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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, 2006
|_| 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|
Indicate by check mark whether the registrant is a shell company (as
defined in Rule 12b-2 of the Exchange Act). 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 July 31, 2006, there were
2,240,120 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, 2006 and
December 31, 2005 3
Consolidated Statements of Income for the quarter and
six months ended June 30, 2006 and 2005 4
Consolidated Statements of Changes in Stockholders' Equity for the
six months ended June 30, 2006 and 2005 5
Consolidated Statements of Cash Flows for the six months ended
June 30, 2006 and 2005 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis 9
Item 3. Controls and Procedures 26
PART II OTHER INFORMATION
Item 1. Legal Proceedings 26
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 27
Item 3. Defaults Upon Senior Securities 27
Item 4. Submission of Matters to a Vote of Security Holders 27
Item 5. Other Information 27
Item 6. Exhibits 27
Signatures 28
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,
2006 2005
---------- ----------
ASSETS
Cash and due from banks $ 14,153 $ 11,179
Federal funds sold 204 82
---------- ----------
Total cash and cash equivalents 14,357 11,261
---------- ----------
Certificates of deposit 3,335 3,295
Securities available for sale, at fair value 80,254 88,375
Securities held to maturity, at amortized cost 27,164 28,769
Federal Home Loan Bank stock, at cost 3,700 6,647
Federal Reserve Bank stock, at cost 774 774
Loans, net of allowance for loan losses of $1,884 and $1,739 247,748 234,613
Banking premises and equipment, net 4,816 4,758
Real estate held for sale 5,167 4,486
Other assets 11,044 11,426
---------- ----------
Total assets $ 398,359 $ 394,404
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $ 294,770 $ 258,860
Short-term borrowings 56,896 71,262
Long-term borrowings 15,439 31,087
Subordinated debentures 13,000 13,000
Other liabilities 974 1,235
---------- ----------
Total liabilities 381,079 375,444
---------- ----------
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 7,167 8,054
Accumulated other comprehensive loss (1,952) (1,159)
Treasury stock, at cost (20,490 shares) (111) (111)
---------- ----------
Total stockholders' equity 17,280 18,960
---------- ----------
Total liabilities and stockholders' equity $ 398,359 $ 394,404
========== ==========
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 Six Months Ended
June 30, June 30,
-------------------- --------------------
2006 2005 2006 2005
-------- -------- -------- --------
Interest and dividend income:
Interest and fees on loans $ 4,327 $ 2,904 $ 8,362 $ 5,625
Interest on debt securities:
Taxable 1,085 1,253 2,146 2,553
Tax-exempt 127 165 255 352
Dividends on equity securities 9 198 108 391
Other interest 70 45 117 90
-------- -------- -------- --------
Total interest and dividend income 5,618 4,565 10,988 9,011
-------- -------- -------- --------
Interest expense:
Interest on deposits 1,736 691 2,898 1,454
Interest on borrowed funds 1,048 1,112 2,282 2,027
Interest on subordinated debentures 234 135 458 249
-------- -------- -------- --------
Total interest expense 3,018 1,938 5,638 3,730
-------- -------- -------- --------
Net interest income 2,600 2,627 5,350 5,281
Provision for loan losses 65 67 65 107
-------- -------- -------- --------
Net interest income, after provision for loan losses 2,535 2,560 5,285 5,174
Other income:
Investment advisory fees 440 385 884 775
Service charges on deposit accounts 299 322 583 605
Credit card fees 196 182 360 342
Trust fees 107 123 210 236
Non-deposit investment fees 81 73 156 180
Gain (loss) on sales and calls of
securities, net 11 16 (49) 62
Rental Income 99 -- 189 --
Valuation reserve for building held for sale (286) -- (286) --
Miscellaneous 39 48 252 140
-------- -------- -------- --------
Total other income 986 1,149 2,299 2,340
-------- -------- -------- --------
Operating expenses:
Salaries and employee benefits 2,372 2,051 4,609 4,132
Occupancy and equipment 645 601 1,355 1,170
Professional fees 388 210 879 427
Credit card interchange 148 136 242 234
Advertising and marketing 246 101 333 161
Data processing 171 190 352 370
ATM processing 110 95 214 187
Other general and administrative 444 317 897 698
-------- -------- -------- --------
Total operating expenses 4,524 3,701 8,881 7,379
-------- -------- -------- --------
Income (loss) before income taxes (1,003) 8 (1,297) 135
Credit for income taxes (354) -- (465) (20)
-------- -------- -------- --------
Net income (loss) $ (649) $ 8 $ (832) $ 155
======== ======== ======== ========
Weighted average common shares outstanding:
Basic 2,220 2,220 2,220 2,220
-------- -------- -------- --------
Diluted 2,220 2,220 2,220 2,220
-------- -------- -------- --------
Earnings (loss) per share:
Basic $ (0.29) $ 0.00 $ (0.37) $ 0.07
======== ======== ======== ========
Diluted $ (0.29) $ 0.00 $ (0.37) $ 0.07
======== ======== ======== ========
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, 2006 AND 2005
(In thousands, except per share data)
Accumulated
Additional Other
Common Paid-in Retained Comprehensive Treasury
Stock Capital Earnings Income (Loss) Stock Total
----------- ------------ ------------ --------------- ----------- -----------
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
($.025 per share) (56) (56)
----------- ---------- ---------- ----------- -------- ---------
Balance at June 30, 2005 2,240 9,936 8,309 (761) (111) 19,613
=========== ========== ========== =========== ======== =========
Balance at December 31, 2005 2,240 9,936 8,054 (1,159) (111) 18,960
--------
Comprehensive loss:
Net loss (832) (832)
Unrealized loss on securities
available for sale, net of
reclassification adjustment
and tax effect (793) (793)
---------
Total comprehensive loss (1,625)
Cash dividends declared
($.025 per share) (55) (55)
----------- ---------- ---------- ----------- -------- ---------
Balance at June 30, 2006 $ 2,240 $ 9,936 $ 7,167 $ (1,952) $ (111) $ 17,280
=========== ========== ========== =========== ======== =========
See accompanying notes to consolidated financial statements.
