Independent Auditors' Report
To the Board of Directors and Stockholders of Somerset Savings Bank:
We have audited the consolidated balance sheets of Somerset Savings Bank and
subsidiaries as of December 31, 1996 and 1995, and the related consolidated
statements of operations, changes in stockholders' equity and cash flows for
each of the years in the three-year period ended December 31, 1996. These
consolidated financial statements are the responsibility of the Bank's
management. Our responsibility is to express an opinion on these consolidated
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above
present fairly, in all material respects, the financial position of Somerset
Savings Bank and subsidiaries as of December 31, 1996 and 1995, and the results
of their operations and their cash flows for each of the years in the three-year
period ended December 31, 1996 in conformity with generally accepted accounting
principles.
As discussed in Note 2 to the consolidated financial statements, the Bank is
operating under a cease and desist order (the "Order") as issued by the Federal
Deposit Insurance Corporation ("FDIC") in March 1991 and as modified in November
1993. The Order required, among other things, the Bank to increase its Tier 1
leverage capital ratio to at least 6.0% by June 30, 1995. At December 31, 1996,
the Bank was not in compliance with the Order's capital requirement. The Bank
submitted a revised capital/profit plan (the "1996 Capital Plan") to the FDIC
and to the Massachusetts Division of Banks, which contemplates that the Bank
will increase its Tier 1 leverage capital ratio solely through the accumulation
of retained earnings, and that the Bank will achieve a Tier 1 leverage capital
ratio of 6.0% during the second quarter of 1997. The 1996 Capital Plan was
approved by the FDIC and projects the continued resolution of nonperforming
assets and sustained profitability.
/s/ Wolf & Company, P.C.
Boston, Massachusetts
February 4, 1997
56
Consolidated Balance Sheets
- --------------------------------------------------------------------------------
December 31,
- --------------------------------------------------------------------------------
1996 1995
- --------------------------------------------------------------------------------
(In Thousands)
ASSETS
Cash and due from banks (note 3) ................... $ 6,942 $ 6,304
Federal Home Loan Bank overnight deposits .......... 1,000 6,000
Interest-bearing deposits in other banks ........... 277 277
- --------------------------------------------------------------------------------
Total cash and cash equivalents .................. 8,219 12,581
- --------------------------------------------------------------------------------
Investment securities -- fair value
$87,633,000 and $61,845,000 (notes 4 and 9) ...... 88,065 61,530
Loans, net of unearned income ...................... 394,956 403,880
Allowance for loan losses .......................... (6,236) (7,136)
- --------------------------------------------------------------------------------
Loans, net (notes 5, 9 and 15) ................... 388,720 396,744
- --------------------------------------------------------------------------------
Other real estate owned, net (note 6) .............. 8,910 11,496
Land, buildings and equipment, net (note 7) ........ 12,575 12,621
Accrued interest receivable ........................ 3,048 3,014
Federal Home Loan Bank of Boston stock, at cost .... 4,422 4,422
Deferred income taxes (note 10) .................... 1,450 1,000
Other assets ....................................... 1,933 3,028
- --------------------------------------------------------------------------------
$ 517,342 $ 506,436
================================================================================
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits (note 8) .................................. $ 442,535 $ 434,007
Borrowed funds (note 9) ............................ 40,447 40,447
Other liabilities (note 12) ........................ 4,512 4,947
- --------------------------------------------------------------------------------
Total liabilities ................................ 487,494 479,401
- --------------------------------------------------------------------------------
Commitments and contingencies (notes 2 and 11)
Stockholders' equity (notes 2 and 13):
Serial preferred stock, $1.00 par value;
5,000,000 shares authorized, none issued
and outstanding .............................. -- --
Common stock, $1.00 par value; 20,000,000
shares authorized, 16,651,602 shares
issued and outstanding ....................... 16,652 16,652
Additional paid-in capital ...................... 18,597 18,597
Retained deficit ................................ (5,401) (8,214)
- --------------------------------------------------------------------------------
Total stockholders' equity .................... 29,848 27,035
- --------------------------------------------------------------------------------
$ 517,342 $ 506,436
================================================================================
See accompanying notes to consolidated financial statements.
57
Consolidated Statements of Operations
- ----------------------------------------------------------------------------------------------------
Years Ended December 31,
- ----------------------------------------------------------------------------------------------------
1996 1995 1994
- ----------------------------------------------------------------------------------------------------
(In Thousands, Except Per Share Data)
Interest and dividend income:
Loans ............................................ $ 35,521 $ 36,350 $ 34,326
Mortgage-backed securities ....................... 4,617 3,498 2,762
Other debt securities ............................ 91 -- 25
Equity securities ................................ 326 346 322
Short-term investments ........................... 303 242 61
- ----------------------------------------------------------------------------------------------------
Total interest and dividend income ............. 40,858 40,436 37,496
- ----------------------------------------------------------------------------------------------------
Interest expense:
Deposits ......................................... 20,202 18,932 16,325
Borrowed funds ................................... 2,126 3,841 2,818
- ----------------------------------------------------------------------------------------------------
Total interest expense ......................... 22,328 22,773 19,143
- ----------------------------------------------------------------------------------------------------
Net interest income ................................ 18,530 17,663 18,353
Provision for loan losses (note 5) ................. 1,200 1,200 1,800
- ----------------------------------------------------------------------------------------------------
Net interest income
after provision for loan losses .............. 17,330 16,463 16,553
- ----------------------------------------------------------------------------------------------------
Other income:
Net gain (loss) on sales of loans ................ 43 54 (32)
Service charges on deposit accounts .............. 587 587 609
Miscellaneous .................................... 427 415 378
- ----------------------------------------------------------------------------------------------------
Total other income ............................. 1,057 1,056 955
- ----------------------------------------------------------------------------------------------------
Operating expenses:
Salaries and employee benefits (notes 12 and 14).. 6,869 6,476 6,085
Occupancy and equipment (notes 7 and 11) ......... 1,536 1,535 1,613
Data processing .................................. 521 447 357
Legal and professional fees ...................... 810 662 814
FDIC insurance assessments ....................... 1,040 1,189 1,296
Costs associated with problem assets ............... 1,873 2,384 4,114
Net loss on other real estate owned (note 6) ....... 855 2,257 9,270
Other general and administrative ................... 2,510 2,491 2,295
- ----------------------------------------------------------------------------------------------------
Total operating expenses ........................... 16,014 17,441 25,844
- ----------------------------------------------------------------------------------------------------
Income (loss) before income taxes .................. 2,373 78 (8,336)
Income tax provision (benefit) (note 10) ........... (440) (1,000) 7
- ----------------------------------------------------------------------------------------------------
Net income (loss) ................................. $2,813 $ 1,078 $ (8,343)
====================================================================================================
Net income (loss) per share ........................ $0.17 $ 0.06 $ (0.50)
- ----------------------------------------------------------------------------------------------------
- ----------------------------------------------------------------------------------------------------
Weighted average shares outstanding ................ 16,652 16,652 16,652
====================================================================================================
See accompanying notes to consolidated financial statements.
58
Consolidated Statements of Changes in
Stockholders' Equity
- ----------------------------------------------------------------------------------------------------------------------
Years Ended December 31, 1996, 1995 and 1994
- ----------------------------------------------------------------------------------------------------------------------
Additional Unearned Total
Common Paid-in Retained Compensation Stockholders
Stock Capital Deficit -ESOP Equity
- ----------------------------------------------------------------------------------------------------------------------
(in Thousands)
Balance at December 31, 1993 .............. $16,652 $ 20,842 $ (949) $(3,294) $ 33,251
Net loss .................................. -- -- (8,343) -- (8,343)
Amortization of ESOP obligation ........... -- -- -- 516 516
- ----------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1994 .............. 16,652 20,842 (9,292) (2,778) 25,424
Net income ................................ -- -- 1,078 -- 1,078
Amortization of ESOP obligation -- -- -- 451 451
Termination of ESOP (note 14) ............. -- (2,245) -- 2,327 82
- ----------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1995 .............. 16,652 18,597 (8,214) -- 27,035
Net income ................................ -- -- 2,813 -- 2,813
- ----------------------------------------------------------------------------------------------------------------------
Balance at December 31, 1996 .............. $16,652 $ 18,597 $(5,401) $ -- $ 29,848
======================================================================================================================
See accompanying notes to consolidated financial statements.
