and expense ratios is
reflected in the Bank's net income and return on assets. For the twelve months
ended March 31, 2004, the Bank had net ROAA of 0.74 percent and core ROAA of
0.72 percent. For its most recent four quarters, the comparable group had a
higher net and core ROAA of 0.83 percent and 0.80 percent, respectively. All
publicly-traded thrifts averaged a higher net ROAA of 1.27 percent and a higher
1.07 percent core ROAA, with New England thrifts at a 0.79 percent core ROAA and
Connecticut thrifts at a 0.82 percent core ROAA.
V. MARKET VALUE ADJUSTMENTS
This is a conclusive section where adjustments are made to determine the
pro forma market value or appraised value of the Corporation based on a
comparison of Naugatuck Valley with the comparable group. These adjustments will
take into consideration such key items as earnings performance, primary market
area, financial condition, asset and deposit growth, dividend payments,
subscription interest, liquidity of the stock to be issued, management, and
market conditions or marketing of the issue. It must be noted that all of the
institutions in the comparable group have their differences among themselves and
relative to the Bank, and, as a result, such adjustments become necessary.
EARNINGS PERFORMANCE
In analyzing earnings performance, consideration was given to net interest
income, the amount and volatility of interest income and interest expense
relative to changes in market area conditions and to changes in overall interest
rates, the quality of assets as it relates to the presence of problem assets
which may result in adjustments to earnings, due to charge-offs, the balance of
current and historical classified assets and real estate owned, the balance of
valuation allowances to support any problem assets or nonperforming assets, the
amount and volatility of noninterest income, and the amount and ratio of
noninterest expenses.
As discussed earlier, the Bank has historically focused on increasing its
net interest income and net income; maintaining its low ratio of nonperforming
assets; monitoring and strengthening its ratio of interest sensitive assets
relative to interest sensitive liabilities, thereby maintaining its overall
interest rate risk; and maintaining adequate allowances for loan losses to
reduce the impact of any unforeseen charge-offs. The Bank has also closely
monitored its higher than average overhead expenses, which have increased in
recent years as a result of branching. During the past five years, Naugatuck
Valley's ratio of noninterest expense to average assets has indicated from 2.49
percent in 1999, which was generally in line with industry averages, to
EARNINGS PERFORMANCE (CONT.)
2.94 percent in 2003 and 2.99 percent for the twelve months ended March 31,
2004, which are significantly higher than the current industry average of 2.29
percent for all publicly-traded thrifts. Following reorganization, the Bank will
endeavor to maintain its higher net interest spread and net interest margin;
increase its non-interest income; strengthen its net income and its lower return
on assets; maintain its lower balances of non-performing and classified assets;
closely monitor its interest rate gap; and reduce its operating expenses.
Earnings are often related to an institution's ability to generate loans.
The Bank was an active originator of both mortgage and non-mortgage loans
in 2001, 2002 and 2003 and during the three months ended March 31, 2004.
Naugatuck Valley's highest volume of originations occurring in 2003, reflecting
the very low interest rate environment. In 2003, the predominant component of
the Bank's one- to four-family residential mortgage loan originations was the
refinancing of existing loans and consequently, its balance of such loans
decreased by 0.59 percent or $781,000. That shrinkage was offset by substantial
increases of 104.6 percent or $7.2 million for construction loans, 38.8 percent
or $4.0 million for commercial real estate loans and 12.6 percent or $2.4
million for consumer loans, predominantly home equity loans. The Bank's lending
activities in 2003 resulted in its overall loan growth of 9.0 percent in 2003,
following growth of 4.8 percent in 2002 and 8.4 percent in 2001. For the three
months ended March 31, 2004, total loan originations were considerably lower
than in the first quarter of 2003, and annualized were also much lower than
during 2003, with all real estate loans increasing $408,000 or $1.6 million
annualized, compared to $10.4 million in 2003. During the first quarter of 2004,
commercial business loans remained generally flat, compared to a $2.5 million
increase in 2003; and consumer loans increased by $1.3 million or $5.2 million
annualized, compared to $2.4 million in 2003.
Total loan originations were at $64.3 million and $101.0 million during
2002 and 2003, respectively, decreasing to $13.7 million or $54.8 million
annualized, during the three months ended March 31, 2004. For the three months
ended March 31, 2004, real estate loans,
EARNINGS PERFORMANCE (CONT.)
commercial business loans and consumer loans, predominantly home equity loans,
represented 66.4 percent, 7.1 percent, and 26.4 percent, respectively, of total
loan originations. In comparison, during 2003, real estate loans, commercial
business loans and consumer loans represented 82.7 percent, 3.2 percent and 14.2
percent, respectively, of total loan originations, indicating a significant
annualized decrease in real estate loans and increases in commercial business
loans and consumer loans in the first quarter of 2004.
Total mortgage and non-mortgage loan originations were $13.7 million for
the three months ended March 31, 2004, reduced by repayments and loan sales of
$12.0 million, resulting in a net increase of $1.7 million in gross loans
receivable to $186.7 million at March 31, 2004, compared to $185.0 million at
December 31, 2003. In 2003, total loan originations were $101.1 million, reduced
by repayments and loan sales of $85.7 million, resulting in a net increase of
$15.3 million in gross loans receivable to $185.1 million at December 31, 2003,
compared to $169.7 million at December 31, 2002.
