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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-QSB
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(Mark One)
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended June 30, 2005
|_| TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ____________ to _____________
Commission File Number 333-114018
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First Ipswich Bancorp
(Exact name of small business issuer as specified in its charter)
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Massachusetts 04-2955061
(State or other jurisdiction of (I.R.S.Employer
incorporation or organization) Identification Number)
31 Market Street,
Ipswich, Massachusetts 01938
(Address of principal executive offices)
(978) 356-3700
(Issuer's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year,
if changed since last report)
Check whether the issuer (1) filed all reports required to be filed by
Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 12
months (or for such shorter period that the registrant was required to file such
reports) and (2) has been subject to such filing requirements for the past 90
days. YES |X| NO |_|
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practical date: At July 31, 2005, there were
2,219,630 shares of common stock outstanding, par value $1.00 per share.
Transitional Small Business Disclosure Format (Check one): YES |_| NO |X|
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FIRST IPSWICH BANCORP AND SUBSIDIARIES
FORM 10-QSB
Index
Page
----
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of June 30, 2005 and
December 31, 2004 3
Consolidated Statements of Income for the quarter and
six months ended June 30, 2005 and 2004 4
Consolidated Statements of Changes in Stockholders' Equity for the
six months ended June 30, 2005 and 2004 5
Consolidated Statements of Cash Flows for the six months ended
June 30, 2005 and 2004 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis 8
Item 3. Controls and Procedures 23
PART II OTHER INFORMATION
Item 1. Legal Proceedings 24
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 24
Item 3. Defaults Upon Senior Securities 24
Item 4. Submission of Matters to a Vote of Security Holders 24
Item 5. Other Information 25
Item 6. Exhibits and Reports on Form 8-K 25
Signatures 26
2
PART I--FINANCIAL INFORMATION
ITEM 1. Financial Statements
FIRST IPSWICH BANCORP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (unaudited)
(In thousands, except share data)
June 30, December 31,
2005 2004
--------- ---------
ASSETS
- ------
Cash and due from banks $ 12,468 $ 8,970
Federal funds sold 72 106
--------- ---------
Total cash and cash equivalents 12,540 9,076
--------- ---------
Certificate of deposit 3,253 3,212
Securities available for sale, at fair value 110,165 153,987
Securities held to maturity, at amortized cost 30,357 31,909
Federal Home Loan Bank stock, at cost 6,647 5,590
Federal Reserve Bank stock, at cost 572 549
Loans, net of allowance for loan losses of $1,627 and $1,340 224,865 168,883
Banking premises and equipment, net 9,941 5,806
Other assets 11,253 8,168
--------- ---------
Total assets $ 409,593 $ 387,180
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
- ------------------------------------
Deposits $ 243,503 $ 254,842
Short-term borrowings 95,739 66,468
Long-term borrowings 34,805 37,383
Subordinated debentures 14,000 7,000
Other liabilities 1,933 1,669
--------- ---------
Total liabilities 389,980 367,362
--------- ---------
Stockholders' equity:
Preferred stock, $1.00 par value; 1,000,000 shares authorized, none issued -- --
Common stock, $1.00 par value; 4,000,000 shares authorized, 2,240,120 issued 2,240 2,240
Additional paid-in capital 9,936 9,936
Retained earnings 8,309 8,210
Accumulated other comprehensive loss (761) (457)
Treasury stock, at cost - 20,490 shares (111) (111)
--------- ---------
Total stockholders' equity 19,613 19,818
--------- ---------
Total liabilities and stockholders' equity $ 409,593 $ 387,180
========= =========
See accompanying notes to consolidatedfinancial statements.
3
FIRST IPSWICH BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (unaudited)
(In thousands, except per share data)
Quarter Ended Six Months Ended
June 30, June 30,
------------------- --------------------
2005 2004 2005 2004
-------- -------- -------- --------
Interest and dividend income:
Interest and fees on loans $ 2,904 $ 2,575 $ 5,625 $ 5,098
Interest on debt securities:
Taxable 1,253 1,203 2,553 2,498
Tax-exempt 165 191 352 383
Dividends on equity securities 198 57 391 110
Other interest 45 35 90 70
-------- -------- -------- --------
Total interest and dividend income 4,565 4,061 9,011 8,159
-------- -------- -------- --------
Interest expense:
Interest on deposits 691 705 1,454 1,223
Interest on borrowed funds 1,112 623 2,027 1,286
Interest on subordinated debentures 135 144 249 288
-------- -------- -------- --------
Total interest expense 1,938 1,472 3,730 2,797
-------- -------- -------- --------
Net interest income 2,627 2,589 5,281 5,362
Provision for loan losses 67 -- 107 --
-------- -------- -------- --------
Net interest income, after provision for loan losses 2,560 2,589 5,174 5,362
Other income:
Investment advisory fees 385 -- 775 --
Service charges on deposit accounts 322 364 605 650
Credit card fees 182 176 342 311
Trust fees 123 112 236 203
Non-deposit investment fees 73 70 180 163
Gain (loss) on sales and calls of securities, net 16 (11) 62 375
Miscellaneous 48 77 140 99
-------- -------- -------- --------
Total other income 1,149 788 2,340 1,801
-------- -------- -------- --------
Operating expenses:
Salaries and employee benefits 2,051 1,821 4,132 3,696
Occupancy and equipment 601 513 1,170 959
Professional fees 210 208 427 495
Credit card interchange 136 146 234 240
Advertising and marketing 101 193 161 263
Data processing 190 156 370 300
ATM processing 95 101 187 191
Other general and administrative 317 381 698 684
-------- -------- -------- --------
Total operating expenses 3,701 3,519 7,379 6,828
-------- -------- -------- --------
Income (loss) before income taxes 8 (142) 135 335
Provision (credit) for income taxes 0 (100) (20) 25
-------- -------- -------- --------
Net income (loss) $ 8 $ (42) $ 155 $ 310
======== ======== ======== ========
Weighted average common shares outstanding:
Basic 2,220 1,761 2,220 1,759
-------- -------- -------- --------
Diluted 2,220 1,854 2,220 1,852
-------- -------- -------- --------
Earnings (loss) per share:
Basic $ 0.00 $ (0.02) $ 0.07 $ 0.18
======== ======== ======== ========
Diluted $ 0.00 $ (0.02) $ 0.07 $ 0.17
======== ======== ======== ========
See accompanying notes to consolidated financial statements.
4
FIRST IPSWICH BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (unaudited)
FOR THE SIX MONTHS ENDED JUNE 30, 2005 AND 2004
(In thousands, except per share data)
Accumulated
Additional Other
Paid-in Retained Comprehensive
Common Stock Capital Earnings Income (Loss) Treasury Stock Total
------------ ------- -------- ------------- -------------- -------
Balance at December 31, 2003 $1,778 $5,894 $7,826 $ (119) $(111) $15,268
-------
Comprehensive income:
Net income 310 310
Unrealized loss on
securities available for
sale, net of
reclassification
adjustment and tax effect (1,265) (1,265)
-------
Total comprehensive income (955)
-------
Proceeds from issuance of common
stock (300,000 shares) 300 3,304 3,604
Cash dividends declared ($.025
per share) (44) (44)
------ ------ ------ ------ ----- -------
Balance at June 30, 2004 2,078 9,198 8,092 (1,384) (111) 17,873
====== ====== ====== ====== ===== =======
Balance at December 31, 2004 2,240 9,936 8,210 (457) (111) 19,818
-------
Comprehensive loss:
Net income 155 155
Unrealized loss on
securities available for
sale, net of
reclassification
adjustment and tax effect (304) (304)
-------
Total comprehensive loss (149)
-------
Cash dividends declared ($.025
per share) (56) (56)
------ ------ ------ ------ ----- -------
Balance at June 30, 2005 $2,240 $9,936 $8,309 $ (761) $(111) $19,613
====== ====== ====== ====== ===== =======
See accompanying notes to consolidated financial statements.