5
FIRST IPSWICH BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(In thousands)
Six Months
Ended June 30,
--------------------
2006 2005
-------- --------
Cash flows from operating activities:
Net income $ (832) $ 155
Adjustments to reconcile net income to net cash provided
(used) by operating activities:
Provision for loan losses (65) 107
Losses (gains) on sales and calls of securities, net 49 (62)
Depreciation and amortization 330 423
Net amortization of securities, including certificate of
deposit 110 185
Increase of valuation reserve for real estate held for sale 286 --
Derivative fair value adjustment 102 (35)
Amortization of core deposit intangible 76 60
Net change in other assets and other liabilities (379) (57)
-------- --------
Net cash provided by operating activities (323) 776
-------- --------
Cash flows from investing activities:
Activity in available-for-sale securities:
Purchases (2,887) (33,417)
Sales 101 56,921
Maturities, calls and paydowns 9,599 19,757
Activity in held-to-maturity securities:
Maturities, calls and paydowns 1,493 1,507
Redemption (purchase) of Federal Home Loan Bank stock 2,947 (1,057)
Purchase of Federal Reserve Bank stock -- (23)
Net cash paid in acquisition of Boston branch -- (29,639)
Loan originations, net of repayments (13,070) (12,757)
Additions to premises and equipment, net (605) (21)
-------- --------
Net cash provided (used) by investing activities (2,422) 1,271
-------- --------
Cash flows from financing activities:
Net increase (decrease) in deposits 35,910 (32,220)
Net increase (decrease) in short-term borrowings (14,366) 29,271
Proceeds from subordinated debenture -- 7,000
Repayment of long-term debt (15,648) (2,578)
Cash dividends paid (55) (56)
-------- --------
Net cash provided by financing activities 5,841 1,417
-------- --------
Net increase (decrease) in cash and cash equivalents 3,096 3,464
Cash and cash equivalents at beginning of period 11,261 9,076
-------- --------
Cash and cash equivalents at end of period $ 14,357 $ 12,540
======== ========
Supplemental disclosures:
Interest paid $ 5,638 $ 3,730
Income taxes paid 50 129
Reclassification of goodwill to fixed assets related to final
purchase accounting of Boston branch 750 --
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 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, 2005.
(2) Stockholders' Equity and Earnings per Share
Basic earnings per share represent income available to common stockholders
divided by the weighted-average number of common shares outstanding for the
period. There are no common stock equivalents outstanding for the three and six
month periods ended June 30, 2006 and June 30, 2005,
(3) Commitments
At June 30, 2006, the Company had outstanding commitments to originate
loans of $20.3 million. Unused lines of credit and open commitments available to
customers at June 30, 2006 amounted to $52.1 million, of which $15.6 million
related to construction loans, $12.1 million related to home equity lines of
credit, $4.9 million related to credit card loans, and $19.5 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 month
periods ended June 30, 2006 and June 30, 2005 is below.
Investment Consolidated
Banking Advisory Totals
------- -------- ------
(Dollars in thousands)
June 30, 2006:
Net interest and dividend income $ 5,350 -- $ 5,350
Other revenue: external customers 1,415 $ 884 2,299
Net income (loss) (1,021) 189 (832)
Assets $ 395,523 $2,836 $ 398,359
June 30, 2005:
Net interest and dividend income $ 5,281 -- $ 5,281
Other revenue: external customers 1,565 $ 775 2,340
Net income 13 142 155
Assets $ 406,845 $2,748 $ 409,593
7
(5) Final Accounting for Boston Branch 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 $43.2 million of loans and the assumption of $20.8 million of
deposits. 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 was allocated to goodwill and a core deposit
intangible related to the long-term value of depositor relationships. The
following table summarizes final fair values of the assets acquired and
liabilities assumed (in thousands):
Assets acquired (in thousands):
Cash $ 102
Loans 43,155
Building and equipment 5,277
Core deposit intangible 1,002
Deposits assumed (20,829)
--------
Fair value of net assets acquired 28,707
Purchase price 29,335
--------
Excess purchase price allocated to goodwill $ 628
========
(6) Real Estate Held for Sale
Real estate held for sale consists of the land and building acquired in the
Boston branch acquisition referenced in Note (5) above. These assets are being
carried at their estimated fair value, less selling costs. A valuation reserve
of $286,000 was recorded during the quarter ended June 30, 2006 because the
estimated fair value, less selling costs, was less than the book value of the
assets.
(7) Investment Portfolio - Other Than Temporary Impairment
The Company owns a collateralized bond obligation security with a book value of
$3.3 million. The market value of the security is approximately $2.8 million as
of June 30, 2006. The Company, through the use of a consultant, has reviewed the
security for other than temporary impairment and determined that all principal
payments are expected to be received at or before final maturity. The Company
will continue to evaluate the security on a periodic basis to determine if other
than temporary impairment should be recognized.
(8) Income Taxes
Deferred tax assets are evaluated to determine whether it is "more likely than
not" that a tax return benefit would be realized when the deferred items
reverse. Evaluation considerations include the availability of historical and
projected taxable income to offset the deferred items in the periods they are
expected to reverse. While the recent trend of operating losses increases the
likelihood that such taxable income may not occur in the future, management has
determined that operational changes which have been made and are being made will
generate sufficient income to allow for the recognition of the deferred tax
assets. No valuation reserve was recorded as of June 30, 2006 or December 31,
2005.
(9) Formal Agreement
On June 28, 2006 the Bank entered into a Formal Agreement with its primary
Federal banking regulator, The Comptroller of the Currency. The agreement calls
for the Bank to achieve higher capital levels, retain competent management,
adopt a new strategic plan, adopt an interest rate risk management plan, and
improve liquidity. The timeframes for completing the various requirements
included in the Agreement range from 90 to 180 days from the date of the
agreement.
8
As a result of becoming subject to the Formal Agreement, the Bank is deemed to
be "adequately capitalized" under Prompt Corrective Action regulations
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 the Bank's continued ability to comply with existing and
future 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 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 acquisitions of the Boston and Cambridge branches of
Atlantic Bank of New York, the Bank has initiated the strategic expansion of its
geographic footprint into the Boston market. The Bank opened a loan production
office in Portsmouth, New Hampshire in the first quarter of 2005, and a full
service branch in the same community in April 2006.
