Item 1. Business
General
Until the
completion of a mutual to stock conversion and
initial public offering of stock on November 20, 1998, Seacoast
Financial Services Corporation (the “Company” or “Seacoast Financial”) was a
mutual holding company created in connection with the reorganization of Compass
Bank for Savings ( “Compass”) into a mutual holding company form of
organization in 1994. The Company is
registered with the Board of Governors of the Federal Reserve System (the
“FRB”) as a bank holding company under the Bank Holding Company Act of 1956, as
amended (the “BHCA”). Since its
formation, the Company has owned 100% of Compass’s outstanding capital stock.
On December 4,
1998, the Company acquired by merger all of the issued and outstanding capital
stock of Sandwich Bancorp, Inc. (“Sandwich”) in a stock-for-stock exchange and
merged Sandwich’s wholly-owned subsidiary, The Sandwich Co-operative Bank
(“Sandwich Bank”), into Compass. This
acquisition was accounted for as a pooling of interests and, accordingly, all
financial data is presented herein as if the Company and Sandwich had always
been combined.
On December 31,
2000, the Company completed its
acquisition of Home Port Bancorp, Inc., holding company for Nantucket Bank, a
three branch savings bank located on Nantucket Island, Massachusetts. This transaction was accounted for under the
purchase method of accounting. As the
closing of this acquisition coincided with the Company’s year-end, the assets
and liabilities of Nantucket Bank are included in the consolidated balance
sheet, as well as the various tables presented herein, as of December 31,
2000. The results of operations of
Nantucket Bank are included herein beginning January 1, 2001. The narrative in this Item I. does not
include Nantucket Bank’s financial operating data, such as the amount of loan
originations, for any period prior to 2001.
See Note 2 to the consolidated financial statements for disclosure of
certain pro forma information. Compass
and Nantucket Bank are collectively referred to herein as “the Banks.”
Compass was
organized in 1855 as a Massachusetts-chartered mutual savings bank, and
reorganized into mutual holding company form in 1994. Nantucket Bank was organized in 1834 as a Massachusetts-chartered
mutual savings bank and reorganized to a stock savings bank in 1988. The Banks’ principal business has been, and
continues to be, gathering deposits from customers within its market areas and
investing those funds in residential and commercial real estate loans, indirect
automobile loans (Compass only), commercial loans, construction loans, home
equity loans and other consumer loans and investment securities. The Banks’ investment portfolios consist
primarily of U.S. Government and agency
securities, corporate bonds, mortgage-backed securities, collateralized
mortgage obligations and, to a lesser extent, marketable equity securities. Individual and business customers have a
variety of deposit accounts with the Banks, including NOW (checking) and other
demand deposit accounts, passbook savings accounts, money market deposit
accounts, Individual Retirement Accounts (“IRAs”) and various certificates of
deposit. In 2001, Compass began to
provide private banking services to both individuals and businesses.
The Banks’
deposits are insured by the Bank Insurance Fund (the “BIF”), as administered by
the Federal Deposit Insurance Corporation (the “FDIC”), up to the maximum
amount permitted by law, except that certain deposits that Compass acquired
from a savings association are insured by the Savings Association Insurance
Fund (the “SAIF”), also administered by the FDIC. Deposit amounts in excess of FDIC insurance limits are insured by
the Depositors Insurance Fund (the “DIF”), a deposit insuring entity for
Massachusetts savings banks. The Banks are voluntary members of the Federal
Home Loan Bank of Boston (FHLB), which serves principally as a credit source in
providing funds for residential mortgage lending.
At December 31,
2001, the Company was the largest publicly traded stock holding company
headquartered in Massachusetts.
