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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2006
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
Commission file number 0 - 12784
WESTBANK CORPORATION
(Exact name of the registrant as specified in its charter)
Massachusetts 04-2830731
(State or other jurisdiction of (I.R.S. Employer I.D. No.)
incorporation or organization)
225 Park Avenue, West Springfield, Massachusetts 01090-0149
(Address of principal executive offices) (Zip Code)
(413) 747-1400
(Registrant's telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 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 large accelerated filer, an
accelerated filer or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act.
Large accelerated filer [ ] Accelerated filer [X] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). YES [ ] NO [X]
Common stock, par value $2.00 per share: 4,823,224 shares outstanding as of
October 31, 2006.
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WESTBANK CORPORATION AND SUBSIDIARIES
INDEX
PART I - FINANCIAL INFORMATION
Page
-----
ITEM 1. Financial Statements
Condensed Consolidated Balance Sheets 3
Condensed Consolidated Statements of Income 4
Condensed Consolidated Statements of Cash Flows 5
Notes to Condensed Consolidated Financial Statements 6-11
ITEM 2. Management's Discussion and Analysis of
Financial Condition and Results of Operations 12-23
ITEM 3. Quantitative and Qualitative Disclosures about Market Risk 24
ITEM 4. Controls and Procedures 24
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings 25
ITEM 1A. Risk Factors 25
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds 26
ITEM 3. Defaults on Senior Securities 26
ITEM 4. Submission of Matters to a Vote of Security Holders 26
ITEM 5. Other Information 26
ITEM 6. Exhibits 27
Signatures 28
2
ITEM 1. FINANCIAL STATEMENTS
WESTBANK CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited) September 30, December 31,
(Dollar amounts in thousands, except share data) 2006 2005
- -------------------------------------------------------------------------------------------
ASSETS
Cash and due from banks:
Non-interest-bearing $ 13,506 $ 13,899
Interest-bearing cash and cash equivalents 421 10
Federal funds sold 512 24
- -------------------------------------------------------------------------------------------
Total cash and cash equivalents 14,439 13,933
- -------------------------------------------------------------------------------------------
Investment securities available for sale, at fair value 166,767 172,073
Investment securities held to maturity, at amortized cost
(fair value of $146,821 at September 30, 2006
and $148,582 at December 31, 2005) 149,746 151,358
- -------------------------------------------------------------------------------------------
Total investment securities 316,513 323,431
- -------------------------------------------------------------------------------------------
Investment in Federal Home Loan Bank stock 7,682 6,450
Loans, net of allowance for loan losses ($4,007 at
September 30, 2006 and $4,199 at December 31, 2005) 450,542 428,260
Property and equipment, net 8,228 7,577
Accrued interest receivable 4,923 4,418
Other real estate owned 500 630
Goodwill 8,837 8,837
Bank-owned life insurance 9,407 9,149
Investment in unconsolidated investee 526 526
Deferred income tax asset, net 1,643 1,471
Other assets 3,810 4,025
- -------------------------------------------------------------------------------------------
TOTAL ASSETS $ 827,050 $ 808,707
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LIABILITIES AND STOCKHOLDERS' EQUITY
Deposits:
Non-interest-bearing $ 78,513 $ 84,300
Interest-bearing 527,865 515,059
- -------------------------------------------------------------------------------------------
Total deposits 606,378 599,359
Borrowed funds 148,528 138,454
Interest payable on deposits and borrowings 1,439 806
Junior subordinated debentures 17,526 17,526
Other liabilities 5,542 5,184
- -------------------------------------------------------------------------------------------
Total liabilities 779,413 761,329
- -------------------------------------------------------------------------------------------
Stockholders' Equity:
Preferred stock, par value $5 per share,
authorized 100,000 shares, none issued
Common stock, par value $2 per share,
authorized 9,000,000 shares, issued
4,849,461 shares at September 30, 2006 and
4,780,274 shares at December 31, 2005 9,699 9,560
Unearned compensation restricted stock - (1,424)
Additional paid in capital 18,357 19,105
Retained earnings 22,076 22,417
Treasury stock, at cost (30,645 shares at September 30,
2006 and 27,317 shares at December 31, 2005) (506) (420)
Accumulated other comprehensive loss (1,989) (1,860)
- -------------------------------------------------------------------------------------------
Total Stockholders' Equity 47,637 47,378
- -------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 827,050 $ 808,707
===========================================================================================
See accompanying notes to condensed consolidated financial statements.
3
WESTBANK CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
Three Months Ended September 30, Nine Months Ended September 30,
(Unaudited) -------------------------------- --------------------------------
(Dollar amounts in thousands, except per share data) 2006 2005 2006 2005
- -----------------------------------------------------------------------------------------------------------------------------
Interest and Dividend Income:
Interest and fees on loans $ 7,227 $ 6,528 $ 20,923 $ 19,315
Interest and dividend income on securities 3,971 3,102 11,633 9,332
Interest from interest-bearing cash equivalents
and federal funds sold 11 2 27 7
- -----------------------------------------------------------------------------------------------------------------------------
Total interest and dividend income 11,209 9,632 32,583 28,654
- -----------------------------------------------------------------------------------------------------------------------------
Interest expense:
Interest on deposits 4,454 3,121 11,819 8,776
Interest on borrowed funds 1,945 928 5,530 2,835
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Total interest expense 6,399 4,049 17,349 11,611
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Net interest income 4,810 5,583 15,234 17,043
Provision for loan losses 45 - 45 140
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Net interest income after
provision for loan losses 4,765 5,583 15,189 16,903
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Non-interest income:
Gain on sale of securities - - - 96
Gain on sale of loans 1 250 17 415
Other non-interest income 961 752 2,758 2,610
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Total non-interest income 962 1,002 2,775 3,121
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Non-interest expense:
Salaries and benefits 2,848 2,736 8,573 8,253
Other non-interest expense 2,309 1,768 5,937 5,262
Occupancy - net 314 334 1,059 1,065
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Total non-interest expense 5,471 4,838 15,569 14,580
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Income before income taxes 256 1,747 2,395 5,444
Provision for income taxes 79 549 728 1,587
- -----------------------------------------------------------------------------------------------------------------------------
Net Income $ 177 $ 1,198 $ 1,667 $ 3,857
=============================================================================================================================
Earnings per share
Basic $ 0.04 $ 0.26 $ 0.35 $ 0.82
Diluted $ 0.04 $ 0.25 $ 0.34 $ 0.79
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See accompanying notes to condensed consolidated financial statements.
4
WESTBANK CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
Nine Months Ended September 30,
(Unaudited) --------------------------------
(Dollar amounts in thousands) 2006 2005
- -------------------------------------------------------------------------------------------------------------------
Operating activities:
Net income $ 1,667 $ 3,857
Adjustments to reconcile net income to net
cash provided by operating activities:
Provision for loan losses 45 140
Write-down of other real estate owned 130 -
Net amortization of premiums and
discounts on investments and loans 152 9
Loan originations - available-for-sale (1,553) (2,063)
Proceeds from sale of available-for-sale loans 1,560 2,061
Depreciation and amortization 481 603
Gain on sale of securities - (96)
Gain on sale of loans (18) (415)
Loss (gain) on sale of other assets 21 (1)
Excess bank-owned life insurance proceeds over book value - (472)
Increase in cash surrender value of bank-owned life insurance (258) (236)
Deferred income taxes (102) 774
Share-based compensation 167 173
Excess tax benefit from share-based compensation (203) -
Income tax benefit from exercise of non-qualified stock options - 44
Changes in assets and liabilities:
Accrued interest receivable (505) 18
Other assets 418 (699)
Accrued interest payable on deposits and borrowings 633 21
Other liabilities 358 572
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Net cash provided by operating activities 2,993 4,290
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Investing activities:
Securities:
Held to maturity:
Purchases (5,000) (26,270)
Proceeds from maturities and principal payments 6,612 9,725
Available for sale:
Purchases (1,008) (7,621)
Proceeds from sales - 1,918
Proceeds from maturities and principal payments 6,071 5,080
Purchase of loans (17,063) (19,648)
Proceeds from loan sales - 44,630
Net increase in loans (5,411) (21,893)
Purchases of property and equipment (1,132) (973)
Proceeds from sale of other assets 29 24
Proceeds from bank-owned life insurance - 839
Purchase of Federal Home Loan Bank stock (1,232) -
===================================================================================================================
Net cash used in investing activities (18,134) (14,189)
===================================================================================================================
Financing activities:
Net increase in deposits 7,019 657
Net decrease in short-term borrowings (23,417) (2,429)
Proceeds from long-term borrowings 60,000 20,000
Repayment of long-term borrowings (26,509) (3,351)
Purchase of common stock (464) (1,632)
Excess tax benefit from share-based compensation 203 -
Proceeds from exercise of stock options,
stock purchase plan and dividend reinvestment 823 702
Dividends paid (2,008) (1,980)
===================================================================================================================
Net cash provided by financing activities 15,647 11,967
===================================================================================================================
Increase in cash and cash equivalents 506 2,068
Cash and cash equivalents at beginning of period 13,933 13,154
===================================================================================================================
Cash and cash equivalents at end of period $ 14,439 $ 15,222
===================================================================================================================
Cash paid:
Interest on deposits and borrowings $ 16,716 $ 11,590
Income taxes, net 907 972
Supplemental disclosure of cash flow information:
Unrealized loss on securities available for sale, net of taxes (129) (1,095)
Transfer of loans to loans held for sale 1,553 21,954
See accompanying notes to condensed consolidated financial statements.
5
WESTBANK CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
NINE MONTHS ENDED SEPTEMBER 30, 2006 AND 2005
(Unaudited)
NOTE A - GENERAL INFORMATION
Westbank Corporation (the "Corporation") is a Massachusetts-chartered
corporation and a registered bank holding company. The Corporation has a
wholly-owned bank subsidiary, Westbank, a Massachusetts-chartered commercial
bank and trust company (the "Bank"). The Bank has two subsidiaries: Park West
Securities Corporation and PWB&T, Inc. ("PWB&T"). The Corporation is
headquartered in West Springfield, Massachusetts. As of September 30, 2006, the
Bank had sixteen offices located in Massachusetts and Connecticut that provide a
full range of retail banking services to individuals, businesses and nonprofit
organizations. The accompanying unaudited condensed consolidated financial
statements include the Corporation, the Bank and the Bank's two subsidiaries.
All significant intercompany balances and transactions have been eliminated in
the accompanying unaudited condensed consolidated financial statements.
NOTE B - BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements for the
three- and nine-month periods ended September 30, 2006 and 2005 have been
prepared in accordance with accounting principles generally accepted in the
United States of America ("generally accepted accounting principles"). Certain
information and note disclosures normally included in financial statements
prepared in accordance with generally accepted accounting principles have been
omitted, pursuant to the rules and regulations of the Securities and Exchange
Commission for interim reports. In the opinion of management, all adjustments
(consisting of normal recurring accruals) considered necessary for a fair
presentation have been included. Operating results for the nine-month period
ended September 30, 2006 are not necessarily indicative of the results that may
be expected for the year ending December 31, 2006. In preparing such financial
statements, management is required to make estimates and assumptions that affect
the reported amounts. Actual results could differ significantly from these
estimates. The costs associated with the merger agreement between NewAlliance
Bancshares, Inc. ("NewAlliance") and the Corporation could have a significant
impact on the operating results of the Corporation for the year ending December
31, 2006. For additional information regarding the merger agreement, see Note J,
"Merger Agreement."
