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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
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FORM 10-QSB
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(Mark One)
|X| QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT
OF 1934
For the quarterly period ended September 30, 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 October 31, 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 September 30, 2007 and
December 31, 2006 3
Consolidated Statements of Operations for the quarter and
nine months ended September 30, 2007 and 2006 4
Consolidated Statements of Changes in Stockholders' Equity
for the nine months ended September 30, 2007 and 2006 5
Consolidated Statements of Cash Flows for the
nine months ended September 30, 2007 and 2006 6
Notes to Consolidated Financial Statements 7
Item 2. Management's Discussion and Analysis 10
Item 3. Controls and Procedures 29
PART II OTHER INFORMATION
Item 1. Legal Proceedings 30
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 30
Item 3. Defaults upon Senior Securities 30
Item 4. Submission of Matters to a Vote of Security Holders 30
Item 5. Other Information 30
Item 6. Exhibits 31
Signatures 31
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,
2007 2006
------------ ------------
ASSETS
Cash and due from banks $ 9,398 $ 11,335
Federal funds sold and interest bearing accounts 15,637 2,164
------------ ------------
Total cash and cash equivalents 25,035 13,499
------------ ------------
Certificates of deposit 3,440 3,378
Securities available-for-sale, at fair value 39,783 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 $1,537 and $1,827 198,252 234,890
Real estate held for sale, net 6,281 5,727
Premises and equipment, net 3,675 4,099
Goodwill 3,641 3,641
Other intangible assets 1,184 1,761
Foreclosed real estate 1,484 --
Other assets 6,472 7,117
------------ ------------
Total assets $ 291,468 $ 332,775
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits $ 225,211 $ 268,868
Short-term borrowings 10,802 13,720
Long-term borrowings 20,831 16,047
Subordinated debentures 13,000 13,000
Other liabilities 2,295 3,269
------------ ------------
Total liabilities 272,139 314,904
------------ ------------
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 shares issued at September 30, 2007 and December 31, 2006 2,365 2,240
Additional paid-in capital 10,806 9,936
Retained earnings 6,976 6,843
Accumulated other comprehensive loss (707) (1,037)
Treasury stock, at cost (20,490 shares) (111) (111)
------------ ------------
Total stockholders' equity 19,329 17,871
------------ ------------
Total liabilities and stockholders' equity $ 291,468 $ 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)
Quarter Ended Nine Months Ended
September 30, September 30,
-------------------- -------------------
2007 2006 2007 2006
-------- -------- -------- --------
Interest and dividend income:
Interest and fees on loans $ 3,701 $ 4,692 $ 11,516 $ 13,054
Interest on debt securities:
Taxable 406 1,010 1,302 3,156
Tax-exempt 23 131 68 386
Dividends on equity securities 35 159 167 267
Other interest 227 94 661 211
-------- -------- -------- --------
Total interest and dividend income 4,392 6,086 13,714 17,074
-------- -------- -------- --------
Interest expense:
Interest on deposits 1,456 1,829 4,713 4,727
Interest on borrowed funds 401 1,083 1,100 3,365
Interest on subordinated debentures 235 243 706 701
-------- -------- -------- --------
Total interest expense 2,092 3,155 6,519 8,793
-------- -------- -------- --------
Net interest income 2,300 2,931 7,195 8,281
Provision for loan losses 274 66 14 131
-------- -------- -------- --------
Net interest income after provision for loan losses 2,026 2,865 7,181 8,150
Other income:
Investment advisory fees 482 453 1,422 1,337
Service charges on deposit accounts 297 296 884 879
Credit card fees 99 219 408 579
Trust fees -- 106 -- 316
Non-deposit investment fees 78 83 212 239
Derivative fair value adjustment (20) 85 147 187
Loss on securities sold or written down, net -- (526) -- (575)
Gain on sale of loans, net -- -- 311 --
Rental income 65 99 216 288
Write-down of fixed assets -- (340) -- (340)
Valuation reserve for real estate held for sale -- (33) -- (319)
Miscellaneous 84 77 211 227
-------- -------- -------- --------
Total other income 1,085 519 3,811 2,818
-------- -------- -------- --------
Operating expenses:
Salaries and employee benefits 1,964 2,392 5,635 7,001
Occupancy and equipment 477 702 1,560 2,057
Professional fees 336 332 970 1,211
Credit card interchange 22 140 168 382
Advertising and marketing 97 51 183 384
Data processing 150 199 488 551
ATM processing 99 114 303 328
Telephone 60 93 202 284
FDIC insurance 139 8 425 25
Other general and administrative 227 319 639 1,008
-------- -------- -------- --------
Total operating expenses 3,571 4,350 10,573 13,231
-------- -------- -------- --------
Income (loss) before income taxes (460) (966) 419 (2,263)
Provision (benefit) for income taxes (74) (340) 286 (805)
-------- -------- -------- --------
Net income (loss) $ (386) $ (626) $ 133 $ (1,458)
======== ======== ======== ========
Weighted average common shares outstanding:
Basic 2,345 2,220 2,333 2,220
-------- -------- -------- --------
Diluted 2,348 2,220 2,336 2,220
-------- -------- -------- --------
Earnings (loss) per share:
Basic $ (0.16) $ (0.28) $ 0.06 $ (0.66)
======== ======== ======== ========
Diluted $ (0.16) $ (0.28) $ 0.06 $ (0.66)
======== ======== ======== ========
See accompanying notes to consolidated financial statements.
