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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-QSB
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(Mark One)
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended March 31, 2007
|_| 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 April 30, 2007, there were
2,344,630 shares of common stock issued and outstanding, par value $1.00 per
share.
Transitional Small Business Disclosure Format (Check one): YES |_| NO |X|
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FIRST IPSWICH BANCORP AND SUBSIDIARIES
FORM 10-QSB
Index
Page
PART I FINANCIAL INFORMATION
Item 1. Financial Statements
Consolidated Balance Sheets as of March 31, 2007 and
December 31, 2006 3
Consolidated Statements of Operations for the three months ended
March 31, 2007 and 2006 4
Consolidated Statements of Changes in Stockholders' Equity for the
three months ended March 31, 2007 and 2006 5
Consolidated Statements of Cash Flows for the three months ended
March 31, 2007 and 2006 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis 9
Item 3. Controls and Procedures 25
PART II OTHER INFORMATION
Item 1. Legal Proceedings 25
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 25
Item 3. Defaults upon Senior Securities 25
Item 4. Submission of Matters to a Vote of Security Holders 25
Item 5. Other Information 25
Item 6. Exhibits 26
Signatures 26
2
PART I--FINANCIAL INFORMATION
ITEM 1. Financial Statements
FIRST IPSWICH BANCORP AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS (unaudited)
(In thousands, except share data)
March 31, December 31,
2007 2006
---------- ----------
ASSETS
Cash and due from banks $ 11,219 $ 11,335
Federal funds sold and interest bearing accounts 17,345 2,164
---------- ----------
Total cash and cash equivalents 28,564 13,499
---------- ----------
Certificates of deposit 3,399 3,378
Securities available-for-sale, at fair value 48,349 53,962
Federal Home Loan Bank stock, at cost 1,447 3,927
Federal Reserve Bank stock, at cost 774 774
Loans, net of allowance for loan losses of $1,647 and $1,827 198,003 234,890
Real estate held for sale, net 6,436 5,727
Premises and equipment, net 3,743 4,099
Goodwill 3,641 3,641
Other intangible assets 1,268 1,761
Other assets 6,879 7,117
---------- ----------
Total assets $ 302,503 $ 332,775
========== ==========
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $ 241,642 $ 268,868
Short-term borrowings 9,809 13,720
Long-term borrowings 15,975 16,047
Subordinated debentures 13,000 13,000
Other liabilities 2,516 3,269
---------- ----------
Total liabilities 282,942 314,904
---------- ----------
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, 2,365,120 and
2,240,120 issued 2,365 2,240
Additional paid-in capital 10,758 9,936
Retained earnings 7,309 6,843
Accumulated other comprehensive loss (760) (1,037)
Treasury stock, at cost (20,490 shares) (111) (111)
---------- ----------
Total stockholders' equity 19,561 17,871
---------- ----------
Total liabilities and stockholders' equity $ 302,503 $ 332,775
========== ==========
See accompanying notes to consolidated financial statements.
3
FIRST IPSWICH BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited)
(In thousands, except per share data)
Three Months Ended March 31,
----------------------------
2007 2006
-------- --------
Interest and dividend income:
Interest and fees on loans $ 4,176 $ 4,035
Interest on debt securities:
Taxable 488 1,061
Tax-exempt 24 128
Dividends on equity securities 37 99
Other interest 189 47
-------- --------
Total interest and dividend income 4,914 5,370
-------- --------
Interest expense:
Interest on deposits 1,745 1,162
Interest on borrowed funds 350 1,234
Interest on subordinated debentures 227 224
-------- --------
Total interest expense 2,322 2,620
-------- --------
Net interest income 2,592 2,750
Provision (credit) for loan losses (175) --
-------- --------
Net interest income after provision for loan losses 2,767 2,750
-------- --------
Other income:
Investment advisory fees 463 444
Service charges on deposit accounts 296 284
Credit card fees 163 164
Trust fees -- 103
Rental income 87 90
Non-deposit investment fees 64 75
Derivative fair value adjustment (38) 110
Gain (loss) on securities sold or written down,
net -- (60)
Gain on sale of Londonderry loans 311 --
Miscellaneous 42 103
-------- --------
Total other income 1,388 1,313
-------- --------
Operating expenses:
Salaries and employee benefits 1,852 2,237
Occupancy and equipment 573 710
Professional fees 261 491
Data processing 165 181
Credit card interchange 87 94
ATM processing 108 104
Advertising and marketing 39 87
Telephone 76 94
Other general and administrative 207 359
-------- --------
Total operating expenses 3,368 4,357
-------- --------
Income (loss) before income taxes 787 (294)
Provision (benefit) for income taxes 321 (111)
-------- --------
Net income (loss) $ 466 $ (183)
======== ========
Weighted average common shares outstanding:
Basic 2,309 2,220
======== ========
Diluted 2,312 2,220
======== ========
Earnings (loss) per share:
Basic $ 0.20 $ (0.08)
======== ========
Diluted $ 0.20 $ (0.08)
======== ========
See accompanying notes to consolidated financial statements.
4
FIRST IPSWICH BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (unaudited)
THREE MONTHS ENDED MARCH 31, 2007 AND 2006
(In thousands, except per share data)
Accumulated
Additional Other
Common Paid-in Retained Comprehensive Treasury
Stock Capital Earnings Loss Stock Total
----- ------- -------- ---- ----- -----
Balance at December 31, 2005 $2,240 $ 9,936 $8,054 $(1,159) $(111) $18,960
Comprehensive loss:
Net loss (183) (183)
Unrealized loss on securities
available-for-sale, net of
reclassification adjustment
and tax effect (441) (441)
-------
Total comprehensive loss (624)
Cash dividends declared
($.0.125 per share) (28) (28)
------ ------- ------ ------- ----- -------
Balance at March 31, 2006 $2,240 $ 9,936 $7,843 $(1,600) $(111) $18,308
====== ======= ====== ======= ===== =======
Balance at December 31, 2006 $2,240 $ 9,936 $6,843 $(1,037) $(111) $17,871
Comprehensive income:
Net income 466 466
Unrealized gain on securities
available-for-sale, net of
reclassification adjustment
and tax effect 277 277
-------
Total comprehensive income 743
Private placement of common stock
(125,000 shares) 125 822 947
------ ------- ------ ------- ----- -------
Balance at March 31, 2007 $2,365 $10,758 $7,309 $ (760) $(111) $19,561
====== ======= ====== ======= ===== =======
See accompanying notes to consolidated financial statements.
