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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 September 30, 2005
|_| TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from to
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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)
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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 |_| NO |X|
State the number of shares outstanding of each of the issuer's classes of
common equity, as of the latest practical date: At September 30, 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 September 30, 2005 and
December 31, 2004 3
Consolidated Statements of Income for the quarter and
nine months ended September 30, 2005 and 2004 4
Consolidated Statements of Changes in Stockholders' Equity for
the nine months ended September 30, 2005 and 2004 5
Consolidated Statements of Cash Flows for the nine months ended
September 30, 2005 and 2004 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis 9
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 25
Item 5. Other Information 25
Item 6. Exhibits and Reports on Form 8-K 25
Signatures 25
2
PART I--FINANCIAL INFORMATION
ITEM 1. Financial Statements
FIRST IPSWICH BANCORP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (unaudited)
(In thousands, except share data)
September 30, December 31,
2005 2004
---------- ----------
ASSETS
Cash and due from banks $ 11,040 $ 8,970
Federal funds sold 168 106
---------- ----------
Total cash and cash equivalents 11,208 9,076
---------- ----------
Certificate of deposit 3,274 3,212
Securities available for sale, at fair value 90,128 153,987
Securities held to maturity, at amortized cost 29,350 31,909
Federal Home Loan Bank stock, at cost 6,647 5,590
Federal Reserve Bank stock, at cost 774 549
Loans, net of allowance for loan losses of $1,686 and $1,340 228,234 168,883
Banking premises and equipment, net 9,638 5,806
Other assets 11,076 8,168
---------- ----------
Total assets $ 390,329 $ 387,180
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $ 267,612 $ 254,842
Short-term borrowings 56,086 66,468
Long-term borrowings 31,640 37,383
Subordinated debentures 14,000 7,000
Other liabilities 1,514 1,669
---------- ----------
Total liabilities 370,852 367,362
---------- ----------
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 8,410 8,210
Accumulated other comprehensive loss (998) (457)
Treasury stock, at cost - 20,490 shares (111) (111)
---------- ----------
Total stockholders' equity 19,477 19,818
---------- ----------
Total liabilities and stockholders' equity $ 390,329 $ 387,180
========== ==========
See accompanying notes to consolidated financial statements.
3
FIRST IPSWICH BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME (unaudited)
(In thousands, except per share data)
Quarter Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
2005 2004 2005 2004
-------- -------- -------- --------
Interest and dividend income:
Interest and fees on loans $ 3,730 $ 2,647 $ 9,355 $ 7,745
Interest on debt securities:
Taxable 1,089 1,462 3,641 3,961
Tax-exempt 177 187 530 570
Dividends on equity securities 108 64 499 174
Other interest 45 37 135 106
-------- -------- -------- --------
Total interest and dividend income 5,149 4,397 14,160 12,556
-------- -------- -------- --------
Interest expense:
Interest on deposits 764 856 2,219 2,079
Interest on borrowed funds 1,154 672 3,180 1,958
Interest on subordinated debentures 238 152 487 440
-------- -------- -------- --------
Total interest expense 2,156 1,680 5,886 4,477
-------- -------- -------- --------
Net interest income 2,993 2,717 8,274 8,079
Provision for loan losses 78 -- 185 --
-------- -------- -------- --------
Net interest income, after provision for loan losses 2,915 2,717 8,089 8,079
Other income:
Investment advisory fees 413 -- 1,187 --
Service charges on deposit accounts 357 363 962 1,013
Credit card fees 211 196 553 508
Trust fees 134 104 370 307
Non-deposit investment fees 94 105 274 267
Gain (loss) on sales and calls of
securities, net (3) 403 58 778
Miscellaneous 248 (38) 390 60
-------- -------- -------- --------
Total other income 1,454 1,133 3,794 2,933
-------- -------- -------- --------
Operating expenses:
Salaries and employee benefits 2,151 1,745 6,283 5,440
Occupancy and equipment 833 542 2,003 1,501
Professional fees 347 250 774 744
Credit card interchange 144 139 377 380
Advertising and marketing 93 113 254 376
Data processing 188 161 558 459
ATM processing 92 103 279 294
Other general and administrative 392 362 1,092 1,049
-------- -------- -------- --------
Total operating expenses 4,240 3,415 11,620 10,243
-------- -------- -------- --------
Income before income taxes 129 435 263 769
Provision (credit) for income taxes (1) 110 (21) 134
-------- -------- -------- --------
Net income $ 130 $ 325 $ 284 $ 635
======== ======== ======== ========
Weighted average common shares outstanding:
Basic 2,220 2,058 2,220 1,859
-------- -------- -------- --------
Diluted 2,220 2,161 2,220 1,962
-------- -------- -------- --------
Earnings (loss) per share:
Basic $ 0.06 $ 0.16 $ 0.13 $ 0.34
======== ======== ======== ========
Diluted $ 0.06 $ 0.15 $ 0.13 $ 0.32
======== ======== ======== ========
See accompanying notes to consolidated financial statements.