For further information, please refer to the Consolidated Financial Statements
and footnotes thereto included in the Westbank Corporation Annual Report on Form
10-K for the year ended December 31, 2005.
NOTE C - FINANCIAL STATEMENT RECLASSIFICATIONS
Certain amounts in the December 31, 2005 and September 30, 2005 financial
statements have been reclassified to conform to the September 30, 2006
presentation.
6
NOTE D - RECENT ACCOUNTING PRONOUNCEMENTS
On September 29, 2006, the Financial Accounting Standards Board ("FASB") issued
Statement of Financial Accounting Standards ("SFAS") No. 158, "Employers'
Accounting for Defined Benefit Pension and Other Postretirement Plans ("SFAS
158"), which amends SFAS 87 and SFAS 106 to require recognition of the
overfunded or underfunded status of pension and other postretirement benefit
plans on the balance sheet. Under SFAS 158, gains and losses, prior service
costs and credits, and any remaining transition amounts under SFAS 87 and SFAS
106 that have not yet been recognized through net periodic benefit cost will be
recognized in accumulated other comprehensive income, net of tax effects, until
they are amortized as a component of net periodic cost. The measurement date -
the date at which the benefit obligation and plan assets are measured - is
required to be the company's fiscal year end. SFAS 158 is effective for
publicly-held companies for fiscal years ending after December 15, 2006, except
for the measurement date provisions, which are effective for fiscal years ending
after December 15, 2008. The Corporation is in the process of evaluating SFAS
158.
On September 13, 2006, the Securities and Exchange Commission ("SEC") issued
Staff Accounting Bulletin ("SAB") No. 108 ("SAB 108"). SAB 108 provides
interpretive guidance on how the effects of the carryover or reversal of prior
year misstatements should be considered in quantifying a potential current year
misstatement. Prior to SAB 108, companies might evaluate the materiality of
financial statement misstatements using either the income statement or balance
sheet approach. The income statement approach focuses on new misstatements added
in the current year and the balance sheet approach focuses on the cumulative
amount of misstatements present in a company's balance sheet. Misstatements that
would be material under one approach could be viewed as immaterial under another
approach and not be corrected. SAB 108 now requires that companies view
financial statement misstatements as material, if they are material according to
either the income statement or balance sheet approach. The Corporation is in the
process of evaluating SAB 108.
On September 15, 2006, the FASB issued SFAS No. 157, "Fair Value Measurements."
This statement applies to other accounting pronouncements that have previously
concluded that fair value is a relevant measurement attribute. Accordingly, SFAS
No. 157 does not require any new fair value measurements. This statement defines
fair value as the price that would be received to sell the asset or paid to
transfer the liability at the measurement date (an exit price). This statement
emphasizes that fair value is a market-based measurement, not an entity specific
measurement and establishes a fair value hierarchy to distinguish between (1)
market participant assumptions developed based on market data and (2) the
reporting entity's own assumptions based on market participant assumptions
developed based on the best information available. SFAS No. 157 also expands
disclosures about the use of fair value to measure assets and liabilities. SFAS
No. 157 is effective for fiscal years beginning after November 15, 2007. The
Corporation has not determined the impact, if any, of adopting SFAS No. 157.
In July 2006, the FASB issued Financial Accounting Standards Interpretation No.
48 ("FIN 48"), "Accounting for Uncertainty in Income Taxes." FIN 48 clarifies
the accounting for uncertainty in income taxes recognized in an enterprise's
financial statements in accordance with FASB Statement No. 109, "Accounting for
Income Taxes." FIN 48 establishes a two-step process for evaluating a tax
position. The Interpretation prescribes a "more-likely-than-not" recognition
threshold and measurement attribute for 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, disclosure and transition. FIN 48 is
effective for fiscal years beginning after December 15, 2006. The Corporation
has not yet determined the impact, if any, of adopting FIN 48.
In March 2006, the FASB issued SFAS No. 156, "Accounting for Servicing of
Financial Assets, an amendment of FASB Statement No. 140. SFAS No. 156 requires
all separately recognized servicing assets and servicing liabilities to be
initially measured at fair value, if practicable. For subsequent measurements,
the standard permits an entity to measure each class of servicing assets or
servicing liabilities using either the amortization method or fair value method.
The decision to subsequently measure a class of servicing assets or liabilities
using the fair value method is irrevocable. SFAS No. 156 is effective for the
first fiscal year that begins after September 15, 2006, which is January 1, 2007
for the Corporation. The Corporation is currently evaluating the potential
impact of adopting SFAS No.156 but does not expect it to have a material effect
on the Corporation's financial condition or results of operations.
In February 2006, the FASB issued SFAS No. 155, "Accounting for Certain Hybrid
Financial Instruments," which amends SFAS No. 133 and SFAS No. 140. SFAS No. 155
permits an entity to apply fair value accounting for any hybrid financial
instruments that contain an embedded derivative that would otherwise require
bifurcation. Changes in fair value would be recognized in the statement of
income. The fair value election may be applied on an instrument-by-instrument
basis. SFAS No. 155 also eliminates a restriction on the passive derivative
instruments that a qualifying special purpose entity may hold. SFAS No. 155 is
effective for those financial instruments acquired or issued after the beginning
of the first fiscal year following September 15, 2006, which is January 1, 2007
for the Corporation. Management does not expect the adoption of SFAS No. 155 to
have a material effect on the Corporation's financial condition or results of
operations.
7
NOTE E - FINANCIAL LETTERS OF CREDIT
The Corporation has financial letters of credit that require the Corporation to
make payment in the event of the customer's default, as defined in the
agreements. The Corporation measures and considers recognition of the fair value
of the guarantee obligation at inception. The Corporation estimates the initial
fair value of the letters of credit based on the fee received from the customer.
The fees collected as of September 30, 2006 were immaterial; therefore, these
guarantee obligations are not reflected in the accompanying condensed
consolidated financial statements. The maximum potential undiscounted amount of
future payments of letters of credit as of September 30, 2006 are approximately
$473,500, all of which will expire within one year. Amounts due under these
letters of credit would be reduced by any proceeds that the Corporation would be
able to obtain in liquidating the collateral for the loans, which varies
depending on the customer. The Corporation has not recorded any contingent
liabilities related to these letters of credit.
NOTE F - DIRECTORS AND EXECUTIVES SUPPLEMENTAL RETIREMENT PLAN
The Westbank Directors and Executives Supplemental Retirement Plan was
established in 2001. Under the Supplemental Retirement Plan, the Bank provides
post-retirement benefits for non-employee Directors who retire from the Board
after reaching age seventy-two (72) and certain executive officers who retire at
age sixty-five (65). The retirement benefit is in the amount of seventy-five
percent (75%) of the Director's or executive's final compensation at retirement
and is payable for the life of the retiree. For the executives, this amount is
reduced by fifty percent (50%) of the primary insurance amount from Social
Security and any employer-provided qualified retirement plans. The Corporation
uses a December 31 measurement date for the plan.
The combined cost of the Corporation's defined benefit portion of the Directors
and Executives Supplemental Retirement Plan includes the following components:
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- --------------------------------
2006 2005 2006 2005
- ----------------------------------------------------------------------------------------------------------
Service cost $ 48,388 $ 41,822 $ 145,164 $ 118,186
Interest cost 74,462 56,960 223,386 162,710
Amortization of prior service cost 55,266 31,235 165,798 93,705
Amortization of net loss 14,962 20,571 44,886 47,508
- ----------------------------------------------------------------------------------------------------------
Net periodic benefit cost $ 193,078 $ 150,588 $ 579,234 $ 422,109
==========================================================================================================
The weighted average assumptions utilized to determine the benefit obligation
and net benefit cost are as follows:
At September 30, 2006 2005
- ----------------------------------------------------------------------
Discount rate 5.75% 5.75%
Rate of increase in compensation levels 5.00% 5.00%
The Corporation funds the Directors and Executives Supplemental Retirement Plan
as benefits become payable. The Corporation contributed $10,500 during the
second quarter of 2006. There are no additional contributions planned for the
year.
The merger agreement with NewAlliance Bancshares, Inc., will result in payment
of all benefits accrued under the Plan. Benefits will be paid to participants
either immediately prior to, or on, the effective date of the acquisition, with
the exception of two retired Directors whose benefits will continue to be paid
by NewAlliance Bancshares subsequent to the merger.
NOTE G - SHARE-BASED COMPENSATION
On January 1, 2006, the Corporation adopted SFAS No. 123(R), "Share-Based
Payment". SFAS No. 123(R) requires the recognition of compensation expense
related to share-based payment transactions under the fair-value-based method.
The Corporation adopted SFAS No. 123(R) using the modified prospective method of
transition. Under the modified prospective method, compensation cost is
recognized on or after the effective date for the portion of awards for which
the requisite service has not yet been rendered. Results from prior periods have
not been retroactively adjusted. The adoption of SFAS No. 123(R) did not have a
material effect on the Corporation's financial condition or results of
operations.
The Corporation has been expensing stock-based compensation since January 1,
2003, as it had previously adopted the fair-value-based method of expense
recognition under SFAS No. 123. The fair-value-based method of expense
recognition in SFAS No. 123(R) is similar to the fair-value-based method
described in SFAS No. 123. However, SFAS No. 123(R) requires that compensation
cost is recognized net of estimated forfeitures. Effective January 1, 2006, the
Corporation recognizes compensation expense net of estimated forfeitures.
8
The Corporation currently accelerates the recognition of compensation cost for
retired employees and Directors at the date of retirement. As of January 1,
2006, for any new awards granted, the Corporation recognizes compensation
expense for the period from the date of grant through the date that the employee
first becomes eligible for retirement. In some cases, this will result in the
recognition of compensation cost over a shorter period than the stated vesting
period. Had the Corporation previously applied the accelerated vesting
methodology in SFAS No. 123(R), additional compensation expense totaling $2,400
and $9,700 would have been recognized for the three months ended September 30,
2006 and 2005, respectively. For the nine months ended September 30, 2006 and
2005, the Corporation would have recognized additional compensation expense
totaling $19,300 and $29,000, respectively.
Prior to the adoption of SFAS No. 123(R), all tax benefits resulting from the
exercise of stock options were presented as operating cash flows in the
Condensed Consolidated Statements of Cash Flows. In accordance with SFAS No.
123(R), for the nine months ended September 30, 2006, the presentation of the
statement of cash flows has changed from prior periods. SFAS No. 123(R) requires
that cash flows resulting from tax deductions in excess of the cumulative
compensation cost recognized for options exercised ("excess tax benefits") be
classified as financing cash flows. For the nine months ended September 30,
2006, excess tax benefits realized from the exercise of stock options of
approximately $203,300 were reported as financing cash flows.