The impact of Naugatuck Valley's primary lending efforts has been to
generate a yield on average interest-earning assets of 5.44 percent for the
twelve months ended March 31, 2004, compared to a higher 5.73 percent for the
comparable group, a lower 5.21 percent for all thrifts and a lower 5.07 percent
for New England thrifts. The Bank's ratio of interest income to average assets
was 5.25 percent for the twelve months ended March 31, 2004, lower than the
comparable group at 5.30 percent, but higher than all thrifts at 4.65 percent
and New England thrifts at 4.62 percent, reflecting the Bank's similar ratio of
nonperforming assets and higher ratio of interest-earning assets.
Naugatuck Valley's 1.87 percent cost of interest-bearing liabilities for
the twelve months ended March 31, 2004, was lower than the comparable group at
2.73 percent, all thrifts at 2.31 and New England thrifts at 2.36 percent, but
modestly higher than the two Connecticut thrifts at 1.72 percent. The Bank's
resulting net interest spread of 3.57 percent for the twelve months ended March
31, 2004, was higher than the comparable group at 3.00 percent, all thrifts at
2.91
EARNINGS PERFORMANCE (CONT.)
percent and New England thrifts at 2.70. The Bank's net interest margin of 3.69
percent, based on average interest-earning assets for the twelve months ended
March 31, 2004, was higher than the comparable group at 3.32 percent, all
thrifts at 3.14 percent and New England thrifts at 3.19 percent.
The Bank's ratio of noninterest income to assets was 0.50 percent,
including gains, for the twelve months ended March 31, 2004, lower than the
comparable group at 0.72 percent, and more notably lower than all thrifts at
1.36 percent and modestly lower than New England thrifts at 0.56 percent. A
small 2.3 percent of the Bank's noninterest income was comprised of gains on the
sale of loans and other assets.
The Bank's operating expenses were significantly higher than the
comparable group, all thrifts and New England thrifts. For the twelve months
ended March 31, 2004, Naugatuck Valley had an operating expenses to assets ratio
of 2.99 percent compared to 2.49 percent for the comparable group, 2.29 percent
for all thrifts and 2.27 percent for New England thrifts. Such higher operating
expenses relate in part to the Bank's lower $37.5 million average deposits per
branch, compared to the comparable group average of $40.9 million in deposits
per branch, as well as its less favorable 73.7 percent efficiency ratio for the
twelve months ended March 31, 2004, compared to the comparable group with an
efficiency ratio of 65.03 percent.
For the twelve months ended March 31, 2004, Naugatuck Valley generated a
lower ratio of noninterest income, a higher ratio of noninterest expenses and a
higher net interest margin relative to its comparable group. The Bank was absent
a provision for loan losses during the twelve months ended March 31, 2004,
compared to 0.11 percent ratio to assets for the comparable group, 0.10 percent
for all thrifts and 0.09 percent for New England thrifts. The Bank's absence of
a provision for loan losses during the twelve months ended March 31, 2004,
reflected a decreasing trend in both nonperforming assets and charge-offs in
recent periods, as well as a ratio of allowance for loan losses to total loans
higher than the comparable and similar
EARNINGS PERFORMANCE (CONT.)
to all thrifts. The Bank's ratio of reserves to nonperforming assets was
moderately lower than the comparable group and very similar to all thrifts.
As a result of its operating characteristics, the Bank's net income and
core income were lower than the comparable group for the twelve months ended
March 31, 2004. Based on net earnings, the Bank had a return on average assets
of 0.50 percent, 0.96 percent, 0.65 percent, 0.91 percent, 0.77 percent in 1999,
2000, 2001, 2002, and 2003, respectively, and 0.72 percent for the twelve months
ended March 31, 2004. For the trailing twelve months, the comparable group had a
higher net ROAA of 0.83 percent, while all thrifts indicated a still higher ROAA
of 1.27 percent. The Bank's core or normalized earnings, as shown in Exhibit 7,
were lower than its net earnings and resulted in a 0.72 percent core return on
assets for the twelve months ended March 31, 2004. That core ROAA was also lower
than the comparable group at 0.81 percent, all thrifts at 1.07 percent and New
England thrifts at 0.79 percent.
Following its reorganization, Naugatuck Valley's earnings will continue to
be dependent on a combination of the overall trends in interest rates, the
consistency, reliability and variation of its noninterest income and overhead
expenses, its asset quality, its future needs for provisions for loan losses and
the continuation of lower charge-offs and nonperforming assets. The Bank's
noninterest income increased significantly in 2002 and 2003 due to higher
originations, primarily refinances at lower interest rates, but it is likely
that a rising interest rate environment will flatten and, perhaps, reduce that
trend. Overhead expenses indicate a moderate annual increases from 1999 to 2003,
with such expenses in the first quarter of 2004 annualizing to a 9.8 percent
increase in 2004 compared to 2003 and remaining significantly higher than
industry averages. The Bank's net interest margin, higher than the comparable
group, has been the result of its lower yield on assets offset by its lower cost
of funds. The impact of this trend has been a generally stable net interest
margin with only mild fluctuation during the last five years and the three
months ended March 31, 2004.
