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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-QSB/A
(Amendment No. 1)
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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, 2006
|_| TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the transition period from ______________ to ______________
Commission File Number 333-114018
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First Ipswich Bancorp
(Exact name of small business issuer as specified in its charter)
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Massachusetts 04-2955061
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
31 Market Street,
Ipswich, Massachusetts 01938
(Address of principal executive offices)
(978) 356-3700
(Issuer's telephone number, including area code)
Not Applicable
(Former name, former address and former fiscal year,
if changed since last report)
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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 |X| NO |_|
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 October 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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EXPLANATORY NOTE
This Amendment No. 1 on Form 10-QSB/A ("Form 10-QSB/A") to the Quarterly Report
of First Ipswich Bancorp (the "Company") on Form 10-QSB for the quarterly period
ended September 30, 2006, initially filed with the Securities and Exchange
Commission (the "SEC") on November 14, 2006 (the "Original Filing"), is being
filed to reflect the restatement of our financial statements at, and for the
three and nine months ended, September 30, 2006 and the notes related thereto.
The decision to restate these financial statements was made to reflect the
correction of the valuation of securities identified for sale in the Original
Filing because the valuations reported in the Original Filing did not reflect
market prices as of the reporting date, September 30, 2006.
Although this Form 10-QSB/A sets forth the Original Filing in its entirety, this
Form 10-QSB/A only amends and restates Items 1 and 2 of Part I, and Item 6 of
Part II of the Original Filing, in each case, solely as a result of, and to
reflect the restatement and, in the case of Item 6 of Part II, solely to provide
currently dated certifications by the Company's Chief Executive Officer and
Chief Financial Officer. In addition, the Company has also amended its response
to Item 3 of Part I of the Original Filing to address the impact of this
Restatement on management's evaluation of its disclosure controls and
procedures. Except for the foregoing portions, no other information in the
Original Filing is amended hereby. Accordingly, the items have not been updated
to reflect other events occurring after the Original Filing or to modify or
update those disclosures affected by subsequent events.
Except for the foregoing amended information, this Form 10-QSB/A continues to
describe conditions as of the date of the Original Filing, and we have not
updated the disclosures contained herein to reflect events that occurred at a
later date. As such, this Form 10-QSB/A should be read in conjunction with the
reports subsequently filed by the Company with the SEC.
This amendment restates the consolidated financial statements and other
financial information for both the three and nine months periods ended September
30, 2006. The following table illustrates the information materially impacted by
this change.
As Originally
Reported Adjustment Restated
---------------------------------------------
Consolidated balance sheet at September 30, 2006
Retained Earnings 6,355 186 6,541
Accumulated other comprehensive income (1,201) (186) (1,387)
Consolidated statements of operations
For the three months ended September 30, 2006
Gain (loss) on sales and calls of securities, net (810) 284 (526)
Income (loss) before taxes (1,250) 284 (966)
Credit for income taxes (438) 98 (340)
Net income (loss) (812) 186 (626)
Basic & diluted earnings per share (0.37) 0.09 (0.28)
For the nine months ended September 30, 2006
Gain (loss) on sales and calls of securities, net (859) 284 (575)
Income (loss) before taxes (2,547) 284 (2,263)
Credit for income taxes (903) 98 (805)
Net income (loss) (1,644) 186 (1,458)
Basic & diluted earnings per share (0.74) 0.08 (0.66)
(dollars in thousands, except per share amounts)
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, 2006 and
December 31, 2005 3
Consolidated Statements of Operations for the quarter and
nine months ended September 30, 2006 and 2005 4
Consolidated Statements of Changes in Stockholders' Equity for the
nine months ended September 30, 2006 and 2005 5
Consolidated Statements of Cash Flows for the nine months ended
September 30, 2006 and 2005 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis 9
Item 3. Controls and Procedures 27
PART II OTHER INFORMATION
Item 1. Legal Proceedings 28
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 28
Item 3. Defaults Upon Senior Securities 29
Item 4. Submission of Matters to a Vote of Security Holders 29
Item 5. Other Information 29
Item 6. Exhibits 29
Signatures 29
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,
2006 2005
---------- ----------
ASSETS
Cash and due from banks $ 14,033 $ 11,179
Federal funds sold 11,394 82
---------- ----------
Total cash and cash equivalents 25,427 11,261
---------- ----------
Certificates of deposit 3,357 3,295
Securities available for sale, at fair value 97,218 88,375
Securities held to maturity, at amortized cost -- 28,769
Federal Home Loan Bank stock, at cost 4,140 6,647
Federal Reserve Bank stock, at cost 774 774
Loans, net of allowance for loan losses of $1,926 and $1,739 250,429 234,613
Banking premises and equipment, net 4,322 4,758
Real estate held for sale 5,134 4,486
Other assets 12,146 11,426
---------- ----------
Total assets $ 402,947 $ 394,404
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $ 276,520 $ 258,860
Short-term borrowings 71,621 71,262
Long-term borrowings 22,392 31,087
Subordinated debentures 13,000 13,000
Other liabilities 2,195 1,235
---------- ----------
Total liabilities 385,728 375,444
---------- ----------
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 6,541 8,054
Accumulated other comprehensive loss (1,387) (1,159)
Treasury stock, at cost (20,490 shares) (111) (111)
---------- ----------
Total stockholders' equity 17,219 18,960
---------- ----------
Total liabilities and stockholders' equity $ 402,947 $ 394,404
========== ==========
See accompanying notes to consolidated financial statements.