4
FIRST IPSWICH BANCORP AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (unaudited)
NINE MONTHS ENDED SEPTEMBER 30, 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 -- -- (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
($.025 per share) -- -- (55) -- -- (55)
-------- -------- -------- -------- -------- --------
Balance at September 30, 2006 $ 2,240 $ 9,936 $ 6,541 $ (1,387) $ (111) $ 17,219
======== ======== ======== ======== ======== ========
Balance at December 31, 2006 $ 2,240 $ 9,936 $ 6,843 $ (1,037) $ (111) $ 17,871
Comprehensive income:
Net income -- -- 133 -- -- 133
Unrealized gain on securities
available-for-sale, net of
reclassification
adjustment and tax effect -- -- -- 330 -- 330
--------
Total comprehensive income -- -- -- -- -- 463
--------
Stock option expense -- 48 -- -- -- 48
Private placement of common stock
(125,000 shares) 125 822 -- -- -- 947
-------- -------- -------- -------- -------- --------
Balance at September 30, 2007 $ 2,365 $ 10,806 $ 6,976 $ (707) $ (111) $ 19,329
======== ======== ======== ======== ======== ========
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,
-------------------------------
2007 2006
---------- ----------
Cash flows from operating activities:
Net income (loss) $ 133 $ (1,458)
Adjustments to reconcile net income (loss) to net cash
provided (used) by operating activities:
Provision for loan losses 14 131
Depreciation and amortization 357 554
Losses on sales and calls of securities, sold or written down, net -- 575
Net amortization of securities, including certificates of deposit 53 92
Valuation reserve for real estate held for sale -- 319
Derivative fair value adjustment (147) (188)
Amortization of core deposit intangible 126 121
Write-down of fixed assets 340
Gain on sale of loans, net (311) --
Stock option expense 48 --
Net change in other assets and other liabilities (661) 1,300
---------- ----------
Net cash provided (used) by operating activities (388) 1,786
---------- ----------
Cash flows from investing activities:
Activity in available-for-sale securities:
Purchases -- (2,887)
Sales 2,760 101
Maturities, calls and paydowns 11,706 17,656
Activity in held-to-maturity securities:
Maturities, calls and paydowns -- 2,094
Redemption of Federal Home Loan Bank stock 2,480 2,507
Additions to premises and equipment, net (602) (675)
Deferred payment to the de Burlo Group, Inc. (1,188) --
Proceeds from the sale of loans 15,330 --
Loan originations, net of repayments 9,753 (15,685)
---------- ----------
Net cash provided by investing activities 40,239 3,111
---------- ----------
Cash flows from financing activities:
Net increase (decrease) in deposits (28,388) 17,660
Net increase (decrease) in short-term borrowings (1,615) 359
Proceeds from long-term borrowings 5,000 10,000
Repayment of long-term borrowings (216) (18,695)
Proceeds from private placement 947 --
Net cash paid on sale of Cambridge branch (4,043) --
Cash dividends paid -- (55)
---------- ----------
Net cash provided (used) by financing activities (28,315) 9,269
---------- ----------
Net increase in cash and cash equivalents 11,536 14,166
Cash and cash equivalents at beginning of period 13,499 11,261
---------- ----------
Cash and cash equivalents at end of period $ 25,035 $ 25,427
========== ==========
Supplemental disclosures:
Interest paid $ 6,523 $ 8,609
Income taxes paid, net 138 58
Reclassification of goodwill to fixed assets related to final purchase
accounting of Boston branch -- 750
Transfer to securities available-for-sale from held-to-maturity -- 26,566
Transfer from loans to foreclosed real estate 1,484 --
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 FIN 48 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 and 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 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 and options
associated with its stock option grant. The Company employs the treasury stock
method to account for the warrants and options in the diluted earnings per share
calculations.
(3) Commitments
At September 30, 2007, the Company had outstanding commitments to
originate loans of $1.5 million. Unused lines of credit and open commitments
available to customers at September 30, 2007 amounted to $32.9 million, of which
$5.5 million related to construction loans, $10.5 million related to home equity
lines of credit, $4.0 million related to credit card loans and $12.9 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, 2007 and September 30, 2006 is below.
Investment Consolidated
Banking Advisory Totals
------- -------- ------
(Dollars in thousands)
September 30, 2007:
- -------------------
Net interest income $ 7,195 -- $ 7,195
Other revenue: external customers 2,389 $ 1,422 3,811
Other expenses: external customers 9,742 831 10,573
Net income (222) 355 133
Total assets $ 287,149 $ 4,319 $ 291,468
September 30, 2006:
- -------------------
Net interest income $ 8,281 -- $ 8,281
Other revenue: external customers 1,481 $ 1,337 2,818
Other expenses: external customers 12,387 844 13,231
Net income (loss) (1,785) 327 (1,458)
Total assets $ 400,079 $ 2,868 $ 402,947
(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
$52,000 was recognized on the sale of the branch, which is included in
miscellaneous income 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) Stock Option Grants
During 2004, the Board of Directors and stockholders approved two stock
option plans, the 2004 Incentive Stock Option Plan for Key Employees and the
2004 Directors Plan. These plans provide for the granting of up to 220,000
options to employees and directors to purchase shares of the Company's common
stock.
On May 16, 2007 the Board of Directors of First Ipswich Bancorp approved
the granting of options to non-employee directors and senior managers. The
options have an exercise price equal to fair market value of the Company's stock
of $9.50 on the grant date, except for Neil St. John Raymond, Chairman, whose
options were granted at an exercise price of $10.45 per share.
The non-employee directors include: Messrs. Borden III, Collins, Deery,
Raymond Jr., Tinti and Ms. Gaskins. Each of the listed directors received 2,000
options, of which 1,000 vested immediately and the remaining options vest over a
four year period. Directors have not received cash fees for their services to
the Company since June 30, 2006 when they temporarily waived their right to such
fees.
The following senior managers received options: Neil St. John Raymond,
7,500, Russell Cole, 10,000, Timothy Felter, 8,000, Jay DiIorio 7,500, Maryjon
Brett, 5,500 and Janice Costa 5,500. The options vest over four years, beginning
on the first anniversary of the grant date.