As a result of the investment management company acquisition at the end of
2004, the Company 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. Investment in the investment management
business has increased the percentage of fee revenue to total revenue, thus
reducing reliance on revenue from the interest margin.
The Company is reporting a net loss of $649,000 for the quarter ended June
30, 2006 as compared to net income of $8,000 in the same period of 2005 and a
net loss of $832,000 for the six months ended June 30, 2006 as compared to net
income of $155,000 for the same period of 2005. The Company's loss for the three
months ended June 30, 2006 reflects continued pressure on the Company's net
interest spread and increased expenses primarily associated with the Company's
growth initiatives. In addition, the Company recorded a valuation reserve of
$286,000 related to real estate held for sale in the quarter ended June 30,
2006. Net interest income at the Company, and the banking industry in general,
continues to be under pressure. Growth of the loan portfolio allowed the Company
to maintain its net interest income level for the first half of 2006 as compared
to the same period of 2005. Loan growth was attained through the purchase of the
new Boston branch in June 2005 and the subsequent hiring of new loan officers
for various markets in 2006. However, salaries and occupancy costs incurred to
9
operate the new branch have had a negative impact on non-interest expenses. In
addition, increased professional fees and advertising and marketing expenses
have had a negative impact on non-interest expenses. It is expected that net
interest income will continue to be under pressure for the remainder of the
year. Management continues to look for strategic steps to improve profitability
by increasing earnings and decreasing expenses.
On June 28, 2006 the Bank entered into a Formal Agreement with its primary
Federal banking regulator, The Comptroller of the Currency. The agreement calls
for the Bank to achieve higher capital levels, retain competent management,
adopt a new strategic plan, adopt an interest rate risk management plan, and
improve liquidity. The timeframe for completing the various components of the
Agreement ranges from 90 to 180 days from the date of the agreement.
The Bank has established a Compliance Committee of the Board of Directors
to ensure compliance with the terms of the Formal Agreement. The Bank has also
retained the services of an investment banker to assist with the development and
execution of plans to meet the requirements identified in the Formal Agreement.
The Bank is currently developing a plan to respond to the requirements set forth
in the Formal Agreement.
The Formal Agreement requires that the Bank develop a strategic business
plan that incorporates the requirements, including higher capital ratios, of the
Formal Agreement. A strategic business plan is in the process of being
completed. The Board and Management have determined that the development of the
plan will consider the acquisitions and divestitures of business lines to
enhance the Company's profitability. Both the Board and Management are committed
to returning the Company to profitability and complying with the Formal
Agreement.
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 total amount of the allowance for loan losses considered necessary.
Management considers impairment of investment securities to be a critical
accounting policy because of the impairments' possible 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 because the estimation of fair values
involves a high degree of judgment and subjectivity in the assumptions utilized.
Comparison of Financial Condition at June 30, 2006 versus December 31, 2005
Total assets were $398.4 million at June 30, 2006, an increase of $4.0
million, or 1.0%, from $394.4 million as of December 31, 2005. Principal
repayments on investment securities totaling $11.3 million and deposit growth of
$35.9 million funded loan portfolio growth of $13.1 million and the repayment of
$30.0 million of FHLB advances.
Loans
Total net loan balances were $247.7 million as of June 30, 2006, an
increase of $13.1 million, or 6%, from $234.6 million as of December 31, 2005.
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. The increase is due primarily to increased
business development efforts of an expanded lending team. Commercial real estate
loans increased to $115.4 million as of June 30, 2006, an increase of $7.0
million, or 6%, from $108.4 million as of December 31, 2005. The Bank's
10
commercial real estate lending strategy stresses quality loan originations to
local businesses, professionals, experienced developers, and investors.
Commercial loans increased $3.6 million, or 8%, to $47.0 million as of June 30,
2006 due primarily to increased business development and lending in new markets.
Construction loan balances increased $2.7 million, or 14%, to $21.6
million as of June 30, 2006 from $18.9 million as of December 31, 2005. The
primary focus of construction lending continues to relate to the financing of
small residential construction projects for the Bank's highly rated commercial
customers.
Residential real estate loan balances of $55.3 million as of June 30, 2006
increased $1.3 million, or 3%, from $54.0 million as of December 31, 2005. 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 have moderated this year. The
Bank continues to monitor the weakness of the real estate market.
The following table presents the composition of the Bank's loan portfolio
by type of loan at the dates indicated.
June 30, December 31,
2006 2005
---------- ----------
(Dollars in thousands)
Real estate mortgage loans:
Residential $ 55,282 $ 53,690
Commercial 115,430 108,404
Construction 21,623 18,918
Equity lines of credit 8,723 10,243
Commercial loans 47,022 43,376
Consumer loans 1,664 1,770
---------- ----------
Total loans 249,744 236,401
Net deferred origination fees (112) (49)
Allowance for loan losses (1,884) (1,739)
---------- ----------
Loans, net $ 247,748 $ 234,613
========== ==========
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, December 31,
2006 2005
---- ----
(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 0.75% 0.74%
For the six months ended June 30, 2006, the Bank recorded a $65,000
provision for loan losses as a result of net growth of the loan portfolio. The
Bank recorded charge-offs of $2,000 and recoveries of $83,000 for the six months
11
ended June 30, 2006. The allowance for loan losses balance was $1,884,000 at
June 30, 2006, an increase of $145,000 since December 31, 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 2006 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 totaled $115.2 million as of June 30, 2006,
a decrease of $12.6 million, or 10%, from $127.8 million as of December 31,
2005. Proceeds from investment securities maturities and principal prepayments
were utilized to fund loan growth.