5
FIRST IPSWICH BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited)
(In thousands)
Three Months Ended March 31,
2007 2006
-------- --------
Cash flows from operating activities:
Net income (loss) $ 466 $ (183)
Adjustments to reconcile net income (loss) to net cash provided by
operating activities:
Provision (credit) for loan losses (175) --
Depreciation and amortization of premises and equipment 146 176
Net amortization of securities, including certificates of deposit 49 38
Derivative fair value adjustment 38 (133)
Amortization of intangible assets 42 61
Gain on sale of Londonderry loans (375) --
Net change in other assets and other liabilities 531 135
-------- --------
Net cash provided by operating activities 722 94
-------- --------
Cash flows from investing activities:
Activity in available-for-sale securities:
Purchases -- (2,887)
Sales 2,760 --
Maturities, calls and paydowns 3,095 3,464
Activity in held-to-maturity securities:
Maturities, calls and paydowns -- 1,066
Redemption of Federal Home Loan Bank stock 2,480 --
Additions to premises and equipment, net (614) (343)
Deferred payment for acquisition of de Burlo (1,188) --
Net cash received in the sale of Londonderry loans 15,330 --
Loan originations, net of repayments 10,213 (3,115)
-------- --------
Net cash provided (used) by investing activities 32,076 (1,815)
-------- --------
Cash flows from financing activities:
Net decrease in deposits (11,957) (5,724)
Net (decrease) increase in short-term borrowings (2,608) 10,270
Repayment of long-term borrowings (72) (326)
Proceeds from private placement 947 --
Net cash paid on sale of Cambridge branch (4,127) --
Net premium on sale of Cambridge branch 84 --
Cash dividends paid -- (28)
-------- --------
Net cash provided (used) by financing activities (17,733) 4,192
-------- --------
Net increase (decrease) in cash and cash equivalents 15,065 2,471
Cash and cash equivalents at beginning of period 13,499 11,261
-------- --------
Cash and cash equivalents at end of period $ 28,564 $ 13,732
======== ========
Supplemental disclosures:
Interest paid $ 2,366 $ 2,620
Income taxes paid, net (9) 27
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, 2006.
In July 2006 the Financial Accounting Standards Board ("FASB") issued
Financial Accounting Standards Interpretation No. 48, "Accounting for
Uncertainty in Income Taxes" (FIN 48) which 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 has implemented FIN48 with no
resulting impact on the financial statements.
In September 2006 FASB issued Statement of Financial Account Standards No.
157, "Fair Value Measurements" (SFAS 157) which 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 February 2007 the FASB issued Statement No. 159, "The Fair Value Option
for Financial Assets and Financial Liabilities - including an amendment of FASB
Statement No. 115", which provides companies with an option to report selected
financial assets and liabilities at fair value. Statement No. 159 also
establishes presentation and disclosure requirements designed to facilitate
comparisons between companies that choose different measurement attributes for
similar types of assets and liabilities. This statement is effective for the
Company on January 1, 2008. The Company has not determined the impact of
implementing adopting SFAS No. 159 on its consolidated financial statements.
The FASB has ratified EITF 06-4, "Accounting for Deferred Compensation and
Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance
Arrangements," and EITF 06-10, "Accounting for Collateral Assignment
Split-Dollar Life Insurance Arrangements," which address accounting for
arrangements whereby the employer purchases a policy to insure the life of an
employee, and separately enters into an agreement to split the policy benefits
between the employer and the employee. These pronouncements, effective for
fiscal years beginning after December 15, 2007, indicate that an obligation
arises as a result of a substantive agreement with an employee to provide future
postretirement benefits and that a liability should be recognized in accordance
with applicable authoritative guidance. Management does not expect that such
pronouncements will have a significant impact on the Company's consolidated
financial statements.
7
(2) Stockholders' Equity and Earnings per Share
Basic earnings per share represents income available to common
stockholders divided by the weighted-average number of common shares outstanding
for the period. Diluted earnings per share represents income available to common
stockholders divided by the sum of the weighted-average number of common shares
outstanding and the weighted-average number of common stock equivalents for
warrants associated the Company's private placement offering. The Company
employs the treasury stock method to account for the warrants in the diluted
earnings per share calculation.
(3) Commitments
At March 31, 2007, the Company had outstanding commitments to originate
loans of $300,000. Unused lines of credit and open commitments available to
customers at March 31, 2007 amounted to $41.6 million, of which $10.2 million
related to construction loans, $11.0 million related to home equity lines of
credit, $4.6 million related to credit card loans and $15.8 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 quarters
ended March 31, 2007 and March 31, 2006 is below.
Investment Consolidated
Banking Advisory Totals
------- -------- ------
(Dollars in thousands)
March 31, 2007:
Net interest income $ 2,592 -- $ 2,592
Other revenue: external customers 925 $ 463 1,388
Other expenses: external customers 3,154 214 3,368
Net income 317 149 466
Total assets $ 298,297 $4,206 $ 302,503
March 31, 2006:
Net interest income $ 2,750 -- $ 2,750
Other revenue: external customers 869 $ 444 1,313
Other expenses: external customers 4,074 283 4,357
Net income (loss) (278) 95 (183)
Total assets $ 395,046 $2,813 $ 397,859
(5) Divestitures
Cambridge, Massachusetts Branch
On March 30, 2007 the Company sold its branch located in Cambridge,
Massachusetts. Upon consummation of the sale, $16.7 million of deposits and
repurchase agreements and $11.9 million of loans were transferred. A loss of
$26,000 was recognized on the sale of the branch, which is included in other
general and administrative expenses on the statement of operations.
Londonderry, New Hampshire Branch
On February 5, 2007 the Company announced that it was closing its branch
located in Londonderry, New Hampshire. In conjunction with that closing, in the
first quarter of 2007 the Bank sold $15.0 million of commercial real estate
loans and commercial loans. A net gain of $311,000 was recognized on the sale of
the loans. The branch was closed on May 11, 2007.
8
(6) Private Placement of Common Stock
On January 26, 2007 the Company raised $1.0 million of new capital through
a private placement of 125,000 shares of common stock. The net proceeds of the
private placement totaled $947,000 after costs of $53,000. Net proceeds were
invested as additional capital in the Company's primary subsidiary, The First
National Bank of Ipswich.
Each investor in private placement also received a warrant to purchase a
number of shares of common stock equal to 20% of the shares subscribed for in
such investor's subscription agreement. The warrants vested immediately, have a
strike price of $8.00, and expire on January 26, 2010.
(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 March 31, 2007 or December 31, 2006.