4
FIRST IPSWICH BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (unaudited)
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2005 AND 2004
(In thousands, except per share data)
Accumulated
Additional Other
Paid-in Retained Comprehensive Treasury
Common Stock Capital Earnings Income (Loss) Stock Total
------------ ------- -------- ------------- ----- -----
Balance at December 31, 2003 $1,778 $5,894 $7,826 $(119) $(111) $15,268
--------
Comprehensive income:
Net income 635 635
Unrealized loss on securities
available for sale, net of
reclassification adjustment
and tax effect (393) (393)
--------
Total comprehensive income 242
--------
Proceeds from issuance of common
stock (300,000 shares) 300 3,304 3,604
Cash dividends declared ($.0375
per share) (71) (71)
------ ------ ------ ----- ----- -------
Balance at September 30, 2004 2,078 9,198 8,390 (512) (111) 19,043
====== ====== ====== ===== ===== =======
Balance at December 31, 2004 2,240 9,936 8,210 (457) (111) 19,818
Comprehensive loss:
Net income 284 284
Unrealized loss on securities
available for sale, net of
reclassification adjustment
and tax effect (541) (541)
--------
Total comprehensive loss (257)
--------
Cash dividends declared ($.0375
per share) (84) (84)
------ ------ ------ ----- ----- -------
Balance at September 30, 2005 $2,240 $9,936 $8,410 $(998) $(111) $19,477
====== ====== ====== ===== ===== =======
See accompanying notes to consolidated financial statements.
5
FIRST IPSWICH BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(In thousands)
For the Nine Months Ended
September 30,
2005 2004
---------- ----------
Cash flows from operating activities:
Net income $ 284 $ 635
Adjustments to reconcile net income to net cash provided (used)
by operating activities:
Provision for loan losses 185 --
Gain on sales and calls of securities, net (58) (778)
Depreciation and amortization 786 516
Net amortization of securities, including certificate of deposit 207 684
Derivative fair value adjustment (50) 116
Amortization of core deposit intangible 83 31
Net change in other assets and other liabilities 429 (730)
---------- ----------
Net cash provided by operating activities 1,008 474
---------- ----------
Cash flows from investing activities:
Purchase of certificates of deposit (896)
Activity in available-for-sale securities:
Purchases (33,417) (148,059)
Sales 60,933 76,418
Maturities, calls and paydowns 35,387 36,594
Activity in held-to-maturity securities:
Purchases (1,476)
Sales 1,116
Maturities, calls and paydowns 2,497 6,541
Purchase of Federal Home Loan Bank stock (1,057) --
Purchase of Federal Reserve Bank stock (225) --
Net cash paid in acquisition of Boston branch (24,852) 0
Loan originations, net of repayments (16,204) (9,100)
Premises and equipment acquired in branch acquisition (4,537)
Purchase of premises and equipment (81) (696)
---------- ----------
18,444 (39,558)
---------- ----------
Cash flows from financing activities:
Net increase (decrease) in deposits (8,111) 49,546
Net cash received in acquisition of Cambridge branch -- 9,552
Net increase (decrease) in short-term borrowings (10,382) (2,443)
Proceeds from subordinated debenture 7,000 --
Repayment of long-term debt (5,743) (15,814)
Proceeds from issuance of common stock 3,604
Cash dividends paid (84) (71)
---------- ----------
Net cash provided by financing activities (17,320) 44,374
---------- ----------
Net increase (decrease) in cash and cash equivalents 2,132 5,290
Cash and cash equivalents at beginning of period 9,076 9,685
---------- ----------
Cash and cash equivalents at end of period $ 11,208 $ 14,975
========== ==========
Supplemental disclosures:
Interest paid $ 5,886 $ 4,477
Income taxes paid 135 122
Due to broker -- 1,385
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 September 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 have increased the number of shares outstanding, but
would not have required an adjustment to income as a result of the conversion.
All warrants outstanding were exercised on December 29, 2004. For the nine
months ended September 30, 2004, all common stock equivalents were considered
dilutive. For the nine months ended September 30, 2005, there are no common
stock equivalents outstanding.