Market Area and Competition
At December 31,
2001, the Company and Compass conducted business from their corporate headquarters
in New Bedford, Massachusetts and the Banks conducted business from 42
full-service branches, seven of which are located in New Bedford and the
remaining 35 of which are located in the Massachusetts communities of Fall
River (two branches), Plymouth (four branches), Fairhaven, Mattapoisett, North
Dartmouth, Seekonk, Somerset, Swansea, Westport, Assonet and Carver, Cape Cod
(twelve branches) and the islands of Martha’s Vineyard (five branches) and
Nantucket (three branches). Compass
also has two limited service high school branches and seven remote ATMs.
In addition, Compass’s indirect auto lending business extends into all
of Eastern Massachusetts and the State of Rhode Island.
The Banks face
significant competition both in generating loans and in attracting
deposits. Compass’s primary market area
is highly competitive and it faces
direct competition from a significant number of financial institutions, many
with either a state-wide, a regional or, in some cases, a national presence.
Several of these financial institutions are significantly larger and have
greater financial resources than Compass.
Compass’s competition for loans comes principally from commercial banks,
savings banks, credit unions, mortgage brokers, mortgage banking companies and
insurance companies. Its most direct
competition for deposits has historically come from savings, cooperative and
commercial banks and credit unions. In
addition, the Banks face competition for depositors’ funds from non-bank
institutions, such as brokerage firms and insurance companies which offer
financial alternatives such as short-term money-market funds, corporate and
government securities funds, mutual funds and annuities.
Nantucket Bank is the
only bank headquartered on Nantucket Island; however, it faces competition from
other banks, mortgage banking companies and other financial service providers,
many of which have significantly greater resources. Its most direct competition for deposits primarily comes from
other banks located on Nantucket Island and in southeastern Massachusetts,
credit unions and brokerage firms.
Nantucket Bank competes for deposits principally by offering depositors
convenient branch hours and locations, personalized customer service, telephone
and computer access to accounts, a wide variety of deposit programs, automated
teller machines and competitive interest rates.
Competition for
real estate loans on Nantucket comes primarily from other banks, mortgage
brokers, mortgage banking companies and other institutional lenders. The competition for loans varies depending
on factors which include, among others, the general availability of lendable
funds and credit, general and local
economic conditions, current interest rate levels, conditions in the
mortgage market and other factors which are not readily predictable.
Lending Activities
General.
The loan portfolio, excluding loans held-for-sale, totaled $2,575.0 million as
of December 31, 2001, representing 77.0% of
total assets on that date. The
Banks primarily make residential real estate loans secured by one- to
four-family residences, indirect auto loans (Compass only) and commercial real estate loans. The Banks also make home equity line of
credit loans, residential and commercial construction loans, commercial loans,
fixed rate home equity loans, personal installment loans and passbook
loans. The majority of loans, including
some loans classified as commercial loans, are collateralized by real estate.
Interest rates
charged on loans are affected primarily by the demand for such loans, the
supply of money available for lending purposes, secondary market mortgage rates
and the rates offered by competitors.
These factors are, in turn, affected by national, regional and local
economic conditions, the levels of federal government spending and revenue,
monetary policies of the FRB and tax policies.
The following table summarizes the composition of the
loan portfolio as of the dates indicated:
(1) Since January 1999, all
indirect auto loans have been originated on a simple interest basis. Accordingly, the balance of unearned
discount will continue to decline as pre-1999 indirect auto loans are repaid.
Loan
Origination and Underwriting - Compass. Loan officers based in each of Compass’s
five regions - Plymouth, Fall River, New Bedford, Cape Cod and Martha’s
Vineyard - originate and underwrite mortgage and commercial loans. Compass also
employs external loan originators, based in each of the regions, who originate
residential mortgage loans. Compass
underwrites consumer loans at its main office, although it originates such
loans at its branches and, in the case of indirect auto loans, through a
network of car dealers located throughout its current market area, Eastern
Massachusetts and Rhode Island.