On July 18, 2007 the Board of Directors of First Ipswich Bancorp approved
the granting of options to certain senior managers. The following individuals
received options: Maryjon Brett 2,500, Janice Costa 2,500 and John DiIorio 500.
The options have an exercise price equal to fair market value of the Company's
stock of $9.25 on the grant date. These options vest over four years, beginning
on the first anniversary of the grant date.
SFAS 123(R) requires the Company to estimate the fair value of stock-based
awards on the date of grant. The Company employed the Binomial options pricing
model to value the options. Accordingly, the Company recognized $34,000 and
$14,000 of employee benefit expense during the second and third quarters of
2007, respectively.
(8) Income Taxes
Deferred tax assets are evaluated to determine whether it is "more likely
than not" that a tax return benefit would be realized when the deferred items
reverse. Evaluation considerations include the availability of historical and
projected taxable income to offset the deferred items in the periods they are
expected to reverse. 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, 2007 or December 31, 2006.
(9) Executive Departure
On August 3, 2007, Ipswich Capital Investment Corp. ("ICIC"), a
wholly-owned subsidiary of the Bank, notified Peter M. Whitman, Jr., that his
employment with ICIC, would terminate on September 3, 2007. Mr. Whitman's
Employment Agreement with ICIC, dated as of January 1, 2005, also terminated on
September 3, 2007. Mr. Whitman was the President of ICIC. Mr. Whitman's
departure is not for "cause" as defined in his Employment Agreement.
9
Under the terms of Mr. Whitman's Employment Agreement, Mr. Whitman will
receive as severance (i) continued payment of his current annual base salary and
current benefits until September 2, 2008, and (ii) an Additional Compensation
Amount (as defined in his Employment Agreement), calculated by reference to the
value of ICIC (to be determined by an independent valuation, for which the
estimated amount has been accrued at September 30, 2007.
The foregoing description of Mr. Whitman's Employment Agreement is
qualified in its entirety by reference to the actual terms of the agreement,
which was filed as Exhibit 10.12 to the Company's Annual Report on Form 10-KSB
for the year ending December 31, 2004 and is incorporated herein by reference.
ITEM 2. Management's Discussion and Analysis
Forward-looking statements
This quarterly report on Form 10-QSB contains and incorporates by
reference "forward-looking statements" within the meaning of Section 27A of the
Securities Act and Section 21E of the Exchange Act. All statements, other than
statements of historical facts, including statements regarding our strategy,
effectiveness of investment programs, evaluations of future interest rate trends
and liquidity, expectations as to growth in assets, deposits and results of
operations, receipt of regulatory approval for pending acquisitions, success of
acquisitions, future operations, market position, financial position, and
prospects, plans and objectives of management are forward-looking statements.
Words such as "believes", "expects," "may," "will," "should," "contemplates," or
"anticipates" may also indicate forward-looking statements. There are a number
of important factors that could cause the Company's actual results to differ
materially from those contemplated by such forward-looking statements. These
important factors include, without limitation, competitive conditions in the
Bank's marketplace generally, the Bank's continued ability to originate quality
loans, fluctuation in interest rates including fluctuations which may affect the
Bank's interest rate spread, real estate conditions in the Bank's lending areas,
changes in the securities or financial markets, changes in loan defaults and
charge-off rates, a deterioration in general economic conditions on a national
basis or in the local markets in which the Company operates, the Bank's
continued ability to attract and retain deposits, the risk that difficulties
will arise in connection with the integration of the operations of acquired
businesses with the operations of the Company's banking or investment management
businesses, the Company's ability to control costs, new accounting
pronouncements, and the Bank's continued ability to comply with existing and
future regulatory requirements. The Company undertakes no obligation to publicly
release the results of any revisions to those forward-looking statements, which
may be made to reflect events or circumstances after the date hereof or to
reflect the occurrence of unanticipated events.
Executive Summary
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 2005 a branch in Boston,
MA was purchased, and in 2006 a de novo branch was opened in Portsmouth, NH. 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. 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 (the "OCC") on June 28, 2006. The Agreement required 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,
10
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, required by the Formal Agreement, since February
28, 2007.
As required by the Formal Agreement, the Company developed and implemented
a strategic plan during the second half of 2006 and first nine months 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. So far
in 2007, the Company has sold its Cambridge branch, raised $1 million in capital
through a private placement offering, sold $15.0 million of loans, and closed
its Londonderry branch.
The Company recognized a net loss of $386,000 for the quarter ended
September 30, 2007 as compared to a net loss of $626,000 for the same period of
2006. Net income for the nine months ended September 30, 2007 was $133,000 as
compared to a net loss of $1,458,000 for the same period of 2006. The net loss
for the third quarter of 2007 was primarily driven by a provision for loan
losses of $274,000 and compensation expense primarily related to the estimated
additional compensation amount due to Peter Whitman. The Bank's ability to
generate consistent 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 means by which this objective 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 deposit insurance assessment from the FDIC significantly impacted both
the third quarter and year-to-date earnings for 2007. The insurance expense
related to the FDIC assessment was $139,000 and $425,000 for the third quarter
of 2007 and the nine months ended September 30, 2007, respectively. The Company
expects that its quarterly FDIC insurance assessment will be reduced to
approximately $60,000 starting in the fourth quarter of 2007. Management
anticipates that earnings will be weak in the fourth quarter of 2007 even after
the reduction of the FDIC insurance assessment.
The Company expects to sell the downtown Boston office building that
houses the Boston branch which is located at 31-33 State Street, before the end
of the fourth quarter. The Bank has retained CB Richard Ellis to sell the
building through a "call for offers" process, and plans to retain a long-term
lease for the branch as part of the deal.
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. 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.