SFAS No. 123(R) requires the Corporation to calculate its pool of excess tax
benefits, or the additional paid-in capital pool (APIC pool), available as of
January 1, 2006, to absorb tax deficiencies that may be recognized in subsequent
periods. On November 10, 2005, the FASB issued FASB Staff Position No. FAS
123(R)-3 "Transition Election Related to Accounting for Tax Effects of
Share-Based Payment Awards." The FASB Staff Position offers an alternative
transition method to account for the tax effects of share-based compensation.
The alternative transition method includes a simplified method to calculate the
beginning balance of the APIC pool. The Corporation has elected to adopt the
alternative transition method provided in the FASB Staff Position for
calculating the tax effects of share-based compensation pursuant to SFAS No.
123(R). The Corporation has not yet calculated the beginning balance of its APIC
pool, as it has one year from the adoption of SFAS No. 123(R) to do so.
Management does not expect the calculation of its APIC pool to have a material
effect on the Corporation.
STOCK OPTION PLAN
The 1996 Incentive Stock Option Plan for Directors and employees was established
in 1996 and amended at the 2002 Annual Meeting of Shareholders. The 1996
Incentive Stock Option Plan was terminated on April 19, 2006 at the 2006 Annual
Meeting of Shareholders.
The termination of the 1996 Incentive Stock Option Plan did not impact the
options outstanding. There are no options available for future grants. At
September 30, 2006, all outstanding stock options are fully vested and
exercisable. There is no unrecognized compensation cost related to these
options.
Stock option activity for the nine months ended September 30, 2006 was as
follows:
Weighted Average Weighted Average Aggregate
Number of Options Exercise Price Remaining Contractual Life Intrinsic Value
- ---------------------------------------------------------------------------------------------------------------------------
Outstanding at January 1, 2006 546,562 $ 10.91
Exercised 76,309 7.43
- ---------------------------------------------------------------------------------------------------------------------------
Outstanding at September 30, 2006 470,253 $ 11.48 4.49 years
- ---------------------------------------------------------------------------------------------------------------------------
Exercisable at September 30, 2006 470,253 $ 11.48 4.49 years $ 5,327,966
===========================================================================================================================
Cash received from options exercised for the nine months ended September 30,
2006 and 2005 was $567,000 and $103,000, respectively. The intrinsic value of
options exercised during the nine-month periods ended September 30, 2006 and
2005 was $763,000 and $151,000, respectively.
As part of the merger agreement, any unexercised options outstanding immediately
prior to the effective date of the merger between the Corporation and
NewAlliance will be canceled and a cash payment will be made in lieu of each
outstanding option. The cash payment will be equal to the difference between
$23.00 (the cash election price under the merger agreement) and the exercise
price of the stock option. There was no cash settlement provision under the
original stock option agreements, so the merger agreement constitutes a change
to the stock option agreements.
SFAS No. 123(R) specifies that the amount of cash or other assets transferred
(or liabilities incurred) to repurchase an equity award shall be charged to
equity, to the extent that the amount paid does not exceed the fair value of the
equity instruments repurchased at the repurchase date. If the amount paid to
settle the equity award exceeds the fair value at the repurchase date, the
excess is recorded as compensation expense. It does not appear that the cash
settlement will be in excess of the fair value at the time of repurchase.
Accordingly, the Corporation will charge the cash settlement to stockholders'
equity. Under the terms of the Merger Agreement, certain executive officers are
required to exercise all of their remaining non-qualified stock options prior to
the effective date of the merger. Based on the estimated options outstanding
immediately prior to the merger, excluding the non-qualified options to be
exercised, the cash settlement will total approximately $3,400,000, on a pre-tax
basis.
9
RESTRICTED STOCK PLAN
On April 21, 2004, Westbank Corporation's stockholders approved the
Corporation's adoption of the 2004 Recognition and Retention Plan ("RRP"), which
allows the Corporation to grant restricted stock awards to certain officers,
employees and outside Directors. During 2004, the Board of Directors granted
92,505 shares of restricted stock pursuant to the RRP. The restricted shares
generally vest at a rate of 12.5% per year over eight years, with acceleration
upon retirement. The restricted common shares are held in trust until vested. On
April 19, 2006, the 2004 RRP was terminated at the Annual Meeting of
Shareholders. The termination of the RRP had no impact on the non-vested
restricted shares outstanding. There are no shares of restricted stock available
for future grants. At September 30, 2006, there were 69,000 shares of non-vested
restricted stock outstanding, held in trust.
In accordance with SFAS No. 123(R), the fair value of restricted stock awards is
estimated on the date of grant based on the market price of our stock and is
amortized to compensation expense on a straight-line basis over the related
vesting periods. The unrecognized compensation cost related to the non-vested
restricted stock award was recorded as unearned compensation in stockholders'
equity at December 31, 2005. As part of the adoption of SFAS No. 123(R), on
January 1, 2006, the unrecognized compensation cost related to the non-vested
restricted stock award was included as a component of additional paid-in
capital.
Activity related to the restricted share plan for the nine months ended
September 30, 2006 was as follows:
Number of Restricted Shares Weighted Average Grant Date Fair Value
-------------------------------------------------------------------------------------------------------
Non-vested at January 1, 2006 80,500 $ 19.30
Granted - -
Vested 11,500 19.30
Forfeited or expired - -
-------------------------------------------------------------------------------------------------------
Non-vested at September 30, 2006 69,000 $ 19.30
=======================================================================================================
At September 30, 2006, there was $1,257,714 of total unrecognized compensation
cost related to the non-vested restricted shares and the weighted average
vesting period of the remaining unvested restricted stock was 5.7 years.
Under the terms of the merger agreement between the Corporation and NewAlliance,
all outstanding non-vested restricted shares will be accelerated and become
fully vested upon shareholder approval of the merger transaction. The
acceleration of the non-vested shares was provided for under the Westbank
Corporation 2004 Recognition and Retention Plan and, therefore, is not
considered a modification.
In this case, the modification of the vesting terms is considered an "improbable
to probable" modification, because at the date of modification (the shareholder
approval date) the vesting of the shares under the original vesting schedules
becomes improbable. The acceleration and immediate vesting of the awards at the
date of modification changes the vesting from improbable to probable of
occurring. Upon modification the original fair value of $19.30 per share becomes
irrelevant.
The Corporation will recognize compensation cost equal to the number of shares
that will vest (69,000 shares) multiplied by the fair value of the award on the
date of modification. Using a hypothetical closing price of $22.00 per share,
the estimated pre-tax compensation cost would be $1,500,000.
The following table represents share-based compensation expense and the related
tax effects:
Nine Months Ended September 30,
-------------------------------
2006 2005
----------------------------------------------------------------------------------------
Share-based compensation expense $ 166,464 $ 172,590
Income tax benefit related to share-based
compensation, recognized in net income 61,703 70,589
Excess tax benefit realized due to exercise of options 203,294 43,912
Share-based compensation expense is included in Salaries and Benefits in the
accompanying Condensed Consolidated Statements of Income.
The Corporation has an ongoing share repurchase plan. Shares are purchased on
the open market and used to satisfy share option exercises. During the nine
months ended September 30, 2006, 27,686 shares were purchased pursuant to the
repurchase plan. There were 5,135 shares purchased under the plan during the
first nine months of 2005. At September 30, 2006, there were 134,333 shares
still available to purchase under the plan.
10
NOTE H - EARNINGS PER SHARE
Basic earnings per share represents income available to common shareholders
divided by the weighted average number of common shares outstanding during the
period. Diluted earnings per share reflects additional common shares that would
have been outstanding if certain potentially dilutive common shares were issued
during the period. For the three-month periods ended September 30, 2006 and
2005, 8,400 and 88,900, respectively, potentially dilutive common shares were
excluded from the following table because the effect was antidilutive. For the
nine-month periods ended September 30, 2006 and 2005, 35,233 and 95,276,
respectively, potentially dilutive common shares were excluded from the
following table because the effect was antidilutive. The following table sets
forth the components of basic and diluted earnings per share:
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- --------------------------------
(Dollar amounts in thousands, except per-share data) 2006 2005 2006 2005
- ---------------------------------------------------------------------------------------------------------------------------------
Net income $ 177 $ 1,198 $ 1,667 $ 3,857
Weighted average shares outstanding
Basic weighted average shares outstanding 4,749,648 4,694,043 4,705,711 4,717,454
Dilutive potential common shares 216,569 176,512 185,764 189,045
- ---------------------------------------------------------------------------------------------------------------------------------
Diluted weighted average shares outstanding 4,966,217 4,870,555 4,891,475 4,906,499
- ---------------------------------------------------------------------------------------------------------------------------------
Earnings per share
Basic earnings per share $ 0.04 $ 0.26 $ 0.35 $ 0.82
Diluted earnings per share $ 0.04 $ 0.25 $ 0.34 $ 0.79
- ---------------------------------------------------------------------------------------------------------------------------------
NOTE I - COMPREHENSIVE INCOME
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- --------------------------------
(Dollar amounts in thousands) 2006 2005 2006 2005
- ---------------------------------------------------------------------------------------------------------------------------------
Net income $ 177 $ 1,198 $ 1,667 $ 3,857
- ---------------------------------------------------------------------------------------------------------------------------------
Change in unrealized loss on securities available for sale,
net of income tax (benefit) expense of $1,046
and $(605) for the three-month and $(69)
and $(596) for the nine-month periods ended
September 30, 2006 and 2005, respectively 1,809 (1,051) (129) (1,038)
Less reclassification adjustment for gains included in net
income, net of income tax expense of $39 for the
nine-month period ended September 30, 2005 - - - (57)
- ---------------------------------------------------------------------------------------------------------------------------------
Other Comprehensive Income (Loss) 1,809 (1,051) (129) (1,095)
- ---------------------------------------------------------------------------------------------------------------------------------
Comprehensive Income $ 1,986 $ 147 $ 1,538 $ 2,762
=================================================================================================================================
NOTE J - MERGER AGREEMENT
On July 18, 2006, the Corporation announced that it had entered into a
definitive agreement whereby NewAlliance Bancshares, Inc., will acquire the
Corporation for approximately $116,000,000 in cash and stock. The terms of the
merger agreement call for each outstanding share of Westbank common stock to be
converted into the right to receive $23.00 in cash or stock. The stock exchange
ratio will be determined by dividing $23.00 by a 20-day average daily closing
price of NewAlliance common stock on the New York Stock Exchange, provided that
should the average NewAlliance price be below $13.30, the exchange ratio will be
fixed at 1.7293, or should the average NewAlliance price be above $14.70, the
exchange ratio will be fixed at 1.5646. The Corporation's shareholders will have
the right to elect either cash or stock, with the constraint that the overall
transaction must be consummated with 50% of the payout in stock and 50% in cash.
If there is an imbalance in elections, there will be a proration of proceeds to
achieve the 50/50 split.