Compass’s loan
underwriting varies depending on the type of loan. It generally includes the use of credit applications, property
appraisals and verification of an applicant’s credit history, employment and
banking relationships to the extent management deems appropriate in each
case. With respect to indirect auto
loans, car dealers originate the loans and transmit loan applications to
Compass for underwriting. Additional
information concerning the underwriting of specific types of loans is set forth
in sections that discuss those loans.
Four senior loan
officers oversee loan origination and underwriting. Individual loan officers may originate loans within certain
approved lending limits. A credit
committee, consisting of senior loan and credit officers, and Compass’s Board
of Directors, or the executive committee thereof, must approve all unsecured
commercial loans over $1.25 million and all secured commercial loans, including
commercial real estate loans, over $2.5 million. Pursuant to its loan policy, Compass generally will not make
loans aggregating more than $12.5 million to any one borrower. Exceptions to this “house” lending limit
must be approved by the Board. At
December 31, 2001, no customers had aggregate borrowing capacity with Compass
exceeding the $12.5 million house limit.
Compass’s legal lending limit, which is set at 20% of its capital, was
approximately $44 million at December 31, 2001.
Loan
Origination and Underwriting - Nantucket Bank.
Loan originations come from a number of sources. Most real estate loan originations are
attributable to referrals from existing customers, real estate brokers,
attorneys and builders as well as walk-in customers and officer calls. Officer calls and referrals are important
sources of commercial and commercial mortgage loan originations. Consumer loans generally are written with
existing depositors.
Each loan
originated by Nantucket Bank is underwritten by its personnel with individual
lending officers having the authority to approve loans up to specified
limits. A credit committee, consisting
of senior loan and other officers, must approve all loans that exceed $700,000
and Nantucket Bank’s Board of Directors, or the executive committee thereof,
must approve all loans over $1.2 million. Nantucket Bank will generally not
make loans to any one borrower with an aggregate balance in excess of its house
lending limit of $2.5 million. At December 31, 2001, one customer had an
aggregate loan balance in excess of such limit. Nantucket Bank’s legal lending limit was approximately $6.5
million at December 31, 2001.
Independent
licensed appraisers are used to appraise the property intended to secure real
estate loans. Nantucket Bank’s
underwriting criteria are designed to minimize the risks of each loan. There are detailed guidelines concerning the
types of loans that may be made, the
nature of the collateral required, the information that must be obtained
concerning the loan applicant and follow-up inspections of collateral after the
loan is made.
The following
table sets forth activity within the loan portfolio for the periods indicated:
(1) Loan activity for these years do not
include Nantucket Bank which was acquired on December 31, 2000.
The Banks charge
origination fees, or points, and collect fees to cover the costs of appraisals
and credit reports on most new residential mortgage loans and on many
commercial real estate loans. The Banks
also collect late charges on real estate and consumer loans. For information regarding the recognition of
loan fees and costs, see Note 1 of the Notes to the Consolidated Financial
Statements.
Loan Maturity and Repricing. The following table presents the contractual
maturity and repricing dates of the Banks’ loan portfolio at December 31, 2001.
The following
table sets forth the balances of loans at December 31, 2001, which are
contractually due or scheduled to reprice after December 31, 2002, segregated
between fixed and adjustable interest rates:
Residential
Real Estate Loans. As of
December 31, 2001, adjustable rate loans represented approximately 44%
and fixed rate loans represented approximately 56% of the Banks’ portfolio of
residential real estate loans secured by one-to four-family residences. Over 90% of this portfolio is secured by
single-family, owner-occupied homes.
During the past
ten years, Compass generally has sold most of the fixed rate residential
mortgage loans originated with terms of 15 years or longer to the Federal Home
Loan Mortgage Corporation (“FHLMC”).
Compass continues to service loans that it has sold to FHLMC and
receives a monthly servicing fee equal to .25% per annum of the outstanding
balance. Compass serviced loans for
others aggregating $287.7 million as of December 31, 2001 and $309.0 million as
of December 31, 2000 and earned $506,000 and $689,000 in servicing fees, net of
the amortization of capitalized mortgage servicing rights, representing 3.10%
and 6.90%, of its noninterest income in
2001 and 2000, respectively.