EARNINGS PERFORMANCE (CONT.)
In recognition of the foregoing earnings related factors, considering
Naugatuck Valley's current performance measures, a downward adjustment has been
made to the Corporation's pro forma market value for earnings performance.
MARKET AREA
Naugatuck Valley's primary market area for both retail deposits and
lending consists of the Connecticut counties of Fairfield and New Haven. The
Bank's home office and three of its four branches are in New Haven County and
one branch is in Fairfield County.
As discussed in Section II, from 1990 to 2000, population increased in all
areas. The population increased by a modest 1.2 percent in Naugatuck and 2.5
percent in New Haven County, a moderate 6.6 percent in Fairfield County, 3.6
percent in Connecticut and 13.2 percent in the United States. From 2000 to 2008,
Naugatuck's population is projected to increase by 3.7 percent with the
populations of Fairfield and New Haven Counties, Connecticut and the United
States projected to increase by 4.3 percent, 2.5 percent, 3.6 percent and 9.9
percent, respectively.
Naugatuck experienced a smaller 4.4 percent increase in households from
1990 to 2000. During that period, households increased by 4.9 percent in New
Haven County, 6.2 percent in Fairfield County, 5.8 percent in Connecticut and
14.7 percent in the United States. From 2000 through 2008, Naugatuck's
households are projected to continue to increase by 5.4 percent, while the
increase is projected to be 5.5 percent in Fairfield County, 4.7 percent in New
Haven County, 5.7 percent in Connecticut and 11.0 percent in the United States.
That historical and projected population and household growth was generally
lower than Connecticut and the United States and moderately lower than the
comparable group markets.
In 2000, the median housing values in Naugatuck and New Haven County
indicated decreases of 6.0 percent and 7.6 percent, respectively, from 1990,
while Fairfield County
MARKET AREA (CONT.)
indicated an increase of 16.4 percent during that ten year period. With the
exception of segments of Fairfield County, the median housing values in
Naugatuck Valley's market area were lower than in Connecticut, but higher than
in the United States. The median housing values in the Bank's market area,
although higher in dollar value than the average of the comparable group markets
due to regional characteristics, indicate lower growth relative to the
comparable group markets.
The average 2000 unemployment rate in the Bank's primary market area was
1.9 percent in Fairfield County and 2.5 percent in New Haven County, with
Connecticut at 2.2 percent and the United States at 4.0 percent. By April, 2004,
the unemployment rate increased to 4.4 percent in Fairfield County and a higher
5.6 percent in New Haven County, while Connecticut's unemployment rate increased
to 5.2 percent and the rate in the United States increased to 5.4 percent. In
April, 2004, the average unemployment of the comparable group markets was
modestly lower than in either of the Bank's two market area counties
Naugatuck Valley's primary market area is both suburban to Waterbury and
exurban, also including smaller communities that are generally less affluent
than the averages for Fairfield and New Haven Counties. For perspective, it
should be noted that Fairfield County demographics include a number of very
affluent residential and resort communities, such as Greenwich and Westport,
which are geographically remote to the Bank's operations, which are concentrated
in the Waterbury and New Haven County areas. In the Bank's primary market area
counties, the services sector represented the primary source of employment in
2000 by a moderate margin, followed by the manufacturing and wholesale/retail
sectors, generally consistent with state and national proportions. By 2000,
however, the wholesale/retail sector and the manufacturing sector both
experienced significant declines as employment sources, with the services sector
growing to more than three times the employment of either the wholesale/retail
and the manufacturing sectors.
MARKET AREA (CONT.)
Based on both deposits and loan originations, the financial competition in
Naugatuck Valley's primary market area is significant, with competition from
both regional institutions and national bank holding companies such as Bank of
America, Wachovia and J.P. Morgan Chase. As of June 30, 2003, the Bank held a
modest 1.2 percent of deposits in New Haven County and 0.09 percent of deposits
in Fairfield County. Total bank and thrift deposits were $14.7 billion and $21.7
billion in New Haven County and Fairfield County, respectively, with banks and
thrifts holding similar shares of deposits.
In recognition of the foregoing factors, we believe that a downward
adjustment is warranted for the Bank's primary market area relative to the
comparable group.
FINANCIAL CONDITION
The financial condition of Naugatuck Valley is discussed in Section I and
shown in Exhibits 1, 2, 5, and 12 through 23, and is compared to the comparable
group in Exhibits 42, 43 and 44. The Bank's ratio of total equity to total
assets was 8.94 percent at March 31, 2004, which was lower than the comparable
group at 11.52 percent, all thrifts at 10.46 percent and New England thrifts at
11.33 percent. With the minority offering completed at the midpoint of the
valuation range, the Corporation's pro forma equity to assets ratio will
increase to approximately 15.14 percent, and the Bank's pro forma equity to
assets ratio will increase to approximately 11.50 percent.
The Bank's mix of assets and liabilities indicates both similarities to
and variations from its comparable group. Naugatuck Valley had a modestly higher
75.3 percent ratio of net loans to total assets at March 31, 2004, compared to
the comparable group at 72.6 percent. All thrifts indicated a lower 67.6
percent, as did New England thrifts at 61.5 percent. The Bank's 12.4 percent
share of cash and investments was higher than the comparable group at 10.6
percent, while all thrifts were at 15.4 percent and New England thrifts were at
a higher 26.2 percent.