3
FIRST IPSWICH BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
(In thousands, except per share data)
Quarter Ended Nine Months Ended
September 30, September 30,
-------------------- --------------------
2006 2005 2006 2005
-------- -------- -------- --------
Interest and dividend income:
Interest and fees on loans $ 4,692 $ 3,730 $ 13,054 $ 9,355
Interest on debt securities:
Taxable 1,010 1,089 3,156 3,641
Tax-exempt 131 177 386 530
Dividends on equity securities 159 108 267 499
Other interest 94 45 211 135
-------- -------- -------- --------
Total interest and dividend income 6,086 5,149 17,074 14,160
-------- -------- -------- --------
Interest expense:
Interest on deposits 1,829 764 4,727 2,219
Interest on borrowed funds 1,083 1,154 3,365 3,180
Interest on subordinated debentures 243 238 701 487
-------- -------- -------- --------
Total interest expense 3,155 2,156 8,793 5,886
-------- -------- -------- --------
Net interest income 2,931 2,993 8,281 8,274
Provision for loan losses 66 78 131 185
-------- -------- -------- --------
Net interest income, after provision for loan losses 2,865 2,915 8,150 8,089
Other income:
Investment advisory fees 453 413 1,337 1,187
Service charges on deposit accounts 296 357 879 962
Credit card fees 219 211 579 553
Trust fees 106 134 316 370
Non-deposit investment fees 83 94 239 274
Gain (loss) on sales and calls of securities, net (526) (3) (575) 58
Rental Income 99 142 288 142
Valuation reserve for building held for sale (33) -- (319) --
Write down of fixed assets (340) -- (340) --
Miscellaneous 162 106 414 248
-------- -------- -------- --------
Total other income 519 1,454 2,818 3,794
-------- -------- -------- --------
Operating expenses:
Salaries and employee benefits 2,392 2,151 7,001 6,283
Occupancy and equipment 702 833 2,057 2,003
Professional fees 332 347 1,211 774
Credit card interchange 140 144 382 377
Advertising and marketing 51 93 384 254
Data processing 199 188 551 558
ATM processing 114 92 328 279
Other general and administrative 420 392 1,317 1,092
-------- -------- -------- --------
Total operating expenses 4,350 4,240 13,231 11,620
-------- -------- -------- --------
Income (loss) before income taxes (966) 129 (2,263) 263
Credit for income taxes (340) (1) (805) (21)
-------- -------- -------- --------
Net income (loss) $ (626) $ 130 $ (1,458) $ 284
======== ======== ======== ========
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 $ (0.28) $ 0.06 $ (0.66) $ 0.13
======== ======== ======== ========
Diluted $ (0.28) $ 0.06 $ (0.66) $ 0.13
======== ======== ======== ========
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, 2006 AND 2005
(In thousands, except per share data)
Accumulated
Additional Other
Paid-in Retained Comprehensive
Common Stock Capital Earnings Loss Treasury Stock Total
------------ ------- -------- ------------- -------------- --------
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 ($.0375 per
share) (84) (84)
------- ------ ------- ------- ------ --------
Balance at September 30, 2005 2,240 9,936 8,410 (998) (111) 19,477
======= ====== ======= ======= ====== ========
Balance at December 31, 2005 2,240 9,936 8,054 (1,159) (111) 18,960
--------
Comprehensive loss:
Net loss (1,458) (1,458)
Unrealized loss on securities
available for sale, net of
reclassification adjustment and
tax effect (228) (228)
--------
Total comprehensive loss (1,686)
--------
Cash dividends declared ($.0250 per
share) (55) (55)
------- ------ ------- ------- ------ --------
Balance at September 30, 2006 $ 2,240 $9,936 $ 6,541 $(1,387) $ (111) $ 17,219
======= ====== ======= ======= ====== ========
See accompanying notes to consolidated financial statements.
5
FIRST IPSWICH BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(In thousands)
Nine Months Ended
September 30,
-------------
2006 2005
-------- --------
Cash flows from operating activities:
Net income (loss) $ (1,458) $ 284
Adjustments to reconcile net income to net cash provided
(used) by operating activities:
Provision for loan losses 131 185
Losses (gains) on sales and calls of securities, net 575 (58)
Depreciation and amortization 554 786
Net amortization of securities, including certificate of deposit 92 207
Increase of valuation reserve for real estate held for sale 319 --
Derivative fair value adjustment (188) (50)
Amortization of core deposit intangible 121 83
Write down of fixed assets 340
Net change in other assets and other liabilities 1,300 (429)
-------- --------
Net cash provided (used) by operating activities 1,786 1,008
-------- --------
Cash flows from investing activities:
Activity in available-for-sale securities:
Purchases (2,887) (33,417)
Sales 101 60,933
Maturities, calls and paydowns 17,656 35,387
Transfer to available for sale from held-to-maturity 26,566 --
Activity in held-to-maturity securities:
Maturities, calls and paydowns 2,094 2,497
Transfer to available for sale from held-to-maturity (26,566) --
Redemption (purchase) of Federal Home Loan Bank stock 2,507 (1,057)
Purchase of Federal Reserve Bank stock -- (225)
Net cash paid in acquisition of Boston branch -- (29,389)
Loan originations, net of repayments (15,685) (16,204)
Additions to premises and equipment, net (675) (81)
-------- --------
Net cash provided (used) by investing activities 3,111 18,444
-------- --------
Cash flows from financing activities:
Net increase (decrease) in deposits 17,660 (8,111)
Net increase (decrease) in short-term borrowings 359 (10,382)
Proceeds from subordinated debenture -- 7,000
Repayment of long-term debt (8,695) (5,743)
Cash dividends paid (55) (84)
-------- --------
Net cash provided (used) by financing activities 9,269 (17,320)
-------- --------
Net increase (decrease) in cash and cash equivalents 14,166 2,132
Cash and cash equivalents at beginning of period 11,261 9,076
-------- --------
Cash and cash equivalents at end of period $ 25,427 $ 11,208
======== ========
Supplemental disclosures:
Interest paid $ 8,609 $ 5,886
Income taxes paid 58 135
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.
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. Through November 14, 2006, the Bank has met all
deadlines listed in the Formal Agreement
As a result of becoming subject to the Formal Agreement, the Bank, is
deemed to be "adequately capitalized" under Prompt Corrective Action
regulations.
In September 2006, the FASB Issued Statement of Financial Account
Standards No. 157, "Fair Value Measurements." (SFAS 157). This statement defines
fair value, establishes a framework for measuring fair value in generally
accepted accounting principles, and expands disclosures about fair value
measurements. SFAS 157 is effective for the Company on January 1, 2008 and is
not expected to have a significant impact on the Company's financial statements.