From November 1998
through September 2001, Compass did not sell fixed rate residential mortgage
loans. In September 2001, management
determined that it would sell a portion of its current fixed rate residential
mortgage loan originations with a term of 15 year or less on a servicing
retained basis. During the fourth quarter
of 2001, Compass sold $43.9 million of such loans and recognized a gain on sale
of $1.0 million. This decision was
based on the historically low interest rates which such loans currently yield
as well as general liquidity considerations.
It has generally
been Nantucket Bank’s policy to sell most of its fixed rate residential
mortgage loans originated with terms greater than 10 years and a portion of its
adjustable rate residential mortgage loans on a servicing retained basis. Loans serviced for others at December 31,
2001 and 2000 amounted to $75.4 million and $73.7 million, respectively,
excluding loans sold to and serviced for Compass.
Adjustable rate
mortgage loans generally reprice either annually, or every three, five, or
seven years and annually thereafter. The interest rate adjustments on these
loans are indexed to the applicable one-year or three-year U.S. Treasury CMT
Index with corresponding add-on margins of varying amounts generally ranging
from 2.75% to 3.25%. Such loans are
subject to certain requirements and limitations set forth in guidelines issued
by the Massachusetts Commissioner of Banks (“the Commissioner”), including
limitations on the amount and frequency of interest rate changes. Rates adjust by no more than one or two
percentage points in each adjustment period and by no more than five or six
percentage points over the life of a loan.
Compass’s owner
occupied residential mortgage loans are generally written in amounts up to 95%
of the appraised value or selling price, whichever is lower, of the property
securing the loan, although the majority of such loans are written with ratios
of 80% or less. Compass generally requires borrowers to obtain private mortgage
insurance with respect to loans with a greater than 80% loan-to-value
ratio. Nantucket Bank’s residential
mortgage loans are generally written with an original loan-to-value ratio of up
to 80% of appraised value.
The Banks each
maintain programs to originate residential mortgage loans to low-to-moderate
income borrowers. At Compass, the loans
have fixed or adjustable interest rates that are typically lower than
prevailing market rates, are closed without points, have substantially lower
closing costs than other residential loans and have terms of up to 30
years. The loans may have up to a 97%
loan-to-value ratio, although borrowers must obtain private mortgage insurance
if the loan-to-value ratio exceeds 80%.
At Nantucket Bank, such loans are closed with no points and may have
loan-to-value ratios up to 90% without private mortgage insurance. The Banks partially fund the loans with
borrowings under either the Community Investment Program (“CIP”) or the New
England Fund (“NEF”) housing programs of the FHLB. These programs permit borrowings from the FHLB at below market
rates to finance the loans. The Banks
had $11.9 million of CIP-funded loans and $23.1 million of NEF-funded loans in
their residential loan portfolios as of December 31, 2001.
Commercial
Real Estate Loans.
The Banks make commercial real estate loans throughout their market
areas and at December 31, 2001, had
$337.3 million in commercial real estate loans in the loan portfolio,
representing 13.1% of total loans.
Properties that
are used for borrowers’ businesses, such as small office buildings, golf
courses, restaurants, inns, retail facilities or multi-family income
properties, generally collateralize commercial real estate loans. The loans typically have terms of up to 20
years and interest rates which adjust over periods of one to five years based
on one of various rate indices.
Commercial real estate loans with fixed interest rates have terms
generally ranging from one to five years.
The Banks consider the experience of management, cash flows and
collateral values when underwriting commercial real estate loans. Compass and Nantucket Bank generally make
commercial real estate loans in an amount equal to no more than 75% of the
appraised value of the property securing the loan and generally require the
owners of businesses seeking commercial real estate loans to personally
guarantee those loans.