FINANCIAL CONDITION (CONT.)
Naugatuck Valley's 6.2 percent ratio of mortgage-backed securities to total
assets was lower than the comparable group at 11.5 percent and similarly lower
than all thrifts at 12.5 percent. The Bank's 77.4 percent ratio of deposits to
total assets was higher than the comparable group at 66.2 percent, all thrifts
at 56.7 percent and New England thrifts at 69.1 percent. Naugatuck Valley's 12.5
percent ratio of borrowed funds to assets was lower than the comparable group at
20.9 percent, much lower than all thrifts at 33.2 percent and lower than New
England thrifts at 18.6 percent.
Naugatuck Valley had intangible assets of 0.01 percent of assets,
consisting of mortgage servicing rights, and had repossessed real estate of 0.05
percent of assets, compared to ratios of 0.17 percent and 0.04 percent of
intangible assets and real estate owned, respectively, for the comparable group.
All thrifts had intangible assets of 0.50 percent and real estate owned of 0.13
percent.
The financial condition of Naugatuck Valley is affected by its $980,000
million balance of nonperforming assets or 0.40 percent of assets at March 31,
2004, compared to a similar 0.38 percent for the comparable group, a higher 0.73
percent for all thrifts and a lower 0.10 percent for New England thrifts.
Historically, the Bank's ratio of nonperforming assets to total assets has been
similar to or somewhat higher than industry averages, but has decreased
considerably in both dollars and ratio since December 31, 1999. The Bank's ratio
of nonperforming assets to total assets was 1.11 percent, 0.65 percent, 0.72
percent, 0.58 percent and 0.46 percent at December 31, 1999, 2000, 2001, 2002,
and 2003, respectively, decreasing slightly to 0.40 percent at March 31, 2004.
The Bank had a lower 6.8 percent share of high risk real estate loans,
compared to 17.8 percent for the comparable group and 21.1 percent for all
thrifts. The regulatory definition of high risk real estate loans is all
mortgage loans other than those secured by one- to four-family residential
properties.
FINANCIAL CONDITION (CONT.)
At March 31, 2004, Naugatuck Valley had $1,811,000 of allowances for loan
losses, which represented 0.75 percent of assets and 0.97 percent of total
loans. The comparable group indicated allowances equal to 0.51 percent of assets
and a smaller 0.67 percent of total loans, while all thrifts had allowances that
averaged a lower 0.65 percent of assets, but a similar 0.98 percent of total
loans. Also significant, however, is an institution's ratio of allowances for
loan losses to nonperforming assets, since a portion of nonperforming assets
might eventually be charged off. Naugatuck Valley's $1,811,000 of allowances for
loan losses, represented 184.8 percent of nonperforming assets at March 31,
2004, compared to the comparable group's slightly higher 209.7 percent, with all
thrifts at a similar 183.2 percent and New England thrifts at a much higher
509.2 percent. Naugatuck Valley's ratio of net charge-offs to average total
loans was 0.11 percent for the twelve months ended March 31, 2004, compared to a
lower 0.05 percent for the comparable group, 0.22 percent for all thrifts and
0.06 percent for New England thrifts. This ratio reflects the Bank's maintenance
of a generally average ratio of reserves to loans, and a similar ratio of
reserves to nonperforming assets. In 2003, the Bank's net charge-offs of
$229,000 followed net charge-offs of $93,000 in 2002, net recoveries of $27,000
in 2001 and higher net charge-off of $258,000 and $451,000 in 2000 and 1999,
respectively. For the three months ended March 31, 2004, the Bank had a recovery
of $1,000 with no charge-offs. For the twelve months ended March 31, 2004,
Naugatuck Valley took no provision for loan losses, but had net charge-offs of
$195,000. Based on available information, the comparable group had a ratio of
provisions for loan losses to net charge-offs of 227.17 percent, with all
thrifts at 167.35 percent and New England thrifts at 151.21 percent.
Naugatuck Valley has a minimal level of interest rate risk, evidenced by
its modestly negative one year cumulative gap of 11.7 percent. The Bank's three
year gap was also a modestly negative 13.2 percent.
Compared to the comparable group, we believe that no adjustment is
warranted for Naugatuck Valley's current financial condition.
ASSET, LOAN AND DEPOSIT GROWTH
During its most recent five calendar years, Naugatuck Valley has been
characterized by lower average rates of growth in assets, loans and deposits
relative to its comparable group. The Bank's average annual asset growth rate
from 1999 to 2003, was 7.3 percent, compared to a higher 10.1 percent for the
comparable group, a significantly higher 14.9 percent for all thrifts, and a
modestly higher 10.6 percent for New England thrifts. The Bank's somewhat lower
asset growth rate is reflective primarily of its smaller increase in loans
during that five year period combined with mildly declining earnings trend. The
Bank's loan portfolio indicates an average annual increase of 6.7 percent from
1999 to 2003, compared to average growth rates of 14.1 percent for the
comparable group, 12.8 percent for all thrifts and 9.5 percent for New England
thrifts.