59
Consolidated Statements of Cash Flows
- ------------------------------------------------------------------------------------------------------------------------------------
Years Ended December 31,
- ------------------------------------------------------------------------------------------------------------------------------------
1996 1995 1994
- ------------------------------------------------------------------------------------------------------------------------------------
(In Thousands)
Cash flows from operating activities:
Net income (loss) ................................................................. $ 2,813 $ 1,078 $ (8,343)
Adjustments to reconcile net income (loss) to net cash
provided by operating activities:
Provision for loan losses ....................................................... 1,200 1,200 1,800
Net amortization (accretion) of premiums and
discounts on investment securities .......................................... 8 (97) 6
Amortization of net deferred loan fees and unearned income ...................... (1,150) (1,274) (965)
Amortization of ESOP obligation ................................................. -- 451 516
Depreciation and amortization expense ........................................... 625 600 654
Loans originated for sale ....................................................... (8,626) (7,059) --
Principal balance of loans sold ................................................. 8,626 7,059 --
Net (gain) loss on sales of portfolio loans ..................................... -- -- 32
Gain on sale of building ........................................................ -- (83) --
Net loss on other real estate owned ............................................. 855 2,257 9,270
Increase in accrued interest receivable ......................................... (34) (245) (47)
Deferred income tax benefit ..................................................... (450) (1,000) --
(Increase) decrease in other assets ............................................. 1,095 (1,012) 2,320
Increase (decrease) in other liabilities ........................................ (435) 616 266
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities ................................... 4,527 2,491 5,509
- ------------------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Proceeds from maturities and call of investment securities ......................... 1,469 -- 1,000
Purchase of investment securities .................................................. (34,650) (5,797) (28,973)
Principal payments received on mortgage-backed securities .......................... 6,638 2,812 6,876
Purchase of Federal Home Loan Bank of Boston stock ................................. -- (572) (367)
Purchase of loans .................................................................. -- -- (10,790)
Proceeds from sales of loans ....................................................... -- -- 6,671
Net (increase) decrease in loans ................................................... 4,896 (502) (1,750)
Proceeds from sales and principal reductions of other real estate owned ............ 4,852 20,596 17,511
Improvements to other real estate owned ........................................... (43) (5,995) (2,318)
Purchase of equipment .............................................................. (579) (211) (159)
Proceeds from sale of building ..................................................... -- 96 --
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities ......................... (17,417) 10,427 (12,299)
- ------------------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net increase (decrease) in deposits ............................................... 8,528 19,512 (15,071)
Proceeds from issuance of borrowings
with maturities in excess of three months ...................................... 10,000 86,000 33,447
Repayment of borrowings with
maturities in excess of three months ........................................... (10,000) (116,000) (10,000)
- ------------------------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) financing activities ......................... 8,528 (10,488) 8,376
- ------------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents ................................. (4,362) 2,430 1,586
Cash and cash equivalents at beginning of year ....................................... 12,581 10,151 8,565
- ------------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year ............................................. $ 8,219 $ 12,581 $ 10,151
====================================================================================================================================
Supplementary Cash Flow Information:
Interest paid on deposits ............................................................ $ 20,276 $ 19,187 $ 16,477
Interest paid on borrowed funds ...................................................... 2,142 3,978 2,619
Property acquired in settlement of loans ............................................. 3,078 7,492 5,440
See accompanying notes to consolidated financial statements.
60
Notes to Consolidated Financial Statements
1. Summary of Significant Accounting Policies
Basis of presentation and consolidation
The consolidated financial statements include the accounts of Somerset
Savings Bank (the "Bank") and its wholly-owned subsidiaries, Somco Investment,
Inc., Somrock Corp., SSB Leeway Corp., Jerad Place II Development Corp. and
Chestco Corp.
On March 31, 1994, Somrock Corp. was dissolved. On June 2, 1995, SSB Leeway
Corp., Jerad Place II Development Corp. and Chestco Corp. were dissolved. The
dissolutions had no significant effect on the consolidated financial statements
of the Bank. All intercompany accounts and transactions have been eliminated in
consolidation.
Use of estimates
In preparing consolidated financial statements in conformity with generally
accepted accounting principles, management is required to make estimates and
assumptions that affect the reported amounts of assets and liabilities as of the
consolidated balance sheet date and reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
Material estimates that are particularly susceptible to significant change in
the near term relate to the determination of the allowance for loan losses, the
valuation of other real estate owned ("OREO") and the valuation of deferred tax
assets.
Business
The Bank provides a broad range of banking and related services to
individuals and small businesses through its five offices in eastern
Massachusetts. Its principal business consists of attracting deposits from the
general public and using such deposits to originate real estate, construction,
commercial and consumer loans.
Reclassification
Certain amounts previously reported have been reclassified to conform to
the current year's presentation.
Cash equivalents
Cash equivalents include amounts due from banks and interest-bearing
deposits in banks.
Investment securities
Debt securities are classified as held to maturity, as there is a positive
intent and ability to hold them to maturity, and are recorded at amortized cost.
Discounts and premiums relating to mortgage-backed securities are amortized
to income by the interest or straight-line method over the estimated terms of
the investments. Income using the straight-line method would not differ
materially if accounted for on the interest method. Discounts and premiums
relating to other investment securities are amortized to income by the interest
method over the terms of the investments. The investment in Savings Bank Life
Insurance stock is carried at cost, as there is no readily determinable fair
value. Gains and losses on the disposition of investment securities are recorded
on the trade date and computed by the specific identification method.
Loans
The Bank grants mortgage, commercial and consumer loans to customers located
primarily in eastern Massachusetts. The ability of the Bank's debtors to honor
their contracts is dependent upon the real estate and construction economic
sectors, as well as the economy in general.
Interest on loans is recognized on a simple interest basis. Unearned income
on loans consists primarily of net deferred loan fees and discounts resulting
from preferential financing terms on sales of OREO. Net deferred loan fees and
discounts on
61
Notes to Consolidated Financial Statements - (Continued)
loans relating to sales of OREO are accreted on the interest method over the
contractual life of the loan. Interest on loans, including impaired loans, and
accretion of net deferred fees is not recognized when the collection of interest
or principal is ninety days or more past due, or earlier when in the judgment of
management collectibility of either principal or interest becomes doubtful. When
a loan is placed on nonaccrual status, all interest previously accrued but not
collected is reversed against current period interest income.
Allowance for loan losses
The adequacy of the allowance for loan losses is evaluated on a regular
basis by management. Factors considered in evaluating the adequacy of the
allowance include previous loss experience, current economic conditions and
their effect on borrowers, the performance of individual loans in relation to
contract terms, the risk characteristics of the loan portfolio and the estimated
fair value of collateral. Provisions for loan losses charged to operations are
based upon management's judgment, reflective of information available at the
time, of the amount necessary to maintain the allowance at a level adequate to
absorb reasonable foreseeable losses. Losses are charged against the allowance
when management believes the collectibility of the principal is unlikely.
Recoveries on loans previously charged-off are credited to the allowance. While
management believes the allowance to be adequate, it should be noted that it is
based on estimates and ultimate losses may vary from the estimates if future
conditions differ substantially from the assumptions used in making the
evaluation. It is possible that future events may result in additional
charge-offs or recoveries and changes in the level of the allowance for loan
losses. Further, various regulatory agencies, as an integral part of their
examination process, periodically review the Bank's allowance for loan losses.
Such agencies may require the Bank to recognize additional provisions to the
allowance based on judgments different from those of management.
The Bank adopted Statement of Financial Accounting Standards ("SFAS") No.