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, 2006 December 31, 2005
----------------------------------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
----------------------------------------------------
(Dollars in thousands)
Securities available for sale:
Mortgage-backed and other collateralized
securities $ 50,413 $ 48,000 $ 64,571 $ 63,257
U.S. Government agency obligations 30,990 30,544 23,287 22,940
Corporate bonds 1,830 1,710 1,816 1,713
Municipal bonds -- -- 369 347
-------- -------- -------- --------
Total debt securities 83,233 80,254 90,043 88,257
Marketable equity securities -- -- 101 118
Total securities available for sale $ 83,233 $ 80,254 $ 90,144 $ 88,375
======== ======== ======== ========
Securities held to maturity:
U.S. Government sponsored enterprise
obligations $ 3,000 $ 2,791 $ 3,000 $ 2,853
Municipal bonds 14,166 13,766 15,128 14,904
Mortgage-backed securities 9,998 9,350 10,641 10,257
-------- -------- -------- --------
Total securities held to maturity $ 27,164 $ 25,907 $ 28,769 $ 28,014
======== ======== ======== ========
The Company owns a collateralized bond obligation security with a book
value of $3.3 million. The market value of the security is approximately $2.8
million as of June 30, 2006. The Moody's rating for the security has dropped to
Aa1 from Aaa at the time of purchase; the S&P rating has dropped to AA- from AAA
at the time of purchase. The Company, through the use of a consultant, has
reviewed the security for other than temporary impairment and determined that
all principal payments are expected to be received at or before final maturity.
The Company will continue to evaluate the security on a periodic basis to
determine if other than temporary impairment should be recognized.
12
Real Estate Held for Sale
The real estate acquired in conjunction with the purchase of the Boston branch
is held for sale and is valued at the lower of cost or market, less selling
expenses. The Bank expects to lease space in the building for branch and lending
operations after the sale of the building.
Deposits
Total deposit balances were $294.8 million as of June 30, 2006, an
increase of $35.9 million, or 14%, from $258.9 million as of December 31, 2005.
Total deposit balances increased primarily because of a special CD promotion in
April 2006.
Non-interest bearing demand deposit balances decreased by $2.9 million, or
6%, during the six month period to $47.9 million as of June 30, 2006. NOW
account balances decreased by $1.4 million, or 4%, to $38.3 million as of June
30, 2006. Regular savings balances decreased $3.8 million, or 11%, to $32.1
million as of June 30, 2006.
Loan growth has been concentrated in commercial real estate and
construction loans, loan relationships which generally do not generate the same
volume of demand deposits as commercial loan relationships. The Bank is
committed to developing a full banking relationship with its customers.
Total money market deposit balances increased $6.8 million, or 14%, to
$56.9 million. Management has opted to price these accounts more aggressively in
2006 as short-term interest rates continue to rise. Total term certificates
increased by $37.2 million, or 45%, to $119.6 million at June 30, 2006 primarily
because of the special CD promotion held in April 2006. Deposit-raising
strategies in 2006 may include promotional programs as well as growth in
market-priced savings, money market, and checking accounts. The Company is also
hopeful that additional commercial deposits will be generated from its
geographic lending plans. The Bank has introduced relationship products which
encourage customers to consider purchases of multiple products and services.
The following table shows the composition of the Company's deposit
balances at the dates indicated.
June 30, December 31,
2006 2005
-------- --------
(Dollars in thousands)
Demand $ 47,882 $ 50,734
NOW 38,346 39,743
Regular savings 32,068 35,875
Money market deposits 56,852 50,058
Term certificates 119,622 82,450
-------- --------
$294,770 $258,860
======== ========
Borrowings
Short-term borrowings decreased by $14.4 million, or 20%, to $56.9 million
as of June 30, 2006. Long-term advances decreased by $15.6 million, or 50%, to
$15.4 million as of June 30, 2006. Borrowings were paid down with proceeds from
the special CD promotion in April 2006.
Stockholders' Equity
Total stockholders' equity decreased from $19.0 million at December 31,
2005 to $17.3 million as of June 30, 2006 due to an increase in accumulated
other comprehensive loss of $793,000 associated with an unrealized loss, net of
tax, on available-for-sale securities; an operating net loss of $832,000 for the
six months ended June 30, 2006; and dividends paid in the amount of $55,000.
13
Comparison of Operating Results for the Quarter Ended June 30, 2006 and 2005
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 as the ability
and willingness of borrowers to fulfill their debt obligations during various
economic cycles.
The net loss for the three months ended June 30, 2006 was $649,000
compared with a net income of $8,000 for the three months ended June 30, 2005.
For the three months ended June 30, 2006, net interest income decreased by
$27,000, non-interest income decreased $163,000, and operating expenses
increased by $823,000, all as compared to the three months ended June 30, 2005.
Interest and Dividend Income
Total interest and dividend income for the quarter-ended June 30, 2006 was
$5.6 million, which was $1.1 million higher than the quarter-ended June 30,
2005. This increase was due to the favorable impact of a higher average asset
yield and higher average interest-earning assets. The yield on interest earning
assets increased to 6.11 % for the quarter-ended June 30, 2006 as compared to
5.14% for the quarter-ended June 30, 2005. In addition, lower yielding
investments were replaced by higher yielding loans. Average interest earning
assets of $368.0 million for the quarter ended June 30, 2006 were $13.0 million
higher than average interest-bearing assets of $355.0 million for the quarter
ended June 30, 2005.
The increase in average yield was due primarily to a changing mix of
assets. Average net loans for the quarter ended June 30, 2006 were $64.1 million
higher than the same quarter of 2005 and average investments were $53.2 million
lower than the same quarter of 2005. The changing mix of earning assets reflects
the Bank's efforts to increase its core lending efforts and decrease reliance on
the investment portfolio for income.
The Bank owns Federal Home Loan Bank of Boston (FHLBB) stock which
normally pays a dividend each quarter. The FHLBB did not declare a dividend in
the second quarter of 2006 because of new capital rules promulgated by its
primary regulator. If the FHLBB had declared a dividend in accordance with its
regular practices, the Company would have realized approximately $70,000 of
additional dividend income in the second quarter of 2006. The FHLBB has
indicated that it expects to resume paying a dividend in the third quarter of
2006 and that it expects to pay a third quarter dividend which compensates for
the missed second quarter dividend.
Interest Expense
Interest expense on interest-bearing liabilities for the quarter-ended
June 30, 2006 was $3.0 million, a $1.1 million increase from the quarter-ended
June 30, 2005. Higher rates paid for deposits and borrowed funds were the single
largest contributor to the increase in interest expense. The average rate paid
for interest bearing liabilities was 3.60% for the quarter ended June 30, 2006
as compared to 2.44% for the same quarter of 2005. The increase in average rates
occurred because of the increase in market short-term rates over the course of
the past year.