In July, 2006 the FASB issued Financial Accounting Standards
Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" (FIN 48).
FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an
entity's financial statements in accordance with FASB Statement No. 109,
"Accounting for Income Taxes". FIN 48 prescribes a recognition threshold and
measurement attributable for the financial statement recognition and measurement
of a tax position taken or expected to be taken in a tax return. FIN 48 also
provides guidance on derecognition, classification, interest and penalties,
accounting in interim periods, disclosures and transitions. FIN 48 is effective
for fiscal years beginning after December 15, 2006. The Company is currently
analyzing the effects of FIN 48.
On September 13, 2006, the Securities and Exchange Commission "SEC" issued
Staff Accounting Bulleting No. 108 ("SAB 108"). SAB 108 provides interpretive
guidance on how the effects of the carryover or reversal of prior year
misstatements should be considered in quantifying a potential current year
misstatement. Prior to SAB 108, Companies might evaluate the materiality of
financial-statement misstatements using either the income statement or balance
approach, with the income statement approach focusing on new misstatements added
in the current year, and the balance sheet approach focusing on the cumulative
amount of misstatement present in a company's balance sheet. Misstatements that
would be material under one approach could be viewed as immaterial under another
approach, and not be corrected. SAB 108 now requires that companies view
financial statement misstatements as material if they are material according to
either the income statement or balance sheet approach. SAB 108 will be
applicable to all financial statements issued by the Company after November 15,
2006. The Company does not expect that SAB 108 will have a significant impact on
the reported results of operations or financial condition.
7
(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 were no common stock equivalents outstanding for the three and
nine month periods ended September 30, 2006 and September 30, 2005.
(3) Commitments
At September 30, 2006, the Company had outstanding commitments to
originate loans of $9.6 million. Unused lines of credit and open commitments
available to customers at September 30, 2006 amounted to $46.1 million, of which
$14.9 million related to construction loans, $11.4 million related to home
equity lines of credit, $4.6 million related to credit card loans, and $15.2
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-month periods ended September 30, 2006 and September 30, 2005 is below.
Investment Consolidated
Banking Advisory Totals
------- -------- ------
(Dollars in thousands)
September 30, 2006:
Net interest and dividend income $ 8,278 $ 3 $ 8,281
Other revenue: external customers 1,481 1,337 2,818
Net income (loss) (1,785) 327 (1,458)
Assets $ 400,079 $2,868 $ 402,947
September 30, 2005:
Net interest and dividend 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
(5) Real Estate Held for Sale
Real estate held for sale consists of the land and building acquired in the
Boston branch acquisition. These assets are being carried at their estimated
fair value, less selling costs. A valuation reserve of $33,000 was recorded
during the quarter ended September 30, 2006 because the estimated fair value,
less selling costs, was less than the book value of the assets. The total
valuation reserve recorded in the first nine months of 2006 was $319,000
(6) Investment Portfolio
Effective September 30, 2006, the Company reclassified $26.6 million of
investments held to maturity into investments available for sale, reflecting the
opinion of management that all investments may not be held until maturity and
that the Company may want to make future strategic changes in the investment
portfolio. The net unrealized loss on the reclassified securities totaled $0.7
million and the after-tax net unrealized loss reflected on the balance sheet in
the "accumulated other comprehensive loss" portion of stockholders' equity was
$0.4 million.
8
In addition, as of September 30, 2006, the Company has identified approximately
$42 million of investment securities classified as available for sale that it
intends to sell as part of the Strategic Plan to achieve compliance with the
Formal Agreement. Accordingly, because the Company no longer has the intent to
hold these securities to maturity, the Company recognized an
other-than-temporary impairment loss of $0.5 million for securities to be sold
whose amortized cost exceeded market value at September 30, 2006. This loss is
reflected in other income in the accompanying consolidated statements of
operations for the quarter and nine months ended September 30, 2006.
The Company owns a collateralized bond obligation security with a book value of
$3.3 million. The market value of the security is approximately $2.7 million as
of September 30, 2006. The Company 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.
(7) 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. 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 September 30, 2006 or December 31, 2005.
(8) Sale of Trust Department
On August 24, 2006, the Bank entered into an agreement to sell the Bank's
traditional Trust Department to Eastern Bank. The initial closing date for the
sale was October 31, 2006. The initial transfer of trust accounts resulted in a
net gain of $330,000. Additional transfers may occur over the course of the next
year as additional clients approve of the change in trustee which would result
in the recognition of additional gains on the sale and transfer up to $40,000 of
additional gains.
(9) Restatement of Financial Statements
These consolidated financial statements have been restated as of December 22,
2006 to reflect the correction of the valuation of securities identified for
sale because the valuations reported in the original financial statements issued
November 14, 2006 did not reflect market prices as of the reporting date,
September 30, 2006. Further information about the securities held for sale can
be found in Footnote 6.
Except for amounts impacted by the foregoing item, no other information in the
Original Filing is amended hereby. Accordingly, the items have not been updated
to reflect other events occurring after November 14, 2006 or to modify or update
those disclosures affected by subsequent events.
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
9
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 first nine months of 2006 has been a challenging time for the Company.
Earnings have been weak, and executive management has undergone change at the
CEO and CFO levels.
On June 28, 2006, the Bank entered into a Formal Agreement with its
primary Federal banking regulator, The Comptroller of the Currency (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. 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 has completed and submitted to the OCC a strategic plan, a
capital plan, a liquidity contingency plan, an interest rate risk management
plan, and a report which includes an evaluation of management. These plans were
submitted on a timely basis and in accordance with the Formal Agreement. The
Formal Agreement calls for, and the OCC has issued, a determination of no
supervisory objection to the Bank's capital and strategic plans.
Both the Board and Management are committed to returning the Company to
profitability and complying with the Formal Agreement.