The definitive agreement has been approved by the Boards of Directors of both
NewAlliance and the Corporation. The transaction also has been approved by the
Federal Deposit Insurance Corporation and the Board of Governors of the Federal
Reserve System. It is subject to approval by the shareholders of the
Corporation, as well as customary regulatory approvals, including the banking
departments of both Connecticut and Massachusetts. The transaction is expected
to close in early 2007.
The merger agreement will result in certain payments under the Corporation's
Change of Control Agreements and Directors and Executive Officer Supplemental
Retirement Plan. Additionally outstanding restricted stock will vest in cash
payments will be made for outstanding options upon approval of the merger. In
addition, the Corporation has adopted a severance plan covering employees not
subject to change of control agreements, which is contingent on the approval of
the merger see note G.
11
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
INFORMATION CONCERNING FORWARD-LOOKING STATEMENTS
The following forward looking statements are made in accordance with the Private
Securities Litigation Reform Act of 1995.
The Corporation has made and may make in the future forward-looking statements
concerning future performance, including but not limited to future earnings and
events or conditions that may affect such future performance. These
forward-looking statements are based upon management's expectations and belief
concerning possible future developments and the potential effect of such future
developments on the Corporation. There is no assurance that such future
developments will be in accordance with management's expectations and belief or
that the effect of any future developments on the Corporation will be those
anticipated by the Corporation's management.
All assumptions that form the basis of any forward-looking statements regarding
future performance, as well as events or conditions which may affect such future
performance, are based on factors that are beyond the Corporation's ability to
control or predict with precision, including future market conditions and the
behavior of other market participants. Factors that could cause actual results
to differ materially from such forward-looking statements include, but are not
limited to, the following:
1. Changes in market interest rates could adversely affect our financial
condition and results of operations.
2. Our commercial real estate and commercial loan portfolios may increase
our credit risk.
3. Increased competition in the banking and financial services industry may
unfavorably affect our business.
4. Increases to the allowance for loan losses would reduce our earnings.
5. Improper functioning of our information technology systems could have an
adverse impact on our operations.
6. Regulatory restrictions and reduced earnings may limit our dividend
payments.
7. Failure to pay interest on our debt may adversely impact our business.
8. Changes in the value of our goodwill could reduce our earnings.
9. We are subject to extensive regulation that could restrict our
activities or impose financial limitations.
10. The Corporation's business could be adversely affected by uncertainty
related to the proposed merger and contractual restrictions while the
proposed merger is pending.
11. Failure to complete the proposed merger could negatively impact the
Corporation's stock price, future business and financial results.
Forward-looking statements speak only as of the date they were made. While the
Corporation periodically reassesses material trends and uncertainties affecting
the Corporation's performance in connection with its preparation of management's
discussion and analysis of results of operations and financial condition
contained in its quarterly and annual reports, the Corporation does not intend
to review, revise or update any particular forward-looking statement.
12
CRITICAL ACCOUNTING POLICIES
The accounting and reporting policies of the Corporation are in accordance with
accounting principles generally accepted in the United States of America and
conform to general practices within the banking industry. In reviewing and
understanding financial information for the Corporation, you are encouraged to
read and understand the significant accounting policies that are used in
preparing the Corporation's consolidated financial statements. These policies
are described in Note 1 to the consolidated financial statements in the
Corporation's Annual Report on Form 10-K.
Certain accounting policies require significant estimates and assumptions that
have a material impact on the carrying value of certain assets and liabilities.
These accounting policies are considered to be critical accounting policies. The
estimates and assumptions used are based on historical experience and other
factors that we believe reasonable under the circumstances. Actual results could
differ significantly from these estimates and assumptions, which could have a
material impact on the carrying values of assets and liabilities at the balance
sheet dates and on the results of operations for the reporting periods.
Management believes that other-than-temporary impairment analysis, accounting
for loans, the allowance for loan losses and goodwill impairment are the
critical accounting policies that require the most significant estimates and
assumptions and are particularly susceptible to significant change in the
preparation of the consolidated financial statements.
OTHER-THAN-TEMPORARY IMPAIRMENT OF INVESTMENT SECURITIES -
Management evaluates securities for other-than-temporary impairment at least on
a quarterly basis and more frequently when economic or market conditions warrant
such evaluation. Consideration is given to the length of time and the extent to
which the fair value has been less than cost, the financial condition and
near-term prospects of the issuer, and the intent and ability of the Corporation
to retain its investment in the issuer for a period of time sufficient to allow
for any anticipated recovery in fair value. Securities that have experienced an
other than temporary decline in value are written down to estimated fair value,
establishing a new cost basis with the amount of the write-down expensed as a
realized loss. If an investment security is deemed other-than-temporarily
impaired, the write-down of that security would have a negative impact on
earnings.
ACCOUNTING FOR LOANS -
Interest income on loans is recorded on an accrual basis. Loan origination fees,
net of certain direct loan origination costs, are deferred and recognized as
income over the life of the related loan as an adjustment to the loan's yield.
Non-accrual loans are loans on which the accrual of interest ceases when the
collection of principal or interest payments is determined to be doubtful by
management. It is the general policy of the Corporation to discontinue the
accrual of interest when principal or interest payments are delinquent ninety
(90) days, unless the loan principal and interest are determined by management
to be fully collectible. Any unpaid amounts previously accrued on these loans
are reversed from income. Interest received on a loan in non-accrual status is
applied to reduce principal or, if management determines that the principal is
collectible, applied to interest on a cash basis. A loan is returned to accrual
status after the borrower has brought the loan current and has demonstrated
compliance with the loan terms for a sufficient period, and management's doubts
concerning collectibility have been removed.
The Corporation measures impairment of loans in accordance with SFAS No. 114,
"Accounting for Impairment of a Loan", as Amended by SFAS No. 118, "Accounting
by Creditors for Impairment of a Loan - Income Recognition and Disclosures"
(collectively "SFAS No. 114"). A loan is recognized as impaired when it is
probable that either principal or interest is not collectible in accordance with
the terms of the loan agreement. Measurement of impairment for commercial loans
is generally based on the present value of expected future cash flows discounted
at the loan's effective interest rate. Commercial real estate loans are
generally measured based on the fair value of the underlying collateral. If the
estimated fair value of the impaired loan is less than the related recorded
amount, a specific valuation allowance is established or a write-down is charged
against the allowance for loan losses. Smaller balance homogenous loans,
including residential real estate and consumer loans, are excluded from the
provisions of SFAS No. 114. Generally, income is recorded only on a cash basis
for impaired loans.
Mortgage loans originated and intended for sale in the secondary market are
carried at the lower of cost or fair value in the aggregate. Net unrealized
losses are recognized through a valuation allowance charged to income.
ALLOWANCE FOR LOAN LOSSES -
The approach the Corporation uses in determining the adequacy of the allowance
for loan losses is an exposure method based on the Corporation's loan loss
history, among other factors. Quarterly, based on an internal review of the loan
portfolio, the Corporation identifies required allowance allocations targeted to
specific recognized problem loans that, in the opinion of management, have
potential loss exposure or uncertainties relative to the depth of the collateral
on these same loans. In addition, the Corporation maintains a formula-based
general allowance against the remainder of the loan portfolio, based on the
overall mix of the loan portfolio and the loss history of each loan category.
The formula-based allowance allocation is calculated by applying loss factors to
outstanding loans by category. Loss factors are based on historical loss
experience. The amount of the recorded allowance above the minimum of the
formula range is based on management's evaluation of relevant factors (e.g.,
local area economic statistics, credit quality trends, loan concentrations,
industry conditions and delinquency levels) and the percentage of the allowance
for loan losses to aggregate loans.
13
The appropriateness of the allowance for loan losses is evaluated quarterly by
management. Factors considered in evaluating the appropriateness of the
allowance include the size and concentration of the portfolio, previous loss
experience, current economic conditions and their effect on borrowers, the
financial condition of individual borrowers and the related performance of
individual loans in relation to contract terms. The provision for loan losses
charged to operating expense is based upon management's judgment of the amount
necessary to maintain the allowance at an appropriate level to absorb losses.
Management also retains an independent loan review consultant to provide advice
on the appropriateness of the loan loss allowance. Loan losses are charged
against the allowance for loan losses when management believes the
collectibility of the principal is unlikely. The allowance for loan losses is a
significant estimate and losses incurred in excess of the allowance would
adversely impact earnings.
At September 30, 2006, the allowance for loan losses totaled $4,007,000,
representing .88% of total loans and 257.8% of non-performing loans. The
Corporation participates in a program to purchase commercial mortgages
guaranteed by the United States Department of Agriculture (USDA) and the United
States Small Business Association (SBA). At September 30, 2006, these commercial
mortgages totaled $19,428,000. The Corporation does not provide an allowance for
loan losses for these purchased commercial loans as they are 100% guaranteed. At
September 30, 2006, the allowance for loan losses represents .92% of total
loans, excluding these loans guaranteed by the USDA and SBA. Please see
"Provision and Allowance for Loan Losses" in this Management's Discussion and
Analysis for further discussion of the Corporation's methodology in determining
the allowance as of September 30, 2006.
GOODWILL IMPAIRMENT -
The Corporation tests its goodwill for impairment on an annual basis and when
other indicators are present. The test for goodwill impairment is dependent on
certain factors that are subject to change. The Corporation selected December
31st as its annual goodwill impairment testing date. If our goodwill is ever
found to be impaired, we would be required to write off all or part of our
goodwill, which would negatively impact our earnings. As of December 31, 2005,
the Corporation deemed that no impairment existed.
OVERVIEW -
The Corporation is a Massachusetts-chartered corporation and a registered bank
holding company. The Corporation has a wholly-owned bank subsidiary, Westbank, a
Massachusetts chartered commercial bank and trust company formed in 1962. The
Bank has two subsidiaries: Park West Securities Corporation and PWB&T. The
Corporation is headquartered in West Springfield, Massachusetts. As of September
30, 2006, the Bank had sixteen offices located in Massachusetts and Connecticut
that provide a full range of retail banking services to individuals, businesses
and nonprofit organizations.
The primary source of Westbank's revenue is interest earned on loans and
securities and fee income. The Corporation has experienced growth and increased
revenue from its commercial lending and leasing.
Westbank Corporation has a growth-oriented strategy focused on shareholder
value, unparalleled service and effective capital management.
RECENT DEVELOPMENTS -
In June 2006, the Bank opened its newly-constructed branch office in Southwick,
Massachusetts.
On July 18, 2006, the Corporation announced that it had entered into a
definitive agreement whereby NewAlliance Bancshares, Inc., will acquire the
Corporation for approximately $116,000,000 in cash and stock. The terms of the
merger agreement call for each outstanding share of Westbank common stock to be
converted into the right to receive $23.00 in cash or stock. The stock exchange
ratio will be determined by dividing $23.00 by a 20-day average daily closing
price of NewAlliance common stock on the New York Stock Exchange, provided that
should the average NewAlliance price be below $13.30, the exchange ratio will be
fixed at 1.7293, or should the average NewAlliance price be above $14.70, the
exchange ratio will be fixed at 1.5646. The Corporation's shareholders will have
the right to elect either cash or stock, with the constraint that the overall
transaction must be consummated with 50% of the payout in stock and 50% in cash.