Interest expense on deposits increased for the quarter-ended June 30, 2006
due equally to an increase in average balances during the quarter ended June 30,
2006 as compared to the same quarter of 2005 and to an increase in the average
rate paid for deposits. Average interest-bearing deposit balances during the
quarter ended June 30, 2006 were $57.9 million higher than the same quarter of
2005. The increase in the 2006 quarter was primarily attributable to a special
CD promotion in April 2006; the promotion raised $49 million in new CD balances.
The average rate paid for deposits during the 2006 quarter was 2.90%, up from
1.52% in the same quarter of 2005.
14
Interest expense on borrowed funds, including subordinated debentures, for
the quarter-ended June 30, 2006 increased slightly by $35,000 to $1.3 million as
compared to the quarter-ended June 30, 2005. The impact of lower average
balances of borrowed funds during the 2006 quarter as compared to the same
quarter of 2005 was offset by increasing interest rates paid on borrowed funds
for the same comparable quarters.
Net Interest Income
Net interest income for the quarter ended June 30, 2006 remained level at
$2.6 million as compared to the quarter ended June 30, 2005. The impact of the
changing mix of earning assets to higher yielding loans offset the general trend
of increasing interest rates. The net interest spread decreased to 2.51% for the
quarter ended June 30, 2006 from 2.70% for the quarter ended June 30, 2005. The
shrinking interest rate spread reflects the impact of the flat yield curve that
has existed for the past year.
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 months ended June 30, 2006 and 2005. The average balances
are derived from average daily balances.
Three Months Ended June 30,
2006 2005
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 $ 70 $ 5,172 5.41% $ 45 $ 3,089 5.83%
Investment securities:
Taxable 1,094 107,462 4.07% 1,451 158,382 3.66%
Tax-exempt 127 14,328 3.55% 165 16,645 3.97%
Loans, net 4,327 241,013 7.18% 2,904 176,930 6.57%
--------------------- ---------------------
Total interest-earning assets 5,618 367,975 6.11% 4,565 355,046 5.14%
------ -----
Noninterest-earning assets 34,097 26,381
-------- --------
Total assets 402,072 381,427
======== ========
Liabilities and
Stockholders' Equity:
Interest-bearing liabilities:
Savings 39 31,568 0.49% 46 35,873 0.51%
NOW 11 36,309 0.12% 14 35,944 0.16%
MMDA 476 57,489 3.31% 342 62,497 2.19%
CD's 1,210 113,966 4.25% 289 47,163 2.45%
--------------------- ---------------------
Total interest-bearing deposits 1,736 239,332 2.90% 691 181,477 1.52%
Other borrowed funds 176 14,031 5.02% 85 10,796 3.15%
Federal Home Loan Bank
advances 872 69,182 5.04% 1,027 117,757 3.49%
Subordinated debentures 234 13,000 7.20% 135 7,692 7.02%
--------------------- ---------------------
Total interest-bearing liabilities 3,018 335,545 3.60% 1,938 317,722 2.44%
------ -----
Noninterest-bearing deposits 47,152 42,811
Other noninterest-bearing
liabilities 1,056 1,206
-------- --------
Total liabilities 383,753 361,739
Total stockholders' equity 18,319 19,688
-------- --------
Total liabilities and
stockholders' Equity $402,072 $381,427
======== =======
Net interest income $2,600 $2,627
====== ======
Interest rate spread 2.51% 2.70%
==== ====
Net interest margin 2.83% 2.96%
==== ====
15
Non-interest Income
Total non-interest income for the quarter ended June 30, 2006 was $1.0
million as compared to $1.1 million for the quarter ended June 30, 2005. The
decrease in the second quarter of 2006 was due to the establishment of a
$286,000 valuation reserve for real estate held for sale in the quarter ended
June 30, 2006. The 2006 quarterly decrease due to the establishment of the
reserve was partially offset by a $55,000 increase of investment advisory fee
revenue in the second quarter of 2006 as compared to the same quarter of 2005
and a $99,000 increase attributable to rental income from the Boston building,
for the same quarters.
A valuation reserve of $286,000 was recorded during the quarter ended June
30, 2006 because the estimated fair value, less selling costs, of real estate
held for sale was less than the book value of the assets. The Company expects to
consummate the sale before the end of 2006. It is possible that changes to the
reserve may occur prior to, and related to, the sale of the real estate.
Non-interest Expense
Total operating expenses increased by $823,000 to $4.5 million for the
quarter ended June 30, 2006. The increase is primarily attributable to increases
of salaries and employee benefits, professional fees, and advertising and
marketing.
Salaries and employee benefits increased $321,000 due primarily to
salaries and benefits in 2006 associated with additional employees related to
expansion initiatives in the Boston and Portsmouth markets as well as efforts to
increase lending staff. Occupancy and equipment expenses increased $44,000 to
$645,000, for the quarter ended June 30, 2006 due to higher utility costs,
higher building maintenance costs due to the Boston building, and higher real
estate taxes. Increases in these areas were partially offset by a decrease in
depreciation in the quarter ended June 30, 2006 as compared to the same quarter
of 2005 which included accelerated depreciation related to the Wal-Mart branches
closed in 2005. Advertising and marketing expenses increased by $145,000 to
$246,000 for the quarter ended June 30, 2006 due primarily to promotional costs
associated with the April 2006 special CD promotion. Professional fees increased
because of fees paid to employment search firms and legal expenses related to
various issues including the Formal Agreement the bank signed with the OCC.
Income Taxes
The net benefit for income taxes increased by $354,000 from $0 for the
quarter ended June 30, 2005, to $354,000 for the quarter ended June 30, 2006.
This was primarily the result of the $1.0 million reduction in pre-tax income
between the same periods. The impact of the pre-tax income reduction was
partially offset by a reduction in tax-exempt municipal income, and a reduction
in dividends eligible for the dividends received deduction.
Deferred tax assets are evaluated to determine whether it is "more likely
than not" that a tax return benefit would be realized when the deferred items
reverse. Evaluation considerations include the availability of historical and
projected taxable income to offset the deferred items in the periods they are
expected to reverse. While the recent trend of operating losses increases the
likelihood that such taxable income may not occur in the future, management has
determined that operational changes which have been made and are being made will
generate sufficient income to allow for the recognition of the deferred tax
assets. No valuation reserve was recorded as of June 30, 2006 or December 31,
2005.