The Strategic Plan calls for the Company to become a high performing
company with an emphasis on community banking and wealth management. The
Strategic Plan will be implemented over the next six months, and will allow the
Bank to achieve the capital ratio objectives established in the Formal
Agreement. The Bank will renew its efforts to meet the core banking needs of its
business and consumer clients. The Plan's capital objectives will be achieved
via a mix of increased revenues and a significant decrease of operating
expenses.
The implementation of the Plan requires restructuring charges.
Restructuring costs totaling $1.1 million on a pre-tax basis and $0.7 million on
an after-tax basis are included in earnings reported for the quarter ended
September 30, 2006. Restructuring costs include impairment losses recognized on
the anticipated sale of securities of $0.5 million, write-downs of fixed assets
no longer intended to be used in operations of the business of $0.3 million, and
severance costs related to personnel changes of $0.2 million. If the
restructuring charges were not recorded in the quarter ended September 30, 2006,
the Company would have reported an after-tax profit of $109,000.
Certain aspects of the Strategic Plan have been announced. The Bank has
initiated the following expense reduction efforts: consolidation of the Rowley
branches, restructuring and reduction of staff levels, sale of the Trust
Department, and a consolidation of operating facilities. Additional efforts are
under way to reduce expenses further.
The Company is reporting a net loss of $626,000 for the quarter ended
September 30, 2006 as compared to net income of $130,000 in the same period of
2005 and a net loss of $1,458,000 for the nine months ended September 30, 2006
as compared to net income of $284,000 for the same period of 2005. The Company's
loss for the three months ended September 30, 2006 reflects losses associated
with the restructuring required to implement the Strategic Plan. Restructuring
costs total $1.1 million on a pretax basis and $0.7 million on an after-tax
basis. 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 nine months of 2006 as
10
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 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.
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. During the quarter ended
September 31, 2006 the Company recognized other-than-temporary permanent
impairment of debt securities with an amortized cost that is lower than market
value which the Bank no longer plans to hold until maturity or recovery of
value. A further discussion of the impairment decision can be found below in the
Investment Securities section of the Comparison of Financial Condition.
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 September 30, 2006 versus
December 31, 2005
Total assets were $402.9 million at September 30, 2006, an increase of
$8.5 million, or 2.2%, from $394.4 million as of December 31, 2005. Principal
repayments on investment securities totaling $19.8 million and deposit growth of
$17.7 million funded loan portfolio growth of $15.8 million and the net
repayment of $10.0 million of FHLB advances.
Loans
Total net loan balances were $250.4 million as of September 30, 2006, an
increase of $15.8 million, or 7%, from $234.6 million as of December 31, 2005.
The Bank continues to focus on originating high quality loans. The increase is
due primarily to increased business development efforts of an expanded lending
team. Commercial real estate loans increased to $118.8 million as of September
30, 2006, an increase of $10.4 million, or 10%, from $108.4 million as of
December 31, 2005. The Bank's commercial real estate lending strategy stresses
quality loan originations to local businesses, professionals, experienced
developers, and investors. Commercial loans increased $3.5 million, or 8%, to
$46.9 million as of September 30, 2006 due primarily to increased business
development and lending in new markets. The loan growth anticipated in the
Strategic Plan will be modest and managed.
Construction loan balances increased $1.1 million, or 6%, to $20.0 million
as of September 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 September 30,
2006 increased $1.6 million, or 3%, from $53.7 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.
11
The following table presents the composition of the Bank's loan portfolio
by type of loan at the dates indicated.
September 30, December 31,
2006 2005
------------- ------------
(Dollars in thousands)
Real estate mortgage loans:
Residential $ 55,308 $ 53,690
Commercial 118,847 108,404
Construction 20,029 18,918
Equity lines of credit 9,787 10,243
Commercial loans 46,917 43,376
Consumer loans 1,665 1,770
--------- ---------
Total loans 252,553 236,401
Net deferred origination fees (198) (49)
Allowance for loan losses (1,926) (1,739)
--------- ---------
Loans, net $ 250,429 $ 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:
September 30, December 31,
2006 2005
---- ----
(Dollars in thousands)
Non-accrual loans $ -- $ --
Troubled debt restructurings $ -- $ --
Loans past due 90 days or more and still accruing $ 5 $ 16
Non-accrual loans to total loans --% --%
Non-performing assets to total assets --% --%
Allowance for loan losses as a percentage of
total loans 0.76% 0.74%
For the nine months ended September 30, 2006, the Bank recorded a $131,000
provision for loan losses to accommodate net growth of the loan portfolio as
well as concerns for the residential real estate market. The Bank recorded
charge-offs of $27,000 and recoveries of $83,000 for the nine months ended
September 30, 2006. The allowance for loan losses balance was $1,926,000 at
September 30, 2006, an increase of $187,000 since December 31, 2005. Management
considers the loan loss allowance to be adequate to provide for potential loan
losses. A continued charge to earnings via a loan loss provision is anticipated
in 2006 due to the expectation of continued loan originations and continuing
concern for the robustness of the residential real estate market.
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.
12
Investment Securities
Total investment securities, which include certificates of deposit,
available-for-sale securities, held-to-maturity securities and Federal Home Loan
Bank and Federal Reserve Bank stock totaled $105.5 million as of September 30,
2006, a decrease of $22.4 million, or 18%, from $127.9 million as of December
31, 2005. Proceeds from investment securities maturities and principal
prepayments were utilized to fund loan growth.
The Bank classified all securities as available for sale as of September
2006. The reclassification of $26.6 million of investments previously classified
as held to maturity into investments available for sale reflects the opinion of
management that all investments may not be held until maturity and that the
Company may want to make strategic changes in the investment portfolio. The net
unrealized loss on the reclassified securities totaled $0.7 million and the
after-tax net unrealized loss reflected on the balance sheet in the "accumulated
other comprehensive loss" portion of stockholders' equity was $0.4 million.
As of September 30, 2006, the Company identified available-for-sale
investment securities with an amortized cost of $42.5 million and a fair value
of $42.2 million that it intends to sell as part of the plan to bring the Bank
into compliance with the capital ratio requirements of the Formal Agreement.