If there is an imbalance in elections, there will be a proration of proceeds to
achieve the 50/50 split.
The definitive agreement has been approved by the Boards of Directors of both
NewAlliance and the Corporation. The transaction also has been approved by the
Federal Deposit Insurance Corporation and the Board of Governors of the Federal
Reserve System. It is subject to approval by the shareholders of the
Corporation, as well as customary regulatory approvals, including the banking
departments of both Connecticut and Massachusetts. The transaction is expected
to close in early 2007.
In August 2006, Westbank closed its East Longmeadow, Massachusetts, supermarket
branch and transferred the deposit and loan accounts to its East Longmeadow,
Massachusetts, branch.
COMPARISON OF FINANCIAL CONDITION AT SEPTEMBER 30, 2006 AND DECEMBER 31, 2005 -
Total assets increased by $18,343,000 to $827,050,000 at September 30, 2006 from
$808,707,000 at December 31, 2005, primarily due to an increase in loans.
Earning assets increased primarily as a result of an increase in gross loans of
$22,090,000. As of September 30, 2006 and December 31, 2005, earning assets
amounted to $779,677,000 or 94.3% of total assets and $762,374,000 or 94.3% of
total assets, respectively. Earning assets include a diverse portfolio of
earning instruments, including loans and securities issued by federal, state and
municipal authorities. These earning assets are financed through a combination
of interest-bearing and interest-free sources.
14
Net loans increased by $22,282,000, or 5.2%, to $450,542,000 at September 30,
2006 from $428,260,000 at December 31, 2005. The net increase in loans consists
of the following changes:
o Commercial real estate and commercial and industrial loans increased by
$25,113,000, or 12.2%, to $231,251,000 at September 30, 2006 from
$206,138,000 at December 31, 2005. The Corporation purchased approximately
$17,063,000 of commercial mortgages during the nine-month period ended
September 30, 2006. These commercial mortgages are guaranteed by the USDA
and the SBA.
o Residential real estate loans, including home equity loans, increased by
$4,532,000, or 2.6%, to $175,747,000 at September 30, 2006 from
$171,215,000 at December 31, 2005.
o Indirect auto loans decreased by $6,426,000, or 16%, to $33,723,000 at
September 30, 2006 from $40,149,000 at December 31, 2005. The decline is a
result of payoffs and normal runoff of the portfolio.
Total deposits increased by $7,019,000, or 1.2%, to $606,378,000 at September
30, 2006 from $599,359,000 at December 31, 2005. Borrowings increased
approximately $10,074,000 during the first nine months of 2006 and totaled
$148,528,000 at September 30, 2006 compared to $138,454,000 at December 31,
2005. The increase in borrowings includes an increase in Federal Home Loan Bank
of Boston fixed-rate advances of $30,000,000 and option advances of $30,000,000,
offset by a decrease in short-term FHLB advances of approximately $23,170,000
and $20,000,000 in option advances called by the FHLB. The Corporation increased
its level of borrowings to fund its loan growth.
Stockholders' equity at September 30, 2006 and December 31, 2005 was $47,637,000
and $47,378,000 respectively, which represented 5.8% of total assets as of
September 30, 2006 and 5.9% of total assets as of December 31, 2005. The
increase in stockholders' equity for the first nine months of 2006 resulted from
net income of $1,667,000 for the nine months ended September 30, 2006, proceeds
from the exercise of stock options, including the income tax benefit,
aggregating approximately $770,000 and the issuance of shares related to the
dividend reinvestment and stock purchase plan, with a combined total of
$280,000.
The increases were partially offset by the payment of quarterly dividends
aggregating $2,008,000, an unrealized loss on securities available for sale, net
of taxes, amounting to approximately $129,000, and the repurchase of 27,686
shares of common stock for a total of $464,000.
RESULTS OF OPERATIONS -
SUMMARY
The Corporation reported net income of $177,000, or $0.04 per diluted share, for
the quarter ended September 30, 2006 as compared to $1,198,000, or $0.25 per
diluted share, for the same period in 2005. For the first nine months of 2006,
net income was $1,667,000 or $0.34 per diluted share, as compared to $3,857,000,
or $0.79 per diluted share, for the first nine months of 2005. The decrease in
net income was largely driven by an increased level of borrowings and deposits
and an increased cost of funds during the first nine months of 2006. In
addition, costs associated with the merger with NewAlliance totaling $480,000
were recorded during the third quarter and had an impact on earnings for the
quarter and year-to-date periods ended September 30, 2006.
INTEREST INCOME
Interest income for the third quarter of 2006 increased $1,577,000, or 16.4% and
totaled $11,209,000 as compared to $9,632,000 for the third quarter of 2005. For
the nine months ended September 30, 2006, interest income was $32,583,000, an
increase of $3,929,000 or 13.7% over the nine months ended September 30, 2005.
Interest income increased for the three- and nine-month periods ended September
30, 2006 primarily due to the Corporation earning higher interest rates on its
loan portfolio and greater volume of investment securities. For the three- and
nine-month periods ended September 30, 2006, the increase in interest income was
more than offset by an increase in interest expense.
INTEREST EXPENSE
Interest expense increased $2,350,000 or 58% for the three months ended
September 30, 2006 and totaled $6,399,000 as compared to $4,049,000 for the same
period in 2005. Interest expense for the first nine months of 2006 was
$17,349,000, an increase of $5,738,000 or 49.4% as compared to $11,611,000 for
the first nine months of 2005. The increase in interest expense for the three-
and nine-month periods ended September 30, 2006 was driven principally by the
increased level of borrowings and deposits, and the increased cost of funds.
15
NET INTEREST AND DIVIDEND INCOME
The Corporation's earning assets include a diverse portfolio of earning
instruments ranging from the Corporation's core business of loan extensions to
interest-bearing securities issued by federal, state and municipal authorities.
These earning assets are financed through a combination of interest-bearing and
interest-free sources.
Net interest income, the most significant component of earnings, is the amount
by which the interest generated by assets exceeds the interest expense on
liabilities. For analytical purposes, the interest earned on tax exempt assets
is adjusted to a "tax equivalent" basis to recognize the income tax savings
which facilitates comparison between taxable and tax exempt assets.
The Corporation analyzes its performance by utilizing the concepts of interest
rate spread and net yield on earning assets. The interest rate spread represents
the difference between the yield on earning assets and interest paid on
interest-bearing liabilities. The net yield on earning assets is the difference
between the rate of interest on earning assets and the effective rate paid on
all interest-bearing liabilities, as well as interest-free sources (primarily
demand deposits and stockholders' equity).
The following tables set forth the information relating to the Bank's average
balances at, and net interest income for, the three- and nine-month periods
ended September 30, 2006 and 2005, and reflect the average yield on assets and
average cost of liabilities for the periods indicated. Yields and costs are
derived by dividing interest income by the average balance of interest-earning
assets and interest expense by the average balance of interest-bearing
liabilities for the periods shown. Average balances are derived from actual
daily balances over the periods indicated. Interest income includes fees earned
from making changes in loan rates and terms and fees earned when real estate
loans are prepaid or refinanced.
Three Months Ended September 30,
-------------------------------------------------------------------------------
(Dollar amounts in thousands) 2006 2005
- ----------------------------------------------------------------------------------------------------------------------
Average Average Average Average
Balance Interest (a) Rate Balance Interest (a) Rate
- ----------------------------------------------------------------------------------------------------------------------
ASSETS
Federal funds sold and
temporary investments $ 789 $ 11 5.58% $ 255 $ 2 3.14%
Securities 325,270 3,979 4.89 274,477 3,106 4.53
Loans (b) 451,982 7,256 6.42 438,094 6,557 5.99
- ----------------------------------------------------------------------------------------------------------------------
Total earning assets 778,041 $ 11,246 5.78% 712,826 $ 9,665 5.42%
- ----------------------------------------------------------------------------------------------------------------------
Loan loss allowance (4,118) (4,543)
All other assets 47,888 45,281
- ----------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 821,811 $ 753,564
======================================================================================================================
LIABILITIES AND EQUITY
Interest-bearing deposits $ 522,834 $ 4,454 3.41% $ 506,673 $ 3,121 2.46%
Borrowed funds 171,594 1,945 4.53 113,257 928 3.28
- ----------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 694,428 $ 6,399 3.69% 619,930 $ 4,049 2.61%
- ----------------------------------------------------------------------------------------------------------------------
Demand deposits 76,684 83,278
Other liabilities 4,413 2,648
Shareholders' equity 46,286 47,708
- ----------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND EQUITY $ 821,811 $ 753,564
======================================================================================================================
Net interest-earning assets $ 83,613 $ 92,896
- ----------------------------------------------------------------------------------------------------------------------
Net interest income (tax equivalent
basis)/Interest rate spread (c) $ 4,847 2.09% $ 5,616 2.81%
- ----------------------------------------------------------------------------------------------------------------------
Net interest margin (d) 2.49% 3.15%
Deduct tax equivalent adjustment 37 33
- ----------------------------------------------------------------------------------------------------------------------
Net Interest Income $ 4,810 $ 5,583
======================================================================================================================
(a) Tax equivalent basis. Interest income on non-taxable investment securities
and loans includes the effects of the tax equivalent adjustments using the
marginal federal tax rate of 34% in adjusting tax exempt interest income to
a fully taxable basis.
(b) Average loan balances above include non-accrual loans. When a loan is
placed in non-accrual status, interest income is recorded to the extent
actually received in cash or is applied to reduce principal.
(c) Interest rate spread represents the difference between the weighted average
yield on interest-earning assets and the weighted average cost of
interest-bearing liabilities.
(d) Net interest margin represents net interest income (tax equivalent) divided
by average interest-earning assets.
16
Nine Months Ended September 30,
-------------------------------------------------------------------------------
(Dollar amounts in thousands) 2006 2005
- ----------------------------------------------------------------------------------------------------------------------
Average Average Average Average
Balance Interest (a) Rate Balance Interest (a) Rate
- ----------------------------------------------------------------------------------------------------------------------
ASSETS
Federal funds sold and
temporary investments $ 763 $ 27 4.72% $ 161 $ 7 5.80%
Securities 327,752 11,657 4.74 274,808 9,343 4.53
Loans (b) 446,472 21,017 6.27 442,107 19,404 5.85
- ----------------------------------------------------------------------------------------------------------------------
Total earning assets 774,987 $ 32,701 5.62% 717,076 $ 28,754 5.35%
- ----------------------------------------------------------------------------------------------------------------------
Loan loss allowance (4,187) (4,518)
All other assets 47,712 45,035
- ----------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 818,512 $ 757,593
======================================================================================================================
LIABILITIES AND EQUITY
Interest-bearing deposits $ 515,552 $ 11,819 3.06% $ 502,433 $ 8,776 2.33%
Borrowed funds 173,181 5,530 4.26 122,641 2,835 3.08
- ----------------------------------------------------------------------------------------------------------------------
Total interest-bearing liabilities 688,733 $ 17,349 3.36% 625,074 $ 11,611 2.48
- ----------------------------------------------------------------------------------------------------------------------
Demand deposits 78,875 83,165
Other liabilities 4,565 1,770
Shareholders' equity 46,339 47,584
- ----------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES AND EQUITY $ 818,512 $ 757,593
======================================================================================================================
Net interest-earning assets $ 86,254 $ 92,002
- ----------------------------------------------------------------------------------------------------------------------
Net interest income (tax equivalent
basis)/Interest rate spread (c) $ 15,352 2.26% $ 17,143 2.87%
- ----------------------------------------------------------------------------------------------------------------------
Net interest margin (d) 2.64% 3.19%
- ----------------------------------------------------------------------------------------------------------------------
Deduct tax equivalent adjustment 118 100
- ----------------------------------------------------------------------------------------------------------------------
Net Interest Income $ 15,234 $ 17,043
======================================================================================================================
(a) Tax equivalent basis. Interest income on non-taxable investment securities
and loans includes the effects of the tax equivalent adjustments using the
marginal federal tax rate of 34% in adjusting tax exempt interest income to
a fully taxable basis.