(3) Commitments
At September 30, 2005, the Company had outstanding commitments to
originate loans of $27 million. Unused lines of credit and open commitments
available to customers at September 30, 2005 amounted to $62.6 million, of which
$36.4 million related to construction loans, $10.5 million related to home
equity lines of credit, $5 million related to credit card loans and $10.7
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 nine
months ended September 30, 2005 follows. There were no separately reportable
segments prior to the acquisition of the de Burlo Group, Inc. on December 31,
2004.
7
Investment Consolidated
Banking Advisory Totals
------- -------- ------
Net interest income $ 8,274 -- $ 8,274
Other revenue: external customers 2,607 $1,187 3,794
Net income 64 220 284
Assets $ 387,581 $2,748 $390,329
Information about reportable segments for the three months ended September
30, 2005 were as follows:
Investment Consolidated
Banking Advisory Totals
------- -------- ------
Net interest income $ 2,993 -- $ 2,993
Other revenue: external customers 1,041 $ 413 1,454
Net income 52 78 130
(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 at the time of the transaction. 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 29.2
-----
Core deposit intangible and goodwill $ 2.5
=====
On October 21, 2005, the post closing settlement statement was signed by
representatives of The First National Bank of Ipswich and Atlantic Bank of New
York. The remaining premium balances were paid, based upon the Deposit
settlement as of the close of business on September 19, 2005. The updated
deposit balances maintained were $18.3 million.
(6) Banking Premises
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.
The Bank has signed a Letter of Intent to assume a location in downtown
Portsmouth, New Hampshire. The purpose of leasing this space is to combine the
temporary loan production office in Portsmouth with the retail branch currently
located at its Newington Wal-Mart location. It is anticipated that this facility
will be operational during the first quarter of 2006.
8
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.
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 August 9th and September 20th. The impact of recent weather related events
throughout the country have had an impact on personal spending as they relate to
travel costs and anticipated heating expenses for the coming winter season. As
such the Northeast real estate market has slowed as the prices of new and
previously owned homes are being impacted by the aforementioned weather issues.
9
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, 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. The Company
anticipates earnings for the three months ending December 31, 2005 to continue
to be impacted negatively by tightening margins. In addition, Management's
decision to close three in-store branch locations by December 31, 2005 has had,
and will continue to have, through December 31, 2005 a negative impact on
earnings due to the increased pace of leasehold amortization and associated
employee expenses.
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 potential materiality to the financial statements and the
judgments involved. Management considers impairment of intangible assets to be a
critical accounting policy because of their materiality to the balance sheet
item and the estimation of fair values involves a high degree of judgment and
subjectivity in the assumptions utilized.
Comparison of Financial Condition at September 30, 2005 versus December 31, 2004
Total assets were $390.3 million at September 30, 2005, an increase of
$3.2 million, or .8%, from $387.2 million as of December 31, 2004. The
completion of the Boston branch acquisition at the end of the second quarter has
impacted various categories on the Company's consolidated balance sheet. The
integration of the loan and deposit portfolios will be the focus of the
following discussion.
Loans
Total net loan balances were $228.2 million as of September 30, 2005, an
increase of $59.7 million, or 35.1%, 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 previously mentioned. They 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, Boston, 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 $100.5 million as of September
30, 2005, an increase of $39.9 million, or 65.8%, 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 $26.1 million, or 132.8%,
to $45.7 million as of September 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 $6.1 million, or 26.4%, to $16.9
million as of September 30, 2005 due primarily to a decline in seasonal sales
activity and the cyclical nature of the level of advanced funds. 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.
10
Residential real estate loan balances, including equity lines of credit,
of $64.8 million as of September 30, 2005 decreased $.4 million, or .61%, from
$65.2 million as of December 31, 2004. The anticipated increase in market rates,
combined with the seasonality of residential consumer purchases have been the
predominate causes for the leveling off of residential real estate loan
balances.
The following table presents the composition of the Bank's loan portfolio
by type of loan at the dates indicated.