Naugatuck Valley's deposits indicate an average annual increase of 7.2
percent from 1999 to 2003. Annual deposit growth was from a low of 0.76 percent
in 1999 to a high of 14.8 percent in 2001, compared to average growth rates of
8.3 percent for the comparable group, 11.0 percent for all thrifts and 9.3
percent for New England thrifts. Notwithstanding its lower rate of deposit
growth, the Bank had a lower 17.7 percent five year average ratio of borrowed
funds to assets, compared to the comparable group at 25.2 percent. The Bank's
combined lower deposit growth and borrowed funds ratio reflects and confirms its
smaller loan growth and funding needs
Considering the demographics and competition in its market area, the
Bank's ability to increase its asset, loan and deposit bases in the future is,
to a great extent, dependent on its being able to competitively price its loan
and savings products, to maintain a high quality of service to its customers, to
increase its market share and to strengthen its loan origination activity.
Naugatuck Valley's primary market area has experienced a relatively modest
increase in population and households between 1990 and 2000 and those increases
are projected to continue at rates similar to or lower than state and national
rates through 2008. The Bank's primary market area indicates 2000 per capita
income and median household income lower than Connecticut but higher than the
United States for Naugatuck and New Haven County. In 2000, housing values in
Naugatuck and New Haven County were also lower than Connecticut but
ASSET, LOAN AND DEPOSIT GROWTH (CONT.)
higher than the United States. As previously noted, the Bank's operations are
concentrated in New Haven County, the location of Naugatuck and four of the
Bank's five offices.
Notwithstanding the proceeds of the contemplated minority offering, the
Bank's primary dependence on its operations in New Haven County could result in
the continuation of lower asset growth in the future as a result of its
competitive operating environment in a market area with modest growth in
population and households, projected to remain lower than state and national
levels and growth in the future. Naugatuck Valley's competitive operating
environment is likely to result in the continuation of lower loan and deposit
growth and systemic asset growth for the Bank relative to the comparable group.
Based on the foregoing factors, we have concluded that a downward
adjustment to the Association's pro forma value is warranted.
DIVIDEND PAYMENTS
The Corporation has not committed to pay an initial cash dividend on its
common stock. The future payment of cash dividends will depend upon such factors
as earnings performance, financial condition, capital position, growth, asset
quality and regulatory limitations. Each of the ten institutions in the
comparable group paid cash dividends during the twelve months ended March 31,
2003, for an average dividend yield of 2.31 percent and an average payout ratio
of 38.94 percent. During that twelve month period, the average dividend yield
was 1.20 percent and the average payout ratio was 34.64 percent for the two
Connecticut thrifts; and the average dividend was 1.94 percent and the average
payout ratio was 40.13 percent for all thrifts.
In our opinion, a downward adjustment to the pro forma market value of
the Corporation is warranted related to dividend payments.
SUBSCRIPTION INTEREST
In 2003 and to date in 2004, investors' interest in new issues has been
generally positive and subscription levels have been consistently high, although
a few issues have received a less than strong reaction from the marketplace.
Overall, although the reaction of IPO investors appears generally to be related
to a number of analytical factors, including the financial performance and
condition of the converting thrift institution, the strength of the local
economy, general market conditions, aftermarket price trends and the
anticipation of continuing merger/acquisition activity in the thrift industry,
the smaller number of offerings appears to have concentrated greater
subscription activity beyond the stronger institutions.
Naugatuck Valley will direct its offering primarily to depositors and
residents in its market area. The board of directors and officers anticipate
purchasing approximately $1.0 million or 4.7 percent of the stock offered to the
public based on the appraised midpoint valuation. At all ranges of the offering,
2.0 percent of the shares issued to the public and to Naugatuck Valley Mutual
will be contributed to Naugatuck Valley Charitable Foundation. The Bank will
form an ESOP, which plans to purchase 8.4 percent of the total shares issued in
the current offering, including the shares issued to Naugatuck Valley Mutual and
the charitable foundation. Additionally, the Prospectus restricts to 15,000
shares, based on the $10.00 per share purchase price, the total number of shares
in the conversion that may be purchased by a single person, and to 20,000 shares
by persons and associates acting in concert.
The Bank has secured the services of Ryan Beck & Co. "Ryan Beck" to
assist in the marketing and sale of the conversion stock.
Based on the size of the offering, recent market movement and current
market conditions, local market interest, the terms of the offering and recent
subscription levels for initial mutual holding company offerings, we believe
that an upward adjustment is warranted for the Bank's anticipated subscription
interest.
LIQUIDITY OF THE STOCK
The Corporation will offer its shares through a subscription offering and,
if required, a subsequent community offering with the assistance of Ryan Beck.
The stock of the Corporation will trade on the NASDAQ National Market and the
Corporation will pursue at least two market makers for its stock.
The Bank's total public offering is considerably smaller in size to the
average market value of the comparable group. The comparable group has an
average market value of $62.6 million for the stock outstanding compared to a
midpoint public offering of $21.5 million for the Corporation, less the ESOP and
the estimated 100,000 shares to be purchased by officers and directors, which
will reduce the Corporation's public market capitalization to approximately
$18.7 million. Of the ten institutions in the comparable group, eight trade on
NASDAQ and two trade on the American Stock Exchange, with those ten institutions
indicating an average daily trading volume of 2,851 shares during the last four
quarters.