16
Comparison of Operating Results for the Six Months Ended June 30, 2006 and 2005
General
The net loss for the six months ended June 30, 2006 was $832,000 compared
with net income of $155,000 for the six months ended June 30, 2005. For the six
months ended June 30, 2006, net interest income increased by $69,000,
non-interest income decreased $41,000, and operating expenses increased
$1,502,000, as compared to the six months ended June 30, 2005.
Interest and Dividend Income
Total interest and dividend income for the six months ended June 30, 2006
was $11.0 million, which was $2.0 million higher than the six months ended June
30, 2005. This increase was due to the favorable impact of a higher average
asset yield and higher average interest-earning assets. The yield on earning
assets increased to 6.03 % for the six months ended June 30, 2006 as compared to
5.03% for the six months ended June 30, 2005. In addition, lower yielding
investments were replaced by higher yielding loans. Average interest earning
assets of $364.7 million for the period ended June 30, 2006 were $6.6 million
higher than average interest-bearing assets of $358.1 million for the period
ended June 30, 2005.
The increase in average yield was due primarily to a changing mix of
assets. Average net loans for the six months ended June 30, 2006 were $64.2
million higher than the same period of 2005 and average investments were $58.7
million lower than the same period of 2005. The changing mix of earning assets
reflects the Bank's efforts to increase its core lending efforts and decrease
reliance on the investment portfolio for income.
The Bank owns Federal Home Loan Bank of Boston (FHLBB) stock which
normally pays a dividend each quarter. The FHLBB did not declare a dividend in
the second quarter of 2006 because of new capital rules promulgated by its
primary regulator. If the FHLBB had declared a dividend in accordance with its
regular practices, the Company would have realized approximately $70,000 of
additional dividend income in the second quarter of 2006. The FHLBB has
indicated that it expects to resume paying a dividend in the third quarter of
2006 and that it expects to pay a third quarter dividend which compensates for
the missed second quarter dividend.
Interest Expense
Interest expense on interest-bearing liabilities for the six months ended
June 30, 2006 was $5.6 million, a $1.9 million increase from the six months
ended June 30, 2005. Higher rates paid for deposits and borrowed funds were the
single largest contributor to the increase in interest expense. The average rate
paid for interest bearing liabilities was 3.40% for the six months ended June
30, 2006 as compared to 2.33% for the same period of 2005. The increase in
average rates occurred because of the increase in market short-term rates over
the course of the past year.
Interest expense on deposits increased for the six months ended June 30,
2006 due primarily to an increase in average balances during the six months
ended June 30, 2006 as compared to the same period of 2005. Average
interest-bearing deposit balances during the six months ended June 30, 2006 were
$33.4 million higher than the same period of 2005. The increase in the 2006
period was primarily attributable to a special CD promotion in April 2006; the
promotion raised $49 million in new CD balances. The average rate paid for
deposit during the first six months of 2006 was 2.59%, up from 1.53% in the same
period of 2005.
17
Interest expense on borrowed funds, including subordinated debentures, for
the six months ended June 30, 2006 increased by $464,000 to $2.7 million as
compared to the six months ended June 30, 2005. The impact of lower average
balances of borrowed funds during the 2006 six month period as compared to the
same period of 2005 was not sufficient to offset increasing interest rates paid
on borrowed funds for the same comparable periods. The average rate paid on
borrowed funds increased to 5.06% in the first six months of 2006 as compared to
3.51% during the first six months of 2005.
The Company relies on dividends from the Bank in order to pay its interest
obligations on the subordinated debentures. At present, the Bank is required to
obtain OCC approval before it pays dividends because of its negative earnings.
While the OCC has granted the Bank approval to pay dividends in the past, there
can be no assurance that the OCC will grant the Bank approval to pay dividends
in the future.
Net Interest Income
Net interest income for the six months ended June 30, 2006 increased by
$69,000, to $5.4 million as compared to the six months ended June 30, 2005. The
small increase in net interest income in the 2006 period was due primarily to
the changing mix of earning assets. The significant increase of higher yielding
loans and corresponding decrease of lower yielding investments offset the impact
of generally increasing market short-term interest rates. Average loan balances
were $64.2 million higher in the six months ended June 30, 2006 than in the six
months ended June 30, 2005 while average investment balances were $58.7 million
lower during the same comparable periods.
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, 2006 and 2005. The average
balances are derived from average daily balances.
Six Months Ended June 30,
2006 2005
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 $ 117 $ 4,132 5.66% $ 90 $ 3,119 5.77%
Investment securities:
Taxable 2,254 107,959 4.18% 2,944 164,553 3.58%
Tax-exempt 255 14,640 3.48% 352 16,737 4.21%
Loans, net 8,362 237,954 7.03% 5,625 173,710 6.48%
---------------------- ---------------------
Total interest-earning assets 10,988 364,685 6.03% 9,011 358,119 5.03%
------- ------
Non-interest-earning assets 33,328 25,283
-------- --------
Total assets 398,013 383,402
======== ========
Liabilities and Stockholders' Equity:
Interest-bearing liabilities:
Savings 81 32,850 0.49% 92 35,560 0.52%
NOW 19 36,446 0.10% 29 35,099 0.17%
MMDA 878 56,802 3.09% 666 64,346 2.07%
CD's 1,920 97,480 3.94% 667 55,189 2.42%
---------------------- ---------------------
Total interest-bearing deposits 2,898 223,578 2.59% 1,454 190,194 1.53%
Other borrowed funds 319 13,270 4.81% 160 11,060 2.89%
Federal Home Loan Bank
advances 1,963 82,139 4.78% 1,867 111,423 3.35%
Subordinated debentures 458 13,000 7.05% 249 7,348 6.78%
---------------------- ---------------------
Total interest-bearing liabilities 5,638 331,987 3.40% 3,730 320,025 2.33%
------- ------
Noninterest-bearing deposits 46,318 42,328
Other noninterest-bearing
liabilities 1,062 1,340
-------- --------
Total liabilities 379,367 363,693
Total stockholders' equity 18,646 19,709
-------- --------
Total liabilities and stockholders'
Equity $398,013 $383,402
======== ========
Net interest income $ 5,350 $5,281
======= ======
Interest rate spread 2.63% 2.70%
===== =====
Net interest margin 2.93% 2.95%
===== =====
18
Non-interest Income
Total non-interest income for the six months ended June 30, 2006 was level
at $2.3 million as compared to the six months ended June 30, 2005. A decrease of
non-interest income in the first half of 2006 due to the establishment of a
$286,000 valuation reserve for real estate held for sale was offset by a
$109,000 increase of investment advisory fee revenue in 2006 as compared to the
same period of 2005 and an $189,000 increase attributable to rental income from
the Boston building, for the same comparable periods. A decrease in the same
comparable periods of $111,000 in gains on sale of investment securities was
offset by increases in fair value of derivatives associated with investment
securities.