ITEM 2. Management's Discussion and Analysis
Forward-looking statements
This quarterly report on Form 10-QSB contains and incorporates by
reference "forward-looking statements" within the meaning of Section 27A of the
Securities Act and Section 21E of the Exchange Act. All statements, other than
statements of historical facts, including statements regarding our strategy,
effectiveness of investment programs, evaluations of future interest rate trends
and liquidity, expectations as to growth in assets, deposits and results of
operations, receipt of regulatory approval for pending acquisitions, success of
acquisitions, future operations, market position, financial position, and
prospects, plans and objectives of management are forward-looking statements.
Words such as "believes", "expects," "may," "will," "should," "contemplates," or
"anticipates" may also indicate forward-looking statements. There are a number
of important factors that could cause the Company's actual results to differ
materially from those contemplated by such forward-looking statements. These
important factors include, without limitation, competitive conditions in the
Bank's marketplace generally, the Bank's continued ability to originate quality
loans, fluctuation in interest rates including fluctuations which may affect the
Bank's interest rate spread, real estate conditions in the Bank's lending areas,
changes in the securities or financial markets, changes in loan defaults and
charge-off rates, a deterioration in general economic conditions on a national
basis or in the local markets in which the Company operates, the Bank's
continued ability to attract and retain deposits, the risk that difficulties
will arise in connection with the integration of the operations of acquired
businesses with the operations of the Company's banking or investment management
businesses, the Company's ability to control costs, new accounting
pronouncements, and the Bank's continued ability to comply with existing and
future regulatory requirements. The Company undertakes no obligation to publicly
release the results of any revisions to those forward-looking statements, which
may be made to reflect events or circumstances after the date hereof or to
reflect the occurrence of unanticipated events.
9
Executive Summary
First Ipswich Bancorp is a nationally-chartered commercial financial
institution that historically has focused on Ipswich, MA and the surrounding
communities. Over the past several years, however, the Company expanded beyond
the eastern Essex County section of Massachusetts. In addition, the Company also
expanded its product offerings over the past several years. In 2004, The de
Burlo Group, a Boston-based investment management business was purchased, in
2005 a branch in Boston, MA was purchased, and in 2006 a de novo branch was
opened in Portsmouth, NH. The Company's rapid expansion failed to generate
revenue streams sufficient to cover increasing levels of overhead costs.
Accordingly, the Company reported four consecutive quarterly losses through
September 30, 2006.
The Bank signed a Formal Agreement with the Office of the Comptroller of
the Currency on June 28, 2006. The Agreement requires the Bank to achieve higher
capital levels, retain competent management, develop a new strategic plan, adopt
a new interest rate risk management plan, and improve liquidity and
profitability. Specifically, the Bank was required by December 31, 2006, to
raise its Tier 1 capital to average assets ratio to a minimum of 8%, the Tier 1
capital to risk-weighted assets ratio to a minimum of 10%, and the total capital
to risk-weighted assets ratio to a minimum of 11%. The Bank has exceeded the
minimum ratios, as listed in the Formal Agreement, since February 28, 2007.
As part of the Formal Agreement, the Company developed and implemented a
strategic plan during the second half of 2006 and first half of 2007. A primary
goal of the plan was to evaluate operations and identify locations and business
lines which were not enhancing the profitability of the Company. In 2007, the
Company sold it Cambridge branch, raised $1 million in capital through a private
placement offering, sold $15.0 million of loans, and closed its Londonderry
branch, the last major initiative of the strategic plan to be completed.
The Company recognized net income of $466,000 for the quarter ended March
31, 2007 as compared to $302,000 for the quarter ended December 31, 2006. This
improvement in profitability was driven by the implementation of the strategic
plan, the foundation of which is a focused and disciplined approach to managing
the Company. The Bank's profitability will be a key factor in the OCC's
evaluation of the appropriateness of relieving the Bank of the Formal Agreement.
A primary objective for the Company going forward is to become a highly
profitable community bank. One of the ways by which this will be accomplished is
a focused effort to grow the small business client base which will generate new
loans and deposits. In addition, the Company continues to evaluate expenses for
additional reductions that can be achieved without unduly impacting the high
level of customer service the Company provides through its branches in Beverly,
Boston, Essex, Gloucester, Ipswich, Newburyport, and Rowley, Massachusetts and
Portsmouth, New Hampshire.
The Company is committed to a focused and disciplined approach to return
the Company to consistent profitability. While significant progress has been
made to reduce expenses, additional effort is needed to restore net income to an
acceptable level. Earnings are expected to be weak in the second quarter of
2007. The focus has shifted from right-sizing the Bank (to meet the capital
requirements of the Formal Agreement) to implementing a plan to enhance
profitability.
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 Bancorp's financial
statements include the allowance for loan losses, impairment of investment
securities and intangible assets, including goodwill, and valuation of deferred
tax assets. 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 level of the allowance for loan losses considered necessary.
Management considers impairment of investment securities to be critical due to
10
the potential materiality of individual investment security holdings. Management
considers impairment of intangible assets to be critical accounting policies
because of the intangible assets' materiality to the financial statements and
inherent judgment in determining valuation. This valuation involves
identification of reporting units and estimation of fair values. The estimation
of fair values involves a high degree of judgment and subjectivity in the
assumptions utilized. The valuation of deferred tax assets is considered
critical because of the degree of judgment required to determine whether it is
more likely than not that tax return benefits will be realized when deferred tax
items reverse.
Comparison of Financial Condition at March 31, 2007 versus December 31, 2006
Total assets were $302.5 million at March 31, 2007 as compared to $332.8
million at December 31, 2006. The decrease of $30.3 million or 9% in total
assets was primarily driven by the sale of $15.0 million of loans associated
with our Londonderry branch and $12.0 million of loans associated with the sale
of our Cambridge branch. A key element of the Company's strategic plan required
shrinking the balance sheet in order to improve capital ratios.
Loans
Total net loan balances were $198.0 million at March 31, 2007, a decrease
of $36.9 million or 16%, from $234.9 million at December 31, 2006. The decrease
in total net loans was primarily driven by the aforementioned sales. Commercial
real estate loans decreased $28.7 million or 27% to $78.3 million at March 31,
2007 from $107.0 million at December 31, 2006. Commercial loans decreased $10.0
million or 23% to $34.4 million at March 31, 2007 from $44.4 million at December
31, 2006. The Bank's lending activities are focused in northeastern
Massachusetts and southern New Hampshire and are diversified by loan types and
industries. The Bank continues to focus on originating high quality loans.