In further examining and analyzing the market for publicly-traded thrift
stocks, we compared various characteristics of the 38 mutual holding companies
with the 233 stock companies. Our findings indicate that both entity types have
generally similar average market capitalization, with mutual holding companies
at $415 million and stock companies at $515 million; and that both entity types
have a generally similar average number of shares outstanding, with mutual
holding companies averaging 15.0 million shares and stock companies averaging
17.1 million shares. We find it significant, however, notwithstanding the
foregoing similarities, that the average daily trading volume of mutual holding
companies was 20,796 during the past twelve months, while stock companies
indicated a much higher average daily volume of 76,757 shares.
Based on the average market capitalization, shares outstanding and daily
trading volume of the comparable group, as well as the relative trading volume
of publicly-traded mutual holding companies, we have concluded that a downward
adjustment to the Corporation's pro forma market value is warranted relative to
the anticipated liquidity of its stock.
MANAGEMENT
The president and chief executive officer of Naugatuck Valley is John C.
Roman, who is also a director. Mr. Roman joined the Bank as vice president and
chief lending officer and was appointed president and chief executive officer
and was elected to the board in 1999. Prior to joining Naugatuck Valley, Mr.
Roman was vice president of MidConn Bank, Kensington, Connecticut, from 1994 to
1998 and served as assistant vice president of Eagle Bank, Bristol, Connecticut,
the successor to MidConn Bank as the result of a merger. Dominic J. Alegi, Jr.
is executive vice president in charge of retail banking and has been with the
Bank since 1970. Mr. Alegi is also executive vice president of Naugatuck Valley
Financial and Naugatuck Valley Mutual Holding Company. Mr. Alegi became
executive vice president in 1989, previously serving the Bank as senior vice
president. Jane H. Walsh is senior vice president and a director, currently
responsible for operations, and has been with the Bank since 1974.
During the past five years and in the first quarter of 2004, Naugatuck
Valley has been able to increase its deposit base, total assets and total
equity, maintain a stable net interest margin, control nonperforming assets,
classified loans and charge-offs, maintain an acceptable gap position, and
maintain its market share in spite of increasing competition. Although the
Bank's earnings and return on assets have been below comparable group and
industry averages, and its operating expenses have been higher than such
averages, management is confident that its branch network is well positioned for
reasonable growth and enhanced profitability following its public offering.
Overall, we believe the Bank to be professionally and knowledgeably
managed, as are the comparable group institutions. It is our opinion that no
adjustment to the pro forma market value of the Corporation is warranted for
management.
MARKETING OF THE ISSUE
The necessity to build a new issue discount into the stock price of a
converting thrift institution continues to be a closely examined issue in
recognition of uncertainty among investors as a result of the thrift industry's
dependence on interest rate trends, recent volatility in the stock market and
pending federal legislation related to the regulation of financial institutions.
Increased merger/acquisition activity, as well as the presence of new
competitors in the financial institution industry, such as de novo institutions,
investment firms, insurance companies and mortgage companies, have resulted in
increased pressure on an individual institution's ability to attract retail
deposits at normal rates rather than premium rates and to deploy new funds in a
timely and profitable manner.
Although we believe that a new issue discount applied to the price to book
valuation approach is appropriate and necessary in some public offerings, in our
opinion, various characteristics of the Corporation's reorganization
transaction, as well as recent market trends, cause us to conclude that such a
discount is not warranted in the case of this particular offering. Consequently,
at this time we have made no adjustment to the Corporation's pro forma market
value related to a new issue discount.
VI. VALUATION METHODS
Historically, the most frequently used method for determining the pro
forma market value of common stock for thrift institutions by this firm has been
the price to book value ratio method, due to the volatility of earnings in the
thrift industry in the early to mid-1990s. As earnings in the thrift industry
stabilized and improved in the late 1990s, more emphasis was placed on the price
to earnings method, particularly considering increases in stock prices during
those years. During the past few years, however, as decreasing interest rates
have had varying effects on individual institutions, depending on the nature of
their operations, the price to book value method has again become pertinent and
meaningful in the objective of discerning commonality and comparability among
institutions. In determining the pro forma market value of the Corporation,
primary emphasis has been placed on the price to book value method, with
additional analytical and correlative attention to the price to earnings and
price to core earnings methods.
In recognition of the volatility and variance in earnings due to
fluctuations in interest rates, the continued differences in asset and liability
repricing and the frequent disparity in value between the price to book approach
and the price to earnings approach, a third valuation method, the price to net
assets method, has also been used. The price to assets method is used less often
for valuing ongoing institutions, but becomes more useful in valuing converting
institutions when the equity position and earnings performance of the
institutions under consideration are different.
In addition to the pro forma market value, we have defined a valuation
range with the minimum of the range being 85.0 percent of the pro forma market
value, the maximum of the range being 115.0 percent of the pro forma market
value, and a super maximum being 115.0 percent of the maximum. The pro forma
market value or appraised value will also be referred to as the "midpoint
value". Inasmuch as the ownership of Naugatuck Valley will remain in the mutual
holding company form, the public offering of the Corporation will be based on
the sale of shares to the public aggregating 43 percent of the fully converted
pro forma market value of the Corporation at each of the valuation ranges
defined in this Report with 2 percent
VALUATION METHODS (CONT.)
of the fully converted valuation being issued to the Foundation for a combined
total of 45.0 percent issued to the public and to the Foundation.