A valuation reserve of $286,000 was recorded during the quarter ended June
30, 2006 because the estimated fair value, less selling costs, of real estate
held for sale was less than the book value of the assets. The Company expects to
consummate the sale before the end of 2006. It is possible that changes to the
reserve may occur prior to, and related to, the sale of the real estate.
Non-interest Expense
Total operating expenses for the six months ended June 30, 2006 increased
by $1,502,000, or 20%, to $8.9 million. A significant reason for the increase is
increased costs associated with the Boston branch purchase in June 2005 and the
Portsmouth branch opening in April 2006. In addition, during the six months
ended June 30, 2006, the Bank incurred professional fees associated with the
Formal Agreement between the Bank and the OCC as well as placement fees
associated with the employment of new lending officers and senior management
personnel. There were no significant operating expenses related to the two new
branches included in the 2005 six month reporting period.
Salaries and employee benefits for the six months ended June 30, 2006
increased $477,000 to $4.6 million. In addition to new employees for the new
branches noted above, the Bank has hired a number of new lending officers to
increase loan originations. Occupancy and equipment expenses increased $185,000
to $1.4 million for the six months ended June 30, 2006 due primarily to
increases in utilities, repairs and maintenance, and real estate taxes which
were partially offset by lower leasehold depreciation expenses. Depreciation on
leasehold improvements decreased by $58,000 to $52,000 for the six months ended
June 30, 2006 due to the acceleration of amortization on the leasehold
improvements at the Wal-Mart branches during the same period of 2005.
Advertising and marketing expenses increased by $172,000 to $333,000 for the six
months ended June 30, 2006 due primarily to higher media costs in 2006.
Professional fees increased by $452,000 to $879,000 for the six months ended
June 30, 2006 due primarily to an increase in legal expenses associated with the
Formal Agreement between the Bank and the OCC as well as placement agency fees
associated with the employment of new lending officers and senior management
personnel. Professional fees were also incurred for accounting and finance
services incurred while the Bank was looking for a CFO.
19
Income Taxes
The net benefit for income taxes increased by $445,000 from $20,000 for
the six months ended June 30, 2005, to $465,000 for the six months ended June
30, 2006. This was primarily the result of the $1.4 million reduction in pre-tax
income for the same periods. The impact of the pre-tax income reduction was
partially offset by a reduction in tax-exempt municipal income, and a reduction
in dividends eligible for the dividends received deduction.
Deferred tax assets are evaluated to determine whether it is "more likely
than not" that a tax return benefit would be realized when the deferred items
reverse. Evaluation considerations include the availability of historical and
projected taxable income to offset the deferred items in the periods they are
expected to reverse. While the recent trend of operating losses increases the
likelihood that such taxable income may not occur in the future, management has
determined that operational changes which have been made and are being made will
generate sufficient income to allow for the recognition of the deferred tax
assets. No valuation reserve was recorded as of June 30, 2006 or December 31,
2005.
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 been utilized in 2006 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.
20
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, 2006 amounted to
$72.3 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, 2006,
the Bank's total borrowing capacity through the FHLB was $106.5 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. The Bank must get
regulatory permission to accept brokered deposits because of its classification
as adequately capitalized.
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 $113.8 million at June 30, 2006. 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 $4 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.
On June 30, 2006, the Company and the Bank exceeded minimum capital
requirements applicable to them. As a result of the Formal Agreement with the
OCC, the Bank is deemed to be "adequately capitalized" under Prompt Corrective
Action regulations. Further, the Formal Agreement requires that the Bank raise
its capital ratios to the following minimum levels by December 31, 2006: total
capital to risk-weighted assets of 11%, tier 1 capital to risk-weighted assets
of 10%, and tier 1 capital to average assets of 8%. Management is currently
considering a number of alternatives that would enable the bank to achieve the
higher capital ratios by December 31, 2006, but at this time a final decision
has not been made. The table below presents the capital ratios at June 30, 2006,
for the Company and the Bank, as well as the minimum regulatory requirements.
Minimum
Minimum Capital
Capital Standards
Standards Beginning on
Actual Prior to 12/31/06 12/31/06
-------------------- ------------------- --------------------
Amount Ratio Amount Ratio Amount Ratio
--------- ---------- ---------- -------- --------- ----------
Bank:
Total capital to risk-weighted assets $28,341 9.76% $23,241 8.00% $31,956 11.00%
Tier 1 capital to risk-weighted assets 26,456 9.11% 11,620 4.00% 29,051 10.00%
Tier 1 capital to average assets 26,456 6.71% 15,769 4.00% 31,539 8.00%
Company:
Total capital to risk-weighted assets $29,755 10.22% $23,296 8.00% $23,296 8.00%
Tier 1 capital to risk-weighted assets 21,281 7.31% 11,648 4.00% 11,648 4.00%
Tier 1 capital to average assets 21,281 5.39% 15,800 4.00% 15,800 4.00%
21
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, 2006, the Bank had $20.3 million of outstanding
commitments to originate loans and $52.1 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 2005. If we determine that goodwill is
impaired at a future date, we would have to write-down its value.
Our 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
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.
Our current loan quality and historical loan growth may not continue,
particularly in new markets or with the loans acquired at the Boston branch
While the Bank has shown a very low level of loan charge-offs and
non-accrual loans in recent years, 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 we
did not perform the original underwriting.
As the Company continues to hire new commercial lenders, the maintenance
of high credit quality and continued growth in loan balances is not assured.