(b) Average loan balances above include non-accrual loans. When a loan is
placed in non-accrual status, interest income is recorded to the extent
actually received in cash or is applied to reduce principal.
(c) Interest rate spread represents the difference between the weighted average
yield on interest-earning assets and the weighted average cost of
interest-bearing liabilities.
(d) Net interest margin represents net interest income (tax equivalent) divided
by average interest-earning assets.
17
VOLUME RATE ANALYSIS
The following tables show how changes in interest rates and changes in the
volume of interest-earning assets and interest-bearing liabilities have affected
the Corporation's interest income and interest expense during the periods
indicated. For each category of interest-earning assets and interest-bearing
liabilities, information is provided with respect to changes attributable to:
(1) changes in volume (change in volume multiplied by the prior rate), (2)
changes in rate (change in rate multiplied by the prior volume), and (3) the net
change. The changes attributable to both changes in volume and rate have been
allocated proportionately to the changes due to volume and the changes due to
rate.
Three Months Ended September 30, 2006
Compared to
(Dollar amounts in thousands) Three Months Ended September 30, 2005
- --------------------------------------------------------------------------------------------
Change Due to
-----------------------
Volume Rate Net Change
- --------------------------------------------------------------------------------------------
Interest Income:
Loans $ 210 $ 489 $ 699
Securities 612 261 873
Federal Funds 8 1 9
- --------------------------------------------------------------------------------------------
Total Interest Earned 830 751 1,581
- --------------------------------------------------------------------------------------------
Interest Expense:
Interest-bearing deposits 102 1,231 1,333
Other borrowed funds 575 442 1,017
- --------------------------------------------------------------------------------------------
Total Interest Expense 677 1,673 2,350
- --------------------------------------------------------------------------------------------
Change in Net Interest Income (Tax Equivalent Basis) $ 153 $ (922) $ (769)
============================================================================================
Net interest and dividend income, on a tax-equivalent basis, decreased by
$769,000 to $4,847,000 for the quarter ended September 30, 2006 as compared to
$5,616,000 for the same period in 2005. The net interest margin was 2.49% for
the quarter ended September 30, 2006 and 3.15% for the quarter ended September
30, 2005.
The decrease in net interest margin is primarily the result of an increase in
the cost of funds. The average cost of interest-bearing liabilities increased
108 basis points to 3.69% for the three months ended September 30, 2006 from
2.61% for the same period in 2005. The increase in the average cost of funds was
partially offset by an increase in the average volume and average yield on
earning assets.
The primary driver for the increase in the cost of funds is an increase in
interest paid on certificates of deposit and borrowed funds. Interest rates paid
to customers on certificates of deposit have been increasing due to the rising
interest rate environment. The cost of borrowed funds has also increased due to
the rising interest rate environment. Higher deposit rates coupled with an
increase in the average borrowings outstanding is the largest driver for the
higher costs. The Corporation has increased its level of borrowings in order to
fund its asset growth.
18
Nine Months Ended September 30, 2006
Compared to
(Dollar amounts in thousands) Nine Months Ended September 30, 2005
- --------------------------------------------------------------------------------------------
Change Due to
-----------------------
Volume Rate Net Change
- --------------------------------------------------------------------------------------------
Interest Income:
Loans $ 196 $ 1,417 $ 1,613
Securities 1,869 445 2,314
Federal Funds 21 (1) 20
- --------------------------------------------------------------------------------------------
Total Interest Earned 2,086 1,861 3,947
- --------------------------------------------------------------------------------------------
Interest Expense:
Interest-bearing deposits 236 2,807 3,043
Other borrowed funds 1,400 1,295 2,695
- --------------------------------------------------------------------------------------------
Total Interest Expense 1,636 4,102 5,738
- --------------------------------------------------------------------------------------------
Change in Net Interest Income (Tax Equivalent Basis) $ 450 $ (2,241) $ (1,791)
============================================================================================
Net interest and dividend income, on a tax-equivalent basis, decreased by
$1,791,000 to $15,352,000 for the nine months ended September 30, 2006 as
compared to $17,143,000 for the same period in 2005. The net interest margin was
2.64% for the nine months ended September 30, 2006 and 3.19% for the nine months
ended September 30, 2005.
The decrease in net interest margin is primarily the result of an increase in
the cost of funds. The average cost of interest-bearing liabilities increased 88
basis points to 3.36% for the nine months ended September 30, 2006 from 2.48%
for the same period in 2005. The increase in the average cost of funds was
partially offset by an increase in the average volume and average yield on
earning assets.
The primary driver for the increase in the cost of funds is an increase in
interest paid on certificates of deposit and borrowed funds. Interest rates paid
to customers on certificates of deposit have been increasing due to the rising
interest rate environment. The cost of borrowed funds has also increased due to
the rising interest rate environment. Higher borrowed funds rates coupled with
an increase in the average borrowings outstanding is the largest driver for the
higher costs. The Corporation has increased its level of borrowings in order to
fund its asset growth.
PROVISION FOR LOAN LOSSES
For the quarters ended September 30, 2006 and 2005, the Bank provided $45,000
and no provision for loan losses. For the quarters ended September 30, 2006 and
2005, recoveries totaled $10,000 and $2,000, respectively, and charge-offs
totaled $171,000 and $32,000 respectively. For the nine months ended September
30, 2006 and 2005, the Bank provided $45,000 for loan losses and $140,000,
respectively. Recoveries totaled $45,000 and $22,000 for the nine months ended
September 30, 2006 and 2005, respectively. Charge-offs totaled $282,000 for the
nine-month period ended September 30, 2006 as compared to $86,000 for the same
period in the prior year. The increase in charge-offs for the quarter and nine
months ended September 30, 2006 is primarily due to the charge-off of two
commercial credits totaling $90,000, combined with activity related to the
Corporation's Overdraft Privilege program that was introduced late in 2005.
Charge-offs and recoveries related to the Overdraft Privilege program flow
through the allowance for loan losses. There was no activity related to this
program during the quarter and nine months ended September 30, 2005. The
provision for loan losses brings the Bank's allowance for loan losses to a level
determined appropriate by management. During the third quarter of 2006,
management recorded an allowance for loan losses totaling $45,000.
The allowance was $4,007,000 or .88% of total loans at September 30, 2006 as
compared to $4,199,000 or 0.97% of total loans at December 31, 2005. The
reduction in the allowance for loan losses is the result of net charge-offs..
The Corporation participates in a program to purchase commercial mortgages
guaranteed by the USDA and SBA. At September 30, 2006, these commercial
mortgages totaled $19,428,000. The Corporation does not provide an allowance for
loan losses for these purchased commercial loans as they are 100% guaranteed. At
September 30, 2006, the allowance for loan losses represents .92% of total
loans, excluding these loans guaranteed by the USDA and SBA, compared to .98% as
of December 31, 2005.
For additional information, see "Provision and Allowance for Loan Losses" in
this Management's Discussion and Analysis.
19
NON-INTEREST INCOME
Non-interest income remained relatively unchanged, totaling $962,000 for the
quarter ended September 30, 2006 and $1,002,000 in the same period of 2005. A
decrease of $249,000 in gains on the sale of loans was offset by an increase in
other non-interest income of approximately $209,000 for the third quarter 2006
as compared to the third quarter 2005. The increase in other non-interest income
consists of an increase totaling $119,000 on income generated from service
charges on deposit accounts, an increase of approximately $25,000 in investment
service fee income and an increase of approximately $37,000 in servicing fee
income.
For the nine months ended September 30, 2006, non-interest income was
$2,775,000, as compared to $3,121,000 for the same period in 2005. The decrease
in non-interest income is partially due to a decrease of $494,000 in gains on
the sale of securities and loans. Other non-interest income also decreased for
the nine months ended September 30, 2006 as compared to the nine months ended
September 30, 2005. The decrease in other non-interest income was primarily due
to the recognition of non-taxable life insurance proceeds of approximately
$472,000 recognized during the nine months ended September 30, 2005 as compared
to no life insurance proceeds recognized during 2006. Excluding non-taxable life
insurance proceeds, other non-interest income increased by $618,000 for the
nine-month period ended September 30, 2006 as compared to the same period in the
prior year. This increase was primarily driven by an increase in income
generated from service charges on deposit accounts of $319,000 and an increase
of approximately $168,000 in investment service fee income. Of the $168,000
increase in investment service fee income, $102,000 is related to the Westco
Financial Services Division, which was introduced in June 2005.
NON-INTEREST EXPENSE
Non-interest expense was $5,471,000 and $4,838,000 for the quarters ended
September 30, 2006 and 2005, respectively. Other non-interest expense increased
$541,000 primarily due to merger-related fees totaling $480,000 associated with
the previously announced merger with NewAlliance and a provision of $108,000 for
other real estate owned in the three months ended September 30, 2006.
For the nine months ended September 30, 2006 and 2005, non-interest expense
totaled $15,569,000 and $14,580,000, respectively. The increase in non-interest
expense for the nine months ended September 30, 2006 was principally driven by
an increase in salaries and benefits and an increase in other non-interest
expense. The increase in salaries and benefits was due to annual increases in
salaries and benefits and an expansion of the Corporation's staff during the
first quarter of 2006. Other non-interest expense increased $675,000 primarily
due to merger-related fees totaling $480,000 associated with the previously
announced merger with NewAlliance and a provision of $130,000 for other real
estate owned in the nine months ended September 30, 2006.