5
FIRST IPSWICH BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(In thousands)
For the Six Months Ended June 30,
2005 2004
---------- ----------
Cash flows from operating activities:
Net income $ 155 $ 310
Adjustments to reconcile net income to net cash provided
(used) by operating activities:
Provision for loan losses 107
Gain on sales and calls of securities, net (62) (375)
Depreciation and amortization 423 336
Net amortization of securities, including certificate of deposit 185 494
Derivative fair value adjustment (35) 15
Amortization of core deposit intangible 60 18
Net change in other assets and other liabilities (57) (393)
---------- ----------
Net cash provided by operating activities 776 405
---------- ----------
Cash flows from investing activities:
Activity in available-for-sale securities:
Purchases (33,417) (103,195)
Sales 56,921 52,142
Maturities, calls and paydowns 19,757 27,372
Activity in held-to-maturity securities:
Purchases
Sales 669
Maturities, calls and paydowns 1,507 4,062
Purchase of Federal Home Loan Bank stock (1,057)
Purchase of Federal Reserve Bank stock (23)
Net cash paid in acquisition of Boston branch (25,102)
Loan originations, net of repayments (12,757) (7,464)
Premises and equipment acquired in branch acquisition (4,537)
Additions to premises and equipment, net (21) (592)
---------- ----------
Net cash provided (used) by investing activities 1,271 (27,006)
---------- ----------
Cash flows from financing activities:
Net increase (decrease) in deposits (32,220) 36,605
Net cash received in acquisition of Cambridge branch 9,552
Net increase (decrease) in short-term borrowings 29,271 (7,973)
Proceeds from subordinated debenture 7,000
Repayment of long-term debt (2,578) (11,537)
Proceeds from issuance of common stock 3,604
Cash dividends paid (56) (44)
---------- ----------
Net cash provided by financing activities 1,417 30,207
---------- ----------
Net increase (decrease) in cash and cash equivalents 3,464 3,606
Cash and cash equivalents at beginning of period 9,076 9,685
---------- ----------
Cash and cash equivalents at end of period $ 12,540 $ 13,291
========== ==========
Supplemental disclosures:
Interest paid $ 3,730 $ 2,769
Income taxes paid 129 48
Due to broker -- 17,475
See accompanying notes to consolidated financial statements
6
FIRST IPSWICH BANCORP AND SUBSIDIARIES
Notes to Consolidated Financial Statements (unaudited)
(1) Basis of Presentation and Consolidation
The accompanying unaudited consolidated financial statements include the
accounts of First Ipswich Bancorp (the "Company"), its wholly-owned subsidiary
The First National Bank of Ipswich (the "Bank"), and the Bank's subsidiaries.
All significant intercompany accounts and transactions have been eliminated in
consolidation.
These unaudited financial statements have been prepared in accordance with
accounting principles generally accepted in the United States of America
("GAAP") for interim financial information and the instructions for Form 10-QSB
and Item 310(b) of Regulation S-B. Accordingly, they do not include all of the
information and footnotes required by GAAP for complete financial statements. In
the opinion of management, all adjustments (consisting only of normal recurring
accruals) necessary for a fair presentation have been included. Interim results
are not necessarily indicative of the results that may be expected for the
entire year. Certain information and footnote disclosures normally included in
the financial statements prepared in accordance with GAAP have been omitted. A
summary of significant accounting policies followed by the Company is set forth
in the Notes to Consolidated Financial Statements in the Company's Annual Report
on Form 10-KSB for the year ended December 31, 2004.
(2) Stockholder's Equity and Earnings per Share
Basic earnings per share represents income available to common
stockholders divided by the weighted-average number of common shares outstanding
for the period. Diluted earnings per share in 2004 reflects additional common
shares (common stock equivalents) that would have been outstanding if dilutive
potential shares had been issued, as well as any adjustment to income that would
result from the assumed issuance. As of June 30, 2004, potential common shares
that may have been issued by the Company related solely to warrants issued in
connection with the Company's subordinated debentures and were determined using
the treasury stock method. Assumed conversion of the outstanding warrants would
increase the number of shares outstanding, but would not require an adjustment
to income as a result of the conversion. All warrants outstanding were exercised
on December 29, 2004.
For the three months ending June 30, 2004, no common stock equivalents
were included in the calculation of earnings per share as the Company reported a
net loss, the effect of which would be anti-dilutive. For the six months ended
June 30, 2004, the Company had no potential common shares outstanding that were
considered anti-dilutive. For the three and six months ended June 30, 2005,
there are no common stock equivalents outstanding.
(3) Commitments
At June 30, 2005, the Company had outstanding commitments to originate
loans of $17.9 million. Unused lines of credit and open commitments available to
customers at June 30, 2005 amounted to $29 million, of which $14 million related
to construction loans, $9.5 million related to home equity lines of credit, $5
million related to credit card loans and $.5 million related to other open
commitments.
(4) Segment Reporting
Information about reportable segments, and reconciliation of such
information to the consolidated financial statements as of and for the six
months ended June 30, 2005 is below. There were no reportable segments prior to
the acquisition of the de Burlo Group, Inc. on December 31, 2004.
Investment Consolidated
Banking Advisory Totals
------- -------- ------
Net interest and dividend income $ 5,281 -- $ 5,281
Other revenue: external customers 1,565 $ 775 2,340
Net income 13 142 155
Assets $406,865 $2,728 $409,593
7
(5) Acquisition
On June 24, 2005, the Company completed the acquisition of the Boston
branch of the Atlantic Bank of New York and the commercial building in which the
Boston branch is located at 33 State Street. The branch acquisition involved the
purchase of approximately $43.3 million in loans and the assumption of
approximately $20.9 million in deposits. The purchase price of the building was
$5.25 million and the premium paid on the deposits was 8%. The purchase was
deemed a business combination and goodwill has been recognized on the
transaction. The purchase price was allocated to assets acquired and liabilities
assumed based on estimates of fair value at the date of acquisition. The excess
of the purchase price over the net fair value of assets acquired and liabilities
assumed is to be allocated, in amounts to be determined, to goodwill and a core
deposit intangible related to the long-term value of depositor relationships.
The following table summarizes estimated fair values of the assets acquired and
liabilities assumed at the date of acquisition (in millions):
Tangible assets acquired - loans and building $ 47.6
Liabilities assumed 20.9
------
Fair value of net assets acquired 26.7
Purchase price 29.4
------
Core deposit intangible and goodwill $ 2.7
======
(6) Subsequent Events
On July 19, 2005, the Bank announced its decision not to exercise its
early 2006 lease renewal options on its three Wal-Mart branch locations in
Manchester, Newington and Salem, New Hampshire.
ITEM 2. Management's Discussion and Analysis
Forward-looking statements
This quarterly report on Form 10-QSB contains and incorporates by
reference "forward-looking statements" within the meaning of Section 27A of the
Securities Act and Section 21E of the Exchange Act. All statements, other than
statements of historical facts, including statements regarding our strategy,
effectiveness of investment programs, evaluations of future interest rate trends
and liquidity, expectations as to growth in assets, deposits and results of
operations, receipt of regulatory approval for pending acquisitions, success of
acquisitions, future operations, market position, financial position, and
prospects, plans and objectives of management are forward-looking statements.
Words such as "believes", "expects," "may," "will," "should," "contemplates," or
"anticipates" may also indicate forward-looking statements. There are a number
of important factors that could cause the Company's actual results to differ
materially from those contemplated by such forward-looking statements. These
important factors include, without limitation, competitive conditions in the
Bank's marketplace generally, the Bank's continued ability to originate quality
loans, fluctuation in interest rates including fluctuations which may affect the
Bank's interest rate spread, real estate conditions in the Bank's lending areas,
changes in the securities or financial markets, changes in loan defaults and
charge-off rates, a deterioration in general economic conditions on a national
basis or in the local markets in which the Company operates, the Bank's
continued ability to attract and retain deposits, the risk that difficulties
will arise in connection with the integration of the operations of acquired
businesses with the operations of the Company's banking or investment management
businesses, the Company's ability to control costs, new accounting
pronouncements, and changing regulatory requirements. The Company undertakes no
obligation to publicly release the results of any revisions to those
forward-looking statements, which may be made to reflect events or circumstances
after the date hereof or to reflect the occurrence of unanticipated events.
8
Executive Summary
The Company is a chartered bank holding company, which provides community
banking services to its principal market areas of northeastern Massachusetts and
southern New Hampshire through its wholly-owned subsidiary, the Bank. The Bank
is a nationally chartered commercial bank that has focused primarily on
originating quality loans and raising consumer and commercial deposits in the
markets it serves. The Bank seeks to expand its product offerings to its
existing customers, as well as increase its customer base in new markets.
Through its acquisition of the Cambridge branch of Atlantic Bank of New
York ("Atlantic Bank") in 2004 and the acquisition of the Boston branch of
Atlantic Bank on June 24, 2005, the Bank has initiated the strategic expansion
of its geographic footprint into the Boston market. To broaden its geographic
expansion, the Bank opened a loan production office in Portsmouth, New Hampshire
in the first quarter of 2005. With its expansion into this market, the Bank has
established a commercial lending presence in the area as a means of possible
expansion in the future.