114, "Accounting by Creditors for Impairment of a Loan," on January 1, 1995.
Under this Statement, a loan is considered impaired when, based on current
information and events, it is probable that a creditor will be unable to collect
the scheduled payments of principal or interest when due according to the
contractual terms of the loan agreement. Impairment is measured on a loan by
loan basis by either the present value of expected future cash flows discounted
at the loan's effective interest rate, the loan's obtainable market price, or
the fair value of the collateral if the loan is collateral dependent.
Substantially all of the Bank's loans which have been identified as impaired
have been measured by the fair value of existing collateral.
The Statement is not applicable to large groups of smaller balance
homogeneous loans that are collectively evaluated for impairment. Accordingly,
the Bank has not applied SFAS No. 114 to its consumer loan portfolio.
SFAS No. 114 also limits the classification of loans as in-substance
foreclosures to situations where the creditor actually receives physical
possession of the debtor's assets. Accordingly, upon adoption of SFAS No. 114,
the Bank transferred loans previously classified as in-substance foreclosures in
the amount of $3,512,000 to its impaired loan portfolio and transferred $546,000
from the allowance for OREO losses to the allowance for loan losses.
The adoption of SFAS No. 114 had no effect on the Bank's assessment of the
overall adequacy of the allowance for loan losses. The restatement of previously
issued financial statements to conform with SFAS No. 114 was expressly
prohibited.
Other real estate owned
OREO is comprised of properties acquired through foreclosure proceedings or
acceptance of a deed in lieu of foreclosure and, prior to January 1, 1995,
properties considered repossessed in-substance. Upon the adoption of SFAS No.
114 on January 1, 1995, all in-substance foreclosed assets that were not in the
Bank's possession were reclassified to loans. Related loss allowances were also
reclassified. OREO is recorded at the lower of the carrying value of the loan or
the net fair value of the property received. Loan losses arising from the
acquisition of such properties are charged against the allowance for loan
losses. Costs relating to development and improvement of property are
capitalized, while operating expenses and any subsequent provisions to reduce
the carrying value to fair value less costs to sell are charged to current
period operations. Gains and losses upon disposition are reflected in operations
as realized.
62
Notes to Consolidated Financial Statements - (Continued)
Losses resulting from preferential financing terms offered to facilitate
sales of OREO are recognized at the time of sale.
During the third quarter of 1994, management announced its intention to
accelerate the disposition of nonperforming assets and was actively considering
a bulk sale of certain OREO properties. As part of this plan, additional
provisions for OREO losses were established. Subsequently, management concluded
that it would be more economically advantageous to abandon the bulk sale and
instead dispose of such assets in separate transactions. The additional
provisions taken during the third quarter of 1994 were maintained to facilitate
accelerated sale transactions.
Land, buildings and equipment
Land is carried at cost. Buildings, leasehold improvements and equipment are
carried at cost, less accumulated depreciation and amortization computed on the
straight-line method over the estimated useful lives of the assets or the terms
of the leases, if shorter. It is the Bank's practice to charge the cost of
maintenance and repairs to operations when incurred; major expenditures for
improvements are capitalized and depreciated.
Income taxes
The Bank recognizes income taxes under the asset and liability method. Under
this method, deferred tax assets and liabilities are established for the
temporary differences between the accounting basis and the tax basis of the
Bank's assets and liabilities at enacted tax rates expected to be in effect when
the amounts related to such temporary differences are realized or settled. A
valuation allowance is established if, based upon available evidence, it is more
likely than not that some portion or all of the deferred tax assets will not be
realized.
Pension
The Bank accounts for pension plan benefits on the net periodic pension cost
method. This method recognizes the compensation cost of an employee's pension
benefit over the employee's approximate service period. Pension costs are funded
in the year of accrual using the aggregate cost method.
Employee stock ownership plan ("ESOP")
Compensation expense is recognized based on cash contributions paid or
committed to be paid to the ESOP. All shares held by the ESOP have been deemed
outstanding for purposes of earnings per share calculations. The value of
unearned compensation to be contributed to the ESOP for future services not yet
performed was reflected in stockholders' equity on the consolidated balance
sheet. Effective December 31, 1995, the Bank terminated the Employee Stock
Ownership Plan. Accordingly, the excess of the amount of ESOP debt payable to
the Bank, at that date, over the fair value of the unallocated shares held by
the ESOP was charged to additional paid-in capital.
Stock compensation plans
In October 1995, the Financial Accounting Standards Board issued SFAS No.
123, "Accounting for Stock-Based Compensation." This Statement encourages all
entities to adopt a fair value based method of accounting for employee stock
compensation plans, whereby compensation cost is measured at the grant date
based on the value of the award and is recognized over the service period, which
is usually the vesting period. However, it also allows an entity to continue to
measure compensation cost for those plans using the intrinsic value based method
of accounting prescribed by APB Opinion No. 25, "Accounting for Stock Issued to
Employees," whereby compensation cost is the excess, if any, of the quoted
market price of the stock at the grant date (or other measurement date) over the
amount an employee must pay to acquire the stock. Stock options issued under the
Bank's stock option plan generally have no intrinsic value at the grant date,
and under Opinion No. 25 no compensation cost is recognized for them. The Bank
has elected to remain with the accounting in Opinion No. 25 and as a result,
must make pro forma disclosures of net income and earnings per share as if the
fair value based method of accounting had been applied. The disclosure
requirements of this Statement are effective for the Bank's consolidated
financial statements for the year ended December 31, 1996. The pro forma
disclosures include the effects of all awards granted on or after January 1,
1995. (See note 13.)
63
Notes to Consolidated Financial Statements -- (Continued)
Interest-rate exchange agreements
Interest-rate exchange agreements (swaps) designated as hedges against
future fluctuations in the interest rates of specifically identified assets or
liabilities are accounted for on the same basis as the underlying asset or
liability, which is amortized cost. Net interest income (expense) resulting from
the differential between exchanging floating and fixed-rate interest payments is
recorded on a current basis in the interest income or expanse account related to
the asset or liability being hedged.
Earnings per share
Earnings per share computations are based on the weighted average number of
shares outstanding during each period. The dilutive effect of stock options
granted is not material.
2. Capital and Related Matters
The Bank is subject to various regulatory capital requirements administered
by the Federal Deposit Insurance Corporation ("FDIC"). Failure to meet minimum
capital requirements can initiate certain mandatory and possibly additional
discretionary actions by regulators that, if undertaken, could have a direct
material effect on the Bank's consolidated financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Bank must meet specific capital guidelines that involve quantitative
measures of its assets, liabilities and certain off-balance-sheet items as
calculated under regulatory accounting practices. The capital amounts and
classification are also subject to qualitative judgements by the regulators
about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Bank to maintain minimum amounts and ratios (set forth in the
following table) of total and Tier 1 capital (as defined) to average and
risk-weighted assets (as defined).
In March 1991, the Bank consented to the issuance of a regulatory order (the
"Order") by the FDIC. On November 15, 1993, the FDIC issued, with the Bank's
consent, a Modification of the Order (the "Modification"). The Modification
required the Bank to have a ratio of Tier 1 leverage capital to total assets (a
"Tier 1 leverage capital ratio") of at least 6.0% by June 30, 1995. The Bank's
Tier I leverage capital ratio was 5.79% at December 31, 1996. As long as the
Order remains in effect, if the Bank's Tier 1 leverage capital ratio at the end
of a month is less that 6.0%, the Bank is required to submit to its regulators a
written plan for increasing its Tier I leverage capital ratio to at least 6.0%.
The Bank has submitted a revised capital/profit plan (the "1996 Capital Plan")
to the FDIC and the Massachusetts Division of Banks. The 1996 Capital Plan
contemplates that the Bank will increase its Tier 1 leverage capital ratio
solely through the accumulation of retained earnings and was approved by the
FDIC in 1996. The Bank currently expects that it will achieve a Tier 1 leverage
capital ratio of 6.0% during the second quarter of 1997. In accordance with the
Order, the Bank may not declare or pay dividends on its common stock without the
prior written consent of the FDIC and the Massachusetts Commissioner of Banks.