The Company contemplates calling a special meeting of shareholders later
in the fourth quarter to vote on a proposed amendment to the Articles of
Organization, which will provide for the reclassification of shares of the
Company's common stock held by shareholders who are the record holders of fewer
than 200 shares of common stock into shares of Series A Preferred Stock, on the
basis of one share of Series A Preferred Stock for each share of common stock
held by such shareholders (the "Reclassification"). The Reclassification is
designed to allow us to suspend our reporting obligations with the SEC and
realize estimated cost savings of approximately $285,000 per year.
The Company first filed a Schedule 13E-3 and preliminary proxy statement
with the SEC outlining the Reclassification on September 11, 2007. The first
amendment to the Schedule 13E-3 and preliminary proxy statement is being filed
today. The Company will file another amendment to the Schedule 13E-3 and the
definitive proxy statement upon completion of SEC review. All shareholders are
advised to read the amended Schedule 13E-3 and definitive proxy statement
carefully when these documents are available, as they will contain important
information about the Reclassification. Shareholders may obtain free copies of
the proxy statement and Schedule 13E-3 when they are available at the SEC's
website at http://www.sec.gov. The Company will mail a copy of the definitive
proxy statement to all shareholders in advance of the special meeting.
11
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, 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
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 September 30, 2007 versus December 31, 2006
Total assets were $291.5 million at September 30, 2007 as compared to
$332.8 million at December 31, 2006. The decrease of $41.3 million or 12% in
total assets was primarily driven by the sale of $15.0 million of loans
associated with our Londonderry branch, $11.9 million of loans associated with
the sale of our Cambridge branch, and $14.5 million of investment maturities and
redemptions. 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 $198.3 million at September 30, 2007, a
decrease of $36.6 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 $21.1 million or 20% to $85.8 million at
September 30, 2007 from $107.0 million at December 31, 2006. Commercial loans
decreased $14.2 million or 32% to $30.2 million at September 30, 2007 from $44.4
million at December 31, 2006. The decrease of the loan portfolio occurred
primarily in the first quarter of the year; net loans were $198.0 million at
March 31, 2007 and $198.3 million at September 30, 2007. 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.
12
The following table presents the composition of the Bank's loan portfolio
by type of loan at the dates indicated.
September 30, 2007 December 31, 2006
------------------ -----------------
(Dollars in thousands)
Real estate mortgage loans:
Commercial $ 85,823 $ 106,965
Residential 54,428 54,898
Construction 17,413 19,414
Home equity 9,979 9,520
Commercial loans 30,214 44,442
Consumer loans 2,071 1,599
------------ ------------
Total loans 198,928 236,838
Net deferred origination fees (139) (121)
Allowance for loan losses (1,537) (1,827)
------------ ------------
Loans, net $ 198,252 $ 234,890
============ ============
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, 2007 December 31, 2006
------------------ -----------------
(Dollars in thousands)
Non-accrual loans $ -- $ --
Troubled debt restructurings -- --
Loans past due 90 days or more and
still accruing 35 3
Foreclosed real estate 1,484 --
Non-accrual loans to total loans 0.00% 0.00%
Non-performing assets to total assets 0.51% 0.00%
Allowance for loan losses as a percentage
of total loans 0.77% 0.77%
During the second quarter of 2007, the Company placed two related loans
totaling $1,748,000 on non-accrual status. During the third quarter of 2007, the
Company transferred these non-accrual loans to the in-substance foreclosures
category. Upon transfer to the in-substance foreclosures category the Company
wrote the property down by $264,000. The property is a residential subdivision.
For the nine months ended September 30, 2007, the Company recorded a
provision for loan losses of $14,000, charge-offs of $308,000, and recoveries of
$4,000. The allowance for loan losses balance stood at $1,537,000 at September
30, 2007, which represents a decrease of $290,000 since December 31, 2006.
Management considers the loan loss allowance to be adequate to provide for
potential loan losses. The Company assesses the adequacy of the allowance for
loan losses each calendar quarter. Although the Company believes that it employs
an appropriate approach to downgrading credits that are experiencing slower than
projected sales and/or increases in loan to value ratios, subsequent evaluations
of the loan portfolio by the Company and its regulators, in light of the factors
then prevailing, may require increases in the allowance for loan losses through
charges to the provision for loan losses.
13
Over the past several years, the Company has experienced very low levels
of loan charge-offs and non-accrual loans. 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. While the real estate market has been under pressure
for the last several quarters, to date, the Company has experienced only a small
increase in problem loans.
Investment Securities
Total investments, which includes certificates of deposit,
available-for-sale securities and Federal Home Loan Bank and Federal Reserve
Bank stock totaled $45.4 million as of September 30, 2007, a decrease of $16.6
million, or 27%, from $62.0 million at December 31, 2006. The Bank has
classified all securities as available-for-sale since September 2006.
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.
The following table presents the composition of the Company's
available-for-sale securities portfolio at the dates indicated
September 30, 2007 December 31, 2006
------------------------ ------------------------
Amortized Fair Amortized Fair
Cost Value Cost Value
---------- ---------- ---------- ----------
(Dollars in thousands)
Mortgage and asset-backed securities $ 29,433 $ 28,558 $ 39,391 $ 38,307
Government-sponsored enterprise obligations 6,039 5,955 10,550 10,293
Corporate bonds 1,867 1,754 1,845 1,745
Municipal bonds 3,622 3,516 3,756 3,617
---------- ---------- ---------- ----------
Total securities available-for-sale $ 40,961 $ 39,783 $ 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. The property is being carried at the lower of
depreciated cost or the estimated fair value less selling costs. A valuation
allowance has been established as appropriate. The Company anticipates that the
sale of the Boston building will be consummated before the end of 2007. It is
possible that changes to the reserve may occur prior to, and related to, the
sale of the real estate. The Company plans to maintain a retail banking branch
and loan production office on the Boston property after the sale.
Deposits
Deposit balances totaled $225.2 million as of September 30, 2007, a
decrease of $43.7 million, or 16%, from $268.9 million as of December 31, 2006.