The following table presents the composition of the Bank's loan portfolio
by type of loan at the dates indicated.
March 31, December 31,
2007 2006
--------- ------------
(Dollars in thousands)
Real estate mortgage loans:
Commercial $ 78,267 $ 106,965
Residential 53,862 54,898
Construction 22,481 19,414
Equity lines of credit 9,189 9,520
Commercial loans 34,442 44,442
Consumer loans 1,508 1,599
--------- ---------
Total loans 199,749 236,838
Net deferred origination fees (99) (121)
Allowance for loan losses (1,647) (1,827)
--------- ---------
Loans, net $ 198,003 $ 234,890
========= =========
11
Asset Quality and Allowance for Loan Losses
The table below summarizes certain key ratios regarding the quality of the
Bank's loan portfolio:
March 31, December 31,
2007 2006
--------- ------------
(Dollars in thousands)
Non-accrual loans $ -- $ --
Troubled debt restructurings -- --
Loans past due 90 days or more and still
accruing 3 3
Non-accrual loans to total loans 0.00% 0.00%
Non-performing assets to total assets 0.00% 0.00%
Allowance for loan losses as a percentage
of total loans 0.82% 0.77%
For the three months ended March 31, 2007, the Company recorded a negative
provision for loan losses of $175,000, charge-offs of $6,000, and recoveries of
$1,000. The allowance for loan losses balance was $1,647,000 at March 31, 2007,
a decrease of $180,000 since December 31, 2006. The negative provision for loan
losses for the quarter ended March 31, 2007 was driven by a decrease in the size
of the Company's loan portfolio over the past several months. Management
considers the loan loss allowance to be adequate to provide for potential loan
losses.
The Company 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, deterioration in credit quality, or appropriate changes in the
reserve estimation process as a result of changes in assumptions, as well as
other possible factors, may cause the loan loss reserve balance to be increased
in the future, perhaps substantially, through charges to current earnings by
increasing the loan loss provision.
Investment Securities
Total investment securities, which includes certificates of deposit,
available-for-sale securities and Federal Home Loan Bank and Federal Reserve
Bank stock totaled $54.0 million as of March 31, 2007, a decrease of $8.0
million, or 13%, from $62.0 million at December 31, 2006. The Bank has
classified all securities as available-for-sale since September 2006.
The Bank sold a restructured asset-backed security during the first
quarter of 2007. During the fourth quarter of 2006 the security had been deemed
to be other-than-temporarily impaired and was written down to fair market value.
No gain or loss was recognized on the subsequent sale of the security. In
addition, given the reduced levels of Federal Home Loan Bank borrowings, the
Bank was required to reduce the amount of Federal Home Loan Bank stock it owned.
Investment securities may be sold for a variety of reasons, including, but
not limited to, swapping into other investment sectors with greater perceived
relative value, neutralizing interest rate risk created by loan, deposit, or
borrowed funds activity, and managing the level of qualifying collateral for
borrowing purposes.
12
The following table presents the composition of the Company's
available-for-sale securities portfolios at the dates indicated
March 31, 2007 December 31, 2006
--------------------- ---------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
--------- --------- --------- ---------
(Dollars in thousands)
Securities available-for-sale:
Mortgage-backed securities $ 34,481 $ 33,386 $ 39,391 $ 38,307
Government-sponsored enterprise
obligations 9,545 9,367 10,550 10,293
Corporate bonds 1,853 1,990 1,845 1,745
Municipal bonds 3,738 3,606 3,756 3,617
--------- --------- --------- ---------
Total securities available-for-sale $ 49,617 $ 48,349 $ 55,542 $ 53,962
========= ========= ========= =========
Real Estate Held for Sale
Real estate held for sale consists of the land and building acquired in
the Boston branch acquisition and a parcel of land behind the Company's main
office. The properties are being carried at the lower of depreciated cost or the
estimated fair value less selling costs. A valuation allowance has been
established as appropriate.
Deposits
Deposit balances totaled $241.6 million as of March 31, 2006, a decrease
of $27.3 million, or 10%, from $268.9 million as of December 31, 2006. The
majority of the decrease was driven by a $23.7 million decline in certificates
of deposit. The decline in certificates of deposit was the result of promotional
certificate of deposit balances running off and the sale of our branch in
Cambridge, Massachusetts. The sale of our Cambridge branch resulted in a
reduction in total deposits (including certificates of deposit) of $15.4
million.
As part of its strategic plan, the Company is pursing small business
owners in its geographic footprint that do not utilize its services. The Company
is hopeful that these efforts will result in new relationships that will result
in additional core deposits.
The following table summarizes the composition of the Bank's deposit
balances at the dates indicated.
March 31, December 31,
2007 2006
--------- ------------
(Dollars in thousands)
Demand $ 39,725 $ 42,682
NOW 33,590 34,537
Regular savings 27,943 29,837
Money market deposits 51,146 48,868
Term certificates 89,238 112,944
-------- --------
$241,642 $268,868
======== ========
13
Borrowings
Short-term borrowings were $9.8 million as of March 31, 2007, a decrease
of $3.9 million, or 29% from $13.7 million as of December 31, 2006. The
contraction related to repurchase agreements which declined $3.9 million or 29%
from $13.7 million as of December 31, 2006. The decline in repurchase agreements
was driven by lower balances in customer sweep accounts. The period-ending
balances for long-term borrowings were flat at $16.0 million.
Stockholder's Equity
Total stockholder's equity increased to $19.6 million as of March 31, 2007
from $17.9 million as of December 31, 2006. The increase was driven by: $947,000
of net proceeds from the Company's private placement, year to date net income of
$466,000 and improvement in the accumulated other comprehensive loss account of
$277,000 associated with an unrealized loss, net of tax, on available-for-sale
securities.
Comparison of Operating Results for the Three Months Ended March 31, 2007
and 2006
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 FHLB borrowings). Operating income is
also dependent upon revenue from non-interest related sources (such as
investment advisory fees and service charges on deposit accounts), the provision
for loan losses, and the increase or decrease in operating expenses. Operating
results are also 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.
Net income for the three months ended March 31, 2007 was $466,000 versus a
net loss of $183,000 for the three months ended March 31, 2006, an improvement
of $649,000. The improvement in earnings is primarily attributable to $989,000
decrease in non-interest expenses, a $311,000 gain on the sale of loans, and a
$175,000 negative provision for loan losses.