In addition to the regulatory consequences of falling below the respective
minimum capital levels set forth in the Order and in the FDIC regulations
generally applicable to state-chartered, FDIC-insured institutions such as the
Bank, Section 38 of the FDIA requires the FDIC to take prompt corrective
supervisory action against undercapitalized institutions. Enacted as part of the
Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"),
Section 38 specifies five capital categories ("well capitalized," "adequately
capitalized," "undercapitalized," "significantly undercapitalized" and
"critically undercapitalized") that are used to determine the extent of
regulatory oversight that must be exercised. The restrictions become
increasingly more severe as an institution's capital category declines.
As of December 31, 1996, the most recent notification from the FDIC
categorized the Bank as adequately capitalized under the regulatory framework
for prompt corrective action. To be categorized as adequately capitalized, the
Bank must maintain minimum total risk-based, Tier 1 risk-based and Tier 1
leverage ratios as set forth in the following table. There are no conditions or
events since the notification that management believes have changed the Bank's
category. The Bank's actual capital amounts and ratios as of December 31, 1996
are also presented in the table.
64
Notes to Consolidated Financial Statements -- (Continued)
Minimum To Be
Adequately
For Minimum Capitalized Under
Capital Prompt Corrective
Actual Adequacy Purposes Action Provisions
---------------------------------------------------------------------
Amount Ratio Amount Ratio Amount Ratio
----------------- --------------------- ---------------------
(Dollars in Thousands)
Total Capital to Risk Weighted Assets: ........ $34,456 9.39% $29,359 8.0% $29,359 8.0%
Tier 1 Capital to Risk Weighted Assets ........ 29,848 8.13 14,680 4.0 14,680 4.0
Tier 1 Capital to Average Assets:
Generally .................................. 29,848 5.79 20,616 to 4.0 to 20,616 4.0
25,770 5.0
Per Order .................................. 29,848 5.79 30,924 6.0 N/A N/A
The Bank's ability to achieve the steps generally contemplated by the 1996
Capital Plan to increase profits and capital is dependent on many factors,
including the continued resolution of its nonperforming assets and sustained
profitability. Failure to achieve the capital targets prescribed by the Order,
as amended by the Modification, or to be at least "adequately capitalized" for
purposes of Section 38 of the FDIA, exposes the Bank to further restrictions and
regulatory actions.
In connection with the Bank's 1993 Common Stock Offering, the Bank
transferred $33,897,000 from additional paid-in capital to retained deficit so
as to eliminate the accumulated deficit from the Bank's books, as of September
30, 1993. The transfer was approved by the Commissioner of Banks as required
under Massachusetts law.
3. Cash and Due From Banks
At December 31, 1996, cash and due from banks of $1,638,000 was utilized to
satisfy the reserve and compensating balance requirements of the Federal Reserve
Bank.
4. Investment Securities
The amortized cost and approximate fair value of investment securities with
gross unrealized gains and losses are as follows:
December 31, 1996
---------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------------------------------------------------------
(In Thousands)
Debt securities:
Federal agency obligations ............................. $ 4,996 $ 5 $ 22 $ 4,979
------- ------ ------- -------
Fixed rate mortgage-backed securities
Federal agency REMICS ................................ 27,100 40 744 26,396
Private issue REMICS ................................. 69 -- 3 66
------- ------ ------- -------
27,169 40 747 26,462
------- ------ ------- -------
Adjustable rate mortgage-backed securities
Federal agency REMICS ................................ 32,255 416 317 32,354
Federal agency pass-throughs ......................... 22,243 272 79 22,436
------- ------ ------- -------
54,498 688 396 54,790
------- ------ -------
Savings Bank Life Insurance stock ......................... 1,402 -- -- 1,402
------- ------ ------- -------
$88,065 $ 733 $ 1,165 $87,633
======= ====== ======= =======
65
Notes to Consolidated Financial Statements -- (Continued)
December 31, 1995
---------------------------------------------------------
Gross Gross
Amortized Unrealized Unrealized Fair
Cost Gains Losses Value
---------------------------------------------------------
(In Thousands)
Debt securities:
Fixed rate mortgage-backed securities
Federal agency REMICS ................................. $28,316 $ 256 $ 230 $28,342
Private issue REMICS .................................. 192 2 1 193
------- ------- ------- -------
28,508 258 231 28,535
------- ------- ------- -------
Adjustable rate mortgage-backed securities
Federal agency REMICS ................................. 14,249 247 124 14,372
Federal agency pass-throughs .......................... 17,364 165 -- 17,529
Private issue pass-throughs ........................... 7 -- -- 7
------- ------- ------- -------
31,620 412 124 31,908
------- ------- ------- -------
Savings Bank Life Insurance stock .......................... 1,402 -- -- 1,402
------- ------- ------- -------
$61,530 $ 670 $ 355 $61,845
======= ======= ======= =======
The amortized cost and approximate fair value of federal agency obligations by
contractual maturity follows. Actual maturities may differ from contractual
maturities because the issuers may have the right to call or repay obligations
with or without call or prepayment penalties.
December 31, 1966
-------------------------
Amortized Fair
Cost Value
-------------------------
(In Thousands)
Over 1 to 5 years ................... $ 996 $1,000
Over 5 to 10 years .................. 4,000 3,979
------ ------
$4,996 $4,979
====== ======
Substantially all of the Bank's mortgage-backed securities have contractual
maturities in excess of 10 years based upon the maturity of the final scheduled
payment. Such securities generally amortize on a regular basis, predominantly
monthly, and are subject to prepayment. Taking into account such contractual
amortization and expected prepayments, a significant amount of principal
reduction will occur within five years.
There is no readily determinable fair value for Savings Bank Life Insurance
stock because of ownership restrictions relating to the stock. Management
believes that the carrying value is equivalent to the fair value.
Mortgage-backed securities with carrying values of $2,697,000 at December
31, 1996 were pledged as collateral against treasury tax and loan deposits and
interest-rate exchange agreements.
66
Notes to Consolidated Financial Statements -- (Continued)
5. Loans
The composition of the loan portfolio at the dates indicated is as
follows:
December 31,
------------------------
1996 1995
------------------------
(In Thousands)
Real estate loans:
Residential ..................................... $ 150,353 $ 155,180
Construction .................................... 35,267 24,499
Commercial ...................................... 192,569 201,266
Second mortgages and equity lines ............... 6,250 5,576
--------- ---------
Total principal balances .................... 384,439 386,521
Less: Due to borrowers on incomplete loans ...... (12,045) (6,600)
Unearned income ............................. (2,277) (2,960)
--------- ---------
Total real estate loans .................. 370,117 376,961
--------- ---------
Commercial loans:
Secured ......................................... 19,414 20,942
Unsecured ....................................... 1,286 1,482
--------- ---------
Total principal balances .................... 20,700 22,425
--------- ---------
Less: Unearned income ........................... (241) (221)
--------- ---------
Total commercial loans ................... 20,459 22,204
--------- ---------
Other loans:
Consumer ........................................ 2,668 2,942
Passbook ........................................ 1,712 1,773
--------- ---------
Total other loans ........................... 4,380 4,715
--------- ---------
Total loans .............................. 394,956 403,880
Less: Allowance for loan losses ................. (6,236) (7,136)
--------- ---------
$ 388,720 $ 396,744
========= =========
At December 31, 1996 and 1995, loans owned by others and serviced by the
Bank amounted to approximately $16,752,000 and $12,714,000, respectively, and
are not included in the accompanying consolidated financial statements.
The following is a summary of the recorded investment in impaired loans
(see note 1):
December 31,
------------------------
1996 1995
------------------------
(In Thousands)
Loans with no valuation allowance ...................... $ 9,702 $11,557
Loans with a corresponding valuation allowance ......... 1,796 2,010
------- -------
Total impaired loans ................................... $11,498 $13,567
======= =======
Corresponding valuation allowance ...................... $ 384 $ 392
======= =======
At December 31, 1996 and 1995, no additional funds were committed to be
advanced in connection with impaired loans.