PROVISION AND ALLOWANCE FOR LOAN LOSSES
Three Months Ended September 30, Nine Months Ended September 30,
-------------------------------- --------------------------------
(Dollar amounts in thousands) 2006 2005 2006 2005
- --------------------------------------------------------------------------------------------------------------------------
Balance at beginning of period $ 4,123 $ 4,462 $ 4,199 $ 4,356
Provision for loan losses 45 - 45 140
- --------------------------------------------------------------------------------------------------------------------------
4,168 4,462 4,244 4,496
- --------------------------------------------------------------------------------------------------------------------------
Less charge-offs:
Commercial and industrial loans 95 - 129 4
Consumer loans 76 32 153 82
- --------------------------------------------------------------------------------------------------------------------------
Total charge-offs 171 32 282 86
- --------------------------------------------------------------------------------------------------------------------------
Add recoveries:
Commercial and industrial loans - - 14 10
Consumer loans 10 2 31 12
- --------------------------------------------------------------------------------------------------------------------------
Total recoveries 10 2 45 22
- --------------------------------------------------------------------------------------------------------------------------
Net charge-offs 161 30 237 64
- --------------------------------------------------------------------------------------------------------------------------
Transfer to reserve for unfunded loan commitments - (149) - (149)
- --------------------------------------------------------------------------------------------------------------------------
Balance at end of period $ 4,007 $ 4,283 $ 4,007 $ 4,283
==========================================================================================================================
Net charge-offs to:
Average loans .04% - .05% 0.01%
Loans at end of period .04% - .05% 0.01%
Allowance for loan losses at January 1 3.83% 0.69% 5.64% 1.47%
Allowance for loan losses at September 30
as a percentage of
Average loans 0.89% 0.98% 0.90% 0.97%
Loans at end of period 0.88% 0.98% 0.88% 0.98%
Loans at end of period (excluding USDA-
and SBA-guaranteed loans) 0.92% 0.98% 0.92% 0.98%
20
The approach the Corporation uses in determining the adequacy of the allowance
for loan losses is an exposure method based on the Corporation's loan loss
history, among other factors. Quarterly, based on an internal review of the loan
portfolio, the Corporation identifies required allowance allocations targeted to
specific recognized problem loans that, in the opinion of management, have
potential loss exposure or uncertainties relative to the depth of the collateral
on these same loans. In addition, the Corporation maintains a formula-based
general allowance against the remainder of the loan portfolio, based on the
overall mix of the loan portfolio and the loss history of each loan category.
The formula allowance allocation is calculated by applying loss factors to
outstanding loans by category. Loss factors are based on historical loss
experience. The amount of the recorded allowance above the minimum of the
formula range is based on management's evaluation of relevant factors (e.g.
local area economic statistics, credit quality trends, loan concentrations,
industry conditions and delinquency levels) and the percentage of the allowance
for loan losses to aggregate loans.
The Corporation measures impairment of loans in accordance with SFAS No. 114,
"Accounting for Impairment of a Loan as Amended by SFAS No. 118, "Accounting by
Creditors for Impairment of a Loan - Income Recognition and Disclosures"
(collectively "SFAS No. 114"). A loan is recognized as impaired when it is
probable that either principal or interest is not collectible in accordance with
the terms of the loan agreement. Measurement of impairment for commercial loans
is generally based on the present value of expected future cash flows discounted
at the loan's effective interest rate. Commercial real estate loans are
generally measured based on the fair value of the underlying collateral. If the
estimated fair value of the impaired loan is less than the related recorded
amount, a specific valuation allowance is established or a write-down is charged
against the allowance for loan losses. Smaller balance homogenous loans,
including residential real estate and consumer loans, are excluded from the
provisions of SFAS No. 114. Generally, income is recorded only on a cash basis
for impaired loans.
The general allowance allocation incorporates general business and economic
conditions, credit quality trends, loan concentrations, industry conditions
within portfolio segments and overall delinquency levels.
The allowance for loan losses is increased by provisions charged against current
earnings. Loan losses are charged against the allowance when management believes
that the collectibility of the loan principal is unlikely. Recoveries on loans
previously charged off are credited to the allowance. Management believes that
the allowance for loan losses is appropriate. While management uses available
information to assess possible losses on loans, future adjustments to the
allowance may be necessary based on changes in non-performing loans, changes in
economic conditions or for other reasons. Any future adjustments to the
allowance would be recognized in the period in which they were determined to be
necessary. In addition, various regulatory agencies periodically review the
Corporation's allowance for loan losses as an integral part of their examination
process. Such agencies may require the Corporation to recognize adjustments to
the allowance, based on judgments different from those of management. Management
also retains an independent loan review consultant to provide advice on the
appropriateness of the loan loss allowance. At September 30, 2006, management
believes the allowance for loan losses is appropriate based on the ongoing
stable economic conditions in the Bank's overall market. Credit quality and
delinquency trends are showing a slight improvement over earlier in the year and
management considers the loan portfolio to have a stable and manageable level of
risk.
NON-ACCRUAL, PAST DUE AND NON-PERFORMING LOANS
September 30, June 30, March 31, December 31, September 30,
(Dollar amounts in thousands) 2006 2006 2006 2005 2005
- ------------------------------------------------------------------------------------------------------------------
Non-accrual loans $ 1,429 $ 1,624 $ 1,377 $ 1,583 $ 1,286
- ------------------------------------------------------------------------------------------------------------------
Loans contractually past
due 90 days or more
still accruing 125 392 429 633 707
- ------------------------------------------------------------------------------------------------------------------
Total non-performing loans $ 1,554 $ 2,016 $ 1,806 $ 2,216 $ 1,993
- ------------------------------------------------------------------------------------------------------------------
Non-performing loans
as a percentage
of total loans 0.34% 0.45% 0.41% 0.51% 0.46%
- ------------------------------------------------------------------------------------------------------------------
Allowance for loan losses
as a percentage of
non-performing loans 257.80% 204.51% 231.06% 189.49% 214.90%
- ------------------------------------------------------------------------------------------------------------------
Other real estate owned - net 500 608 608 630 630
- ------------------------------------------------------------------------------------------------------------------
Total non-performing assets $ 2,054 $ 2,624 $ 2,414 $ 2,846 $ 2,623
Non-performing assets
as a percentage
of total assets 0.25% 0.32% 0.29% 0.35% 0.34%
- ------------------------------------------------------------------------------------------------------------------
In September 2006, Westbank signed a purchase and sale agreement to sell its
other real estate owned property. The settlement date of the sale was October
20, 2006. The value of the property was written down $108,000 to the sale price
of $500,000 during the three months ended September 30, 2006.
21
DISCUSSION OF MARKET RISK
Market risk is the risk of loss due to adverse changes in market prices and
rates. The Corporation's primary market risk is its exposure to interest rate
risk, which is inherent in its lending, investing and deposit activities. The
management of interest rate risk, coupled with directives to build shareholder
value and profitability, is an integral part of the Corporation's overall
operating strategy. The Corporation's approach to interest rate risk management
concentrates on fundamental strategies to structure its balance sheet including
the composition of its assets and liabilities. Its approach reflects managing
interest rate risk through the use of fixed and adjustable rate loans and
investments, rate-insensitive checking accounts, as well as a combination of
fixed and variable rate deposit products and borrowed funds. The Corporation
does not utilize interest rate futures, swaps or options transactions.
On a quarterly basis, an interest rate risk exposure compliance report is
prepared and presented to the Corporation's Board of Directors. The risk
exposure report contains a simulation model that measures the sensitivity of
future net interest income to changes in interest rates. All changes are
measured as percentage changes from projected net interest income in a flat rate
scenario (base level). The estimated changes in net interest income are compared
to current limits established by management and approved by the Board of
Directors. The following table sets forth, as of September 30, 2006, the
estimated change in net interest income given a 100 or 200 basis point change in
interest rates over the subsequent twelve month period:
Change in Interest Rates Percentage Change in
(In Basis Points) Net Interest Income
- --------------------------------------------------------------------------------
+ 200 (7.00)%
+ 100 (3.00)
Base level -
- 100 2.00
- 200 4.00
The simulation model utilized to create the results presented above uses various
assumptions regarding cash flows from principal repayments on loans and
mortgage-backed securities and/or call activity on investment securities. Actual
results could differ significantly from these assumptions, which could result in
significant differences in the calculated projected change.
The Corporation seeks to manage the mix of asset and liability maturities to
control the effect of changes in the general level of interest rates on net
interest income. Except for its effect on the general level of interest rates,
inflation does not have a material impact on the Corporation's earnings due to
the rate of variability and short-term maturities of its earning assets.
LIQUIDITY AND CAPITAL RESOURCES
Liquidity refers to the Corporation's ability to generate adequate amounts of
cash to fund loan originations, security purchases, deposit withdrawals, and
fund dividends on the Corporation's common stock and the amounts due under the
junior subordinated debentures. The Corporation's primary sources of liquidity
are principal and interest payments on loans and investment securities, as well
deposits and sales of available-for-sale securities and mortgage loans. Loan
repayments and maturing investments are a relatively predictable source of
funds, while deposit flows and mortgage prepayments are greatly influenced by
interest rates and local and general economic factors. The primary source of
funds for the payment of dividends by the Corporation is dividends paid to the
Corporation by the Bank. The Corporation has not used any off-balance-sheet
financing arrangements for liquidity purposes.
In addition, the Corporation has significant borrowing capacity to fund its
liquidity needs. The majority of borrowings to date have consisted primarily of
advances from the FHLB, of which the Bank is a member. Under the terms of the
collateral agreement with the FHLB, the Bank pledges residential mortgage loans
and mortgage-backed securities, as well as the Bank's stock in the FHLB, as
collateral for such transactions. During the third quarter of 2006, the
Corporation increased its utilization of borrowings as a source of funds. The
average balance of borrowings for the third quarters of 2006 and 2005 were
$171,594,000 and $113,257,000 respectively.
Liquidity management requires close scrutiny of the mix and maturity of
deposits, borrowings and short-term investments. Cash and due from banks,
federal funds sold, investment securities and mortgage-backed securities
available for sale, as compared to deposits and borrowings, are used by the
Corporation to compute its liquidity on a daily basis. The Corporation's
liquidity position is monitored by the Asset/Liability Committee, based on
policies approved by the Board of Directors. The Committee meets regularly to
review and direct the Bank's investment, lending and deposit-gathering
activities.
At September 30, 2006, the Corporation maintained cash balances, short-term
investments and investments available for sale totaling
$181,206,000, representing 22% of total assets, versus $186,006,000 or 23% of
total assets at December 31, 2005. At September 30, 2006, the Corporation had
certificates of deposit maturing within the next 12 months amounting to
$313,794,000. Based on historical experience, the Corporation anticipates that a
significant portion of the maturing certificates of deposit will be renewed with
the Corporation. Management of the Corporation believes that its current
liquidity is sufficient to meet current and anticipated funding and operating
needs.
22
At September 30, 2006, the Corporation exceeded each of the applicable
regulatory capital requirements. As of September 30, 2006, the most recent
notification from the FDIC categorized the Bank as "well capitalized" under the
regulatory framework for prompt corrective action. To be categorized as "well
capitalized", the Bank must maintain minimum total risk-based, Tier 1 risk-based
and Tier 1 leverage ratios as set forth in the following table. There are no
conditions or events since that notification that management believes have
changed the Bank's category. The Corporation's and the Bank's actual capital
ratios as of September 30, 2006 are also presented in the following table.