Interest and Dividend Income
Total interest and dividend income for the three months ended March 31,
2007 was $4.9 million, a decrease of $.5 million from the three months ended
March 31, 2006. The decrease was primarily driven by lower levels of earning
assets. For the three months ended March 31, 2007 average earning assets were
$294.4 million versus $361.5 million for the three months ended March 31, 2006.
The lower level of earning assets is a direct result from the implementation of
the Company's strategic plan. Average investment securities declined by $68.7
million while average loans declined by $10.4 million. Partially mitigating the
lower level of average earning assets was a favorable change in the mix of
assets, as well as higher yields on the average earning assets. The average
yield on average earning assets during the first quarter of 2007 was 6.77% as
compared to the 6.02% for the first quarter of 2007.
14
Interest Expense
Interest expense was $2.3 million for the quarter ended March 31, 2007;
this represents a $298,000 decrease from the same quarter of 2006. The majority
of the decline is attributable to lower levels of average wholesale funding
which decreased by $80.3 million versus the same quarter of 2006. The average
rate paid for interest-bearing liabilities was 3.59% for the three months ended
March 31, 2007 versus 3.24% for the three months ended March 31, 2006.
Interest expense on interest-bearing deposits for the three months ended
March 31, 2007 increased by $583,000 to $1.7 million as compared to the same
quarter of 2006. This increase was primarily due to an increase in the average
rate paid for interest-bearing deposits and change in the mix of deposits. The
average rate paid on deposits increased to 3.19% from 2.27% in the first quarter
of 2006. The Bank's average interest-bearing deposit balances for the three
months ended March 31, 2007 totaled $221.6 million, a $13.9 million increase as
compared to the same quarter of 2006. A shift in average deposit balances from
lower cost savings, NOW, and money market accounts to higher cost certificates
of deposit, also contributed to the increase in the average rate paid for
interest-bearing deposits.
Interest expense on borrowed funds, including subordinated debentures, for
the quarter-ended March 31, 2007, decreased by $881,000 to $577,000 as compared
to the quarter-ended March 31, 2006. The decrease was primarily due to
significantly lower average levels of FHLB advances.
Net Interest Income
Net interest income for the three months ended March 31, 2007 decreased by
$158,000 to $2.6 million as compared to $2.8 million for the three months ended
March 31, 2006. The decline in net interest income was driven by an overall
shrinkage of the Company's balance sheet. Average total assets for the three
months ended March 31, 2007 were $326.0 million versus $393.4 million for the
same quarter in 2006. While net interest income declined, net interest margin
improved. Net interest margin was 3.57% for the three months ended March 31,
2007 versus 3.08% for the same quarter of 2006, an improvement of 49 basis
points. The reduction in investment securities coupled with the reduction in
wholesale funding drove the improvement in net interest margin.
15
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 March 31, 2007 and March 31, 2006. The
average balances are derived from average daily balances.
Three Months Ended March 31,
-------------------------------------------------------------------------------------------
2007 2006
-------------------------------------------- ------------------------------------------
Interest Interest
Income/ Average Average Rate Income/ Average Average Rate
Expense Balance Earned/Paid Expense Balance Earned/Paid
-------------------------------------------------------------------------------------------
(Dollars in thousands)
Assets:
Interest-earning assets:
Short-term investments $ 190 $ 15,688 4.90% $ 47 $ 3,678 5.18%
Investment securities:
Taxable 524 50,114 4.13% 1,160 107,620 4.37%
Tax-exempt 24 3,750 2.55% 128 14,957 3.47%
Loans, net 4,176 224,859 7.53% 4,035 235,268 6.96%
----------------------- -----------------------
Total interest-earning assets 4,914 294,411 6.77% 5,370 361,523 6.02%
-------- --------
Noninterest-earning assets 31,588 31,831
---------- ----------
Total assets 325,999 393,354
========== ==========
Liabilities and Stockholders' Equity:
Interest-bearing liabilities:
Savings 34 29,224 0.48% 42 34,146 0.50%
NOW 36 34,780 0.42% 8 36,585 0.09%
MMDA 456 53,103 3.48% 402 56,108 2.91%
CD's 1,219 104,467 4.73% 710 80,811 3.56%
----------------------- -----------------------
Total interest-bearing deposits 1,745 221,574 3.19% 1,162 207,650 2.27%
Federal Home Loan Bank advances 228 16,009 5.77% 1,090 95,239 4.64%
Subordinated debentures 227 13,000 7.07% 224 13,000 6.99%
Other borrowed funds 122 11,443 4.31% 144 12,501 4.67%
----------------------- -----------------------
Total interest-bearing liabilities 2,322 262,026 3.59% 2,620 328,390 3.24%
-------- --------
Noninterest-bearing deposits 42,685 45,046
Other noninterest-bearing liabilities 2,563 1,126
---------- ----------
Total liabilities 307,274 374,562
Total stockholders' equity 18,725 18,792
---------- ----------
Total liabilities and stockholders'
equity $325,999 $393,354
========== ==========
Net interest income $2,592 $2,750
======== =========
Interest rate spread 3.18% 2.78%
========== ==========
Net interest margin 3.57% 3.08%
========== ==========
16
Non-interest Income
Total non-interest income increased $75,000 to $1,388,000 for the three
months ended March 31, 2007 as compared to the same quarter of 2006. The first
quarter of 2007 benefited from a $311,000 gain on sale of loans, slightly higher
levels of investment advisory fees and service charges on deposits, which was
offset by a loss in value of investment securities tied to the performance of
equity markets and a reduction of trust fee income. The Company owns three
investments which have returns indexed to returns of various equity market
indicies. The change in valuation of the embedded equity options is recorded as
miscellaneous non-interest income. The net change recorded in the first quarter
of 2006 was a gain of $110,000 versus a loss $38,000 in the same quarter of
2007. In addition, $103,000 of trust fees were recorded in the first quarter of
2006 versus none in the first quarter of 2007. The Company sold the trust
division in the fourth quarter of 2006. The first quarter of 2006 also includes
a loss of $60,000 on the sale of securities.
Non-interest Expense
Total operating expenses decreased by $989,000 to $3.4 million for the
three months ended March 31, 2007 as compared to the same quarter of 2006.
Salaries and employee benefits decreased by $385,000 to $1.9 million due
primarily to a reduction in headcount. Occupancy and equipment expenses
decreased $137,000 to $573,000 for the three months ended March 31, 2007. The
decrease was primarily attributable to the absence of branch decommissioning
charges and lower levels of depreciation. Professional fees decreased $230,000
to $261,000 for the three months ended March 31, 2007 due primarily to decreased
expenses associated with regulatory matters, lower levels of placement agency
fees, and the absence of professional services required in 2006 while the
Company's chief financial officer position was vacant. Other general and
administrative expenses decreased $152,000 to $207,000 for the three months
ended March 31, 2007 primarily due to lower levels of expense associated with
training, meals and entertainment, and office supplies.