Commercial real
estate lending entails greater credit risks than residential mortgage lending
to owner-occupants. The repayent of
commercial real estate loans depends on the business and financial condition of
the borrower. Changes in economic
conditions or government regulations, which neither the Banks nor their
borrowers control, could have an adverse impact on the cash flows generated by
properties securing commercial real estate loans and on the value of such
properties.
Construction
Loans. The Banks make
both residential and commercial construction loans throughout their market
area. Compass typically makes the loans
to either owner-borrowers who will occupy the properties (residential
construction) or licensed and experienced developers for the construction of
single-family home developments that generally have no more than 30 housing
lots and, to a lesser extent, end users of
commercial properties (commercial construction). Commercial construction
loans to end users are generally originated with permanent financing already
committed.
The Banks
generally increase the loan-to-value ratios on such loans as construction
progresses. Before any work has
commenced, and while a construction loan’s only collateral is a plot of land,
Compass will typically finance only up to 70% of the value of that land. Once construction has begun, Compass will
generally make residential construction loans in amounts up to 90% (for primary
homes) and 80% (for secondary homes) of the lesser of the appraised value of
the property, as completed, or the property’s cost of construction. Nantucket Bank generally makes construction
loans on owner-occupied primary or secondary residences up to 80% of appraised
value (up to 70% of land value). The
Banks generally make commercial construction loans in amounts up to 75% of the
lesser of the property’s appraised value, as completed, or construction cost
and generally require developers seeking commercial construction loans to
personally guarantee them. The proceeds
of construction loans are disbursed in stages and require either loan officers
or appointed professionals to inspect each project’s progress before the Banks
disburse additional funds and to verify that borrowers have completed project
phases.
Residential
construction loans to owner-borrowers generally convert to a fully amortizing
long-term mortgage loan upon completion of construction. Commercial construction loans generally have
terms of six months to a maximum of two years.
The Banks had $108.6 million in construction loans in their loan
portfolios, representing 4.2% of total loans, as of December 31, 2001.
Construction
lending, particularly commercial construction lending, entails greater credit
risk than residential mortgage lending to owner-occupants. Economic events and
changes in government regulations, which neither the Banks nor their borrowers
control, could have an adverse impact on the value of properties securing
construction loans and on the borrowers’ ability to complete projects financed
and, if not the borrower’s residence, sell them for expected amounts at the
time the projects were commenced.
Home
Equity Loans. These loans are revolving lines of credit and
are typically secured by second mortgages on one- to four-family owner-occupied
properties. Interest rates on home
equity loans normally adjust based on the prime rate of interest. The lines of credit are available for up to
ten years at the end of which they become term loans which are amortized for
periods up to 10 years. The Banks do
not originate home equity line of credit loans with loan-to-value ratios in
excess of 80%. The Banks had $45.7
million in home equity loans, representing 1.8% of the loan portfolio, as of
December 31, 2001. The undrawn portion
of home equity lines of credit totaled $50.5 million as of December 31, 2001
Commercial
Loans. The Banks primarily make commercial loans to businesses
that operate in and around their primary market area of Southeastern
Massachusetts including Nantucket, Martha’s Vineyard and Cape Cod.
The Banks review
the financial resources, debt-to-equity ratios, cash flows and their own
experience with businesses when underwriting commercial loans and generally
require business owners to personally guarantee commercial loans. Commercial loans are generally
collateralized by equipment, leases, inventory and/or accounts receivable. Many commercial loans are also
collateralized by real estate, but are not classified as commercial real estate
loans because such loans are not made for the purpose of acquiring, refinancing
or constructing the real estate partially securing the loan. Commercial loans provide, among other
things, working capital, equipment financing, financing for leasehold
improvements and financing for acquisitions.