As a result of the investment management company acquisition at the end of
2004, the Bank has also initiated its goal of expanding its product offerings
within the investment management area and broadening its fee-generating
businesses. The Bank plans to cross-sell its core banking services to the new
investment customers acquired, as well as cross-sell additional investment
products to its existing customer base. The investment management acquisition
has increased the Company's percentage of fee revenue to total revenue, thus
reducing reliance on revenue from the interest margin.
Financial market conditions continue to pressure the net interest margins
in the banking industry. As anticipated by the financial markets, the Federal
Open Market Committee raised the Federal Funds target rate 25 basis points on
both May 3rd and June 30th. The Committee believes that, even after these
actions, the stance of monetary policy remains accommodative and, coupled with
robust underlying growth in productivity, is providing ongoing support to
economic activity. The spread between the two- and ten-year treasury has
continued to narrow in recent months.
The Company anticipates comparable earnings for the six months ended
December 31, 2005 as compared to the six months ended June 30, 2005. As a result
of the anticipation of continued pressure on the net interest margin, primarily
as a result of the continued increase in short term interest rates and flat
yield curve, and expenses associated with the Sarbanes-Oxley internal control
assessment project, as well as branch integration, initiatives, and improvements
at various locations, net income for the year-ended December 31, 2005 may be
lower than for the year-ended December 31, 2004.
Critical Accounting Policies
Critical accounting policies are defined as those that reflect significant
judgments and uncertainties, and the application of which could potentially
result in materially different results under different assumptions and
conditions. Accounting policies considered critical to the Company's financial
statements include the allowance for loan losses and impairment of securities
and intangible assets, including goodwill and core deposit intangibles. The
methodology for assessing the appropriateness of the allowance for loan losses
is considered a critical accounting policy by management due to the degree of
judgment involved, the subjectivity of the assumptions utilized, and the
potential for changes in the economic environment that could result in changes
to the amount of the allowance for loan losses considered necessary. Management
considers impairment of investment securities to be a critical accounting policy
because of its possible materiality to the financial statements. Management
considers impairment of intangible assets to be a critical accounting policy
because it is a material balance sheet item and the estimation of fair values
involves a high degree of judgment and subjectivity in the assumptions utilized.
9
Comparison of Financial Condition at June 30, 2005 versus December 31, 2004
Total assets were $409.6 million at June 30, 2005, an increase of $22.4
million, or 5.8%, from $387.2 million as of December 31, 2004. All major loan
categories increased, partially offset by a decrease in total investment
securities balances.
Loans
Total net loan balances were $224.9 million as of June 30, 2005, an
increase of $56 million, or 33.2%, from $168.9 million as of December 31, 2004.
The increase in loans was due primarily to $43 million of loans acquired with
the Boston branch, which consist of commercial real estate and commercial loans.
A majority of these loans are located in Suffolk County and were originated for
local businesses. The Bank's lending activities continue to be focused in
northeastern Massachusetts and southern New Hampshire and are diversified by
loan types and industries. The Bank continues to focus on originating high
quality loans and targeting expansion of its geographic loan footprint into the
Boston, Massachusetts and Portsmouth, New Hampshire areas.
Commercial real estate loans increased to $93.7 million as of June 30,
2005, an increase of $33.1 million, or 54.6%, from $60.6 million as of December
31, 2004. The Bank's commercial real estate lending strategy stresses quality
loan originations to local businesses, professionals, experienced developers,
and investors. Commercial loans increased $25.5 million, or 129.7%, to $45.1
million as of June 30, 2005 due primarily to loans acquired with the Boston
branch, as well as increased business development, lending in new markets, and
favorable small business lending conditions.
Construction loan balances decreased $3.8 million, or 16.2%, to $19.2
million as of June 30, 2005 due primarily to sales activity, the cyclical nature
of the level of advanced funds, and one large loan conversion to permanent
financing. The primary focus of construction lending continues to relate to the
financing of small residential construction projects for the Company's highly
rated commercial customers.
Residential real estate loan balances, including equity lines of credit,
of $66.8 million as of June 30, 2005 increased $1.6 million, or 2.5%, from $65.2
million as of December 31, 2004. As the Bank does not sell fixed rate
residential loans into the secondary market, long-term fixed rate loans have not
been priced aggressively at this point in the economic cycle. Credit conditions
have continued to be favorable, although new and existing home sales prices and
activity has moderated in recent months.
The following table presents the composition of the Bank's loan portfolio
by type of loan at the dates indicated.
June 30, December 31,
2005 2004
---------- ----------
(Dollars in thousands)
Real estate mortgage loans:
Residential $ 55,934 $ 55,749
Commercial 93,715 60,616
Construction 19,189 23,016
Equity lines of credit 10,902 9,465
Commercial loans 45,085 19,627
Consumer loans 1,686 1,792
---------- ----------
Total loans 226,511 170,265
Net deferred origination fees (19) (42)
Allowance for loan losses (1,627) (1,340)
---------- ----------
Loans, net $ 224,865 $ 168,883
========== ==========
10
Asset Quality and Allowance for Loan Losses
The table below summarizes certain key ratios regarding the quality of the
Bank's loan portfolio:
June 30, 2005 December 31, 2004
------------- -----------------
(Dollars in thousands)
Non-accrual loans $ -- $ --
Troubled debt restructurings -- --
Loans past due 90 days or more and still accruing -- 16
Non-accrual loans to total loans -- --
Non-performing assets to total assets -- --
Allowance for loan losses as a percentage of
total loans 0.72% 0.79%
For the six months ended June 30, 2005, the Bank recorded a $107,000
provision for loan losses as a result of growth in loan originations. The Bank
recorded charge-offs of $21,000 and recoveries of $3,000 for the six months
ended June 30, 2005. The allowance for loan losses balance was $1,627,000 at
June 30, 2005, an increase of $287,000 since December 31, 2004. The allowance
for loan losses balance was augmented by $197,500 as a result of purchase
accounting associated with the Boston branch acquisition in June 2005.
Management considers the loan loss allowance to be adequate to provide for
potential loan losses, though a continued charge to earnings via a loan loss
provision is anticipated in 2005 due to the anticipation of continued loan
growth.
While the Bank has continued to enjoy a very low level of loan charge-offs
and non-accrual loans, and expects to continue to do so, economic or other
external factors, a deterioration in credit quality, or appropriate changes in
the reserve estimation process as a result of changes in assumptions, as well as
other possible factors, may cause the loan loss reserve balance to be increased
in the future, perhaps substantially, through charges to current earnings by
increasing the loan loss provision.
Investment Securities
Total investment securities, which includes certificates of deposit,
available-for-sale securities, held-to-maturity securities and Federal Home Loan
Bank and Federal Reserve Bank stock were $151.0 million as of June 30, 2005, a
decrease of $44.2 million, or 22.7%, from $195.2 million as of December 31,
2004. Investment security sales of $56.9 million and calls and principal
pay-downs on investment securities of $19.8 were partially replaced by
investment security purchases of $33.4 million, while the remaining proceeds on
investment securities sales and calls were utilized to fund loan demand. In
planning for the anticipated higher interest rates and increasing loan demand, a
greater percentage of investment securities purchases were amortizing
securities, many with average lives under one year, short-term money market
preferred stock, or shorter maturity agency securities. This purchasing strategy
facilitated the availability of investment funds to meet anticipated loan
funding requirements in the second quarter of 2005, while also minimizing the
need to sell securities at unfavorable prices.
Investment securities may be sold for a variety of reasons, including, but
not limited to, swapping into other investment sectors with greater perceived
relative value, neutralizing interest rate risk created by loan, deposit, or
borrowed funds activity, managing the level of leverage and risk-based capital,
and managing the level of qualifying collateral for borrowing purposes. In the
first quarter of 2005, certain investment securities were sold and re-invested
into different investment sectors to neutralize the interest rate risk impact of
higher balances and rates on short-term borrowings. Investment securities sold
consisted primarily of 10/1 agency mortgage backed obligations, which earn a
fixed rate for ten years and then adjust annually thereafter, and certain longer
maturity agency bonds. Proceeds from these sales were re-invested primarily into
floating rate instruments. Certain non-agency bonds that are not eligible to be
used as collateral for borrowing purposes were also sold and re-invested into
agency bonds in order to increase the level of qualifying collateral. Due to a
continued flattening of the yield curve, the short-term yield give-up on
floating rate assets as compared to intermediate and longer-term fixed rate
alternatives is not as significant as it had been several months ago.