The majority of the decrease was driven by a $34.6 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.
14
As part of its strategic plan, the Company is pursuing 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.
September 30, December 31,
2007 2006
------------ ------------
(Dollars in thousands)
Demand $ 39,148 $ 42,682
NOW 32,805 34,537
Regular savings 27,287 29,837
Money market deposits 47,613 48,868
Certificates of deposit 78,358 112,944
------------ ------------
$ 225,211 $ 268,868
============ ============
Borrowings
Short-term borrowings were $10.8 million as of September 30, 2007, a
decrease of $2.9 million, or 21% from $13.7 million as of December 31, 2006. The
contraction related to repurchase agreements which declined $2.9 million or 21%
from $13.7 million as of December 31, 2006. The decline in repurchase agreements
was driven by lower balances in customer sweep accounts. Long-term borrowings
were $20.8 million as of September 30, 2007, an increase of $4.8 million, or 30%
from $16.0 million as of December 31, 2006. The increase was driven by a new
$5.0 million callable fixed rate advance from the Federal Home Loan Bank of
Boston.
Stockholder's Equity
Total stockholder's equity increased to $19.3 million as of September 30,
2007 from $17.9 million as of December 31, 2006. The increase was primarily
driven by: $947,000 of net proceeds from the Company's private placement,
year-to-date net income of $133,000 and improvement in the accumulated other
comprehensive loss account of $330,000 associated with an unrealized loss, net
of tax, on available-for-sale securities.
Comparison of Operating Results for the Quarters Ended September 30, 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 (deposit balances and 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.
15
The net loss for the three months ended September 30, 2007 was $386,000
versus a net loss of $626,000 for the three months ended September 30, 2006, an
improvement of $240,000. The improvement in earnings is primarily attributable
to a $779,000 decrease in non-interest expenses, and a $566,000 improvement in
non-interest income. The provision for loan losses was $274,000 for the three
months ended September 30, 2007 versus $66,000 for the same period in 2006. Net
interest income was $2.3 million for the three months ended September 30, 2007
versus $2.9 million for the same period in 2006. The benefit for taxes was
$74,000 for the three months ended September 30, 2007 versus a tax benefit of
$340,000 for the same period in 2006.
Interest and Dividend Income
Total interest and dividend income for the quarter ended September 30,
2007 was $4.4 million, a decrease of $1.7 million from the quarter ended
September 30, 2006. The decrease was primarily driven by lower levels of earning
assets. For the quarter ended September 30, 2007 average earning assets were
$265.0 million versus $364.9 million for the quarter ended September 30, 2006.
The lower level of earning assets is a direct result of the implementation of
the Company's strategic plan. Average investment securities declined by $65.1
million while average loans declined by $48.6 million The average yield on
average earning assets during the third quarter of 2007 was 6.58% as compared to
6.62% for the third quarter of 2006.
Interest Expense
Interest expense was $2.1 million for the quarter ended September 30,
2007; this represents a $1.1 million decrease from the same quarter of 2006. The
majority of the decline was attributable to lower levels of average interest
bearing liabilities which decreased by $98.6 million versus the same quarter of
2006. The average rate paid for interest-bearing liabilities was 3.58% for the
quarter ended September 30, 2007 versus 3.79% for the quarter ended September
30, 2006.
Interest expense on interest-bearing deposits for the quarter ended
September 30, 2007 decreased by $373,000 to $1.5 million as compared to the same
quarter of 2006. This decrease was primarily due to lower levels of
interest-bearing deposits. Average interest-bearing deposit balances for the
quarter ended September 30, 2007 totaled $187.0 million, a $51.4 million
decrease as compared to the same quarter of 2006. Offsetting the decrease in
interest bearing deposit balances was an increase in the average rate paid on
the deposits. The average rate paid on deposits increased to 3.09% from 3.04% in
the third quarter of 2007 as compared to the same quarter of 2006.
Interest expense on borrowed funds, including subordinated debentures, for
the quarter-ended September 30, 2007, decreased by $690,000 to $636,000 as
compared to the quarter-ended September 30, 2006. The decrease was primarily due
to significantly lower average levels of FHLB advances.
Net Interest Income
Net interest income for the quarter ended September 30, 2007 decreased by
$631,000 to $2.3 million as compared to $2.9 million for the quarter ended
September 30, 2006. The decline in net interest income was driven by an overall
shrinkage of the Company's balance sheet. Average total assets for the quarter
ended September 30, 2007 were $293.6 million versus $396.4 million for the same
quarter in 2006. While net interest income declined, net interest margin
improved. Net interest margin was 3.44% for the quarter ended September 30, 2007
versus 3.19% for the same quarter of 2006, an improvement of 25 basis points.
The reduction in investment securities and wholesale funding was a primary
factor in the improvement in net interest margin.