The Banks offer both term and revolving commercial loans. The former have either fixed or adjustable
rates of interest and, generally, terms of between four and seven years. Term loans generally amortize during their
life, although some loans require a lump sum payment at maturity. Revolving commercial lines of credit
typically have one-year terms, renewable annually, and rates of interest which
are normally indexed to the prime rate of interest.
Commercial
borrowers are not concentrated in any one particular industry. As of December 31, 2001, the commercial loan
portfolio included, among others, floor plan loans to auto dealerships, loans
to hotels, inns and other tourism-related businesses, loans to golf courses,
loans to building trade companies and loans to retailers. As of December 31, 2001 the Banks had $115.6
million in commercial loans, representing 4.5% of the loan portfolio.
Commercial lending
entails greater credit risks than residential mortgage lending to
owner-occupants. Repayment of both
secured and unsecured commercial loans depends substantially on the borrower’s
underlying business, financial condition and cash flows. Unsecured loans generally involve a higher
degree of risk of loss than do secured loans because, without collateral,
repayment is wholly dependent upon the success of the borrower’s business. Secured commercial loans are generally
collateralized by equipment, leases, inventory and/or accounts receivable.
Indirect
Auto and Other Consumer Loans. Compass emphasizes indirect auto lending through a network of
over 200 car dealers. Compass has been
in the indirect auto lending business since 1985 and has increased its
portfolio of indirect auto loans to
$600.2 million at December 31, 2001, or 23.3% (net of unearned discount) of the
loan portfolio. In developing its
network, Compass has historically focused on dealers in its primary market areas
and in Rhode Island. Because of
increasing competition for these loans in its market area and management’s
intent to continue to increase this portion of the loan portfolio, Compass has
expanded its network of car dealers to communities throughout Eastern
Massachusetts.
Compass makes
indirect auto loans collateralized by both new and used cars. The loans have terms of up to six years for
those secured by new vehicles and five and a half years for those secured by
used vehicles. As of December 31, 2001,
approximately half of Compass’s indirect auto loans were secured by new car
loans. Compass does not engage in auto
lease financing.
In connection with
the origination of indirect auto loans, the interest rate charged to the
borrower by the dealer is generally one to two percentage points higher than
the “buy rate” or rate earned by Compass.
The difference between the two rates is referred to as the “spread”. At loan inception, the computed dollar value
of the spread is prepaid by Compass to the car dealer. Such prepaid amounts are generally subject
to rebate in the event the underlying loan is prepaid or defaults. In recent
years, more dealers have opted to receive either a reduced spread or a flat fee
in exchange for elimination of their rebate obligation. The dealer’s ability to refund any portion
of the unearned prepaid interest, which amounted to $15.3 million at December
31, 2001, is subject to economic conditions generally, and the financial condition
of the dealer. To mitigate this risk,
Compass withholds a portion of the spread at loan origination as a dealer
reserve. The amount withheld, in the
aggregate, generally approximates 1% of the outstanding balance of loans
originated by each dealer. At December
31, 2001, the balance of the dealer reserve was $5.2 million, or 0.9% of the
balance of indirect auto loans.
Indirect auto
lending entails greater risks than residential mortgage lending to
owner-occupants. Although Compass has
not historically experienced significant delinquencies in this portfolio,
borrowers may be more likely to become delinquent on a car loan than on a
residential mortgage loan secured by their primary residence. Moreover, car values depreciate rapidly and,
in the event of default, principal loss as a percentage of the loan balance
depends upon the mileage and condition of the vehicle at the time of
repossession, factors over which Compass has no control.
The Banks make a variety of other consumer loans,
including fixed rate home equity loans, personal installment loans, education
loans, and passbook loans. The Banks do
not offer credit card loans. Other
consumer loans totaled $56.0 million, or 2.2% of the loan portfolio, as of
December 31, 2001.