Accordingly, because the Company no longer has the intent to hold these
securities to recovery or maturity, the Company recognized, in the quarter ended
September 30, 2006, the $0.5 million unrealized loss for securities to be sold
whose amortized cost exceeded market value at September 30, 2006. Management
does not anticipate the need to identify other specific securities for sale.
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, 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 $ 61,754 $ 59,961 $ 64,571 $ 63,257
U.S. Government agency obligations 21,893 21,640 23,287 22,940
Corporate bonds 1,838 1,736 1,816 1,713
Municipal bonds 13,847 13,881 369 347
--------- --------- --------- ---------
Total debt securities 99,332 97,218 90,043 88,257
Marketable equity securities -- -- 101 118
Total securities available for sale $ 99,332 $ 97,218 $ 90,144 $ 88,375
========= ========= ========= =========
Securities held to maturity:
U.S. Government sponsored enterprise
obligations $ -- $ -- $ 3,000 $ 2,853
Municipal bonds -- -- 15,128 14,904
Mortgage-backed securities -- -- 10,641 10,257
--------- --------- --------- ---------
Total securities held to maturity $ -- $ -- $ 28,769 $ 28,014
========= ========= ========= =========
13
The Company owns a collateralized bond obligation security with a book
value of $3.3 million. The market value of the security is approximately $2.7
million as of September 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 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.
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 $276.5 million as of September 30, 2006, an
increase of $17.6 million, or 7%, 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 $4.0 million, or
8%, during the nine month period to $46.8 million as of September 30, 2006. NOW
account balances decreased by $5.0 million, or 13%, to $34.7 million as of
September 30, 2006. Regular savings balances decreased $4.3 million, or 12%, to
$31.6 million as of September 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's new
Strategic Plan is committed to developing a full banking relationship with its
customers.
Total money market deposit balances increased $6.0 million, or 12%, from
December 31, 2006 to $56.1 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 $24.9 million, or 30%, to $107.4 million at
September 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 reward customers who have multiple products and
services.
The following table shows the composition of the Company's deposit
balances at the dates indicated.
September 30, December 31,
2006 2005
------------- ------------
(Dollars in thousands)
Demand $ 46,770 $ 50,734
NOW 34,737 39,743
Regular savings 31,604 35,875
Money market deposits 56,051 50,058
Term certificates 107,358 82,450
---------- ----------
$ 276,520 $ 258,860
========== ==========
14
Borrowings
Short-term borrowings increased by $.4 million, or 1%, to $71.6 million as
of September 30, 2006. Long-term advances decreased by $8.7 million, or 28%, to
$22.4 million as of September 30, 2006. Borrowings were paid down with proceeds
from the special CD promotion in April 2006. The Company expects to pay down
Federal Home Loan Bank advances with proceeds from the sale of assets identified
in the Company's Strategic Plan. There may be prepayment penalties incurred as
the Company pays down long-term advances. The advances to be repaid, the
associated prepayment penalties, and the timing of the prepayments have not been
identified at this time.
Stockholders' Equity
Total stockholders' equity decreased from $19.0 million at December 31,
2005 to $17.2 million as of September 30, 2006 due to an operating net loss of
$1,458,000 for the nine months ended September 30, 2006; and dividends paid in
the amount of $55,000.
Comparison of Operating Results for the Quarter Ended September 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 September 30, 2006 was $626,000
compared with a net income of $130,000 for the three months ended September 30,
2005. For the three months ended September 30, 2006, net interest income
decreased by $62,000, non-interest income decreased $935,000, and operating
expenses increased by $110,000, all as compared to the three months ended
September 30, 2005.
Interest and Dividend Income
Total interest and dividend income for the quarter-ended September 30,
2006 was $6.1 million, which was $.9 million higher than the quarter-ended
September 30, 2005. This increase was due to the favorable impact of a higher
average asset yield, higher average interest-earning assets, and a higher than
normal dividend from the Federal Home Loan Bank. The Company received $94,000
more in FHLB dividends during the quarter ended September 30, 2006 due to the
timing of FHLB dividend declarations; the Company does not anticipate future
extra payments. The yield on interest earning assets increased to 6.62% for the
quarter-ended September 30, 2006 as compared to 5.64% for the quarter-ended
September 30, 2005. In addition, lower yielding investments were replaced by
higher yielding loans. Average interest earning assets of $364.9 million for the
quarter ended September 30, 2006 were $.1 million lower than average
interest-bearing assets of $365.0 million for the quarter ended September 30,
2005.
The increase in average yield was due primarily to a changing mix of
assets. Average net loans for the quarter ended September 30, 2006 were $26.0
million higher than the same quarter of 2005 and average investments were $30.3
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.
15
Interest Expense
Interest expense on interest-bearing liabilities for the quarter-ended
September 30, 2006 was $3.2 million, a $1.0 million increase from the
quarter-ended September 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 3.79% for the quarter
ended September 30, 2006 as compared to 2.64% 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 September 30,
2006 due equally to an increase in average balances during the quarter ended
September 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 September 30, 2006 were $44.0 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 3.04%, up significantly from 1.57% in the same quarter of 2005.
Interest expense on borrowed funds, including subordinated debentures, for
the quarter-ended September 30, 2006 decreased slightly by $66,000 to $1.3
million as compared to the quarter-ended September 30, 2005. The increase in
interest expense on borrowed funds was driven primarily by decreasing balances.
Net Interest Income
Net interest income for the quarter ended September 30, 2006 was $2.9
million compared to $3.0 million for the quarter ended September 30, 2005. The
impact of the changing mix of earning assets to higher yielding loans offset a
lower net interest margin. The net interest spread decreased to 2.83% for the
quarter ended September 30, 2006 from 3.00% for the quarter ended September 30,
2005. The shrinking interest rate spread reflects the impact of the (inverted
now) flat yield curve that has existed for the past year. In addition, the Bank
has aggressively priced certain money market accounts and certificates of
deposit in order to grow deposits and pay down FHLB advances. Although the Bank
offered premium rates at the time of account opening, those rates are now at or
below market rates.