It should be noted that the fewer number of shares offered to the public
and the lower proceeds resulting from that offering will result in actual
pricing ratios considerably higher than those determined in the fully converted
valuation of the Corporation where higher proceeds are assumed; and it should be
noted that such higher pricing ratios, presented in detail in the offering
prospectus, are pertinent to the prospective minority shareholders and their
evaluation of the offering.
In applying each of the valuation methods, consideration was given to the
adjustments to the Bank's pro forma market value discussed in Section V.
Downward adjustments were made for the Bank's earnings performance, market area,
asset, loan and deposit growth, dividends, and liquidity of the stock. An upward
adjustment was made for subscription interest. No adjustments were made for the
Bank's financial condition, management and marketing of the issue.
PRICE TO BOOK VALUE METHOD
In the valuation of thrift institutions, the price to book value method
focuses on an institution's financial condition, and does not give as much
consideration to the institution's long term performance and value as measured
by earnings. Due to the earnings volatility of many thrift stocks, the price to
book value method is frequently used by investors who rely on an institution's
financial condition rather than earnings performance. Although this method is,
under certain circumstances, considered somewhat less meaningful for
institutions that provide a consistent earnings trend, it remains significant
and reliable when an institution's performance or general economic conditions
are experiencing volatile or uncustomary trends related to
PRICE TO BOOK VALUE METHOD (CONT.)
internal or external factors, and serves as a complementary and correlative
analysis to the price to earnings and price to assets approaches.
It should be noted that the prescribed formulary computation of value
using the pro forma price to book value method returns a price to book value
ratio below market value on a fully converting institution. As noted previously,
however, in the case of an initial mutual holding company minority offering
where a majority of the shares will not be held by the public, the application
of the prescribed formulary computation to the sale of all the shares based on
the full valuation of the institution necessarily returns a higher book value
per share and a lower price to book value ratio than is reflective of the actual
number of shares to be owned by the public and the proceeds generated by such a
smaller offering. In most instances, nevertheless, such a value remains below
current comparable market values.
Exhibit 50 shows the average and median price to book value ratios for the
comparable group which were 120.40 percent and 117.5 percent, respectively. The
full comparable group indicated a moderately wide range, from a low of 92.58
percent (Lincoln Bancorp) to a high of 140.87 percent (Wayne Savings
Bancshares). The comparable group had slightly higher average and median price
to tangible book value ratios of 121.89 percent and 119.36 percent,
respectively, with the range of 95.15 percent to a higher 140.87 percent.
Excluding the low and the high in the group, the comparable group's price to
book value range narrowed from a low of 108.69 percent to a high of 139.69
percent; and the comparable group's price to tangible book value range also
narrowed from a low of 109.77 percent to a high of 140.00.
Considering the foregoing factors in conjunction with the adjustments made
in Section V, we have determined a fully converted pro forma price to book value
ratio of 74.91 percent and a price to tangible book value ratio of 75.24 percent
at the midpoint. The price to book value ratio increases from 70.93 percent at
the minimum to 81.08 percent at the super maximum, while the price to tangible
book value ratio increases from 71.32 percent at the minimum to 81.41
PRICE TO BOOK VALUE METHOD (CONT.)
percent at the super maximum. The price to book value ratio is 74.97 percent
without recognition of the 2.0 percent foundation and is a higher $51.7 million
value at the midpoint.
The Corporation's pro forma price to book value and price to tangible book
value ratios of 74.91 percent and 75.24 percent, respectively, as calculated
using the prescribed formulary computation indicated in Exhibit 49, are
influenced by the Bank's equity level and local market, as well as subscription
interest in thrift stocks and overall market and economic conditions. Further,
the Corporation's ratio of equity to assets after conversion at the midpoint of
the valuation range will be approximately 12.67 percent compared to 11.52
percent for the comparable group. Based on the price to book value ratio and the
Bank's total equity of $21,656,000 at March 31, 2004, the indicated fully
converted pro forma market value of the Corporation using this approach is
$50,116,051 at the midpoint (reference Exhibit 49).
PRICE TO EARNINGS METHOD
The foundation of the price to earnings method is the determination of the
earnings base to be used, followed by the determination of an appropriate price
to earnings multiple. As indicated in Exhibit 3, Naugatuck Valley's after tax
net earnings for the twelve months ended March 31, 2004, were $1,755,000, and
the Bank's core earnings for that period were a lesser $1,697,000, based on the
adjustments shown in Exhibit 7. To determine the pro forma market value of the
Corporation by using the price to earnings method, we applied the core earnings
base of $1,697,000.
In determining the price to core earnings multiple, we reviewed the range
of price to core earnings and price to net earnings multiples for the comparable
group and all publicly-traded thrifts. The average price to core earnings
multiple for the comparable group was 17.78, while the median was 14.94. The
average price to net earnings multiple was a similar 15.11 and the median
multiple was 16.97. The comparable group's price to core earnings multiple was
lower
PRICE TO EARNINGS METHOD (CONT.)
than the 23.31 average multiple for all publicly-traded, FDIC-insured thrifts
and higher than their median of 17.09. The range in the price to core earnings
multiple for the comparable group was from a low of 11.68 (LSB Financial Corp.)
to a high of 23.02 (First Bancorp of Indiana). The range in the price to core
earnings multiple for the comparable group, excluding the high and low ranges,
was from a low multiple of 14.25 to a high of 22.21 times earnings for eight of
the ten institutions in the group, indicating a modest narrowing of the range.