11
The following table presents the composition of the Company's
available-for-sale and held-to-maturity securities portfolios at the dates
indicated
June 30, 2005 December 31, 2004
----------------------- -----------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
---------- ---------- ---------- ----------
(Dollars in thousands)
Securities available for sale
U.S. Government agency obligations $ 39,377 $ 39,047 $ 54,105 $ 53,868
Trust preferred securities -- -- 970 974
Mortgage-backed securities 64,478 63,728 78,946 78,575
Corporate bonds 1,801 1,748 1,786 1,746
Municipal bonds 627 598 635 610
---------- ---------- ---------- ----------
Total debt securities 106,283 105,121 136,442 135,773
Marketable equity securities 84 99 84 104
Preferred stock 4,956 4,945 18,456 18,110
---------- ---------- ---------- ----------
Total securities available for sale $ 111,323 $ 110,165 $ 154,982 $ 153,987
========== ========== ========== ==========
Securities held to maturity
U.S. Government agency obligations $ 3,000 $ 2,927 $ 3,000 $ 2,928
Municipal bonds 15,580 15,590 16,201 16,098
Mortgage-backed securities 11,777 11,610 12,708 12,524
---------- ---------- ---------- ----------
Total securities held to maturity $ 30,357 $ 30,127 $ 31,909 $ 31,550
========== ========== ========== ==========
Deposits
Total deposit balances were $243.5 million as of June 30, 2005, a decrease
of $11.3 million, or 4.5%, from $254.8 million as of December 31, 2004. Total
deposit balances decreased primarily due to the pricing of term deposits to
discourage the renewal of premium rate funds in February, partially offset by
the acquisition of approximately $21 million of deposits in June 2005 from the
new Boston branch. The acquired deposits consisted of approximately $11.3
million of checking balances, $3.9 million of savings balances, and $6.2 million
of term deposit balances.
Term deposit balances decreased $22.2 million, or 30.2%, to $51.4 million,
as of June 30, 2005. Approximately 40% of the $31 million in nine-month funds
raised last May were retained at a favorable spread to shorter term treasury
rates, during a period of a continued expectation of an increase in the Federal
funds target rate by the FOMC. Term deposit outflows were funded primarily by
short-term borrowings.
Non-interest bearing demand deposit balances increased $9.2 million, or
22.3%, to $50.3 million as of June 30, 2005. NOW account balances increased $2.5
million, or 6.8%, to $40 million as of June 30, 2005. Regular savings balances
increased $6.2 million, or 17.7%, to $40.9 million as of June 30, 2005. The
above three categories increased primarily as a result of the Boston deposits
acquired.
Total money market deposit balances decreased $7 million, or 10.3%, to
$60.9 million after increasing significantly in 2004, as management has opted to
price this account less aggressively in 2005 as short-term interest rates
continue to rise, after pricing more aggressively in 2004 to increase market
share while rates were lower. While deposit-raising strategies in 2005 may
include promotional programs, growth in market-priced savings, money market, and
checking balances continues to be targeted. The Company is also hopeful that
additional commercial deposits will be generated from its geographic lending
plans.
12
The following table shows the composition of the Company's deposit
balances at the dates indicated.
June 30, December 31,
2005 2004
---------- ----------
Demand $ 50,270 $ 41,098
NOW 40,045 37,505
Regular savings 40,931 34,767
Money market deposits 60,854 67,858
Term certificates 51,403 73,614
---------- ----------
$ 243,503 $ 254,842
========== ==========
Borrowings
Short-term borrowings increased $29.3 million, or 44%, to $95.7 million as
of June 30, 2005. Short-term borrowings increased for two primary reasons: as a
means of replacing net deposit outflows and to provide required funding for the
loan acquisition. Long-term advances decreased $2.6 million, or 6.9%, to $34.8
million as of June 30, 2005 due to scheduled monthly paydowns on amortizing
advances. Subordinated debentures increased $7 million, or 100%, to $14 million
as of June 30, 2005 due to the Company's participation in a pooled trust
preferred transaction in the amount of $7 million.
Stockholders' Equity
Total stockholders' equity decreased from $19.8 million at December 31,
2004 to $19.6 million as of June 30, 2005 due primarily to an increase in
accumulated other comprehensive loss of $304,000 associated with an unrealized
loss, net of tax, on available-for-sale securities, partially offset by net
income of $155,000 for the six months ended June 30, 2005.
Comparison of Operating Results for the Quarter and Six Months Ended
June 30, 2005 and 2004
General
Operating results are largely determined by the net interest spread on the
Company's primary assets (loans and investment securities) and its primary
liabilities (consumer deposit balances and Federal Home Loan Bank borrowings).
Operating results are also impacted by revenue from non-interest related sources
(such as service charges on deposit accounts), the provision for loan losses,
and operating expenses. Operating results are significantly impacted by general
economic conditions; in particular the general level of interest rates and the
resultant impact on asset yields and the cost of funds, as well the ability and
willingness of borrowers to fulfill their debt obligations during various
economic cycles.
Net income for the six months ended June 30, 2005 was $155,000 compared
with $310,000 for the six months ended June 30, 2004, a decrease of $155,000, or
50%. For the six months ended June 30, 2005, net interest income decreased
$81,000, or 1.5%, non-interest income increased $539,000, or 29.9%, and
operating expenses increased $551,000, or 8.1%, as compared to the six months
ended June 30, 2004.
Net income for the three months ended June 30, 2005 was $8,000 compared
with a net loss of $42,000 for the three months ended June 30, 2004, an increase
of $50,000, or 119%. For the three months ended June 30, 2005, net interest
income increased $38,000, or 1.5%, non-interest income increased $361,000, or
45.8%, and operating expenses increased $182,000, or 5.2%, as compared to the
three months ended June 30, 2004.
Interest and Dividend Income
Total interest and dividend income for the six months ended June 30, 2005
was $9.0 million, which was $852,000, or 10.4%, higher than the six months ended
June 30, 2004. This increase was due to the favorable impact of higher average
interest-earning assets of $358.2 million for the six months ended June 30,
2005, as compared to $320.1 million for the six months ended June 30, 2004. The
yield on earning assets of 5.03% for the six months ended June 30, 2005 was 7
13
basis points lower than for the six months ended June 30, 2004. Average net
loans for the six months ended June 30, 2005 increased $14.3 million, or 8.9%,
to $173.7 million, while the yield on loans for the six months ended June 30,
2005 was 6.48%; 9 basis points higher than the six months ended June 30, 2004. A
higher loan yield was due to a higher concentration of commercial loan balances
and commercial real estate loan balances in 2005 as compared to 2004.
Total interest and dividend income for the quarter-ended June 30, 2005 was
$4.6 million, which was $504,000, or 12.4%, higher than the quarter-ended June
30, 2004. This increase was due to the favorable impact of higher average
interest-earning assets and a higher asset yield. Average interest-bearing
assets of $355 million for the quarter ended June 30, 2005 were $30.3 million
higher than average interest-bearing assets of $324.7 million for the quarter
ended June 30, 2004. The yield on earning assets increased to 5.14% for the
quarter-ended June 30, 2005 as compared to 5.00% for the quarter-ended June 30,
2004 due primarily to higher short-term interest rates. Average net loans for
the quarter ended June 30, 2005 increased $15.3 million, or 9.5%, to $176.9
million.
Interest Expense
Interest expense on interest-bearing deposits for the six months ended
June 30, 2005 increased $231,000, or 18.9%, to $1.5 million as compared to the
six months ended June 30, 2004. This increase was due to a higher cost of
deposits and higher average interest-bearing deposit balances. The cost of
interest-bearing deposits increased 11 basis points to 1.53% for the six months
ended June 30, 2005 versus 1.42% for the six months ended June 30, 2004. Average
interest-bearing deposit balances of $190.2 million for the six months ended
June 30, 2005 were $17.9 million, or 10.4%, higher than the six months ended
June 30, 2004. The increase in the cost of deposits was due primarily to an
increased cost on MMDA balances of 25 basis points to 2.07% for the six months
ended June 30, 2005 and an increase in average MMDA balances of $18.3 million,
or 39.6%, to $64.3 million for the six months ended June 30, 2005. Money market
deposit balances increased as customers opted for a product that tends to earn
an interest rate that fluctuates with changes in short term interest rates.