Delinquent Loans and Loan Review
Delinquent
Loans. Compass’s Managed Asset Group performs a monthly
review of all delinquent loans with a principal balance in excess of $150,000
and reviews the status of each account with the appropriate Lending Department
Manager and/or Account Officer. In
addition, Compass’s Board of Directors reviews delinquency statistics, by loan
type, on a monthly basis. Nantucket
Bank’s Loan Review Committee, which includes all of its loan officers and other
officers and directors , reviews the status of all delinquent borrowers on a
monthly basis. Nantucket Bank’s Board
of Directors and/or Executive Committee thereof reviews all loans past due two
or more payments each month.
The actions taken
with respect to delinquencies vary depending upon the nature of the delinquent
loans and the period of delinquency.
The Banks’ asset management philosophy is predicated upon early
detection and response to delinquent and default situations. The Banks
seek to make arrangements to cure the entire default over the shortest
time frame. Generally, the Banks
require that a delinquency notice be mailed no later than the 10th day of
delinquency. A second notice is mailed
on the 15th day of delinquency. A late
charge is usually assessed on loans where the scheduled payment is unpaid after
15 days. After mailing the delinquency
notices, the Banks’ asset management staff call the borrower to ascertain the
reasons for delinquency and the prospects for payment. On loans secured by one- to four-family
owner- occupied properties, the Banks
attempt to work out a payment schedule with the borrower in order to
avoid foreclosure. If these efforts do
not achieve a satisfactory arrangement, the loan is referred to legal counsel
and counsel initiates foreclosure proceedings.
At any time prior to a sale of the property at foreclosure, the Banks
will terminate foreclosure proceedings if the borrower is able to work out a
satisfactory payment plan. On loans
secured by commercial real estate properties, the Banks also seek to reach a
satisfactory payment plan so as to avoid foreclosure. Prior to foreclosure, the Banks will generally obtain an updated
appraisal of the property.
The following
table sets forth a summary of certain delinquency information as of the dates
indicated:
Loan
Review. The Banks use an internal rating system to monitor
and evaluate the credit risk inherent in their loan portfolios and to identify
potential problem loans. At the time of
loan approval, all commercial, commercial real estate and commercial
construction loans are assigned a rating based on all of the factors considered
in originating the loan. The initial
loan rating is recommended by the loan officer who originated the loan and
approved by the individuals or committee responsible for approving it.
Loan quality
ratings are utilized as major criteria in the compilation of the Asset Watch
List. All loans with loan ratings of 4
(Special Mention), 5 (Substandard) or 6 (Doubtful) are included in a monthly
Asset Watch List. Watch List ratings
are an integral part of the evaluation of the adequacy of the loan loss
reserve. Loan officers are expected to submit appropriate rating changes when
facts come to their attention that warrant an upgrade or downgrade in a loan
rating. In addition, loan ratings are
generally reviewed on an annual basis.
Loans that are
rated Substandard or Doubtful coincide with the classifications used by federal
regulators in their examination of financial institutions. Generally, a loan is considered Substandard
if it is inadequately protected by the current net worth and paying capacity of
the borrowers and/or the collateral pledged.
Substandard loans include those characterized by the distinct
possibility that the Banks will sustain some loss if the deficiencies are not
corrected. Loans classified as Doubtful
have all the weaknesses inherent in those classified Substandard with the added
characteristic that the weaknesses present make collection or liquidation in
full, on the basis of currently existing facts, highly questionable and
improbable. Loans classified as Loss
are those considered uncollectible and of such little value that their
continuance as assets without establishment of a specific loss reserve and/or
charge-off is not warranted. Loans
which do not currently expose the Banks
to sufficient risk to warrant classification in one of the
aforementioned categories but possess weaknesses are designated Special
Mention.
Compass also
utilizes an independent third party to conduct periodic (generally semi-annual)
credit analysis of its commercial and commercial real estate loan portfolios
and to analyze trends in loan delinquency and non-performing loans. The level of Classified Loans as determined
by Compass is reconciled to the level of Classified Loans as determined by the
independent loan review.