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 September 30, 2006 and 2005. The average
balances are derived from average daily balances.
16
Three Months Ended September 30,
2006 2005
Average Average
Interest Rate Interest Rate
Income/ Average Earned/ Income/ Average Earned/
Expense Balance Paid Expense Balance Paid
-------------------------------------------------------------------------
(Dollars in thousands)
Assets
Interest earning assets:
Federal funds sold and certificate
of deposit $ 94 $ 7,232 5.13% $ 45 $ 3,058 5.89%
Investment securities:
Taxable 1,169 95,636 4.85% 1,197 124,334 3.85%
Tax-exempt 131 14,156 3.68% 177 15,712 4.51%
Loans, net 4,692 247,872 7.51% 3,730 221,900 6.72%
--------------------- ----------------------
Total interest-earning assets 6,086 364,896 6.62% 5,149 365,004 5.64%
---------- ----------
Noninterest-earning assets 31,530 33,734
----------- ------------
Total assets 396,426 398,738
=========== ============
Liabilities and Stockholders' Equity:
Interest-bearing liabilities:
Savings 39 31,309 0.49% 50 39,987 0.50%
NOW 11 35,533 0.12% 13 38,601 0.13%
MMDA 486 57,179 3.37% 347 62,852 2.21%
CD's 1,293 114,400 4.49% 354 53,004 2.67%
--------------------- ----------------------
Total interest-bearing deposits 1,829 238,421 3.04% 764 194,444 1.57%
Other borrowed funds 193 14,990 5.08% 112 11,920 3.76%
Federal Home Loan Bank advances 890 63,874 5.53% 1,042 106,088 3.93%
Subordinated debentures 243 13,000 7.43% 238 14,000 6.80%
--------------------- ----------------------
Total interest-bearing liabilities 3,155 330,285 3.79% 2,156 326,452 2.64%
---------- ----------
Noninterest-bearing deposits 46,567 51,383
Other noninterest-bearing liabilities 1,701 1,085
----------- ------------
Total liabilities 378,553 378,920
Total stockholders' equity 17, 873 19,818
----------- ------------
Total liabilities and stockholders'
Equity $396,426 $398,738
=========== ============
Net interest income $ 2,931 $ 2,993
========== ==========
Interest rate spread 2.83% 3.00%
========= ========
Net interest margin 3.19% 3.28%
========= ========
Non-interest Income
Total non-interest income for the quarter ended September 30, 2006 was $.2
million as compared to $1.5 million for the quarter ended September 30, 2005.
The second quarter of 2006 included $526,000 of security losses and $340,000 of
fixed asset write-offs related to the Bank's restructuring program. The loss on
securities is discussed further in the Investment Securities section of the
Comparison of Financial Condition. The write-off of fixed assets relates to
leasehold improvements and equipment that the Company is ceasing to use as a
result of the implementation of the Strategic Plan. Partially offsetting the
quarterly decrease was a $40,000 increase of investment advisory fee revenue.
17
Non-interest Expense
Total operating expenses increased by $110,000 to $4.4 million for the
quarter ended September 30, 2006 as compared to the same quarter of 2005. The
increase was driven mainly by the $200,000 expense in the quarter ended
September 30, 2006 for severance payments related to staff reductions resulting
from the implementation of the Strategic Plan.
Salaries and employee benefits increased by $241,000 in the quarter ended
September 30, 2006 as compared to the same quarter of 2005. The increase was
primarily driven by $200,000 of severance related expense associated with the
Bank's restructuring program. Partially offsetting the increase were decreases
of $131,000 of occupancy and equipment expenses and $42,000 of marketing and
advertising expenses.
The Company's Strategic Plan includes implementing cost savings which are
anticipated to reduce all categories of non-interest expenses including
salaries, professional fees, advertising and marketing and occupancy costs. The
success in achieving these cost reductions is an integral part of achieving the
status of a high performing Company.
Income Taxes
The net benefit for income taxes increased by $339,000 from $1,000 for the
quarter ended September 30, 2005, to $340,000 for the quarter ended September
30, 2006. This was primarily the result of the $1.1 million reduction in pre-tax
income between the same periods.
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 September 30, 2006 or December
31, 2005.
Comparison of Operating Results for the Nine Months Ended September 30, 2006
and 2005
General
The net loss for the nine months ended September 30, 2006 was $1,458,000
compared with net income of $284,000 for the nine months ended September 30,
2005. Restructuring costs totaling $1.1 million on a pre-tax basis and $0.7
million on an after-tax basis are included in earnings reported for the quarter
ended September 30, 2006. Also included in the nine month reported earnings are
write-downs of real estate held for sale in the pre-tax amount of $0.3 million.
For the nine months ended September 30, 2006, net interest income
increased by $7,000 non-interest income decreased $976,000, and operating
expenses increased $1,611,000, as compared to the nine months ended September
30, 2005.
Interest and Dividend Income
Total interest and dividend income for the nine months ended September 30,
2006 was $17.1 million, which was $2.9 million higher than the nine months ended
September 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 6.25% for the nine months ended September 30, 2006
as compared to 5.24% for the nine months ended September 30, 2005. In addition,
lower yielding investments were replaced by higher yielding loans. Average
interest earning assets of $365.1 million for the period ended September 30,
2006 were $4.7 million higher than average interest-earning assets of $360.4
million for the period ended September 30, 2005.
18
The increase in average yield was due primarily to a changing mix of
assets. Average net loans for the nine months ended September 30, 2006 were
$51.3 million higher than the same period of 2005 and average investments were
$49.1 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.