16
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, 2007 and September 30,
2006. The average balances are derived from average daily balances.
Three Months Ended September 30,
-----------------------------------------------------------------------------------------
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:
Other short-term investments $ 227 $ 21,098 4.27% $ 94 $ 7,232 5.13%
Investment securities:
Taxable 441 41,027 4.28% 1,169 95,636 4.85%
Tax-exempt 23 3,634 2.47% 131 14,156 3.68%
Loans 3,701 199,260 7.37% 4,692 247,872 7.51%
----------------------- ------------------------
Total interest-earning assets 4,392 265,019 6.58% 6,086 364,896 6.62%
-------- ---------
Non-interest-earning assets 28,578 31,530
----------- -----------
Total assets $ 293,597 $ 396,426
=========== ===========
Liabilities and Stockholders' Equity:
Interest-bearing liabilities:
Savings 33 26,437 0.49% 39 31,309 0.49%
NOW 24 30,850 0.31% 11 35,533 0.12%
MMDA 408 46,576 3.48% 486 57,179 3.37%
CD's 991 83,173 4.72% 1,293 114,400 4.49%
----------------------- ------------------------
Total interest-bearing deposits 1,456 187,036 3.09% 1,829 238,421 3.04%
Federal Home Loan Bank advances 269 19,823 5.38% 890 63,874 5.53%
Subordinated debentures 235 13,000 7.18% 243 13,000 7.43%
Other borrowed funds 132 11,867 4.41% 193 14,990 5.08%
----------------------- ------------------------
Total interest-bearing liabilities 2,092 231,726 3.58% 3,155 330,285 3.79%
-------- ---------
Non-interest-bearing deposits 40,011 46,567
Other non-interest-bearing liabilities 2,245 1,701
----------- -----------
Total liabilities 273,982 378,553
Total stockholders' equity 19,615 17,873
----------- -----------
Total liabilities and stockholders'
equity $ 293,597 $ 396,426
=========== ===========
Net interest income $ 2,300 $ 2,931
======== =========
Interest rate spread 2.99% 2.83%
=========== ===========
Net interest margin 3.44% 3.19%
=========== ===========
17
Non-interest Income
Total non-interest income increased $566,000 to $1.1 million for the
quarter ended September 30, 2007 as compared to the same quarter of 2006. The
improvement in non-interest income was driven by the absence in 2007 of both
$526,000 of losses on securities sold or written down and $340,000 of fixed
asset write-downs taken during the third quarter of 2006. Partially offsetting
the losses were $106,000 of trust fees in the third quarter of 2006 versus none
in the third quarter of 2007 because the Company sold the trust department in
October of 2006. In addition, the third quarter of 2006 includes $133,000 of
merchant credit card processing fees versus $8,000 in the third quarter of 2007
because the Company has outsourced this service.
Non-interest Expense
Total operating expenses decreased by $779,000 to $3.6 million for the
quarter ended September 30, 2007 as compared to the same quarter of 2006. This
reduction in expense is a direct result of the implementation of the Company's
strategic plan. Salaries and employee benefits decreased by $428,000 to $2.0
million primarily due to a reduction in the number of employees, offset by an
increase in severance expense in the third quarter of 2007. Occupancy and
equipment expenses decreased by $225,000 to $477,000 for the quarter ended
September 30, 2007. The decrease was primarily attributable to lower levels of:
utilities expense, maintenance and repair costs, rent expense, and other
miscellaneous occupancy expenses. As part of the strategic plan the Company has
closed several facilities. In addition, other general and administrative
expenses decreased $92,000 to $227,000 for the quarter ended September 30, 2007.
Partially offsetting these declines was an increase in FDIC insurance expense in
the third quarter of 2007. FDIC insurance expense was $139,000 during the third
quarter of 2007 versus $8,000 during the third quarter of 2006. The increase was
driven by a revised FDIC insurance assessment process. As a result of tangible
improvements stemming from the implementation of the strategic plan, it is
anticipated that this expense will decrease by approximately $104,000 per
quarter after October 2007.
Income Taxes
For the quarter ended September 30, 2007 the Company recorded a benefit
for income taxes of $74,000 versus a benefit for income taxes of $340,000 for
the same quarter of 2006.
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, 2007 or December 31, 2006.
The effective tax benefit rate of 16% for the quarter reflects the fact
that the costs of implementing the process to reclassify common stockholders are
not deductible for income tax purposes. These non-deductible reclassification
expenses represent a significant portion of pretax income.
Comparison of Operating Results for the Nine Months Ended September 30, 2007
and 2006
General
Net income for the nine months ended September 30, 2007 was $133,000
compared with a net loss of $1,458,000 for the nine months ended September 30,
2006. For the nine months ended September 30, 2007, net interest income
decreased by $1.1 million, non-interest income increased $993,000, and operating
expenses decreased $2.7 million, as compared to the nine months ended September
30, 2006. The provision for loan losses was $14,000 for the nine months ended
September 30, 2007 versus $131,000 for the same period in 2006. The provision
for taxes was $286,000 for the nine months ended September 30, 2007 versus a
benefit for taxes of $805,000 for the same period in 2006.
18
Interest and Dividend Income
Total interest and dividend income for the nine months ended September 30,
2007 was $13.7 million, which was $3.4 million lower than the nine months ended
September 30, 2006. The decline was primarily resulted from by lower levels of
average interest-earning assets. While average balances declined the yield on
earning assets increased to 6.63% for the nine months ended September 30, 2007
as compared to 6.25% for the nine months ended September 30, 2006. The
improvement in yield was primarily driven by higher yielding loans replacing
lower yielding investments. Average interest earning assets of $276.4 million
for the period ended September 30, 2007 were $88.7 million lower than average
interest-bearing assets of $365.1 million for the period ended September 30,
2006.
The increase in average yield was due primarily to a changing mix of
assets. While average net loans for the nine months ended September 30, 2007
were $34.5 million lower than the same period of 2006, average investments were
$68.8 million lower than the same period of 2006. The changing mix of earning
assets reflects the Bank's efforts to increase its core lending efforts and
decrease its reliance on the investment portfolio for income.
Interest Expense
Interest expense on interest-bearing liabilities for the nine months ended
September 30, 2007 was $6.5 million, a $2.3 million decrease from the nine
months ended September 30, 2006. The decrease was driven by lower levels of
interest-bearing liabilities. Average interest-bearing liabilities of $242.9
million for the period ended September 30, 2007 were $88.5 million lower than
average interest-bearing liabilities of $331.4 million for the period ended
September 30, 2006.
The average rate paid for interest bearing liabilities was 3.59% for the
nine months ended September 30, 2007 as compared to 3.55% for the same period of
2006. 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 was flat on a comparative basis. The average
rate paid for deposit during the first nine months of 2007 was 3.13%, up from
2.76% in the same period of 2006. Average interest-bearing deposit balances
during the nine months ended September 30, 2007 were $27.1 million lower than
the same period of 2006.