Consideration was given to the adjustments to the Corporation's pro forma
market value discussed in Section V. In recognition of those adjustments, we
have determined a fully converted price to core earnings multiple of 28.16 at
the midpoint, based on Naugatuck Valley's core earnings of $1,697,000 for twelve
months ended March 31, 2004.
Based on the Bank's core earnings base of $1,697,000 (reference Exhibit
49), the fully converted pro forma market value of the Corporation using the
price to earnings method is $49,901,388 at the midpoint.
PRICE TO ASSETS METHOD
The final valuation method is the price to assets method. This method is
not frequently used, since the calculation incorporates neither an institution's
equity position nor its earnings base. Additionally, the prescribed formulary
computation of value using the pro forma price to net assets method does not
recognize the runoff of deposits concurrently allocated to the purchase of
conversion stock, returning a pro forma price to net assets ratio below its true
level following conversion. Further, once again as previously noted, the
prescribed formulary computation of fully converted pro forma value does not
recognize the lower pro forma asset base resulting from small offering proceeds.
PRICE TO ASSETS METHOD (CONT.)
Exhibit 50 indicates that the average price to assets ratio for the
comparable group was 13.65 percent and the median was 13.16 percent. The range
in the price to assets ratios for the comparable group varied from a low of 9.75
percent (LSB Financial Corp.) to a high of 18.10 percent (Atlantic Liberty
Financial). The range narrows modestly with the elimination of the two extremes
in the group to a low of 10.89 percent and a high of 16.80 percent.
Consistent with the previously noted adjustments, it is our opinion that
an appropriate price to assets ratio for the Corporation is 17.43 percent at the
midpoint, which ranges from a low of 16.55 percent at the minimum to 24.93
percent at the super maximum.
Based on the Bank's March 31, 2004, asset base of $242,148,000, the
indicated pro forma market value of the Corporation using the price to assets
method is $50,025,458 at the midpoint (reference Exhibit 49).
VALUATION CONCLUSION
Exhibit 55 provides a summary of the valuation premium or discount for
each of the valuation ranges when compared to the comparable group based on each
of the fully converted valuation approaches. At the midpoint value, the fully
converted price to book value ratio of 74.91 percent for the Corporation
represents a discount of 37.78 percent relative to the comparable group and
decreases to 32.66 percent at the super maximum. As presented Exhibits 51
through 54 of this Report and as further detailed in the offering prospectus,
however, recognizing the lower actual proceeds to be realized by the offering to
the public of only 43 percent of the pro forma fully converted shares, the
Corporation's pro forma book value and pro forma book value per share will be
significantly lower and its corresponding price to book value ratio will be
higher at the offering price of $10.00 per share. Specifically, the sale to the
public of 43 percent of the shares, with 2 percent issued to the Foundation and
the remaining 55 percent of the shares retained by the Corporation, results in a
price to book value ratio of 116.14 percent,
VALUATION CONCLUSION (CONT.)
127.23 percent, 136.80 percent and 146.20 percent at the minimum, midpoint,
maximum and adjusted maximum of the actual offering range, respectively. Those
ratios represent a discount at the minimum and premiums at the midpoint, the
maximum and adjusted maximum relative to the average of the comparable group of
3.54 percent, for the discount, and 5.67 percent, 13.62 percent and 21.43
percent for the premiums at the minimum, midpoint, maximum and adjusted maximum
of the actual offering range, respectively.
The price to core earnings multiple of 28.16 for the Corporation at the
midpoint value indicates a premium of 58.43 percent, increasing to a premium of
106.39 percent at the super maximum. The price to assets ratio at the midpoint
of 17.43 percent represents a premium of 27.74 percent, increasing to a premium
of 82.69 percent at the super maximum.
It is our opinion that as of May 21, 2004, the fully converted pro forma
market value of the Corporation, is $50,000,000 at the midpoint, representing
5,000,000 shares at $10.00 per share. The fully converted pro forma valuation
range of the Corporation is from a minimum of $42,500,000 or 4,250,000 shares at
$10.00 per share to a maximum of $57,500,000 or 5,750,000 shares at $10.00 per
share, with such range being defined as 15 percent below the appraised value to
15 percent above the appraised value. The maximum, as adjusted, defined as 15
percent above the maximum of the range, is $66,125,000 or 6,612,500 shares at
$10.00 per share (reference Exhibits 51 to 54).
The fully converted pro forma appraised value of Naugatuck Valley
Financial Corporation as of May 21, 2004, is $50,000.000 at the midpoint.
[IN ACCORDANCE WITH RULE 202 OF REGULATION S-T, THE EXHIBITS TO THIS CONVERSION
VALUATION APPRAISAL REPORT ARE BEING FILED IN PAPER PURSUANT TO A CONTINUING
HARDSHIP EXEMPTION.]