September 30, December 31,
2005 2004
------------- ------------
(Dollars in thousands)
Real estate mortgage loans:
Residential $ 54,617 $ 55,749
Commercial 100,510 60,616
Construction 16,933 23,016
Equity lines of credit 10,198 9,465
Commercial loans 45,695 19,627
Consumer loans 1,991 1,792
--------- ---------
Total loans 229,944 170,265
Net deferred origination fees (24) (42)
Allowance for loan losses (1,686) (1,340)
--------- ---------
Loans, net $ 228,234 $ 168,883
========= =========
Asset Quality and Allowance for Loan Losses
The table below summarizes certain key ratios regarding the quality of the
Bank's loan portfolio:
September 30, December 31,
2005 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 0.73% 0.79%
For the nine months ended September 30, 2005, the Bank recorded a $185,000
provision for loan losses as a result of growth in loan originations. The Bank
recorded charge-offs of $42,000 and recoveries of $4,000 for the nine months
ended September 30, 2005. The allowance for loan losses was $1,686,000 at
September 30, 2005, an increase of $346,000 since December 31, 2004. The
allowance 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.
11
Investment Securities
Total investment securities, which includes available-for-sale securities,
held-to-maturity securities and Federal Home Loan Bank and Federal Reserve Bank
stock were $130.1 million as of September 30, 2005, a decrease of $65.1 million,
or 33.3%, from $195.2 million as of December 31, 2004. Available for sale
investment security sales of $60.9 million and calls and principal pay-downs on
investment securities of $35.4 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 half of 2005, while also minimizing the need to sell securities at
unfavorable prices.
The following table presents the composition of the Company's
available-for-sale and held-to-maturity securities portfolios at the dates
indicated
September 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 $ 30,870 $ 30,437 $ 54,105 $ 53,868
Trust preferred securities -- -- 970 974
Mortgage-backed securities 55,560 54,463 78,946 78,575
Corporate bonds 1,808 1,742 1,786 1,746
Municipal bonds 370 350 635 610
--------- --------- --------- ---------
Total debt securities 88,608 86,992 136,442 135,773
Marketable equity securities 84 98 84 104
Preferred stock 2,956 3,038 18,456 18,110
--------- --------- --------- ---------
Total securities available for sale $ 91,648 $ 90,128 $ 154,982 $ 153,987
========= ========= ========= =========
Securities held to maturity
U.S. Government agency obligations $ 3,000 $ 2,871 $ 3,000 $ 2,928
Municipal bonds 15,118 14,920 16,201 16,098
Mortgage-backed securities 11,232 10,930 12,708 12,524
--------- --------- --------- ---------
Total securities held to maturity $ 29,350 $ 28,721 $ 31,909 $ 31,550
========= ========= ========= =========
Deposits
Total deposit balances were $267.6 million as of September 30, 2005, an
increase of $12.8 million, or 5.0%, from $254.8 million as of December 31, 2004.
Total deposit balances increased primarily due to the September 2005 certificate
of deposit promotion celebrating the opening of the new Boston branch
acquisition. This promotion caused an infusion of time deposits in the amount of
$38 million with a maturity of eleven months and a rate of 4.25%. Approximately
$26 million represented new funds with the remaining $12 million representing
balance transfers from current customer accounts. The acquisition of the Boston
branch in June assumed new balances of $18 million through the end of September.
Term deposits declined by over $22 million during the first two quarters
of 2005 due to the decision to allow a 2004 new branch certificate of deposit
promotion to run off in anticipation of the Boston branch promotion previously
mentioned.
12
Non-interest bearing demand deposit balances increased $13.1 million or
32%. NOW account balances declined slightly $.5 million or 1%, while regular
savings increased by $2.4 million or 6.8%. The fluctuation in these categories
was caused by two primary events -- the acquisition of the Boston branch
accounts and internal transfers to the time deposit promotion previously
mentioned.
Money market balances continued to decline during the third quarter. Total
balances, now $54.7 million at September 30, 2005 have declined $13.1 million
since December 31, 2004 or 19.3%. Money market promotions at competitive
institutions during the first half of 2005 was the primary factor through June
30th of 2005. Internal transfers related to the Boston branch certificate of
deposit promotion was the primary cause of reduction through the third quarter
of 2005.
The following table shows the composition of the Company's deposit
balances at the dates indicated.
September 30, December 31,
2005 2004
------------- ------------
Demand $ 54,228 $ 41,098
NOW 37,048 37,505
Regular savings 37,129 34,767
Money market deposits 54,732 67,858
Term certificates 84,475 73,614
---------- ----------
$ 267,612 $ 254,842
========== ==========
Borrowings
Short-term borrowings declined $10.4 million, or 15.6%, to $56 million
from $66.4 million at December 2004. Long-term borrowings declined $5.7 million,
or 15.4% to $31.6 million from $37.4 million at year end 2004. Combined,
borrowings declined $16.1 million or 15.5% to $87.6 million from year end 2004
balances of $103.8 million.
The primary cause for these declines were due to the deposit inflow from
the Boston branch certificate of deposit promotion.