67
Notes to Consolidated Financial Statements -- (Continued)
At December 31, 1996 and 1995, unpaired loans totaling $5,524,000 and
$3,996,000, respectively were on nonaccrual status. Impaired loans totaling
$3,798,000 and $7,863,000 at December 31, 1996 and 1995, respectively, are
classified as restructured loans and are included in the restructured loan
totals below. For the years ended December 31, 1996 and 1995, the average
recorded investment in impaired loans amounted to $12,904,000 and $10,910,000,
respectively. The Bank recognized $646,000 and $349,000, respectively, of
interest income on impaired loans during the period that they were impaired.
At December 31, 1996 and 1995, nonaccrual loans amounted to $6,203,000 and
$4,742,000, respectively.
At December 31, 1996 and 1995, restructured loans on accrual status amounted
to $19,137,000 and $35,336,000, respectively. Interest income that would have
been recorded under the original terms of these loans compared to the interest
income actually recognized is as follows:
Years Ended December 31,
------------------------
1996 1995 1994
------------------------
(In Thousands)
Interest income that would have been recorded ..... $2,153 $3,732 $3,417
Interest income recognized ........................ 1,523 2,434 2,093
------ ------ ------
Interest income forgone ........................... $ 630 $1,298 $1,324
====== ====== ======
An analysis of the allowance for loan losses is as follows:
Years Ended December 31,
------------------------
1996 1995 1994
------------------------
(In Thousands)
Balance at beginning of year ..................... $ 7,136 $ 8,121 $ 8,254
Provision for loan losses ........................ 1,200 1,200 1,800
Recoveries ....................................... 949 720 624
------- ------- -------
9,285 10,041 10,678
Loans charged-off ................................ (3,049) (3,451) (2,557)
Transfer from allowance for OREO losses
upon adoption of SFAS No. 114 (see note 1) .. -- 546 --
------- ------- -------
Balance at end of year ...................... $ 6,236 $ 7,136 $ 8,121
======= ======= =======
68
Notes to Consolidated Financial Statements -- (Continued)
6. Other Real Estate Owned
A summary of OREO is as follows:
December 31,
----------------------
1996 1995
----------------------
(In Thousands)
Raw land and construction projects ............... $ 5,719 $ 6,878
One to four family residential property .......... 150 549
Residential condominiums ......................... 543 --
Commercial condominiums .......................... -- 1,278
Other commercial property ........................ 5,343 6,998
-------- --------
11,755 15,703
Deposits received ................................ (18) (15)
Allowance for losses ............................. (2,827) (4,192)
-------- --------
$ 8,910 $ 11,496
======== ========
An analysis of the allowance for losses on OREO is as follows:
Years Ended December 31,
------------------------------
1996 1995 1994
------------------------------
(In Thousands)
Balance at beginning of year .................. $ 4,192 $ 7,823 $ --
Provision for losses .......................... 900 2,775 9,211
Losses charged to the allowance ............... (2,265) (5,860) (1,388)
Transfer to allowance for loan losses
upon adoption of SFAS No. 114 (note 1) ...... -- (546) --
------- ------- -------
Balance at end of year ........................ $ 2,827 $ 4,192 $ 7,823
======= ======= =======
An analysis of the net loss on OREO is as follows:
Years Ended December 31,
----------------------------------
1996 1995 1994
----------------------------------
(In Thousands)
Provision for losses ................... $ 900 $ 2,775 $9,211
Net loss (gain) on sales ............... (45) (518) 59
------ ------- ------
$ 855 $ 2,257 $9,270
====== ======= ======
Included in the net loss are interest rate losses resulting from
preferential financing terms offered to facilitate sales of OREO. For the years
ended December 31, 1996, 1995 and 1994, interest rate losses totaled $56,000,
$1,665,000 and $887,000, respectively. Accretion of these amounts included in
interest income amounted to $828,000, $927,000 and $686,000 for the years ended
December 31, 1996, 1995 and 1994, respectively.
69
Notes to Consolidated Financial Statements -- (Continued)
7. Land, Buildings and Equipment
A summary of the cost and accumulated depreciation and amortization of land,
buildings and equipment and their estimated useful lives is as follows:
December 31, Estimated
-------------- Useful
1996 1995 Lives
-------------- ---------
(In Thousands)
Land ............................................... $ 2,430 $ 2,430 --
Buildings .......................................... 11,989 11,913 5-50 years
Leasehold improvements ............................. 544 544 3-10 years
Equipment .......................................... 2,596 2,093 3-10 years
-------- -------
17,559 16,980
Less: Accumulated depreciation and amortization .... (4,984) (4,359)
-------- -------
$ 12,575 $12,621
======== =======
Depreciation and amortization expense for the years ended December 31, 1996,
1995 and 1994 amounted to $625,000, $600,000 and $654,000, respectively.
8. Deposits
A summary of deposit balances, by type, is as follows:
Years Ended December 31,
------------------------
1996 1995
------------------------
(In Thousands)
Demand deposits .............................. 18,967 $ 16,274
-------- --------
NOW accounts ................................. 25,142 25,273
Money market deposits ........................ 44,463 46,501
Regular and other ............................ 69,719 71,861
-------- --------
Total savings deposits ................... 139,324 143,635
-------- --------
Term certificates ............................ 284,244 274,098
-------- --------
$442,535 $434,007
======== ========
70
Notes to Consolidated Financial Statements -- (Continued)
A summary of certificate accounts by maturity, is as follows:
December 31, 1996
-----------------------------------------------------------------------
Under $100,000 Over $100,000 Total
-----------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Amount Rate Amount Rate Amount Rate
--------------------- ----------------------- ----------------------
(Dollars in Thousands)
Within one year ...... $130,672 5.6% $27,520 5.5% $158,192 5.6%
One to two years ..... 49,083 6.0 6,047 6.1 55,130 6.0
Two to three years ... 31,448 5.9 7,559 6.0 39,007 5.9
Over three years ..... 24,389 6.7 7,526 6.7 31,915 6.7
-------- ------- --------
$235,592 5.8 $48,652 5.8 $284,244 5.8
======== ======= ========
December 31, 1995
-----------------------------------------------------------------------
Under $100,000 Over $100,000 Total
-----------------------------------------------------------------------
Weighted Weighted Weighted
Average Average Average
Amount Rate Amount Rate Amount Rate
--------------------- ----------------------- ----------------------
(Dollars in Thousands)
Within one year ...... $132,342 5.7% $19,469 5.6% $151,811 5.7%
One to two years ..... 44,913 6.0 5,801 6.0 50,714 6.0
Two to three years ... 26,913 6.3 3,188 6.5 30,101 6.3
Over three years ..... 33,263 6.7 8,209 6.7 41,472 6.7
-------- ------- --------
$237,431 6.0 $36,667 6.0 $274,098 6.0
======== ======= ========
9. Borrowed Funds and Interest-Rate Exchange Agreement
Borrowings consist of the following advances from the Federal Home Loan Bank
of Boston ("FHLBB"):
Interest December 31,
Maturity Date Rate 1996 1995
------------------------- -------- -------- --------
(In Thousands)
Short-term borrowings:
February 23, 1996 ............ 5.80% $ -- $ 5,000
------- --------
Long-term borrowings:
October 17, 2000 (1)(2) ...... 5.49 20,000 20,000
October 24, 2000 (1) ......... 5.48 10,000 15,000
October 2, 2001 (1) .......... 5.53 10,000 --
December 1, 2014 ............. 5.42 447 447
------- --------
40,447 35,447
------- --------
$40,447 $ 40,447
======= ========
(1) Interest rate adjusts quarterly.
(2) The Bank has entered into an interest-rate exchange agreement with a
notional amount of $20,000,000 that matures on October 17, 2000.