Income Taxes
For the quarter ended March 31, 2007 the Company recorded a net provision
for income taxes of $321,000 versus a net benefit for income taxes of $111,000
for the same quarter of 2006. The shift to provision for income taxes from
benefit for income taxes was driven by a $1,081,000 improvement in pre-tax
income.
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 March 31, 2007 or December 31, 2006.
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 adjusts upward. A continual trade-off, which is
managed and monitored on an ongoing basis, exists between exposure to interest
rate risk and current income. In general, during periods with a normalized yield
curve, a wider mismatch between the re-pricing periods of interest rate
sensitive assets and liabilities can produce higher current net interest income.
The management of interest rate risk considers several factors, including, but
not limited to, the nature and extent of actual and anticipated embedded options
and other attributes of the balance sheet, the perceived direction of market
interest rates, and the risk appetite of management and the Asset/Liability
Management Committee ("ALCO"). Members of the ALCO consist of the chief
executive officer, the chief financial officer, the senior loan officer, the SVP
of Operations and IT and the SVP of Retail Banking, one board member and others.
The Committee discusses the asset/liability mix on the balance sheet and reviews
exposures to changes in interest rates.
17
Certain retail strategies were implemented in 2006 to generate deposit
growth, particularly in new markets. As a result of significant new deposit
funds, the Bank was able to pay down Federal Home Loan Bank (FHLB) advances and
improve the Bank's liquidity position.
The principal strategies management utilizes to manage interest rate risk
with respect to the loan portfolio is associated with pricing and structure.
Although loans originated at relative low points in the interest rate cycle
produce lower short-term yields than those originated at higher points in the
rate cycle, prepayments into low rates occur more rapidly on higher rate loans
as the incentive to refinance is apparent. The Company has not positioned itself
as a market leader with respect to pricing long-term fixed-rate residential
mortgages in the current environment. However, the Company has and will continue
to originate fixed-rate loans for its portfolio in order to serve its customers,
preferring ten or fifteen year final maturities. Additional strategies employed
to mitigate loan interest rate risk in this environment include targeting
shorter amortization periods, increasing the frequency of interest rate resets
or shortening the period of time until the first interest rate reset date, and
encouraging the origination of floating rate loans.
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. The Company primarily relies upon the investment
securities portfolio to balance the interest rate risks produced by retail loan
and deposit activity. The interest rate risk of the balance sheet in varying
interest rate scenarios has been reduced over the past several quarters as
management has positioned the net interest income stream for reduced volatility
regardless of the direction of interest rates.
On a quarterly basis, an outside advisor performs financial modeling of
the balance sheet using certain industry data assumptions. The output from the
models, which project the Company's financial performance over certain periods
under certain interest rate environments, are reviewed and analyzed as a basis
for targeting certain product structures in the future, as well as commenting on
pricing decisions in order to encourage or discourage customer choices. While
Management is currently pleased with the interest rate sensitivity position of
the Bank, there is no guarantee that the Bank will be able to continue to
generate low cost deposits and gather high yielding assets.
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 Bank liquidity contingency plan calls for the Bank to manage loan
originations and the level of the investment portfolio as well as FHLBB advance
availability so that deposit flows can be accommodated.
18
The Bank utilizes advances from the Federal Home Loan Bank of Boston (the
"FHLBB") 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 March 31, 2007 amounted to $16.0
million. The Bank's ability to borrow from the FHLBB 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 occupied residential mortgage loans and
government-sponsored enterprise obligations. As of March 31, 2007, the Bank's
total borrowing capacity through the FHLBB was $45.3 million. The Bank has
additional capacity to borrow through such instruments as repurchase agreements
utilizing federal agency obligations and mortgage-backed securities as
collateral, as well as brokered deposits. The Formal Agreement does require that
the Bank get permission of the OCC and FDIC prior to accepting brokered
deposits.
A major portion of the Bank's liquidity consists of cash and cash
equivalents, short-term investments, government-sponsored enterprise 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. On a monthly basis, the Bank
currently generates an average of approximately $1.4 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.
At March 31, 2007, the Bank and the Company exceed all regulatory capital
requirements applicable to them. The table below presents the capital ratios at
March 31, 2007, for the Bank and Bancorp, as well as the minimum regulatory
requirements.
Minimum Capital
Minimum Requirements
Actual Capital Requirements Per OCC
----------------------- ---------------------- -------------------------
Amount Ratio Amount Ratio Amount Ratio
---------- --------- ---------- -------- ---------- ---------
(Dollars in thousands)
Bank:
Total capital to risk-weighted assets $26,949 13.3% $17,193 8.0% $23,640 11.0%
Tier 1 capital to risk-weighted assets 28,596 12.5 8,596 4.0 21,491 10.0
Tier 1 capital to average assets 28,596 8.4 12,866 4.0 25,733 8.0
Consolidated:
Total capital to risk-weighted assets $30,061 13.9% $17,269 8.0% N/A N/A
Tier 1 capital to risk-weighted assets 22,187 10.3 8,635 4.0 N/A N/A
Tier 1 capital to average assets 22,187 6.9 12,908 4.0 N/A N/A
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 and all other off-balance sheet instruments 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 March 31, 2007, the Bank had $300,000 of outstanding
commitments to originate loans and $41.6 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.
19
Business Risks
The Bank is subject to a Formal Agreement with the OCC.
The Bank is subject to a Formal Agreement dated June 28, 2006 with the
OCC. The direct costs of compliance include legal and consulting fees, higher
FDIC insurance rates, 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 heightened regulatory demands are satisfied. The agreement
requires the Bank to obtain approval from the OCC prior to paying dividends and
restricts the ability of the Bank to pursue certain growth opportunities. In
addition, it requires the Bank to maintain higher levels of capital than other
financial institutions without similar regulatory issues.
The Bank has achieved the initial requirements of the agreement, including
achieving higher capital ratios (which were achieved on February 28, 2007). The
principal initial requirements were that the Board would achieve higher capital
ratios as part of a new three-year capital program, retain competent management,
develop a new three-year strategic plan, adopt a new interest rate management
plan, improve liquidity, and establish a Compliance Committee.