Stockholders' Equity
Total stockholders' equity decreased from $19.8 million at December 31,
2004 to $19.5 million as of September 30, 2005 due primarily to an increase in
the accumulated other comprehensive loss of $541,000 associated with an
unrealized loss, net of tax, on available-for-sale securities resulting from a
general increase in interest rates and the resultant impact on the Company's
debt securities available for sale. This was partially offset by net income of
$284,000 for the nine months ended September 30, 2005.
Comparison of Operating Results for the Quarter and Nine Months Ended
September 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 (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, investment advisory fees), 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.
13
Net income for the nine months ended September 30, 2005 was $284,000
compared with $635,000 for the nine months ended September 30, 2004, a decrease
of $351,000, or 55%. For the nine months ended September 30, 2005, net interest
income increased $195,000, or 2.41%, non-interest income increased $861,000, or
29.4%, and operating expenses increased $1.4 million or 13.4%, as compared to
the nine months ended September 30, 2004. The increase in the provision for loan
losses for the nine months ended September 30,, 2005 reflects the significant
growth in the loan portfolio and the Boston acquisition of approximately $43
million in new loans.
Net income for the three months ended September 30, 2005 was $130,000
compared with $325,000 for the three months ended September 30, 2004, a decrease
of $195,000, or 60%. For the three months ended September 30, 2005, net interest
income increased $276,000, or 10.2%, non-interest income increased $321,000, or
28.3%, and operating expenses increased $825,000, or 24.2%, as compared to the
three months ended September 30, 2004. The increase in the provision for loan
losses for the three months ended September 30, 2005 reflects the growth in the
loan portfolio from not only the original branch network but also the new Boston
branch and the loan production office located in Portsmouth, New Hampshire.
Interest and Dividend Income
Total interest and dividend income for the nine months ended September 30,
2005 was $14.2million, which was $1.6 million, or 12.8%, higher than the nine
months ended September 30, 2004. This increase was due to the favorable impact
of higher average interest-earning assets of $360.4 million for the nine months
ended September 30, 2005, as compared to $331.5 million for the nine months
ended September 30, 2004. The yield on earning assets of 5.24% for the nine
months ended September 30, 2005 was 19 basis points higher than for the nine
months ended September 30, 2004. Average net loans for the nine months ended
September 30, 2005 increased $28.9 million, or 17.9%, to $190 million, while the
yield on loans for the nine months ended September 30, 2005 was 6.57%; 16 basis
points higher than the nine months ended September 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. A significant portion of
this growth was due to the acquisition of the Boston branch location at the end
of the second quarter.
Total interest and dividend income for the quarter-ended September 30,
2005 was $5.1 million, which was $752,000, or 17.1%, higher than the
quarter-ended September 30, 2004. This increase was due to the favorable impact
of higher average interest-earning assets and a higher asset yield. Average
interest-earning assets of $365 million for the quarter ended September 30, 2005
were $10.9 million higher than average interest-bearing assets of $354.1 million
for the quarter ended September 30, 2004. The yield on earning assets increased
to 5.64% for the quarter-ended September 30, 2005 as compared to 4.97% for the
quarter-ended September 30, 2004 due primarily to higher loan yields. Average
net loans for the quarter ended September 30, 2005 increased $57.6 million, or
35%, to $221.9 million. This growth was predominately impacted by the Boston
branch acquisition.
Interest Expense
Interest expense on interest-bearing deposits for the nine months ended
September 30, 2005 increased $140,000, or 6.7%, to $2.2 million as compared to
the nine months ended September 30, 2004. This increase was due to a higher cost
of deposits specifically in the money market and time deposit categories. The
cost of interest-bearing deposits increased 4 basis points to 1.54% for the nine
months ended September 30, 2005 versus 1.50% for the nine months ended September
30, 2004. Average interest-bearing deposit balances of $191.6 million for the
nine months ended September 30, 2005 were $6.8 million, or 3.7%, higher than the
nine months ended September 30, 2004. The increase in the cost of deposits was
due primarily to an increased cost on MMDA balances of 21 basis points to 2.12%
for the nine months ended September 30, 2005 and an increase in average MMDA
balances of $13.8 million, or 27.5%, to $63.8 million for the nine months ended
September 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.
14
Interest expense on deposits for the quarter-ended September 30, 2005
decreased $92,000, or 10.7%, to $764,000 as compared to the quarter-ended
September 30, 2004. Interest expense on deposits decreased for the quarter-ended
September 30, 2005 due primarily to a decrease in average interest-bearing
deposit balances to $194.4 million, a decrease of $15.1 million, or 7.2%.