Interest expense on borrowed funds, including subordinated debentures, for
the nine months ended September 30, 2007 decreased by $2.3 million to $1.8
million as compared to the nine months ended September 30, 2006. The impact of
lower average balances of borrowed funds during the nine month period ended
September 30, 2007 as compared to the same period of 2006 offset increasing
interest rates paid on borrowed funds for the same comparable periods. The
average rate paid on borrowed funds increased to 5.84% in the first nine months
of 2007 as compared to 5.29% during the first nine months of 2006.
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 level of earnings.
The Company can give no assurance that the OCC will grant the Bank approval to
pay dividends in the future. At September 30, 2007 the Company had enough cash
on hand to pay interest on the subordinated debentures, at current prevailing
rates, through October 2007. Interest expense on subordinated debentures and the
average balance outstanding in the first nine months of 2007 were relatively
level compared to the first nine months of 2006.
19
Net Interest Income
Net interest income for the nine months ended September 30, 2007 decreased by
$1.1 million, to $7.2 million as compared to the nine months ended September 30,
2006. The decrease in net interest income in the 2007 period was due primarily
to the lower levels of average earning assets. Offsetting the lower levels of
earning assets was a changing mix of earning assets. The increase of higher
yielding loans and corresponding decrease of lower yielding investments as a
percentage of average earning assets helped mute the impact of lower levels of
earning assets. Average loan balances were 75% of average earning assets for the
nine months ended September 30, 2007 versus 66% for nine months ended September
30, 2006. Conversely, investment balances were 18% of average earning assets for
the nine months ended September 30, 2007 versus 32% for nine months ended
September 30, 2006.
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, 2007 and 2006. The average
balances are derived from average daily balances.
Nine Months Ended September 30,
-----------------------------------------------------------------------------------------
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:
Other short-term investments $ 661 $ 20,034 4.41% $ 211 $ 5,491 5.12%
Investment securities:
Taxable 1,469 45,777 4.30% 3,423 103,819 4.41%
Tax-exempt 68 3,704 2.44% 386 14,477 3.56%
Loans 11,516 206,838 7.44% 13,054 241,296 7.23%
----------------------- -------------------------
Total interest-earning assets 13,714 276,353 6.63% 17,074 365,083 6.25%
-------- ------------
Non-interest-earning assets 28,899 31,272
------------- ------------
Total assets 305,252 396,355
============= ============
Liabilities and Stockholders' Equity:
Interest-bearing liabilities:
Savings 99 27,484 0.48% 120 32,331 0.49%
NOW 82 32,453 0.34% 30 36,138 0.11%
MMDA 1,294 49,999 3.46% 1,364 56,929 3.20%
CD's 3,238 91,594 4.73% 3,213 103,182 4.16%
----------------------- -------------------------
Total interest-bearing deposits 4,713 201,530 3.13% 4,727 228,580 2.76%
Federal Home Loan Bank advances 722 17,267 5.59% 2,854 75,984 5.02%
Subordinated debentures 706 13,000 7.26% 701 13,000 7.21%
Other borrowed funds 378 11,099 4.55% 511 13,850 4.93%
----------------------- -------------------------
Total interest-bearing liabilities 6,519 242,896 3.59% 8,793 331,414 3.55%
-------- ------------
Non-interest-bearing deposits 40,670 45,279
Other non-interest-bearing liabilities 2,323 1,378
------------- ------------
Total liabilities 285,889 378,071
Total stockholders' equity 19,363 18,284
------------- ------------
Total liabilities and stockholders'
Equity $ 305,252 $ 396,355
============= ============
Net interest income $ 7,195 $ 8,281
========= ============
Interest rate spread 3.05% 2.70%
============= ============
Net interest margin 3.48% 3.03%
============= ============
20
Non-interest Income
Total non-interest income for the nine months ended September 30, 2007
increased $993,000 as compared to the nine months ended September 30, 2006. The
increase was primarily driven by the absence of $575,000 of security
write-downs, the absence of $340,000 of fixed asset write-downs, and the absence
of a $319,000 valuation reserve for real estate held for sale, because the
estimated fair value at that time, less selling costs, of real estate held for
sale was less than the book value of the assets. In addition, the Company
recognized a $311,000 net gain on the sale of Londonderry loans in 2007. For the
nine months ended 2006 the Company recognized $316,000 of trust fees versus $0
for the nine months ended 2007.
Non-interest Expense
Total operating expenses for the nine months ended September 30, 2007
decreased $2.7 million or 20%, to $10.6 million. The 20% decrease in
non-interest expenses was driven by the implementation of the Company's
strategic plan. Salaries and employee benefits decreased $1.4 million to $5.6
million. The decrease was driven by a reduction in the number of employees.
Occupancy and equipment expenses decreased $497,000 to $1.6 million, advertising
and marketing expenses decreased $201,000 to $183,000. Other general and
administrative expenses decreased $369,000 to $639,000. Conversely, FDIC
insurance expense increased $400,000 to $425,000, due to a revision of the FDIC
insurance assessment process.
Income Taxes
For the nine months ended September 30, 2007 the Company recorded a
provision for income taxes of $286,000 versus a benefit for income taxes of
$805,000 for the nine months ended 2006. The shift to provision for income taxes
from benefit for income taxes was driven by a $2,682,000 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. 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, 2007 or December
31, 2006.
The effective tax rate of 68% for the nine month period reflects the fact
that the costs of implementing the process to reclassify common stockholders are
not deductible for income tax purposes. These non-deductible reclassification
expenses represent a significant portion of pretax income.
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
21
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.
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, and to maintain liquidity. .
The Bank liquidity contingency plan calls for the Bank to manage loan
originations and the level of the investment portfolio as well as Federal Home
Loan Bank of Boston (the "FHLBB") advance availability so that deposit flows can
be accommodated.