The Board is required to ensure adherence on an ongoing basis to the
three-year strategic and capital plans and to perform its other obligations
under the agreement. The failure of the Board to ensure such adherence or
perform such obligations could result in further regulatory actions by the OCC,
which would have a materially adverse financial effect on the Bank and the
Company.
The value of goodwill and other intangible assets may need to be written down.
The Company recorded goodwill and other intangible assets at the time of
purchase of The de Burlo Group and the Boston branch. A substantial portion of
the purchase price of the investment management company was allocated to
goodwill and other intangible assets. If we determine that goodwill or other
intangible assets are impaired at a future date, we will have to record a
write-down of value through the Company's income statement.
Our expansion into the investment management business poses several risks.
We may not be able to retain existing investment management clients, nor
attract new ones. Lack of new clients or the loss of existing clients could
reduce the fee income generated from this business. In addition, the business
acquired generates more than 50% of its revenue from five Massachusetts
municipal pension funds. The loss of these clients would 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 of retention with customer knowledge and
customer service in this industry.
Our current loan quality and historical loan growth may not continue,
particularly in new markets or with the loans acquired with the Boston branch.
While the Bank has shown a very low level of loan charge-offs and
non-accrual loans in recent years, and expects to continue to do so, there can
be no assurance that these favorable results will continue in the future. Credit
quality standards may change, substantial growth may weaken underwriting or
other controls, or new customers or relationships may not perform as expected.
Despite our due diligence on the Boston branch portfolio, there is a risk that
loan quality may deteriorate as these loans are to customers we do not know, nor
did we perform the original underwriting.
20
If our allowance for loan losses is not sufficient to cover actual loan losses,
our earnings would decrease.
In an attempt to mitigate any loan losses we may incur, we maintain an
allowance for loan losses based on, among other things, national and regional
economic conditions, historical loss experience and delinquency trends among
loan types. However, we cannot predict loan losses with certainty and we cannot
assure you that charge offs in future periods will not exceed the allowance for
loan losses. In addition, regulatory agencies, as an integral part of their
examination process, review our allowance for loan losses and may require
additions to the allowance based on their judgment about information available
to them at the time of their examination. Factors that require an increase in
our allowance for loan losses could reduce our earnings.
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 to be increased through charges to current earnings by increasing the
loan loss provision. Despite our due diligence on the Boston branch portfolio,
there is a risk that loan quality may deteriorate as these loans are to
customers we do not know, nor did we perform the original underwriting.
As Bancorp operates in its new geographic loan footprint, including Boston,
Massachusetts and Portsmouth, New Hampshire, and hires new commercial lenders,
the maintenance of high credit quality and continued growth in loan balances is
not assured.
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 and thus revenue may not support future
growth or an increase in shareholder value. Operating results are also
significantly impacted by factors beyond management's control such as interest
rate conditions and general economic conditions; in particular the general level
of interest rates and the resultant impact on asset yields and the cost of
funds, as well as the ability and willingness of borrowers to fulfill their debt
obligations during various economic cycles.
If we are unable to increase revenue to offset our committed increase in
expenses, our earnings may not improve. If our earnings do not improve, our
access to capital may be impacted or regulatory scrutiny may increase.
The Company implemented a strategic plan in the third quarter of 2006 to
address the concerns for poor profitability. Initiatives to improve revenues
and/or reduce expenses may not be successful in improving the Company's
profitability. Poor profitability may impact the Company's ability to retain or
attract customers and 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, or suburban office space vacated by the Bank as part of the
implementation of the strategic plan, on the terms or lease-up ratio we
anticipate. Lower than anticipated rental income from these locations may reduce
our net income.
We may not be able to attract new deposit customers in new markets or retain
existing deposit customers.
We have opened new branches in 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 lack of recognition of
our name, loyalty to existing banks, or other competitive or market factors.
21
Bancorp 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 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 in deposit fee income.
Bancorp is hopeful that solid growth will occur in all core deposit
categories, particularly in new markets. Growth cannot be assured, however,
particularly during a period whereby consumers may perceive more value in other
investment options. The inability to grow deposits ultimately limits asset
growth.
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.
Bancorp is subject to review and oversight of several governmental
regulatory agencies. Such agencies impose certain guidelines and restrictions,
such as capital requirement 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 Bank has entered into an agreement with its primary regulator, the
Office of the Comptroller of the Currency (OCC). The Bank has achieved all of
the major requirements of the Agreement, including capital ratio requirements
which were exceeded in February 2007. The agreement calls for on-going
compliance with the Agreement terms. While management will diligently attempt to
maintain compliance with the terms of the Agreement, it is possible that
circumstances might arise which would make the Bank no longer in compliance with
the Agreement. Further regulatory action could result in further limitations
being imposed upon the Bank.
22
Implementation of Sarbanes-Oxley Section 404
The regulations implementing Section 404 of the Sarbanes-Oxley Act of 2002
will require us to provide our assessment of the effectiveness of our internal
control over financial reporting beginning with our Annual Report on Form 10-KSB
for the fiscal year ending December 31, 2007. Our independent auditors will be
required to confirm in writing whether our assessment of the effectiveness of
our internal control over financial reporting is fairly stated in all material
respects, and separately report on whether they believe we maintained, in all
material respects, effective internal control over financial reporting as of
December 31, 2008.
We believe that we currently have adequate controls over financial
reporting and that any weakness identified in our internal controls will not be
material. We cannot assure you that we will not discover material weaknesses in
our internal controls. We also cannot assure you that we will complete the
process of our evaluation and the auditors' attestation on time. If a material
weakness is discovered, corrective action may be time consuming, costly and
further divert the attention of management and its resources. The disclosure of
a material weakness, even if quickly remedied, could reduce the market's
confidence in our financial statements and lower the stock price, especially if
a restatement of financial statements for past periods were to be necessary.
The Bancorp is dependent upon the Bank for cash to pay interest on subordinated
debentures.
The Bancorp raised capital by issuing trust preferred stock which is
supported by subordinated debentures. The Bancorp's primary source of cash to
pay the interest on the subordinated debentures is the Bank. The Agreement with
the OCC requires that the OCC grant approval prior to the Bank declaring
dividends to its parent, Bancorp. The OCC's withholding of permission to pay a
dividend could cause the Bancorp to make an election to defer interest payments
on the subordinated debentures unless an alternative source of cash is
identified. No assurance can be given that the OCC will approve future dividends
to the Bancorp.
The Bancorp had $498,000 of cash on hand at March 31, 2007. This amount is
sufficient to make interest payments on subordinated debentures, at current
prevailing rates, through September 2007.