Average interest-bearing deposit balances decreased due to a decrease of $25.2
million, or 32.2%, to $53 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. The impact of the Boston
branch certificate of deposit promotion held at the end of September 2005 had
limited impact in this quarter.
Interest expense on borrowed funds for the nine months ended September 30,
2005 increased $1.2 million, or 62.4%, to $3.2 million as compared to the nine
months ended September 30, 2004. The increase was due primarily to an increase
of 93 basis points to 3.54% in the cost of Federal Home Loan Bank advances, due
to the increases in the Federal Funds target rate, and an increase in the
average balance in Federal Home Loan Bank advances in 2005 of $21 million, or
23.7%. Federal Home Loan Bank Advances were higher for the nine months ended
September 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 September 30,
2005 increased $482,000, or 71.7%, to $1.2 million as compared to $672,000 for
the quarter-ended September 30, 2004. The increase was due primarily to an
increase of 105 basis points to 3.93% in the cost of Federal Home Loan Bank
advances, due to the increases in the Federal Funds target rate, and an increase
in the average balance in Federal Home Loan Bank advances for the quarter-ended
September 30, 2005 of $25.4 million, or 31.5% as a result of funding the Boston
branch acquistion. Federal Home Loan Bank Advances were higher for the quarter
ended September 30, 2005 due to lower average deposit balances, combined with
higher average assets.
Net Interest Income
Net interest income for the nine months ended September 30, 2005 increased
$195,000, or 2.4%, to $8.3 million as compared to the nine months ended
September 30, 2004. The increase in the net interest margin reflects the
increases in the average balances of interest earning assets, more specifically
the nearly 18% rise in the volume of loans over the same period in 2004. The
acquisition of the Boston branch, the opening of the loan production office in
Portsmouth, New Hampshire, along with the continued loan growth in our primary
community bank market were all factors in the loan volume growth. Earnings from
debt and equity securities declined 1% while the investment portfolio remained
approximately the same average balance of $170 million for both periods. This,
along with the substantial rise in borrowing expenses have accounted for the
limited growth in net interest income for the first nine months.
Net interest income for the quarter ended September 30, 2005 increased
$276,000 or 10.2% to $3 million as compared to the quarter ended September 30,
2004. The increase in net interest income for the quarter can be primarily
attributed to the increased average balances in the loan portfolio. This is the
first full quarter with the Boston acquisition portfolio included in quarterly
calculations. The increase was offset by substantial increases in borrowing
expenses related to the rising interest rate environment and the new borrowings
related to the Boston branch acquisition. This improvement in the third quarter
of 2005 spread is the primary reason for year to date net interest income to
turn positive in 2005.
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 three and nine months ended September 30, 2005 and 2004.
The average balances are derived from average daily balances.
15
Nine Months Ended September 30,
2005 2004
Interest Average Interest Average
Income/ Average Rate Income/ Average Rate
Expense Balance Earned/Paid Expense Balance Earned/Paid
--------------------------------------------------------------------------------------
(Dollars in thousands)
Assets
Interest earning assets:
Federal funds sold and certificate
of deposit $ 135 $ 3,099 5.81% $ 106 $ 2,740 5.16%
Investment securities: (1)
Taxable 4,140 151,169 3.65% 4,135 150,793 3.66%
Tax-exempt 530 16,222 4.36% 570 16,896 4.50%
Loans, net 9,355 189,950 6.57% 7,745 161,088 6.41%
-------------------------- ---------------------------
Total interest-earning assets 14,160 360,440 5.24% 12,556 331,517 5.05%
------------ ------------
Noninterest-earning assets 28,129 21,365
------------- --------------
Total assets 388,569 352,882
============= ==============
Liabilities and Stockholders' Equity:
Interest-bearing liabilities:
Savings 142 37,052 0.51% 123 33,070 0.50%
NOW 43 36,279 0.16% 70 37,140 0.25%
MMDA 1,013 63,843 2.12% 718 50,075 1.91%
CD's 1,021 54,453 2.50% 1,168 64,514 2.41%
-------------------------- ---------------------------
Total interest-bearing deposits 2,219 191,627 1.54% 2,079 184,799 1.50%
Other borrowed funds 271 11,350 3.18% 224 11,649 2.56%
Federal Home Loan Bank advances 2,909 109,626 3.54% 1,734 88,601 2.61%
Subordinated debentures 487 9,590 6.77% 440 9,000 6.52%
-------------------------- ---------------------------
Total interest-bearing liabilities 5,886 322,193 2.44% 4,477 294,049 2.03%
------------ ------------
Noninterest-bearing deposits 45,376 41,180
Other noninterest-bearing liabilities 1,254 1,301
------------- --------------
Total liabilities 368,823 336,530
Total stockholders' equity 19,746 16,532
------------- --------------
Total liabilities and stockholders'
Equity $ 388,569 $ 352,882
============= ==============
Net interest income $ 8,274 $ 8,079
============ ============
Interest rate spread 2.80% 3.02%
============ =========
Net interest margin 3.06% 3.25%
============ =========
(1) Excludes investment securities traded and not settled.