This agreement effectively converts this advance from the FHLBB to a
fixed-rated instrument with an interest rate of 6.035%.
71
Notes to Consolidated Financial Statements -- (Continued)
The Bank has an available line of credit of $10,295,000 with the FHLBB at an
interest rate that adjusts daily. At December 31, 1996 and 1995, no borrowings
were outstanding under this line of credit.
All borrowings from the FHLBB are secured by certain qualified collateral. At
December 31, 1996, the Bank had qualified collateral listed with the FHLBB
consisting of residential mortgage loans and mortgage-backed securities totaling
$146,900,000 representing a maximum borrowing capacity of approximately
$119,000,000.
10. Income Taxes
The allocation of federal and state income taxes is as follows:
Years Ended December 31,
----------------------------
1996 1995 1994
----------------------------
(In Thousands)
Current tax provision:
Federal ..................................... $ -- $ -- $ --
State ....................................... 10 -- 7
------- ------- ----
10 -- 7
------- ------- ----
Deferred:
Federal ..................................... 838 -- --
State ....................................... 110 -- --
------- ------- ----
948 -- --
------- ------- ----
Reversal of valuation reserve
due to anticipation of future income ...... (1,398) (1,000) --
------- ------- ----
$ (440) $(1,000) $ 7
======= ======= ====
The reasons for the differences between the statutory federal income tax rate
of 34% and the effective tax rates are summarized as follows:
Years Ended December 31,
------------------------------
1996 1995 1994
------------------------------
(In Thousands)
Tax at statutory rate of 34% ............................ $ 807 $ 27 $(2,834)
Increase (decrease) resulting from:
State income tax, net of federal benefit ........... (158) (127) --
Change in valuation allowance - net of reduction
of carryforwards due to change in control ........ (1,077) (904) 2,850
Other, net ......................................... (12) 4 (9)
------- ------- -------
Income tax provision (benefit) .......................... $ (440) $(1,000) $ 7
======= ======= =======
72
Notes to Consolidated Financial Statements -- (Continued)
Deferred income taxes relating to temporary differences between the financial
reporting basis and the tax basis of the Bank's assets and liabilities are as
follows:
December 31,
------------------
1996 1995
------------------
(In Thousands)
Deferred tax assets:
Allowance for loan losses ..................... $ 3,593 $ 3,320
Writedowns and capitalized expenses on OREO ... 3,763 4,487
Net operating loss carryforward ............... 2,988 2,626
Deferred loss on below market rate loans ...... 501 816
Alternative minimum tax credit carryforward ... 294 294
Other ......................................... 357 432
-------- --------
Gross deferred assets ....................... 11,496 11,975
Valuation allowance .............................. (10,046) (10,975)
-------- --------
Net deferred tax asset ........................... $ 1,450 $ 1,000
======== ========
A valuation allowance is established when it is more likely than not that
some portion of the deferred income tax asset will not be realized. As of
December 31, 1994, management established a valuation allowance for almost all
of the net operating loss and tax credit carryforwards. At December 31, 1996,
the Bank anticipates that future taxable income will be realized to allow the
recognition of $1,450,000 of such benefits.
A summary of the activity in the valuation allowance applicable to the net
deferred tax asset is as follows:
Years Ended December 31,
----------------------------------
1996 1995 1994
----------------------------------
(In Thousands)
Balance at beginning of year ................................ $ 10,975 $ 12,653 $ 9,337
Change in assumptions due to anticipation of future income .. (1,398) (1,031) --
Benefits created from current year's operations ............. 554 -- 3,685
Benefits forfeited during the year .......................... (85) (647) (369)
-------- -------- --------
Balance at end of year ...................................... $ 10,046 $ 10,975 $ 12,653
======== ======== ========
The Bank has included, as a potential asset, a benefit of $513,000 for the
forgiveness from taxation of its "thrift status tax bad debt reserve" as of its
1987 base year as a result of its interpretation of tax legislation signed into
federal law in August 1996. All of this potential benefit has been fully
reserved against and is reflected in the analysis of the valuation reserve as
benefits created from the current year's operations.
As of December 31, 1996, the Bank had a net operating loss carryforward for
federal tax purposes of $28,300,000 expiring as follows: $13,900,000, 1997;
$5,200,000, 2007; $4,000,000, 2008 and $200,000 in 2009 and $5,000,000 in 2010.
Tax credit carryforwards of approximately $1,100,000 expire in years 2004
through 2010. Alternative minimum tax credit carryforwards of $294,000 have no
expiration date and are available to offset regular tax.
The Bank's 1993 Common Stock Offering resulted in a "change in control" for
income tax purposes. As a result, the net operating loss and tax credit
carryforwards are limited so that only $177,000 per year can be utilized to
offset taxable income generated during the years in the carryforward period
which expires in 2008. Accordingly, approximately $19,500,000 of such loss
carryforwards and nearly all of the tax credit carryforwards are expected to be
lost as a result of the 1993 Offering. The preceding table of gross deferred tax
asset items at December 31, 1996 and 1995 reflects the reduction in the
available carryforwards due to the change in control.
73
Notes to Consolidated Financial Statements -- (Continued)
11. Commitments and Contingencies
Employment and special termination agreement
The Bank has entered into a five-year employment agreement with the
President providing for specified minimum annual compensation and the
continuation of benefits currently received, The agreement is automatically
extended on each anniversary date for successive five-year periods unless notice
is given prior to the anniversary date. However, such employment may be
terminated for cause, as defined, without incurring any continuing obligations.
The agreement provides for certain lump-sum severance payments within a
three-year period following a "change in control" of the Bank, as defined in the
agreement.
Financial instruments with off-balance sheet risk
The Bank is a party to financial instruments with off-balance-sheet risk in
the normal course of business to meet the financing needs of its customers and
to reduce its own exposure to fluctuations in interest rates. These financial
instruments include commitments to extend credit, standby letters of credit and
interest-rate exchange agreements. Such instruments involve, to varying degrees,
elements of credit and interest rate risk in excess of the amount recognized in
the accompanying consolidated balance sheets. The contract and notional amounts
of these instruments reflect the extent of involvement the Bank has in these
particular classes of financial instruments.
For commitments to extend credit and standby letters of credit, the Bank's
exposure to credit loss is represented by the contractual amount of those
instruments. The Bank uses the same credit policies in making commitments and
conditional obligations as it does for on-balance-sheet instruments. For
interest-rate exchange agreements, the notional amounts do not represent
exposure to credit loss. The Bank's credit exposure on these agreements is
limited to the value of interest-rate exchange agreements that have become
favorable to the Bank.
The following financial instruments were outstanding at the dates indicated:
Contract or Notional Amount
---------------------------
December 31,
---------------------------
1996 1995
------------ ------------
(In Thousands)
Financial instruments whose contract amounts represent credit risk:
Unadvanced funds on construction loans ........................................ $12,045 $ 6,600
Commitments to grant loans .................................................... 15,863 4,255
Unadvanced funds on lines of credit ........................................... 10,385 8,163
Standby letters of credit and other guarantees ................................ 1,211 909
Financial instruments whose notional amount exceeds the amount of credit risk:
Interest-rate exchange agreement ............................................. 20,000 20,000
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and typically
require payment of a fee. The commitments for lines of credit may expire without
being drawn upon, and therefore, the total commitment amounts do not necessarily
represent future cash requirements. The Bank evaluates each customer's
creditworthiness on a case by case basis. Funds disbursed under these financial
instruments, except for certain commercial loans and commercial lines of credit,
are collateralized by real estate and other business assets.
Standby letters of credit and other guarantees are conditional commitments
issued by the Bank to guarantee the performance of a customer to a third party.
These agreements are primarily issued to support borrowing arrangements. The
credit risk involved in issuing letters of credit is essentially the same as
that involved in extending loan facilities to customers. Other guarantees are
generally collateralized by deposits held by the Bank. Unsecured letters of
credit amounted to $211,000, and $111,000 at December 31, 1996 and 1995,
respectively.