22
The opening of a branch 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 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 branch 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. 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 our earnings do not improve, our access to capital may be impacted
further and regulatory scrutiny will continue to 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.
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.
The Bank may not generate positive earnings in future periods when timing
differences related to deferred tax assets reverse. If future earnings cannot be
reasonable forecasted, a deferred tax asset valuation allowance may need to be
established which would have an additional negative impact on earnings.
We may not be able to attract new deposit customers in new markets or retain
existing deposit customers
We have opened 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 continued focus on growth
in core deposit categories will generate sufficient growth in targeted deposit
categories and continued growth of deposit fee income.
23
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 when 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.
Our capital and expense budgets may limit our ability to compete with larger
financial institutions
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.
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 remains flat, net interest income may be further
reduced. Liquidity could be reduced in the future if customers choose other
investment options. Liquidity could also be negatively impacted if current
strategies to increase deposit balances 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 this 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 low interest rates, it is important that growth in
longer-term checking and savings balances occurs in several markets.
24
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.
Our allowance for losses on loans and leases may not be adequate to cover all
future losses on existing loan and lease balances outstanding.
We have established an allowance for loan losses that we believe is adequate to
offset probable losses on our existing loans and leases. There can be no
assurance that any future declines in real estate market conditions, general
economic conditions or changes in regulatory policies will not require us to
increase our allowance for loan and lease losses, which would adversely affect
our results of operations.
The Bank signed a Formal Agreement with the OCC in June 2006. The bank may not
be able to achieve the requirements of the Agreement and may be subject to
further restriction imposed by the OCC.
The agreement calls for the Bank to achieve higher capital levels, retain
competent management, adopt a new strategic plan, adopt an interest rate risk
management plan, and improve liquidity. Failure to achieve the objectives stated
in the Agreement could result in the Bank being subject to further regulatory
action and limitation on the Bank's ability to conduct regular banking
activities.
The Formal Agreement requires that the Bank attain certain regulatory
capital ratios by December 31, 2006. The Company's ability to raise the capital
needed to meet the ratios set forth in the Formal Agreement will depend on a
number of factors, including conditions in the capital markets at that time, the
Company's financial performance, and the SEC's willingness to grant the Company
a waiver of the capital raising restriction described above. If the Bank is not
able to raise new capital it may have to begin a program to shrink the size of
the Bank. This could have a negative impact on the Bank's ability to originate
new loans. The elimination of business lines of the Bank could have further
negative impact on earnings if a reduction of operating expenses does not offset
the loss of income from disposed assets.
The direct costs of compliance with the Formal Agreement include legal and
consulting fees, higher FDIC insurance rates, increased examination fees, and
staffing costs, which all decrease earnings and reduce the capital base. Other
costs include significant dedication of resources that shift the focus of the
organization away from growing the customer base to ensuring that past issues
are addressed and controls are put into place to prevent future issues. The
Formal Agreement will restrict the ability of the Company and the Bank to
declare dividends, of the Company to acquire treasury stock and the Bank to
engage in certain non-bank activities. In addition, the Bank is required to
maintain higher levels of capital than other financial institutes without
similar regulatory issues. The management team has been actively engaged in
addressing the specific issues raised in the Formal Agreement and ensuring
compliance with all requirements. Noncompliance with such Formal Agreement may
also have adverse effects upon the Company and the Bank.
25
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
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 set forth below, there has been no material changes in legal
proceedings from the information provided in Item 3, "Legal Proceedings" of the
Company's Quarterly Report on Form 10-QSB for the quarter ended March 31, 2006.
31-33 State Street
On December 7, 2005, the Company was served with a Violation Notice by the
City of Boston Inspectional Services Department concerning unsafe maintenance
and areas of exterior spalling of masonry with respect to the building owned by
the Company's wholly owned subsidiary, First Ipswich Realty Company, LLC
("Realty LLC") at 31-33 State Street, Boston, Massachusetts. Realty LLC is
listed as a defendant in the civil action now pending before the Boston Housing
Court. Realty LLC has entered into negotiations with the City concerning
remedial actions required to bring the building facade into compliance with the
Massachusetts State Building Code and a tentative agreement has been reached in
principle with respect to the timeframe for the completion of the repairs.
Realty LLC believes that if all of the repairs are made in a timely manner,
consistent with the agreement reached in principle, no further action will be
taken by the City and that the complaint will be dismissed. Realty LLC has, as
of this date, performed certain remedial work to eliminate what are believed to
be emergency repairs. The remaining repair work commenced in the summer of 2006
and should be completed by January 7, 2007, depending upon the weather, labor
disputes, casualty, and other causes beyond the control of Realty LLC. It is
contemplated that responsibility for the timely completion of the repairs will
transfer to the buyer of the property.
26
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
Not applicable.
ITEM 3. Defaults Upon Senior Securities
Not applicable.
ITEM 4. Submission of Matters to a Vote of Security Holders
On April 19, 2006, the Company held its Annual Meeting of Stockholders.
The following actions were taken at the Annual Meeting:
1. The following eleven 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 1,581,831 1,830
Timothy R. Collins 1,581,831 1,830
John T. Coughlin 1,582,861 800
Craig H. Deery 1,581,831 1,830
Edward D. Dick 1,581,831 1,830
Stephanie R. Gaskins 1,581,831 1,830
Donald P. Gill 1,582,861 800
H. A. Patrician, Jr. 1,582,861 800
Neil St. John Raymond 1,581,831 1,830
Neil St. John Raymond, Jr. 1,582,861 800
William J. Tinti 1,582,861 800
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, 2006 was approved as follows: 1,583,601 votes for, and 60
votes against. There were no abstentions and no broker non-votes with respect to
this action.
ITEM 5. Other Information
None
ITEM 6. Exhibits
31.1 Certification of Chief Executive Officer pursuant to Rule 15d-14(a)
of the Securities Exchange Act of 1934.
31.2 Certification of Chief Financial Officer pursuant to Rule 15d-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.
27
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: August 14, 2006 By: /s/ Russell G. Cole
-----------------------
Russell G. Cole
President and Chief Executive Officer
Date: August 14, 2006 By: /s/ Timothy L. Felter
-----------------------
Timothy Felter
Senior Vice President and Chief Financial Officer