Interest expense on deposits for the quarter-ended June 30, 2005 decreased
$14,000, or 2%, to $691,000 as compared to the quarter-ended June 30, 2004.
Interest expense on deposits decreased for the quarter-ended June 30, 2005 due
primarily to a decrease in average interest-bearing deposit balances to $181.5
million, a decrease of $4.6 million, or 2.5%. Average interest-bearing deposit
balances decreased due to a decrease of $17.5 million, or 27%, to $47.2 million
in average interest-bearing certificate of deposit balances, as a result of the
non-renewal of balances maturing in February from the term deposit promotion in
May 2004, partially offset by the impact of an increase of $13 million, or
26.3%, to $62.5 million in average money market deposit balances.
Interest expense on borrowed funds for the six months ended June 30, 2005
increased $741,000, or 57.6%, to $2 million as compared to the six months ended
June 30, 2004. The increase was due primarily to an increase of 85 basis points
to 3.35% in the cost of Federal Home Loan Bank advances, due to the increases in
the Federal Funds target rate, and a higher average balance in Federal Home Loan
Bank advances in 2005 of $18.8 million, or 20.3%. Federal Home Loan Bank
Advances were higher for the six months ended June 30, 2005 due to a higher rate
of growth in average assets as compared to deposit balances.
Interest expense on borrowed funds for the quarter-ended June 30, 2005
increased $489,000, or 78.5%, to $1.1 million as compared to $623,000 for the
quarter-ended June 30, 2004. The increase was due primarily to an increase of 86
basis points to 3.49% in the cost of Federal Home Loan Bank advances, due to the
increases in the Federal Funds target rate, and a higher average balance in
Federal Home Loan Bank advances for the quarter-ended June 30, 2005 of $35.7
million, or 43.5%. Federal Home Loan Bank Advances were higher for the quarter
ended June 30, 2005 due to lower average deposit balances, combined with higher
average assets.
14
Net Interest Income
Net interest income for the six months ended June 30, 2005 decreased
$81,000, or 1.5%, to $5.3 million as compared to the six months ended June 30,
2004. The decrease in net interest income in 2005 was due primarily to a
decrease of 40 basis points, from 3.35% to 2.95%, in the net interest margin.
The margin narrowed primarily due to the continued increase in short-term
interest rates and flattening of the yield curve. While loan yields have not
increased of any significance in this environment, the increase in short-term
interest rates, the primary driver of the Company's funding costs, has resulted
in an increase in the cost of deposits and borrowed funds. The margin also
decreased due to a higher percentage of shorter duration investment securities
to neutralize the interest rate risk of continued growth in short duration
liabilities: certificates of deposit, money market deposit balances, and
short-term Federal Home Loan Bank borrowings. The decrease in the net interest
margin was substantially offset by an increase of $38.1 million, or 11.9%, in
average interest-earning assets to $358.2 million for the six months ended June
30, 2005.
Net interest income for the quarter ended June 30, 2005 increased $38,000,
or 1.5%, to $2.6 million as compared to the quarter ended June 30, 2004. The
increase in net interest income in the second quarter of 2005 was due primarily
to higher average earning assets, partially offset by a lower net interest
margin of 2.96%, or 23 basis points, as compared to 3.19% for the quarter ended
June 30, 2004. Average earning assets increased $30.3 million, or 9.3%, to $355
million in the second quarter of 2005 primarily as a result of the increase in
average loans.
Average Balances and Yields
The following table presents a summary of the Company's interest-earning
assets and their average yields, and interest-bearing liabilities and their
average rates for the six months ended June 30, 2005 and 2004. The average
balances are derived from average daily balances.
Six Months Ended June 30,
2005 2004
Interest Interest
Income/ Average Average Rate Income/ Average Average Rate
Expense Balance Earned/Paid Expense Balance Earned/Paid
---------------------------------------------------------------------------------
(Dollars in thousands)
Assets
Interest earning assets:
Federal funds sold and certificate
of deposit $ 90 $ 3,119 5.77% $ 70 $ 2,560 5.47%
Investment securities: (1)
Taxable 2,944 164,553 3.58% 2,608 141,147 3.70%
Tax-exempt 352 16,737 4.21% 383 16,933 4.52%
Loans, net 5,625 173,710 6.48% 5,098 159,442 6.39%
----------------------- -----------------------
Total interest-earning assets 9,011 358,119 5.03% 8,159 320,082 5.10%
--------- ---------
Noninterest-earning assets 25,283 20,358
------------ ------------
Total assets 383,402 340,440
============ ============
Liabilities and Stockholders' Equity:
Interest-bearing liabilities:
Savings 92 35,560 0.52% 81 32,627 0.50%
NOW 29 35,099 0.17% 36 36,006 0.20%
MMDA 666 64,346 2.07% 419 46,077 1.82%
CD's 667 55,189 2.42% 687 57,586 2.39%
----------------------- -----------------------
Total interest-bearing deposits 1,454 190,194 1.53% 1,223 172,296 1.42%
Other borrowed funds 160 11,060 2.89% 133 10,528 2.53%
Federal Home Loan Bank advances 1,867 111,423 3.35% 1,153 92,616 2.49%
Subordinated debentures 249 7,348 6.78% 288 9,000 6.40%
----------------------- -----------------------
Total interest-bearing liabilities 3,730 320,025 2.33% 2,797 284,440 1.97%
--------- ---------
Noninterest-bearing deposits 42,328 39,453
Other noninterest-bearing liabilities 1,340 1,246
------------ ------------
Total liabilities 363,693 325,139
Total stockholders' equity 19,709 15,301
------------ ------------
Total liabilities and stockholders'
Equity $383,402 $340,440
============ ============
Net interest income $5,281 $5,362
========= =========
Interest rate spread 2.70% 3.13%
========== ===========
Net interest margin 2.95% 3.35%
========== ===========
(1) Excludes investment securities traded and not settled.
15
The following table presents a summary of the Company's interest-earning
assets and their average yields, and interest-bearing liabilities and their
average rates for the three months ended June 30, 2005 and 2004. The average
balances are derived from average daily balances.
Three Months Ended June 30,
2005 2004
Interest Interest
Income/ Average Average Rate Income/ Average Average Rate
Expense Balance Earned/Paid Expense Balance Earned/Paid
---------------------------------------------------------------------------------
(Dollars in thousands)
Assets
Interest earning assets:
Federal funds sold and certificate
of deposit $ 45 $ 3,089 5.83% $ 35 $ 2,621 5.34%
Investment securities: (1)
Taxable 1,451 158,382 3.66% 1,260 143,650 3.51%
Tax-exempt 165 16,645 3.97% 191 16,907 4.52%
Loans, net 2,904 176,930 6.57% 2,575 161,572 6.37%
---------------------- -----------------------
Total interest-earning assets 4,565 355,046 5.14% 4,061 324,750 5.00%
-------- ---------
Noninterest-earning assets 26,381 21,575
------------ ------------
Total assets 381,427 346,325
============ ============
Liabilities and Stockholders' Equity:
Interest-bearing liabilities:
Savings 46 35,873 0.51% 42 34,027 0.49%
NOW 14 35,944 0.16% 23 37,941 0.24%
MMDA 342 62,497 2.19% 261 49,501 2.11%
CD's 289 47,163 2.45% 379 64,634 2.35%
---------------------- -----------------------
Total interest-bearing deposits 691 181,477 1.52% 705 186,103 1.52%
Other borrowed funds 85 10,796 3.15% 79 11,332 2.79%
Federal Home Loan Bank advances 1,027 117,757 3.49% 544 82,063 2.65%
Subordinated debentures 135 7,692 7.02% 144 9,000 6.40%
---------------------- -----------------------
Total interest-bearing liabilities 1,938 317,722 2.44% 1,472 288,498 2.04%
-------- ---------
Noninterest-bearing deposits 42,811 41,789
Other noninterest-bearing liabilities 1,206 1,068
------------ ------------
Total liabilities 361,739 331,355
Total stockholders' equity 19,688 14,970
------------ ------------
Total liabilities and stockholders'
Equity $381,427 $346,325
============ ============
Net interest income $2,627 $2,589
======== =========
Interest rate spread 2.70% 2.96%
============ ============
Net interest margin 2.96% 3.19%
============ ============
(1) - Excludes investment securities traded and not settled.