Minimum for Capital
Actual Adequacy Purposes
------------------- -------------------
Amount Ratio Amount Ratio
-------- -------- -------- --------
September 30, 2006
Total Capital (to Risk Weighted Assets)
Consolidated $ 60,685 12.91% $ 37,611 8.00%
Bank 58,592 12.51 37,460 8.00
Tier 1 Capital (to Risk Weighted Assets)
Consolidated 55,539 11.81 18,806 4.00
Bank 54,430 11.62 18,730 4.00
Tier 1 Capital (to Average Assets)
Consolidated 55,539 6.85 32,447 4.00
Bank 54,430 6.67 32,646 4.00
The primary source of funds for payments of dividends by the Corporation are
dividends paid to the Corporation by the Bank. Bank regulatory authorities
generally restrict the amounts available for payments of dividends if the effect
thereof would cause the capital of the Bank to be reduced below applicable
capital requirements. These restrictions, thus, indirectly affect the
Corporation's ability to pay dividends.
OFF-BALANCE-SHEET ARRANGEMENTS
The Corporation does not have any off-balance-sheet arrangements that have or
are reasonable likely to have a current or future effect on the Corporation's
financial condition, changes in financial condition, revenues or expenses,
results of operations, liquidity, capital expenditures or capital resources that
is material to investors. The Corporation's primary financial instruments with
off-balance-sheet risk are limited to loan servicing for others, obligations to
fund loans to customers pursuant to existing commitments, unused lines of credit
and commitments to sell mortgage loans through loan sales agreements.
There were no material changes in the Corporation's off-balance sheet
commitments during the first nine months of 2006. There were no material changes
to payments due under contractual obligations during the nine months ended
September, 2006, except for the addition of $30,000,000 in FHLB option advances
and $30,000,000 in FHLB fixed-rate term advances. The scheduled maturities of
these option advances are $10,000,000 in 2011 and $20,000,000 in 2016. The
scheduled maturities of the fixed-rate term advances are $6,000,000 in 2007,
$6,000,000 in 2008, $6,000,000 in 2009, $6,000,000 in 2010 and $6,000,000 in
2011.
23
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The information required by this item as of September 30, 2006, can be found in
Item 2. Management's Discussion and Analysis of Financial Condition and Results
of Operations, "Discussion of Market Risk." A more detailed discussion of market
risk is presented in the Corporation's Annual Report on Form 10-K for the
year-ended December 31, 2005.
ITEM 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, management of the
Corporation carried out an evaluation, under the supervision and with the
participation of the Corporation's principal executive officer and principal
financial officer, of the effectiveness of the Corporation's disclosure controls
and procedures. Based on this evaluation, the Corporation's principal executive
officer and principal financial officer concluded that the Corporation's
disclosure controls and procedures are effective in ensuring that information
required to be disclosed by the Corporation in reports that it files or submits
under the Securities Exchange Act of 1934, as amended, is (i) recorded,
processed, summarized and reported within the time periods specified in the
Securities and Exchange Commission's rules and forms, and (ii) accumulated and
communicated to the Corporation's management, including the Corporation's
principal executive officer and principal financial officer, as appropriate, to
allow timely decisions regarding required disclosure. It should be noted that
the design of the Corporation's disclosure controls and procedures is based in
part upon certain reasonable assumptions about the likelihood of future events,
and there can be no reasonable assurance that any design of disclosure controls
and procedures will succeed in achieving its stated goals under all potential
future conditions, regardless of how remote. The Corporation's principal
executive and financial officers have concluded that the Corporation's
disclosure controls and procedures are, in fact, effective at a reasonable
assurance level.
There have been no changes in the Corporation's internal control over financial
reporting (to the extent that elements of internal control over financial
reporting are subsumed within disclosure controls and procedures) identified in
connection with the evaluation described in the above paragraph that occurred
during the Corporation's last fiscal quarter that have materially affected, or
are reasonably likely to materially affect, the Corporation's internal control
over financial reporting.
24
PART II - OTHER INFORMATION
ITEM 1. Legal Proceedings
Certain litigation is pending against the Corporation and its
subsidiaries. Management, after consultation with legal counsel, does
not anticipate that any liability arising out of such litigation will
have a material effect on the Corporation's financial statements.
ITEM 1A. Risk Factors
Except for the risk factors set forth below relating to the proposed
acquisition of the Corporation by NewAlliance, there have been no
material changes to the risk factors previously disclosed in the
Corporation's Annual Report on Form 10-K for the year ended December
31, 2005.
The Corporation's business could be adversely affected by uncertainty
related to the proposed merger and contractual restrictions while the
proposed merger is pending. Uncertainty about when and whether the
merger will be completed and the effects of the merger may have an
adverse effect on the Corporation. These uncertainties could cause
depositors and others that deal with the Corporation to seek to
change their existing business relationships with the Corporation,
which could negatively affect growth, revenues and results of
operations. In addition, the merger agreement restricts the
Corporation from taking specified actions without the buyer's
approval. These restrictions could prevent the Corporation from
pursuing attractive business opportunities that may arise prior to
the completion of the proposed merger.
Failure to complete the proposed merger could negatively impact the
Corporation's stock price, future business and financial results.
Completion of the merger is subject to the satisfaction of various
conditions, including the approval by the Corporation's shareholders,
as well as regulatory approvals. Although the Corporation's board of
directors will, subject to fiduciary exceptions, recommend that the
Corporation's shareholders approve and adopt the merger agreement,
there is no assurance that the merger agreement and the merger will
be approved, and there is no assurance that the other conditions to
the completion of the merger will be satisfied. If the merger is not
completed, we will be subject to several risks, including the
following:
o under certain circumstances, if the merger is not completed, the
Corporation may be required to pay the buyer a termination fee of
$4,500,000;
o the current market price of the Corporation's common stock may
reflect a market assumption that the merger will occur, and a
failure to complete the merger could result in a negative
perception by the stock market of the Corporation generally and a
decline in the market price of the Corporation's common stock;
o certain costs relating to the merger, such as legal, accounting
and financial advisory fees, are payable by the Corporation
whether or not the merger is completed;
o matters related to the merger may distract the Corporation's
management and employees from day-to-day operations and require
substantial commitments of time and resources which could
otherwise have been devoted to other opportunities that could
have been beneficial to the Corporation;
o the Corporation would continue to face the risks that it
currently faces as an independent company.
25
ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds
Share Repurchase Plan - During the fourth quarter of 2003, the Board
of Directors approved a new stock repurchase program of up to 5% of
the Corporation's stock. The value of the 5% stock of the Corporation
at the time of the announcement was approximately $3,800,000. There
is no termination date associated with the program. The following
table represents repurchases of Westbank Corporation's stock for the
three months ended September 30, 2006.
Total number of Maximum number
shares purchased of shares yet to be
Total number as part of publicly purchased under
of shares Average price announced plans announced plans
Period purchased paid per share or programs or programs
-----------------------------------------------------------------------------------------------------
July 1-31, 2006 5,536 $ 17.98 83,571 134,333
August 1-31, 2006 - -
September 1-30, 2006 - -
-----------------------------------------------------------------------------------------------------
Total 5,536 $ 17.98
-----------------------------------------------------------------------------------------------------
ITEM 3. Defaults on Senior Securities - None
ITEM 4. Submission of Matters to a Vote of Security Holders - None
ITEM 5. Other Information - None
26
ITEM 6. Exhibits
2.4 Agreement and Plan of Merger by and among NewAlliance
Bancshares, Inc., and NewAlliance Bank and Westbank
Corporation and Westbank, dated as of July 18, 2006
(incorporated by reference to Exhibit 2.4 of Registrant's
Form 8-K filed with the SEC on July 19, 2006)
3.1 Articles of Organization, as amended (Incorporated by
reference to Exhibit 3.1 of Registrant's Form S-4/A
filed with the SEC on November 3, 1998)
3.2 Bylaws, as amended (Incorporated by reference to
Exhibit 3.2 of Registrant's Form S-4 filed with the SEC
on September 30, 1998)
10.1 1995 Directors Stock Option Plan (Incorporated by
reference to Exhibit A of Registrant's Proxy Statement
filed with the SEC on March 31, 1995)
10.2 1996 Stock Incentive Plan (Incorporated by reference to
Exhibit A of Registrant's Proxy Statement filed with
the SEC on March 21, 1996)
10.3 Westbank Corporation Dividend Reinvestment and Common
Stock Purchase Plan (Incorporated by reference to Exhibit
4.1 of Registrant's Form S-3D filed with the SEC on June
19, 1997)
10.4 Employment Agreement dated December 17, 2003 between
Westbank Corporation and Donald R. Chase (Incorporated by
reference to Exhibit 10.1 of Registrant's Annual Report
on Form 10-K for the year ended December 31, 2003)
10.5 Form of Change of Control Agreements among Westbank
Corporation, Westbank and certain officers (Incorporated
by reference to Exhibit 10.2 of Registrant's Annual
Report on Form 10-K for the year ended December 31, 2003)
10.6 Westbank Corporation 2004 Recognition and Retention Plan
(Incorporated by reference to Appendix A of Registrant's
Proxy Statement filed with the SEC on March 9, 2004)
10.7 Indenture by and between Westbank Corporation and
Wilmington Trust Company, as Trustee, dated September 20,
2004 for Floating Rate Junior Subordinated Deferrable
Interest Debentures (Incorporated by reference to Exhibit
10.1 of Registrant's Form 8-K filed with the SEC on
September 24, 2004)
10.8 Indenture by and between Westbank Corporation and
Wilmington Trust Company, as Trustee, dated September 20,
2004 for Fixed/Floating Rate Junior Subordinated
Deferrable Interest Debentures (Incorporated by reference
to Exhibit 10.2 of Registrant's Form 8-K filed with the
SEC on September 24, 2004)
10.9 Guarantee Agreement by and between Westbank Corporation
and Wilmington Trust Company, dated September 20, 2004
(Incorporated by reference to Exhibit 10.3 of
Registrant's Form 8-K filed with the SEC on September 24,
2004)
10.10 Guarantee Agreement by and between Westbank Corporation
and Wilmington Trust Company, dated September 20, 2004
(Incorporated by reference to Exhibit 10.4 of
Registrant's Form 8-K filed with the SEC on September 24,
2004)
10.11 Westbank Corporation 2006 Equity Incentive Plan
(Incorporated by reference to the Appendix of
Registrant's Proxy Statement filed with the SEC on March
14, 2006)
10.12 Employee Stock Ownership Plan (Executed prior to Edgar on
January 1, 1989)
31.1 Certification of Chief Executive Officer, pursuant to
Rule 13a-14(a)/15d-14(a)
31.2 Certification of Chief Financial Officer, pursuant to
Rule 13a-14(a)/15d-14(a)
32.1 Certification of Chief Executive Officer, pursuant to
Section 1350
32.2 Certification of Chief Financial Officer, pursuant to
Section 1350
27
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this Quarterly Report to be signed on its behalf by
the undersigned thereunto duly authorized.
WESTBANK CORPORATION
Date: November 7, 2006 /s/ Donald R. Chase
-------------------------------------
Donald R. Chase
President and Chief Executive Officer
Date: November 7, 2006 /s/ John M. Lilly
-------------------------------------
John M. Lilly
Treasurer and Chief Financial Officer
28