74
Notes to Consolidated Financial Statements -- (Continued)
Interest-rate exchange agreements are used by the Bank in the management of
interest-rate risk. These instruments are currently used to manage interest rate
exposure on borrowed funds, and are not used for speculative purposes. The Bank
controls the credit risk of such agreements through credit approval and
monitoring procedures.
Lease commitments
Pursuant to the terms of non-cancelable lease agreements in effect at
December 31, 1996, future minimum rent commitments aggregate $260,000 through
2001. Certain leases contain options to extend for periods of five years as well
as real estate tax escalation clauses. These costs are not included above. Rent
expense for the years ended December 31, 1996, 1995 and 1994 amounted to
$131,000, $127,000 and $118,000, respectively.
Minimum future rental income
Pursuant to the terms of a non-cancelable lease agreement, the Bank is
committed to lease a portion of its office space to an unrelated third party for
a term which expires July 31, 1999. Minimum rental income, arising from this
agreement, for the years ended December 31, 1997, 1998 and 1999 amounts to
$243,000, $247,000 and $144,000, respectively.
The lease contains an option to extend for a period of ten years and
requires reimbursement for real estate tax increases. The income from this
option and reimbursement is not included above. Rental income for the years
ended December 31, 1996, 1995 and 1994, amounted to $294,000, $269,000 and
$235,000, respectively.
Contingencies
In the ordinary course of business, various legal claims are made against
the Bank from time to time, and, in the opinion of management, none of these
claims pending or threatened as of December 31, 1996 will have a material effect
on the Bank's consolidated financial position.
12. Employee Benefit Plans
Pension plan
The Bank provides basic and supplemental pension benefits for eligible
employees through the Savings Banks Employees Retirement Association's ("SBERA")
Pension Plan. Each employee reaching the age of 21 and having completed at least
1,000 hours of service in the previous twelve-month period beginning with such
employee's date of employment automatically becomes a participant in the
retirement plan. All participants are fully vested upon the completion of three
years of service or at age 62, if earlier.
Net pension expense for the plan years ended October 31, 1996, 1995 and 1994
consisted of the following:
1996 1995 1994
---------------------------
(In Thousands)
Service cost-benefits earned during year ...... $ 431 $ 327 $ 263
Interest cost on projected benefits ........... 336 341 221
Actual return on plan assets .................. (598) (704) (213)
Net amortization and deferral ................. (13) (13) (13)
Amortization of net loss (gain) ............... 288 407 (136)
----- ----- -----
$ 444 $ 358 $ 122
===== ===== =====
Total pension expense for the years ended December 31, 1996, 1995 and 1994
amounted to $447,000, $475,000 and $153,000, respectively.
75
Notes to Consolidated Financial Statements -- (Continued)
According to SBERA's actuary, the funded status of the plan at October 31,
1996 and 1995 (the dates as of which information is available) is as follows:
1996 1995
-------------------
(In Thousands)
Plan assets at fair value .................................... $ 4,575 $ 3,962
Actuarial present value of projected benefit obligation ...... 4,891 4,797
------- -------
Deficiency of plan assets over projected benefit obligation .. (316) (835)
Unrecognized net surplus since adoption of SFAS No. 87 ....... (145) (158)
Unrecognized net loss (gain) ................................. (674) 173
------- -------
Accrued pension cost ......................................... $(1,135) $ (820)
======= =======
The accumulated benefit obligation at October 31, 1996 amounted to
$3,070,000, which was less than the fair value of plan assets at that date. Of
this amount, $3,048,000 is vested and $22,000 is non-vested.
Actuarial assumptions used to calculate the projected benefit obligation
were as follows:
October 31,
------------------------------
1996 1995 1994
------ ------ ------
Discount rate .............................. 7.50% 7.00% 8.00%
Expected long-term rate of return .......... 8.00 8.00 8.60
Annual salary increases .................... 6.00 6.00 6.00
401(k) plan
In 1995, the Bank adopted a 401(k) savings plan that provides for voluntary
contributions by eligible employees ranging from one to fifteen percent of their
compensation, subject to certain limitations. Each employee reaching the age of
21 and having completed one year of service is eligible to participate in the
plan. Under the terms of the plan, the Bank may at its discretion, match a
percentage of the employees' contributions. The Bank's matching contribution is
determined on an annual basis and all Bank contributions will be used to
purchase the Bank's common stock. For the years ended December 31, 1996 and
1995, the Bank made matching contributions totaling $165,000 and $0,
respectively to the plan.
Supplemental compensation agreements
The former Chairman of the Board and the President have entered into
supplemental compensation agreements with the Bank that provide for payments
upon attaining age 62 and are subject to certain limitation as set forth in the
agreements. The present value of these future payments is provided for over the
terms of employment. The expense associated with these agreements totaled
$18,000 for each of the years ended December 31, 1996, 1995 and 1994.
13. Stock Option Plans
The Bank has 1,009,000 shares of Common Stock reserved for the benefit of
directors and certain senior employees under the Amended and Restated 1986
Incentive Stock Option Plan and the 1995 Equity Incentive Plan. Both incentive
stock options and non-qualified stock options may be granted with a maximum
option term of ten years. The Bank's 1995 Equity Incentive Plan also provides
for stock appreciation rights, performance stock units, restricted stock, stock
units, book value awards.
76
Notes to Consolidated Financial Statements -- (Continued)
The Bank applies APB Opinion 25 and related Interpretations in accounting
for the plans. Accordingly, compensation cost has been recognized to the extent
that the quoted market price of the common stock at the date of grant exceeds
the amount that the employee is required to pay. Had compensation cost for the
Bank's stock-based compensation plans been determined based on the fair value at
the grant dates consistent with the method prescribed by SFAS No. 123, the
Bank's net income and earnings per share would have been reduced to the pro
forma amounts indicated below:
Years Ended December 31,
------------------------
1996 1995
-------- ---------
(In Thousands
Except Per Share Data)
Net income As reported ................. $ 2,813 $ 1,078
Pro forma ................... 2,744 1,030
Earnings per share As reported ................. $ 0.17 $ 0.06
Pro forma ................... 0.16 0.06
Stock option activity is as follows:
Years Ended December 31,
-------------------------------------------------------------
1996 1995 1994
------------------- ------------------ -----------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------------------- ------------------ -----------------
Shares under option:
Outstanding at beginning of period .. 251,750 $ 1.25 48,000 $32.71 48,000 $32.71
Granted ............................. -- -- 251,750 1.25 -- --
Canceled ............................ -- -- (48,000) $32.71 -- --
------- ------- ------
Outstanding at end of period ........ 251,750 1.25 251,750 1.25 48,000 32.71
------- ------- ------
Exercisable at end of period ........ 50,350 1.00 -- -- 48,000 32.71
======= ======= ======
Weighted average fair value
of options granted during the year .. $ -- $ 0.89 $ --
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 1995: dividend yield of 0.0 percent, expected
volatility of 58%, risk-free interest rate of 7.42% and expected lives of 6
years.
77
Notes to Consolidated Financial Statements -- (Continued)
Information pertaining to options outstanding at December 31, 1996 is as
follows:
Options Options
Outstanding Exercisable
----------------------------------------- -----------------------
Weighted
Average Weighted Weighted
Remaining Average Average
Exercise Number Contractual Exercise Number Exercise
Price Outstanding Life Price Exercisable Price
- --------- ----------- ----------- -------- ----------- --------
$1.00 83,959 4.2 years $1.00 50,350 $1.00
1.25 83,958 4.2 years 1.25 - -
1.50 83,833 4.2 years 1.50 - -
------- ------
251,750 4.2 years 1.25 50,350 1.00
======= ======
14. Employee Stock Ownership Plan
In 1986, the Bank established an Employee Stock Ownership Plan and Trust
("ESOP") for the benefit of each employee that has reached the age of 21 and has
completed at least 1,000 hours of service. Effective December 31, 1995, the Bank
terminated the Plan.