16
Non-interest Income
Total non-interest income increased $539,000, or 30%, to $2.3 million for
the six months ended June 30, 2005 as compared to the six months ended June 30,
2004. The increase was primarily due to an increase in investment advisory fees
due to the acquisition of The de Burlo Group, Inc. at the end of 2004. The
Company earned investment advisory fee revenue of $775,000 for the six months
ended June 30, 2005 versus $0 for the six months ended June 30, 2004. The
increase in investment advisory fee revenue was partially offset by a decrease
of $313,000, or 83.5%, on gains on the sale of investment securities to $62,000
for the six months ended June 30, 2005 due primarily to the flattening of the
yield curve.
Total non-interest income increased $361,000, or 45.8%, to $1,149,000 for
the quarter ended June 30, 2005 as compared to $788,000 for the quarter ended
June 30, 2004. The increase in the second quarter of 2005 was primarily due to
investment advisory fee revenue of $385,000 for the quarter ended June 30, 2005
versus $0 for the quarter ended June 30, 2004.
Non-interest Expense
Total operating expenses increased $551,000, or 8.1%, to $7.4 million for
the six months ended June 30, 2005. Salaries and employee benefits increased
$436,000, or 11.8%, to $4.1 million for the six months ended June 30, 2005.
Salaries and benefits of $416,000 in 2005 associated with the investment
management company acquired at the end of 2004 accounted for a significant
majority of the increase. Occupancy and equipment expenses increased $211,000,
or 22%, to $1.2 million for the six months ended June 30, 2005 due primarily to
increases in rent expense and depreciation on leasehold improvements. Rent
expense increased $78,000, or 26.4%, to $373,000 for the six months ended June
30, 2005 due primarily to the opening of the Cambridge and Beverly branches in
early 2004 and rent expense associated with the investment management company
office. Depreciation on leasehold improvements increased $52,000, or 88%, to
$111,000 for the six months ended June 30, 2005 due to the acceleration of
amortization on the leasehold improvements at the Wal-Mart branches.
Acceleration of amortization, as a result of a change in the expected period of
occupancy from fifteen years to five years, will result in increased expense of
approximately $300,000 for the six months ended December 31, 2005. Advertising
and marketing expenses decreased $102,000, or 38.8%, to $161,000 for the six
months ended June 30, 2005 due primarily to lower media costs as well as the
2004 marketing campaign and promotional costs associated with the new branches.
Data processing expense increased $70,000, or 23.3%, to $370,000 for the six
months ended June 30, 2005 due primarily to increased branch infrastructure.
Professional fees decreased $68,000, or 13.7%, to $427,000 for the six months
ended June 30, 2005 due primarily to a decrease in legal expenses associated
with several matters related to growth plans and expansion initiatives in 2004.
Total operating expenses increased $182,000, or 5.2%, to $3.7 million for
the quarter ended June 30, 2005. Salaries and employee benefits increased
$230,000, or 12.6%, due primarily to salaries and benefits in 2005 associated
with the investment management company acquired at the end of 2004. Occupancy
and equipment expenses increased $88,000, or 17.2%, to $601,000, for the quarter
ended June 30, 2005 due to rent expense associated with the investment
management company office and acceleration of amortization on the leasehold
improvements at the Wal-Mart branches. Advertising and marketing expenses
decreased $92,000, or 47.7%, to $101,000 for the quarter ended June 30, 2005 due
primarily to lower media costs as well as 2004 marketing campaign and
promotional costs associated with new branches. Data processing expense
increased $34,000, or 21.8%, to $190,000 for the quarter ended June 30, 2005 due
primarily to increased branch infrastructure.
Income Taxes
The effective tax rate is significantly lower than the statutory federal
tax rate of 34% for two primary reasons. First, the Company operates three
subsidiary security corporations, which by statute have a lower state income tax
rate. Also, the Company has a high ratio of tax-exempt municipal bond interest
income as a percentage of consolidated pre-tax income. The decrease in the
effective tax rate from the six months ended June 30, 2004 (7.5%) to the six
months ended June 30, 2005 (-14.8%) results from a decrease in pre-tax income of
$200,000, which increases the impact of the security corporations and the
17
tax-exempt municipal portfolio. Also, in the six months ended June 30, 2005, the
Company earned an increased amount of dividends eligible for the federal
dividends received deduction.
The same issues outlined above effect the quarters ended June 30, 2004 and
2005, respectively, in a similar manner. In addition, during the second quarter
of 2005, the Company revised its projected estimated effective income tax rate
for the year ending December 31, 2005 and revised its year-to-date estimated
income tax provision accordingly.
Asset/Liability Management
A principal operating objective of the Bank is to produce stable earnings
by achieving a favorable interest rate spread that can be sustained during
fluctuations in prevailing interest rates. Since the Bank's principal
interest-earning assets generally have longer terms to maturity than its primary
source of funds, i.e., deposit liabilities, increases in general interest rates
will generally result in an increase in the Bank's cost of funds before the
yield on its asset portfolio increases. A continual trade-off, which is managed
and monitored on an ongoing basis, exists between exposure to interest rate risk
and current income. In general, during periods with a normalized yield curve, a
wider mismatch between the re-pricing periods of interest rate sensitive assets
and liabilities can produce higher current net interest income. The management
of interest rate risk considers several factors, including, but not limited to,
the nature and extent of actual and anticipated embedded options and other
attributes of the balance sheet, the perceived direction of market interest
rates, and the risk appetite of management and the Asset/Liability Management
Committee ("ALCO"). Members of the ALCO consist of the chief executive officer,
the chief financial officer, the senior loan officer, one board member, and
others. The committee discusses the asset/liability mix on the balance sheet and
reviews the impact of projected behavioral changes in the components of the
balance sheet as a result of changes in interest rates.
Certain strategies have continued to be implemented in the first and
second quarter of 2005 to reduce the current level of interest rate risk given
the prospects for an improving economy and an increase in market interest rates.
These strategies currently include, but are not limited to, fixing the cost of
certain liability sources, adding interest rate sensitivity to the investment
securities portfolio, and shortening the duration of certain newly originated
commercial loan products. On an ongoing basis, management analyzes the pros and
cons of positioning with a narrower or wider interest rate mismatch and whether
an asset sensitive or liability sensitive balance sheet is targeted and to what
degree. This analysis considers, but is not limited to, originating adjustable
and fixed rate mortgage loans, managing the cost and structure of deposits,
analyzing actual and projected asset cash flow, considering the trade-offs of
short versus long-term borrowings, and reviewing the pros and cons of certain
investment security sectors.
Quarterly, asset/liability modeling is performed with the assistance of an
outside advisor which projects the Bank's financial performance over certain
periods under certain interest rate environments. The results of the process are
reported and discussed at the ALCO meeting on at least a quarterly basis.
Liquidity and Capital Resources
The Bank's primary sources of funds consist of deposits, borrowings,
repayment and prepayment of loans and investment securities, sales of
securities, maturities and early calls of securities, and funds provided from
operations. While scheduled repayments of loans and investment securities are
predictable sources of funds, prepayments on loans and investment securities as
well as other behavioral variables on certain other balance sheet components are
not predictable with certainty. For example, the general level of interest
rates, economic conditions, and competition largely influence prepayments on
loans and investment securities and the renewal rate on term deposits. The Bank
primarily uses its liquidity resources to fund existing and future loan
commitments, to fund net deposit outflows, to invest in other interest-earning
assets, to maintain liquidity, and to pay operating expenses.
From time to time, the Bank utilizes advances from the Federal Home Loan
Bank of Boston (the "FHLB") primarily in connection with its management of the
interest rate sensitivity of its assets and liabilities, to complement or
supplement the volume of retail funding, as well as to selectively capitalize on
leverage opportunities. Total advances outstanding at June 30, 2005 amounted to
$120.8 million. The Bank's ability to borrow from the FHLB is dependent upon the
amount and type of collateral the Bank has to secure the borrowings. Such
collateral consists of, but is not limited to, one-to-four family owner-occupied
residential mortgage loans and federal agency obligations. As of June 30, 2005,
18
the Bank's total borrowing capacity through the FHLB was $143.6 million. The
Bank has additional capacity to borrow federal funds from other banks and
through such instruments as repurchase agreements utilizing federal agency
obligations and mortgage-backed securities as collateral, as well as brokered
deposits.