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 September 30, 2005 and 2004. The
average balances are derived from average daily balances.
16
Three Months Ended September 30,
2005 2004
Interest Average Interest Average
Income/ Average Rate Income/ 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 $ 3,058 5.89% $ 37 $ 3,095 4.78%
Investment securities: (1)
Taxable 1,197 124,334 3.85% 1,526 169,874 3.59%
Tax-exempt 177 15,712 4.51% 187 16,823 4.45%
Loans, net 3,730 221,900 6.72% 2,647 164,344 6.44%
------------------------- -------------------------
Total interest-earning assets 5,149 365,004 5.64% 4,397 354,136 4.97%
---------- -----------
Noninterest-earning assets 37,734 23,167
-------------- -------------
Total assets 398,738 377,303
============== =============
Liabilities and Stockholders' Equity:
Interest-bearing liabilities:
Savings 50 39,987 0.50% 43 33,945 0.51%
NOW 13 38,601 0.13% 34 39,384 0.35%
MMDA 347 62,852 2.21% 299 57,986 2.06%
CD's 354 53,004 2.67% 480 78,220 2.45%
------------------------- -------------------------
Total interest-bearing deposits 764 194,444 1.57% 856 209,535 1.63%
Other borrowed funds 112 11,920 3.76% 91 13,868 2.62%
Federal Home Loan Bank advances 1,042 106,088 3.93% 581 80,659 2.88%
Subordinated debentures 238 14,000 6.80% 152 9,000 6.76%
------------------------- -------------------------
Total interest-bearing liabilities 2,156 326,452 2.64% 1,680 313,062 2.15%
---------- -----------
Noninterest-bearing deposits 51,383 44,697
Other noninterest-bearing liabilities 1,085 1,114
-------------- -------------
Total liabilities 378,920 358,873
Total stockholders' equity 19,818 18,430
-------------- -------------
Total liabilities and stockholders'
Equity $ 398,738 $ 377,303
============== =============
Net interest income $ 2,993 $ 2,717
========== ===========
Interest rate spread 3.00% 2.82%
========= =========
Net interest margin 3.28% 3.07%
========= =========
(1) - Excludes investment securities traded and not settled.
Non-interest Income
Total non-interest income increased $861,000, or 29%, to $3.8 million for
the nine months ended September 30, 2005 as compared to the nine months ended
September 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 $1.2 million for the
nine months ended September 30, 2005. This is the first year of operation.
Rental income earned from the operation of the Boston building during the third
quarter, which was the first full quarter of ownership, was $142,000. The
increase in investment advisory fee revenue and miscellaneous rental income was
partially offset by a decrease of $720,000, or 92.5%, on gains on the sale of
investment securities to $58,000 for the nine months ended September 30, 2005.
Market valuations have not afforded the same measure of securities gains in 2005
as was available in 2004.
17
Total non-interest income increased $321,000, or 28.3%, to $1.5 million
for the quarter ended September 30, 2005 as compared to $1.1 million for the
quarter ended September 30, 2004. The increase in the third quarter of 2005 was
primarily due to investment advisory fee revenue of $413,000 for the quarter
ended September 30, 2005, as noted previously in its first year of operation. In
addition, the acquisition of the Boston branch and the associated rental income
from tenants in the amount of $142,000 was the other major category impacting
non-interest income for the third quarter of 2005. This is the first quarter
that this activity has been recognized for financial purposes.
Non-interest Expense
Total operating expenses increased $1.4 million, or 13.4%, for the nine
months ending September 30, 2005 to $11.6 million from $10.2 million for the
same nine month period ending September 30, 2004. Salaries and employee benefits
increased $843,000 or 15.5% for the nine month comparative period. The addition
of the investment advisory group, the loan production staff located in
Portsmouth, New Hampshire, the Boston loan and retail staff included in the
Boston acquisition all of which are new in the 2005 totals coupled with a full
year of employee related expenses for the Cambridge and Beverly branch staff
which came on board mid year of 2004, are the causes for the growth in employee
related expenses.