Interest Expense
Interest expense on interest-bearing liabilities for the nine months ended
September 30, 2006 was $8.8 million, a $2.9 million increase from the nine
months ended September 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 3.55% for the nine
months ended September 30, 2006 as compared to 2.44% 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 nine months ended September
30, 2006 due primarily to an increase in average balances during the nine months
ended September 30, 2006 as compared to the same period of 2005. Average
interest-bearing deposit balances during the nine months ended September 30,
2006 were $37.0 million higher than the same period of 2005. The increase in the
2006 period was primarily attributable to premium rate money market accounts
introduced in the first quarter of 2006 and a special CD promotion in April
2006; the CD promotion raised $49 million in new CD balances. The average rate
paid for deposit during the first nine months of 2006 was 2.76%, up from 1.54%
in the same period of 2005.
Interest expense on borrowed funds, including subordinated debentures, for
the nine months ended September 30, 2006 increased by $399,000 to $4.1 million
as compared to the nine months ended September 30, 2005. The impact of lower
average balances of borrowed funds during the 2006 nine 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 5.29% in the first nine months of 2006 as
compared to 3.76% during the first nine 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 capital levels.
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 nine months ended September 30, 2006 increased
by $7,000, to $8.3 million as compared to the nine months ended September 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 $51.3 million higher in the nine months ended
September 30, 2006 than in the nine months ended September 30, 2005 while
average investment balances were $49.1 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 nine months ended September 30, 2006 and 2005. The average
balances are derived from average daily balances.
19
Nine Months Ended September 30,
2006 2005
Average Average
Interest Rate Interest Rate
Income/ Average Earned/ Income/ Average Earned/
Expense Balance Paid Expense Balance Paid
---------------------------------------------------------------------------
(Dollars in thousands)
Assets
Interest earning assets:
Federal funds sold and certificate
of deposit $ 211 $ 5,491 5.12% $135 $ 3,099 5.81%
Investment securities:
Taxable 3,423 103,819 4.41% 4,140 151,169 3.65%
Tax-exempt 386 14,477 3.56% 530 16,222 4.36%
Loans, net 13,054 241,296 7.23% 9,355 189,950 6.57%
--------------------- -------------------------
Total interest-earning assets 17,074 365,083 6.25% 14,160 360,440 5.24%
---------- ------------
Non-interest-earning assets 31,272 28,129
----------- -------------
Total assets 396,355 388,569
=========== =============
Liabilities and Stockholders' Equity:
Interest-bearing liabilities:
Savings 120 32,331 0.49% 142 37,052 0.51%
NOW 30 36,138 0.11% 43 36,279 0.16%
MMDA 1,364 56,929 3.20% 1,013 63,843 2.12%
CD's 3,213 103,182 4.16% 1,021 54,453 2.50%
--------------------- -------------------------
Total interest-bearing deposits 4,727 228,580 2.76% 2,219 191,627 1.54%
Other borrowed funds 511 13,850 4.93% 271 11,350 3.18%
Federal Home Loan Bank advances 2,854 75,984 5.02% 2,909 109,626 3.54%
Subordinated debentures 701 13,000 7.21% 487 9,590 6.77%
--------------------- -------------------------
Total interest-bearing liabilities 8,793 331,414 3.55% 5,886 322,193 2.44%
---------- ------------
Noninterest-bearing deposits 45,279 45,376
Other noninterest-bearing liabilities 1,378 1,254
----------- -------------
Total liabilities 378,071 368,823
Total stockholders' equity 18,284 19,746
----------- -------------
Total liabilities and stockholders'
Equity $396,355 $388,569
=========== =============
Net interest income $ 8,281 $ 8,274
========== ============
Interest rate spread 2.70% 2.80%
========== ==========
Net interest margin 3.03% 3.06%
========== ==========
Non-interest Income
Total non-interest income for the nine months ended September 30, 2006 was
at $2.8 million versus $3.8 million for the nine months ended September 30,
2005. The decrease in non-interest income for nine months ended September 30,
2006 was primarily due to security write-downs and losses of $575,000, the
establishment of a $319,000 valuation reserve for real estate held for sale, a
$150,000 increase of investment advisory fee revenue in 2006 as compared to the
same period of 2005, and a $146,000 increase attributable to rental income from
the Boston building, for the same comparable periods.
The valuation reserve for real estate held for sale of $319,000 was
recorded during the nine months ended September 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 complete the rehabilitation
work required to bring the facade up to acceptable standards and then remarket
the property. It is expected that the rehabilitation work will increase the
value of the property and accordingly the costs of the rehabilitation work will
be added to the basis of the building. It is possible that changes to the
reserve may occur prior to, and related to, the sale of the real estate which is
anticipated in 2007. The Company plans to fully lease-up the property to
maximize rental income.
20
Non-interest Expense
Total operating expenses for the nine months ended September 30, 2006
increased by $1.6 or 14%, to $13.2 million. The increase includes increased
costs associated with the Boston branch purchase in June 2005 and the Portsmouth
branch opening in April 2006. In addition, during the nine months ended
September 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 nine month reporting period.
Salaries and employee benefits for the nine months ended September 30,
2006 increased $718,000 to $7.0 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 severance expense. Occupancy and equipment expenses
increased $54,000 to $2.1 million for the nine months ended September 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 $198,000 to
$81,000 for the nine months ended September 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 $130,000 to
$384,000 for the nine months ended September 30, 2006 due primarily to higher
media costs in the first and second quarters of 2006. Professional fees
increased by $437,000 to $1,211,000 for the nine months ended September 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 completing its search for a CFO in the
first quarter of 2006.
Income Taxes
The net benefit for income taxes increased by $784,000 from $21,000 for
the nine months ended September 30, 2005, to $805,000 for the nine months ended
September 30, 2006. This was primarily the result of the $2.5 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. 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 September 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
21
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.
The pro forma impact of the Strategic Plan was modeled using the same
asset/liability model that the Company uses on a quarterly basis. The output
from the model indicated that the Company would still be within the limits
included in the Company's current Asset/Liability Management policy.
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.
The Formal Agreement required the Bank to formulate a liquidity
contingency plan. The plan calls for the Bank to manage loan originations and
the level of the investment portfolio as well as FHLB advances availability so
that deposit flows can be accommodated.
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, 2006 amounted to
$78.4 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,
2006, the Bank's total borrowing capacity through the FHLB was $102.0 million.