A major portion of the Bank's liquidity consists of cash and cash
equivalents, short-term investments, U.S. Government and federal agency
obligations, mortgage-backed securities, and other debt securities. The level of
these assets is dependent upon the Bank's operating, lending, and financing
activities during any given period. Certificates of deposit, which are scheduled
to mature in one year or less, totaled $41.8 million at June 30, 2005. Based
upon historical experience, the Bank believes that a significant portion of such
deposits will remain with the Bank. On a monthly basis, the Company currently
generates an average of approximately $6 million in cash flow from the loan and
investment securities portfolios. These funds are primarily used to either
re-invest in new loans and investment securities or utilized in conjunction with
the management of the level of deposit balances or borrowed funds.
At June 30, 2005, the Company and the Bank continued to exceed all
regulatory capital requirements applicable to them. The table below presents the
capital ratios at June 30, 2005, for the Company and the Bank, as well as the
minimum regulatory requirements.
Minimum
Capital
Actual Requirements
Bank: Amount Ratio Amount Ratio
------------------- --------------------
Total capital to risk-weighted assets $29,490 11.00% $21,760 8.00%
Tier 1 capital to risk-weighted assets 27,863 10.39% 10,880 4.00%
Tier 1 capital to average assets 27,863 7.30% 15,152 4.00%
Company:
Total capital to risk-weighted assets $30,479 11.34% $21,806 8.00%
Tier 1 capital to risk-weighted assets 21,643 8.05% 10,903 4.00%
Tier 1 capital to average assets 21,643 5.70% 15,175 4.00%
Off-Balance Sheet Arrangements
The Company is a party to financial instruments with off-balance sheet
risk in the normal course of business primarily associated with meeting the
financing needs of our customers. We may also enter into off-balance sheet
strategies to manage the interest rate risk profile of the Company. Loan
commitments involve, to varying degrees, elements of credit, interest rate, and
liquidity risk.
Lending commitments include commitments to originate loans and to fund
unused lines of credit. The Bank evaluates each customer's creditworthiness on a
case-by-case basis. At June 30, 2005, the Bank had $17.9 million of outstanding
commitments to originate loans and $29 million of unused lines of credit. The
Bank anticipates that it will have sufficient funds available to meet these
commitments, though some commitments may expire and many unused lines are not
drawn upon.
Business Risks
Our recent acquisitions may result in a write-down of goodwill
Our financial condition may be negatively impacted by a write-down of
goodwill. A substantial portion of the purchase price of the investment
management company is allocated to goodwill. Goodwill was also created from the
acquisition of the Boston branch in June. If we determine that goodwill is
impaired at a future date, we would have to write-down its value.
Our expansion into the investment management business poses several risks
We may not be able to retain existing investment management clients, nor
attract new ones. Lack of new clients or the loss of existing clients could
reduce the fee income generated from this business. In addition, the business
acquired generates a majority of its revenue from a handful of clients, thus the
loss of one or two large clients could materially reduce fee income.
19
We may not be able to indefinitely retain existing investment management
personnel. Loss of key personnel could negatively impact customer retention or
growth due to the high orientation to customer knowledge and customer service in
this industry.
Our current loan quality and historical loan growth may not continue,
particularly in new markets or with the loans acquired at the new Boston branch
While the Bank has shown a very low level of loan charge-offs and
non-accrual loans in recent years, and expects to continue to do so, there can
be no assurance that these favorable results will continue in the future. Credit
quality standards may change, substantial growth may weaken underwriting or
other controls, or new customers or relationships may not perform as expected.
Economic or other external factors, deterioration in credit quality, or
appropriate changes in the reserve estimation process as a result of changes in
assumptions, as well as other possible factors, may cause the loan loss
allowance balance to be increased through charges to current earnings by
increasing the loan loss provision.
There can be no assurance that loan customers associated with the loan
balances acquired with the Boston office will choose to remain our customers.
Competition for loans is intense and a majority of the loans could be refinanced
elsewhere without financial hardship to the borrower. Despite our due diligence
on the portfolio, there is also a risk that loan quality may deteriorate as
these loans are to customers we do not know, nor did we perform the original
underwriting.
As the Company continues to target expansion of its geographic loan
footprint and the hiring of new commercial lenders, the maintenance of high
credit quality and continued growth in loan balances is not assured.
The opening of a loan production office in Portsmouth, New Hampshire
offers no assurances that sufficient loan balances of acceptable quality can be
generated to offset the current and future operating expenses of the operation.
The origination of high quality loans, which the Bank is accustomed to, also
cannot be assured.
Our strategy involves significant growth and earnings may not be in accordance
with expectations
We have experienced significant growth in assets, acquired an investment
management business, purchased two new branches in two non-contiguous markets,
and opened a loan production office in a non-contiguous market. Revenue growth
may not meet our expectations in one or more of these areas, while expenses have
already been incurred and expense commitments for the future have been made.
Entering into new markets and new lines of businesses with limited or no
experience or pre-existing business presence poses an inherent risk.
Due to competitive conditions, market conditions, and other factors,
growth in deposit balances, loan balances, or investment management revenues may
not be in accordance with expectations and thus revenue may not support future
growth or an increase in shareholder value. Operating results are also
significantly impacted by factors beyond management's control such as interest
rate conditions and general economic conditions; in particular the general level
of interest rates and the resultant impact on asset yields and the cost of
funds, as well as the ability and willingness of borrowers to fulfill their debt
obligations during various economic cycles.
If we are unable to increase revenue to offset our committed increase in
expenses, our earnings may not improve. If our earnings do not improve, our
access to capital may be impacted or regulatory or governmental scrutiny may
increase.
The Company also may not be successful in retaining or attracting key
management personnel. Loss of key management personnel may result in the delay
or cancellation of plans or strategies under consideration, increased expenses,
operational inefficiencies, or lost revenue.
20
We may not be successful in leasing the commercial space acquired in
Boston on the terms or lease-up ratio we anticipate. Lower than anticipated
rental income from this location may reduce our net income.
We may not be able to attract new deposit customers in new markets or retain
existing deposit customers
We have opened new branches in several non-contiguous markets that are
presently served by other financial institutions. We may not be successful in
generating revenue by raising deposits and originating loans to offset the
initial and ongoing expense of operating these new locations due to loyalty to
existing banks or other competitive or market factors.
The Company anticipates, although cannot assure, that a significant
portion of new customers obtained from its premium-rate term deposit specials
will remain customers for the indefinite future and avail themselves of
additional bank products and services. Our business may be negatively impacted
if we are unable to retain new customers with market-priced deposit products or
cross-sell loan and investment management products.
Management anticipates, but cannot assure, that branch expansion and
continued focus on growth in core deposit categories will generate sufficient
growth in targeted deposit categories and continued growth in deposit fee
income.
The Company is hopeful that solid growth will occur in all core deposit
categories, particularly in new markets. Growth cannot be assured, however,
particularly during a period whereby consumers may perceive more value in other
investment options. The inability to grow deposits ultimately limits asset
growth. An inability to grow deposits sufficient to support loan-funding
requirements would result in an increase in the Bank's already high level of
reliance on generally higher cost wholesale funding. We also may not be able to
retain deposit balances at the Wal-Mart branches after these locations are
closed.
Our capital and expense budgets may limit our ability to compete with larger
financial institutions
We have completed, and will continue to consider, the acquisition of new
businesses or the establishment of new products. Additional such plans may
require an additional issuance of common stock, which may be dilutive to
existing shareholders. These strategies may also significantly increase
operating expenses, which may reduce our net income if sufficient revenue is not
generated.
Our current and future earnings, in addition to our capital, may not allow
us to compete with other institutions with regards to pricing deposits, pricing
loans, investing in new technologies, or investing in new initiatives. Our
growth and future earnings may be limited if we are unable to keep pace with
rapid technological innovation or if we are unable to compete with marketing and
promotional expense budgets of our larger competitors.
Banking is a highly regulated industry and restrictions, limitations, or new
laws could impact our business
Several non-banking competitors are not subject to strict lending and
deposit disclosure laws that impact national banks. Our commitment to compliance
with laws and regulations and the cost to do so could impact the decision of
customers to seek our banking services or our ability to devote sufficient
attention to business development as opposed to consumer compliance.
The Company is subject to review and oversight of several governmental
regulatory agencies. Such agencies impose certain guidelines and restrictions,
such as capital requirements and lending limits that may impact our ability to
compete with other financial service providers who may not be subject to these
restrictions.
New laws or changes in existing laws may limit the ability to expand or
enter into new businesses that otherwise may be available to other financial
service providers.