Similarly, occupancy and equipment expenses increased $502,000 or 33% to
$2 million for the nine months ending September 30, 2005. The increases in rent
expense and leasehold improvement depreciation for Beverly, Boston, Cambridge
and Portsmouth branch locations and the investment management location, all
either new in 2005 or a full nine months expense compared to a partial period in
2004, were the primary cause for this increase. The other major impact in this
category is the accelerated amortization of occupancy and equipment expenses for
the closing of our three Wal-Mart branch locations by year end 2005. The
original quarterly amortization was $18,000 per quarter. By comparison, the
third quarter amortization was approximately $173,000 and the fourth quarter
amortization will be approximately $288,000. The benefit to this action will be
the positive impact on earnings in 2006 as there will be no expenses related to
these locations in this category.
Total operating expenses increased $825,000 or 24% for the quarter ending
September 30, 2005. The two primary categories which impacted this increase was
again the additional staff related to our branch growth and the addition of the
investment management company and the associated salary and occupancy expenses
in their respective categories. Salary and employee benefits increased $406,000
or 23.3% for the quarter end September 30, 2005. Occupancy expenses increased
$291,000 or 53% for the quarter. Professional fees increased $97,000 or 39% to
$347,000 for the quarter end September 30,2005. Costs associated with
recruitment fees, consultants for a systems conversion, and, increased legal and
audit fees associated with additional regulatory commitments were the causes for
the increase in this category.
Income Taxes
The provision for income taxes for both the three month quarter end and
nine months ended September 30, 2005 are similarly impacted by two factors.
First, the company operates three subsidiary security corporations, which by
statute have a lower state income tax rate. These security corporations reflect
the majority of the company's investment portfolios, and as such receive the
benefit of the lower state tax rate. Secondly, the ratio of tax-exempt municipal
bond interest as a percentage of consolidated pre-tax income derives a benefit
of federal tax exemption.
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
18
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 during the first three
quarters 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 September 30, 2005
amounted to $76.7 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 September 30, 2005, the Bank's total borrowing capacity through the FHLB
was $116.6 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 $77.6 million at September 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
19
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 September 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 September 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 $29,547 10.98% $21,518 8.00%
Tier 1 capital to risk-weighted assets 27,838 10.35% 10,759 4.00%
Tier 1 capital to average assets 27,838 7.06% 15,764 4.00%
Company:
Total capital to risk-weighted assets $30,937 11.47% $21,581 8.00%
Tier 1 capital to risk-weighted assets 22,052 8.17% 10,791 4.00%
Tier 1 capital to average assets 22,052 5.58% 15,795 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 September 30, 2005, the Bank had $27million of
outstanding commitments to originate loans and $24.8 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.
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.
20
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.
21
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. 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.
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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.
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.
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 acting 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
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upon that evaluation, the Chief Executive Officer and acting Chief
Financial Officer concluded that management believes 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 Exchange Act is recorded, processed, summarized
and reported, within the time periods specified in the Securities and
Exchange Commission's ("SEC") rules and forms. The intent is 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.
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
Not applicable
ITEM 5. Other Information
Not applicable.
ITEM 6. Exhibits and Reports on Form 8-K
(a) Exhibits
31.1 Certification of Chief Executive Officer and acting Chief
Financial Officer pursuant to Rule 13a-14(a) of the Securities
Exchange Act of 1934.
32.1 Certification of Chief Executive Officer and acting 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 third
quarter of 2005:
On July 19, 2005, the Company filed a report on Form 8-K announcing
that the Bank had decided not to exercise its early 2006 lease renewal
options on its three Wal-Mart branch locations in New Hampshire. The
announcement was made by reference to a press release.
On August 9, 2005, the Company filed a report on Form 8-K /A to
update its previous disclosure concerning the acquisition by the Bank of a
branch located in Boston, Massachusetts from Atlantic Bank of New York.
On August 12, 2005, the Company filed a report on Form 8-K
announcing its financial results for the quarter and six months ended June
30, 2005. The announcement was made by reference to a press release.
On September 26, 2005, the Company filed a report on Form 8-K
announcing the resignation of its Senior Vice President, Treasurer and
Chief Financial Officer.
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.
FIRST IPSWICH BANCORP
Date: November 14, 2005 By: /s/ Donald P. Gill
---------------------
Donald P. Gill
President and Chief Executive Officer and
Acting Chief Financial Officer
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