The Bank had contributed to the Plan for each Plan year an amount determined
by the Bank in its discretion and had generally made contributions to the ESOP
based on the debt service requirements of the loans payable by the ESOP to the
Bank. Participants could also elect to make contributions to the Plan on an
after-tax basis in an amount from 1% to 10% of compensation. The Bank matched
participation contributions up to 5% of compensation.
Shares purchased with loan proceeds were held in a suspense account and
released for allocation to participants as the loans were repaid. The ESOP had
not acquired any unallocated shares since 1989.
At December 31, 1995, shares held by the ESOP were as follows:
Allocated ................................................ 131,490
Committed to be allocated ................................ 2,215
Unallocated .............................................. 60,780
-------
194,485
=======
Upon termination of the ESOP, participants became fully vested in the
allocated shares held by the ESOP. As of December 31, 1995, the market value of
the unallocated shares, which were sold in the open market during 1996, was
approximately $82,000 and loans by the ESOP payable to the Bank amounted to
$2,327,000. As a result, the Bank transferred the difference of $2,245,000 from
Unearned compensation - ESOP to Additional paid-in capital to reflect the
termination of the ESOP.
Total ESOP compensation expense amounted to $175,000 and $516,000 for the
years ended December 31, 1995 and 1994, respectively.
15. Related Party Transactions
In the ordinary course of business, the Bank has granted loans to its
executive officers and Directors amid their affiliates. The aggregate amount of
such loans which exceeded $60,000 in aggregate outstanding to any one individual
amounted to $1,429,000 and $1,463,000 at December 31, 1996 and 1995,
respectively. During the year ended December 31, 1996, total principal
additions were $4,000 and total principal reductions were $38,000.
78
Notes to Consolidated Financial Statements -- (Continued)
16. Fair Values of Financial Instruments
The following disclosure of the estimated fair values of financial
instruments is made in accordance with the requirements of SFAS No. 107,
"Disclosures About Fair Value of Financial Instruments." The estimated fair
value amounts have been determined by using available quoted market information
or other valuation methodologies permitted under SFAS No. 107.
The fair value estimates provided are made at a specific point in time,
based on relevant market information and the characteristics of the financial
instrument. The estimates do not provide for any premiums or discounts that
could result from concentrations of ownership of financial instruments. Certain
fair value estimates are based on subjective judgments regarding current
economic conditions, risk characteristics of the financial instruments, future
expected loss experience, prepayment assumptions, and other factors. The
resulting estimates involve uncertainties and therefore cannot be determined
with precision. Changes made to any of the underlying assumptions could
significantly affect the estimates.
The estimated fair values, and related carrying or notional amounts, of the
Bank's financial instruments are as follows:
December 31, 1996 December 31, 1995
------------------ -------------------
Carrying Fair Carrying Fair
Value Value Value Value
------------------ -------------------
(In Thousands)
Assets:
Cash and cash equivalents ...... $8,219 $8,219 $12,581 $12,581
Investment securities .......... 88,065 87,633 61,530 61,845
Federal Home Loan Bank stock ... 4,422 4,422 4,422 4,422
Loans, net ..................... 388,720 390,966 396,744 389,445
Accrued interest receivable .... 3,048 3,048 3,014 3,014
Liabilities:
Deposits ....................... 442,535 443,620 434,007 435,488
Borrowed funds ................. 40,447 39,754 40,447 40,428
Accrued interest payable ....... 1,737 1,737 1,827 1,827
Contractual Contractual
or Notional Fair or Notional Fair
Amount Value Amount Value
-------------------------------------------------
Off-balance sheet financial instruments:
Commitments to extend credit ........ $39,504 $ -- $19,927 $ --
Interest-rate exchange agreement .... 20,000 119 20,000 (440)
The following methods and assumptions were used to estimate the fair value
of each class of financial instruments for which it is practicable to estimate
fair value.
Cash and cash equivalents
The carrying values for cash and cash equivalents approximate fair value
because of the short-term maturity of these instruments.
Investment securities
The fair values presented for investment securities are based on quoted bid
prices received from securities dealers. The fair value of restricted equity
securities approximates carrying value.
79
Notes to Consolidated Financial Statements -- (Continued)
Loans
Fair value estimates are based on loans with similar financial
characteristics. Loans have been segregated by homogeneous groups for
calculation purposes and presented as single line items for disclosure purposes.
Fair value estimates are estimated by discounting contractual cash flows
adjusted for prepayment estimates and using discount rates approximately equal
to current market rates on loans with similar characteristics and maturities.
The fair value of nonaccrual loans was estimated using the estimated fair values
of the underlying collateral.
Federal Home Loan Bank stock
The carrying value for Federal Home Loan Bank stock approximates fair value.
If redeemed, the Bank will receive an amount equal to the par value of the
stock.
Accrued interest receivable and payable
The carrying values for accrued interest receivable and payable approximate
fair value because of the short-term nature of these financial instruments.
Deposits
The fair values reported for regular, demand, NOW, and money market accounts
are equal to their respective carrying values. The fair values disclosed are, by
definition, equal to the amount payable on demand at the reporting date. The
fair values reported for term certificates are based upon the discounted value
of contractual cash flows. The discount rates are representative of approximate
rates currently offered on term certificates with similar remaining maturities.
Borrowed funds
The value of borrowed funds is estimated by discounting the contractual cash
flows at rates currently available to the Bank for debt with similar terms and
maturities.
Commitments
The Bank's commitments for unused lines of credit, unadvanced construction
loans, and loan commitments are primarily at floating rates and, accordingly
fair value is immaterial.
Financial instruments
The fair value reported for the interest-rate exchange agreement is based on
a dealer quote.
80
Notes to Consolidated Financial Statements -- (Continued)
17. Quarterly Data (Unaudited)
Summaries of consolidated operating results on a quarterly basis are as
follows:
Year Ended December 31, 1996 Year Ended December 31, 1995
------------------------------------------ ----------------------------------------
Fourth Third Second First Fourth Third Second First
Quarter Quarter Quarter Quarter Quarter Quarter Quarter Quarter
------- ------- ------- ------- ------- ------- ------- -------
(In Thousands, Except Per Share Data)
Interest and dividend income ............ $10,425 $10,241 $ 10,152 $10,040 $ 10,134 $10,372 $10,123 $9,807
Interest expense ........................ 5,645 5,579 5,499 5,605 5,703 5,886 5,818 5,366
------- ------- -------- ------- -------- ------- ------- ------
Net interest income ..................... 4,780 4,662 4,653 4,435 4,431 4,486 4,305 4,441
Provision for loan losses ............... 300 300 300 300 300 300 300 300
------- ------- -------- ------- -------- ------- ------- ------
Net interest income after provision
for loan losses ....................... 4,480 4,362 4,353 4,135 4,131 4,186 4,005 4,141
------- ------- -------- ------- -------- ------- ------- ------
Other income ............................ 310 273 250 224 276 262 311 207
Net loss on OREO ........................ 225 198 217 215 1,314 349 320 274
Operating expenses ...................... 3,754 3,820 3,852 3,733 3,686 3,761 3,790 3,947
------- ------- -------- ------- -------- ------- ------- ------
Income (loss) before income taxes ....... 811 617 534 411 (593) 338 206 127
Income taxes (1) ........................ -- 10 (100) (350) (1,000) -- -- --
------- ------- -------- ------- -------- ------- ------- ------
Net Income .............................. $ 811 $ 607 $ 634 $ 761 $ 407 $ 338 $ 206 $ 127
======= ======= ======== ======= ======== ======= ======= ======
Net income per share .................... $ 0.05 $ 0.04 $ 0.04 $ 0.05 $ 0.02 $ 0.02 $ 0.01 $ 0.01
======= ======= ======== ======= ======== ======= ======= ======
Quarterly per share amounts may not total to the full year due to
rounding.
(1) Refer to "Management's Discussion and Analysis -- Results of
Operations -- Provision for Income Taxes" for a discussion regarding
the income tax benefit recognized in 1996 and 1995.
81