The Bank has additional capacity to borrow funds 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. The
Bank plans to utilize the proceeds from the sale of assets to pay down FHLB
advances. Some of the pay downs may result in the Company incurring prepayment
penalties because the Company is prepaying advances prior to maturity. The
Company has not determined which advances may be prepaid, the amount of
prepayment penalties that may be incurred, or the time period in which the
prepayment penalties may be incurred.
22
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 $102.4 million at September 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 September 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 total tier 1 capital to risk-weighted average assets of 8%.
Management is currently implementing a Strategic Plan that would enable the bank
to achieve the higher capital ratios in a time period acceptable to the OCC. The
table below presents the capital ratios at September 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 $27,757 9.78% $22,706 8.00% $31,221 11.00%
Tier 1 capital to risk-weighted assets 25,831 9.10% 11,353 4.00% 28,382 10.00%
Tier 1 capital to average assets 25,831 6.55% 15,775 4.00% 31,550 8.00%
Company:
Total capital to risk-weighted assets $29,261 10.28% $22,764 8.00% $22,764 8.00%
Tier 1 capital to risk-weighted assets 20,537 7.22% 11,382 4.00% 11,382 4.00%
Tier 1 capital to average assets 20,537 5.23% 15,705 4.00% 15,705 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, 2006, the Bank had $9.6 million of
outstanding commitments to originate loans and $46.1 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.
23
Business Risks
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. In addition, the costs of compliance
with the Formal Agreement may adversely affect earnings in the near future.
The agreement calls for the Bank to achieve higher capital ratio 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 limit 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 must reduce assets and/or raise
capital. The Company's ability to raise capital to meet the capital 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. The elimination of certain business
lines and/or assets 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 Bank has received a written letter of no supervisory objection to the
Bank's Strategic Plan and capital plan. Management has started and expects to
continue to implement the plans over the next six months.
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 restricts 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 institutions 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.
Goodwill associated with acquisitions may become impaired and require a
write-down of value
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 in December 2004 was 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.
24
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.
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.
25
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.
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 as well as prohibits the pay down of the Bank's 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.
26
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 occur in several markets.
The Company has had some success in increasing the level of adjustable
rate loans and loans with shorter amortization periods or maturity dates, but
has had little success in extending the terms of its deposits. These trends may
reduce net interest income in the future.
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.
ITEM 3. CONTROLS AND PROCEDURES
The Company maintains disclosure controls and procedures (as defined in Exchange
Act Rule 15d-15(e)) that are designed to assure that information required to be
disclosed in its Exchange Act reports is recorded, processed, summarized and
reported within the time periods specified in the Securities and Exchange
Commission's rules and forms, and that such information is accumulated and
communicated to management, including the Chief Executive Officer and Chief
Financial Officer, as appropriate, to allow timely decisions regarding required
disclosures.
Upon learning of the accounting error included in the 10-QSB filed on November
14, 2006, management reviewed the adequacy of the Company's disclosure controls
and procedures as of the end of the period covered by this report. Management
evaluated the adequacy of the disclosure controls and procedures with its Board
of Directors and Audit Committee. Management also reviewed the adequacy of the
disclosure controls and procedures, in light of the error, with the Company's
27
independent auditors. In all cases, the discussion included consideration as to
whether the error indicated any requirement to amend or supplement the Company's
controls and procedures. As a result of these discussions, the Chief Executive
Officer and the Chief Financial Officer concluded that the Company's disclosure
controls and procedures were not operating effectively as of the end of the
period covered by this report because an error related to the valuation of
investment securities held for sale was not detected prior to the filing of the
report. The evaluation identified a need for a clearer segregation of
responsibilities in connection with the preparation and review of documentation
to support the preparation of quarterly and annual financial statements.
Subsequent to the quarter ended September 30, 2006, the Company made changes in
the organizational structure to provide a clearer segregation of
responsibilities in connection with the preparation and review of documentation
to support the preparation of quarterly and annual financial statements. Except
for the improvement described above, there have been no other changes in the
internal control over financial reporting that have materially affected, or are
reasonably likely to materially affect, our internal control over financial
reporting.
We do not expect that internal controls over financial reporting will prevent
all errors or all instances of fraud. A control system, no matter how well
designed and operated, can provide only reasonable, not absolute, assurance that
the control system's objectives will be met. Further, the design of a control
system must reflect the fact that there are resource constraints, and the
benefits of controls must be considered relative to their costs. Because of the
inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that all control issues within its company have been
detected. These inherent limitations include the realities that judgments in
decision-making can be faulty, and that breakdowns can occur because of simple
error or mistake. The design of any system of controls is based in part upon
certain assumptions about the likelihood of future events, and any design may
not succeed in achieving its stated goals under all potential future conditions.
Over time, controls may become inadequate because of changes in conditions or
deterioration in the degree of compliance with policies or procedures. Because
of the inherent limitation of a cost-effective control system, misstatements due
to error or fraud may occur and not be detected.
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 September 30,
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 in January 2007, depending upon the weather, labor
disputes, casualty, and other causes beyond the control of Realty LLC. The
estimated cost to complete the repair work is currently estimated at $1 million.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
Not applicable.
28
ITEM 3. Defaults Upon Senior Securities
Not applicable.
ITEM 4. Submission of Matters to a Vote of Security Holders
Not applicable
ITEM 5. Other Information
None
ITEM 6. Exhibits
2.1 Agreement for the Acquisition of Accounts and Certain Assets
Relating to the Trust Business of The First National Bank of Ipswich
by Eastern Bank, dated August 24, 2006 (incorporated by reference to
Exhibit 10.1 to the Company's Current Report on Form 8-K filed on
August 24, 2006).
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.
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: December 22, 2006 By: /s/ Russell G. Cole
-------------------------
Russell G. Cole
President and
Chief Executive Officer
Date: December 22, 2006
By: /s/ Timothy L. Felter
-------------------------
Timothy Felter
Senior Vice President and
Chief Financial Officer
29