21
The interest rate environment may reduce our earnings or liquidity or the
Company may not respond sufficiently to changes in interest rates or other
factors impacting the business
Changes in the interest rate environment may have a significant impact on
the future earnings and liquidity of the Company. If interest rates continue to
rise or the yield curve continues to flatten, net interest income may narrow
further. Liquidity could be reduced in the future if customers choose other
investment options in an improving economy. Liquidity could also be negatively
impacted if current strategies to increase deposit balances in several new
locations do not occur as planned due to competitive or other factors. Although
we may be successful raising deposits in certain markets, we may have to pay
higher than planned rates on these deposits to do so.
An increase in market interest rates, continued competition from several
local and national financial institutions, and increased reliance on higher cost
funding sources could also cause higher rates paid on deposits without an equal
or greater increase on yields on new loans.
The Company assesses its interest rate risk and liquidity needs
frequently, however, there is no assurance that its assessments result in
appropriate actions on a timely basis or that interest rates do not change
rapidly without corrective actions.
The Company maintains its entire portfolio of long-term fixed rate loans
on its books and is thus susceptible to interest rate risk in the event of a
higher rate environment to the extent the prepayment activity on these loans
falls, while the cost of funds increases. To the extent longer-term fixed rate
loans are being held on the books at historic lows in a protracted low interest
rate environment, it is important that growth in longer-term checking and
savings balances occurs in several markets.
The Company has had some success in increasing the level of adjustable
rate loans and loans with shorter amortization periods or maturity dates, but
has had little success in extending the terms of its deposits. These trends may
reduce net interest income in the future.
Given the strong emphasis on generating new loans, the risk exists that
loan demand could place a strain on liquidity. The Bank may have to slow its
pace of new loan approvals and thus may generate less interest income without
sufficient liquidity.
The Company's inability to file audited financial statements for the Boston
branch of the Atlantic Bank may impair the Company's ability to raise capital
Typical of the banking industry, the Company is unable to obtain audited
financial statements of a retail branch. Under SEC rules, the Company may be
unable, until early 2008, to raise capital through a public offering or a
private offering to unaccredited investors without having filed audited
financial statements for the Boston branch. The Company may raise capital, if it
so chooses, through a private offering of its securities to accredited
investors. The Company may be able to raise capital through a public offering or
a private offering to unaccredited investors before early 2008 if it chooses to
submit 2005 and/or 2006 audited financial statements of the Company to the SEC
and the SEC subsequently grants a waiver of this restriction on raising capital.
ITEM 3. Controls and Procedures
(a) Evaluation of disclosure controls and procedures.
As required by Rule 15d-15 under the Securities Exchange Act of
1934, as amended (the "Exchange Act"), the Company's management conducted
an evaluation with the participation of the Company's Chief Executive
Officer and Chief Financial Officer, regarding the effectiveness of the
Company's disclosure controls and procedures, as of the end of the last
fiscal quarter. In designing and evaluating the Company's disclosure
controls and procedures, the Company and its management recognize that any
controls and procedures, no matter how well designed and operated, can
provide only a reasonable assurance of achieving the desired control
objectives, and management necessarily was required to apply its judgment
in evaluating and implementing possible controls and procedures. Based
upon that evaluation, the Chief Executive Officer and Chief Financial
Officer concluded that they believe the Company's disclosure controls and
procedures are reasonably effective to ensure that information required to
be disclosed by the Company in the reports it files or submits under the
22
Exchange Act is recorded, processed, summarized and reported, within the
time periods specified in the Securities and Exchange Commission's ("SEC")
rules and forms. We intend to continue to review and document our
disclosure controls and procedures, including our internal controls and
procedures for financial reporting, and we may from time to time make
changes to the disclosure controls and procedures to enhance their
effectiveness and to ensure that our systems evolve with our business.
(b) Changes in internal controls over financial reporting.
There were no changes in the Company's internal controls over
financial reporting identified in connection with the Company's evaluation
of its disclosure controls and procedures that occurred during the
Company's last fiscal quarter that have materially affected, or are
reasonably likely to materially affect the Company's internal control over
financial reporting.
PART II -- OTHER INFORMATION
ITEM 1. Legal Proceedings
Except as described below, the Company is not involved in any pending
legal proceedings other than routine legal proceedings occurring in the ordinary
course of business that, in the aggregate, involved amounts believed by
management to be immaterial to the financial condition and operations of the
Company.
By letter dated July 26, 2004, the Massachusetts Department of
Environmental Protection notified the Bank of audit findings and non-compliance
concerning the parking lot behind the Bank's main office, which has been found
to contain certain contaminants. Investigations done to date observe that
contamination characteristic of coal tar and oil is located on the property.
That notice stated that the Bank has not met the requirements of "Downgradient
Property Status" for which the Bank had applied in 1996. The notice directed the
Bank to submit a revised application or to take other action as may be required
under the Massachusetts Contingency Plan. By letter dated July 28, 2005, the
Massachusetts Department of Environmental Protection notified the Bank of the
requirement to remediate the site. On August 11, 2005, bank management met with
appropriate parties to initiate resolution of the matter. The Bank has an
accrual on its books which potential expenses are not anticipated to exceed.
On October 12, 2004, the Bank sent a notice of termination of the Bank's
lease of premises at 22 Market Square, Portsmouth, New Hampshire, to its then
landlord thereunder, LBJ Properties, LLC, because the premises had been
determined by the Bank's consultants to be unsuitable for the Bank's purposes. A
dispute existed between the Bank and LBJ Properties, LLC over whether the Bank
had the right to terminate the lease. On May 24, 2005, the Bank paid an amount
to settle the dispute that was less than the amount accrued on its books and
thus the settlement had no impact on second quarter earnings.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
Not applicable.
ITEM 3. Defaults Upon Senior Securities
Not applicable.
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ITEM 4. Submission of Matters to a Vote of Security Holders
On April 13, 2005, the Company held its Annual Meeting of Stockholders.
The following actions were taken at the Annual Meeting:
1. The following twelve nominees were elected to serve as directors for a
one-year term and until their successors are duly elected and qualified by the
following votes:
Name For Withheld
- --------------------------- --------- --------
Robert R. Borden, III 1,602,681 100
Timothy R. Collins 1,602,681 100
Franz Colloredo-Mansfeld 1,602,681 100
John T. Coughlin 1,602,681 100
Craig H. Deery 1,602,681 100
Edward D. Dick 1,602,681 100
Stephanie R. Gaskins 1,602,681 100
Donald P. Gill 1,602,681 100
H.A. Patrician, Jr. 1,602,681 100
Neil St. John Raymond 1,602,681 100
Neil St. John Raymond, Jr. 1,602,681 100
William J. Tinti 1,602,681 100
There were no abstentions or broker non-votes with respect to this action.
2. A proposal to ratify the selection of Wolf & Company, P.C. as the
Company's independent registered public accounting firm for the fiscal year
ending December 31, 2005 was approved as follows: 1,601,121 votes for, and 100
votes against. There were 1,560 abstentions and no broker non-votes with respect
to this action.
ITEM 5. Other Information
Not applicable.
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits
31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a)
of the Securities Exchange Act of 1934.
31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a)
of the Securities Exchange Act of 1934.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
(b) Reports on Form 8-K
The Company filed the following reports on Form 8-K during the second quarter of
2005:
On April 15, 2005, the Company filed a report on Form 8-K regarding the
retirement of two members of the Board of Directors.
On May 13, 2005, the Company filed a report on Form 8-K announcing its
financial results for the quarter ended March 31, 2005. The announcement was
made by reference to a press release.
On June 24, 2005, the Company filed a report on Form 8-K to announce that
the Bank completed the purchase of certain of the assets and assumed certain of
the deposit and other liabilities of the Boston, Massachusetts branch of
Atlantic Bank of New York.
On June 29, 2005, the Company filed a report on Form 8-K regarding
additional details of the Bank's acquisition of the Boston, Massachusetts branch
of Atlantic Bank of New York.
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SIGNATURES
In accordance with the requirements of the Securities Exchange Act of
1934, the registrant has duly caused this report to be signed on its behalf by
the undersigned, thereunto duly authorized.
Date: August 12, 2005 By: /s/ Donald P. Gill
-----------------------------
Donald P. Gill
President and Chief Executive Officer
Date: August 12, 2005 By: /s/ Michael J. Wolnik
-----------------------------
Michael J. Wolnik
Senior Vice President,
Chief Financial Officer,
and Treasurer
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