The interest rate environment may reduce our earnings or liquidity or Bancorp
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 Bancorp. If interest rates continue to rise
or the yield curve continues to flatten, net interest income may narrow further.
Liquidity could be reduced in the future if customers choose other investment
options in an improving economy. Liquidity could also be negatively impacted if
current strategies to increase deposit balances in several new locations do not
occur as planned due to competitive or other factors. Although we may be
successful raising deposits in certain markets, we may have to pay higher than
planned rates on these deposits to do so.
An increase in market interest rates, continued competition from several
local and national financial institutions, and increased reliance on higher cost
funding sources could also cause higher rates paid on deposits without an equal
or greater increase on yield on new loans.
Bancorp 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.
Bancorp maintains its entire portfolio of long-term fixed rate loans on
its books and is thus susceptible to interest rate risk in the event of a higher
rate environment to the extent the prepayment activity on these loans falls,
while the cost of funds increases. To the extent longer-term fixed rate loans
are being held on the books at historic lows in a protracted low interest rate
environment, it is important that growth in longer-term checking and savings
balances occurs in several markets.
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Bancorp 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 it deposits. These trends may reduce
net interest income in the future.
Given the strong emphasis on generating new loans, the risk exists that
loan demand could place a strain on liquidity. Bancorp may have to slow its pace
of new loan approvals and thus may generate less interest income.
The Company's information systems may experience an interruption or breach in
security.
We rely heavily on technology and information systems to conduct our
business. Any failure, interruption or breach in security of these systems could
result in failures or disruptions in our customer relationship management,
general ledger, deposit, loan and other systems. While we have policies and
procedures designed to prevent or limit the effect of the failure, interruption
or security breach of our systems, there can be no assurance that any such
failures, interruptions or security breaches will not occur. The occurrence of
any failures, interruptions or security breaches could damage our reputation,
result in a loss of customer business, subject us to additional regulatory
scrutiny, or expose us to civil litigation and possible financial liability, any
of which could have a material adverse effect on our financial condition and
results of operations.
The Bancorp may require additional capital in the future, but that capital may
not be available when it is needed.
Bancorp and the Bank are required by Federal regulatory authorities to
maintain adequate levels of capital to support their operations. The Company may
at some point want or need to raise additional capital to comply with regulatory
requirements, including requirements under the Bank's agreement with the OCC, or
to support growth. Bancorp's ability to raise additional capital, if needed,
will depend on conditions in the capital markets at that time, which are outside
Bancorp's control, and on its financial performance. Accordingly, Bancorp cannot
assure you of its ability to raise additional capital if needed or on terms
acceptable to Bancorp.
The Bancorp's inability to file audited financial statements for the Boston
branch of Atlantic Bank may impair the Company's ability to raise capital.
Typical of the banking industry, Bancorp is unable to obtain audited
financial statements of a retail branch. Under SEC rules, Bancorp 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 through a
private offering of its securities to accredited investors.
Your ability to sell your shares of common stock at the times and in the amounts
you desire may be limited.
Although our common stock is listed for trading on the Over-the-Counter
Bulletin Board, the trading volume in our common stock is thin and average daily
volumes are much lower than those of other larger financial services companies.
We are not listed on the NASDAQ or any other securities exchange. While there
are investment securities brokers/dealers who make a market in our common stock,
there is no active trading market for our common stock and thus you may not be
able to sell the shares of common stock that you own at the times and in the
amounts you would otherwise like to.
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Our directors and executive officers beneficially own a significant portion of
our common stock.
Our directors and executive officers beneficially own 53.0% of our common
stock. As a result, such stockholders would most likely control the outcome of
corporate actions requiring shareholder approval, including the election of
directors and the approval of significant corporate transactions, such as a
merger or sale of all or substantially all of our assets. We can provide no
assurance that the investment objectives of such stockholders will be the same
as our other stockholders.
ITEM 3. Controls and Procedures
(a) Evaluation of disclosure controls and procedures.
As required by Rule 15d-15 under the Securities Exchange Act of 1934, as
amended (the "Exchange Act"), the Company's management conducted an evaluation
with the participation of the Company's Chief Executive Officer and Chief
Financial Officer, regarding the effectiveness of the Company's disclosure
controls and procedures, as of the end of the last fiscal quarter. In designing
and evaluating the Company's disclosure controls and procedures, the Company and
its management recognize that any controls and procedures, no matter how well
designed and operated, can provide only a reasonable assurance of achieving the
desired control objectives, and management necessarily was required to apply its
judgment in evaluating and implementing possible controls and procedures. Based
upon that evaluation, the Chief Executive Officer and Chief Financial Officer
concluded that they believe the Company's disclosure controls and procedures are
reasonably effective to ensure that information required to be disclosed by the
Company in the reports it files or submits under the Exchange Act is recorded,
processed, summarized and reported, within the time periods specified in the
Securities and Exchange Commission's ("SEC") rules and forms. We intend to
continue to review and document our disclosure controls and procedures,
including our internal controls and procedures for financial reporting, and we
may from time to time make changes to the disclosure controls and procedures to
enhance their effectiveness and to ensure that our systems evolve with our
business.
(b) Changes in internal controls over financial reporting.
There were no changes in the Company's internal controls over financial
reporting identified in connection with the Company's evaluation of its
disclosure controls and procedures that occurred during the Company's last
fiscal quarter that have materially affected, or are reasonably likely to
materially affect the Company's internal control over financial reporting.
PART II -- OTHER INFORMATION
ITEM 1. Legal Proceedings
There have been no material changes in legal proceedings from the
information provided in Item 3, "Legal Proceedings" of the Company's Annual
Report on Form 10KSB for the year ended December 31, 2006.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
As previously disclosed in the Company's Form 8-K filed on January 26,
2007, the contents of which are incorporated herein by reference, the Company
raised a total of $1,000,000 through a private offering of common stock and
warrants to accredited investors in the first quarter of 2007.
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
Not applicable.
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ITEM 6. Exhibits
(a) Exhibits
31.1 Certification of Chief Executive Officer pursuant to Rule
13a-14(a) of the Securities Exchange Act of 1934.
31.2 Certification of Chief Financial Officer pursuant to Rule
13a-14(a) of the Securities Exchange Act of 1934.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.
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: May 15, 2007 By: /s/ Russell G. Cole
-----------------------
Russell G. Cole
President and Chief Executive Officer
Date: May 15, 2007 By: /s/ Timothy L. Felter
-----------------------
Timothy L. Felter
Senior Vice President,
Chief Financial Officer, and
Treasurer
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