22
The Bank utilizes advances from 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
September 30, 2007 amounted to $20.8 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 September 30, 2007, the Bank's total borrowing capacity through the FHLBB was
$33.0 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.
The Bank signed a Formal Agreement with the Office of the Comptroller of
the Currency on June 28, 2006. The Agreement required the Bank to take various
actions including raising capital ratios to levels prescribed in the Agreement.
Specifically the Bank was required, by December 31, 2006, to raise its Tier 1
capital to average assets ratio to a minimum of 8%, its Tier 1 capital to
risk-weighted assets ratio to a minimum of 10%, and its total capital to
risk-weighted assets to a minimum of 11%. As of December 31, 2006, the Bank did
not attain these ratios. Subsequently, the OCC extended the deadline to achieve
the capital ratios until March 31, 2007. The Bank exceeded at February 28, 2007
and continues to exceed the minimum ratios, as listed in the Formal Agreement.
At September 30, 2007, Bancorp had $123,000 of cash on hand. Projected
interest payments due in October, 2007 on Bancorp's subordinated debentures will
deplete its level of cash on hand at September 30, 2007. The Bank intends to get
a loan from a third party; the proceeds of the loan will be used to pay the
interest on the subordinated debentures. The Bank needs to borrow at least
$750,000 to cover interest payments on the subordinated debentures through
September 30, 2008. Neither the third party nor the terms of the loan have been
finalized.
At September 30, 2007, the Bank and the Company exceed all regulatory
capital requirements applicable to them. The table below presents the capital
ratios at September 30, 2007, for the Bank and Bancorp, as well as the minimum
regulatory requirements.
23
Minimum Capital
Statutory Minimum Requirements
Actual Capital Requirements Per OCC
------------------- --------------------- --------------------
Amount Ratio Amount Ratio Amount Ratio
--------- -------- ---------- ------- --------- --------
(Dollars in thousands)
Bank:
Total capital to risk-weighted assets $ 28,603 13.4% $ 17,059 8.0% $ 23,456 11.0%
Tier 1 capital to risk-weighted assets 27,066 12.7 8,530 4.0 21,324 10.0
Tier 1 capital to average assets 27,066 9.4 11,581 4.0 23,162 8.0
Consolidated:
Total capital to risk-weighted assets $ 29,748 13.9% $ 17,113 8.0% N/A N/A
Tier 1 capital to risk-weighted assets 21,891 10.2 8,557 4.0 N/A N/A
Tier 1 capital to average assets 21,891 7.5 11,608 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 September 30, 2007, the Bank had $1.5 million of
outstanding commitments to originate loans and $32.9 million of unused lines of
credit. The Bank anticipates that it will have sufficient funds available to
meet these commitments, though some commitments may expire and many unused lines
are not drawn upon.
Business Risks
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.
24
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, 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 we did not perform the original underwriting.
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 acquired an investment management business, purchased a new branch
in a non-contiguous market, 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.
25
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 significantly increase revenue and decrease expenses, our
earnings may not improve to the extent necessary to permit access to capital or
to avoid increased regulatory scrutiny.
The Company initiated 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 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.
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.
26
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. 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.
Implementation of Sarbanes-Oxley Section 404
The regulations implementing Section 404 of the Sarbanes-Oxley Act of 2002
(SOX 404) 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 Company has not started to implement SOX 404. The Company anticipates
that stockholders will approve a reclassification plan which will allow the
Company to suspend its reporting requirements with the Securities and Exchange
Commission (the "SEC"). If the reclassification plan is not effective before
December 31, 2007, the Company will not be prepared to comply with the
requirements of SOX 404.
27
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 dividends from 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 currently withholds
permission from the Bank to pay a dividend. If the OCC does not permit the Bank
to make a dividend payment aggregating approximately $250,000, Bancorp may be
forced to elect to defer interest payments on the subordinated debentures during
December 2007 and January 2008 unless an alternative source of cash is
identified. Currently, management is evaluating several options to help address
the projected short-fall of cash at the Bancorp. No assurance can be given that
the OCC will approve future dividends to the Bancorp.
The Bancorp had $123,000 of cash on hand at September 30, 2007. This
amount is sufficient to make interest payments on subordinated debentures, at
current prevailing rates, through October 31, 2007. The Bank intends to get a
loan from a third party; the proceeds of the loan will be used to pay the
interest on the subordinated debentures. The Bank will need to borrow at least
$750,000 to cover interest payments on the subordinated debentures through
September 30, 2008. Neither the third party nor the terms of the loan have been
finalized.
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 rise or the
yield curve remains flat, 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.
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
28
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 an investor 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.
Stockholders' ability to sell your shares of common stock at the times and in
the amounts they 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 stockholders may
not be able to sell the shares of common stock that they own at the times and in
the amounts they would otherwise like to.
Our directors and executive officers beneficially own a significant portion of
our common stock.
At September 30, 2007 our directors and executive officers beneficially
owned 48.1% 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
29
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 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 10-KSB for the year ended December 31, 2006.
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
Not applicable.
ITEM 3. Defaults Upon Senior Securities
Not applicable.
ITEM 4. Submission of Matters to a Vote of Security Holders
Not applicable
ITEM 5. Other Information
Not applicable.
30
ITEM 6. Exhibits
(a) Exhibits
20.1 Letter to Shareholders from Russell G. Cole, President and Chief
Executive Officer, incorporated by reference to Exhibit 20.1 to the
Company's Form 8-K filed with the SEC on September 11, 2007.
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: November 2, 2007 By: /s/ Russell G. Cole
----------------------
Russell G. Cole
President and Chief Executive Officer
Date: November 2, 2007 By: /s/ Timothy L. Felter
----------------------
Timothy L. Felter
Senior Vice President, Chief Financial
Officer, and Treasurer
31