On a quarterly
basis (monthly at Nantucket Bank), a management group at each bank comprised of
senior officers reviews the status and classification of each loan assigned a
rating of Substandard, Doubtful or Loss.
Loans, or portions of loans, classified Loss are charged off against the
allowance for loan losses. These groups
also assess the overall adequacy of the allowance for loan losses at each bank,
including the general valuation allowance established to recognize the inherent
risk associated with each specific category of lending.
In January 2001, the Company’s Board of Directors
formed a Risk Management Committee at which time the position of Senior Credit
Officer at Compass was created. The
Senior Credit Officer is responsible for all administrative matters related to
the credit function at Compass and provides management and the Board of
Directors with such information as loan concentrations, risk rating migration,
compliance and tracking of exceptions.
The classification of loans and the amount of the
valuation allowances set aside for estimated losses is subject to review by the
FDIC and the Commissioner. Based on
their reviews, these agencies can order the establishment of additional general
or specific loss allowances. The FDIC,
in conjunction with the other federal banking agencies, has adopted an
interagency policy statement on allowances for loan and lease losses. The policy statement provides guidance for
banks on both the responsibilities of management for the assessment and
establishment of adequate allowances and guidance for banking agency examiners
to use in determining the adequacy of a bank’s valuation methodology. Generally, the policy statement recommends
that banks have effective systems and controls to identify, monitor and address
asset quality problems; that management analyze all significant factors that
affect the collectibility of loans in a reasonable manner; and that management
establish acceptable valuation processes that meet the objectives set forth in
the policy statement. While the Banks
believe that they have established adequate specific and general allowances for
losses on loans, actual losses are dependent upon future events and, as such,
further additions to the allowance for loan losses may become necessary. See “- Allowance for Loan Losses.”
At December 31, 2001, loans designated as Substandard
but which were not classified as non-accrual loans totaled $7.5 million. Of these potential problem loans, $6.4
million were commercial real estate loans and all but $827,000 were
contractually past due less than 60 days.
Non-Accrual Loans, Non-Performing
Assets and Restructured Loans
The following table sets forth information regarding
non-performing assets:
(1) Non-accrual loans include loans 90 days or
more past due and other loans which have been identified as presenting
uncertainty with respect to the collectibility of interest or principal. See Note 4 for exception to this policy.
(2) Restructured loans represent performing loans
for which concessions (such as reductions of interest rates to below market
terms and/or extension of repayment terms) have been granted due to borrower’s
financial condition. The balances
presented exclude restructured loans on non-accrual status.
(3) Non-performing loans are comprised of
non-accrual loans and restructured loans.
(4) Consumer loans, including indirect auto loans,
are not placed on non-accrual status due to the expedited manner in which these
loans are resolved and the immaterial balance of individual loans.
Allowance for Loan Losses
The allowance for loan losses is established through
provisions for loan losses based on management’s on-going evaluation of the
risks inherent in the loan portfolio.
Factors considered in the evaluation process include growth of the loan
portfolio, the risk characteristics of the types of loans in the portfolio,
geographic and large borrower concentrations, current regional economic and
real estate market conditions that could affect the ability of borrowers to
pay, the value of underlying collateral and trends in loan delinquencies and
charge-offs. The allowance for loan
losses is maintained at an amount management considers adequate to cover
estimated losses in the loan portfolio which are deemed probable and estimable
based on information currently known to management. See “ - Delinquent Loans and Loan Review.”
The following table sets forth activity in the allowance for loan
losses for the periods indicated:
The allowance for loan losses is available for
offsetting credit losses in connection with any loan, but is internally
allocated among loan categories as part of the process for evaluating the
adequacy of the allowance for loan losses.
The following table sets forth information concerning the allocation of
the allowance for loan losses at the dates indicated:
Allocated reserves for loan losses are determined
using both a formula-based approach applied to groups of loans and an analysis
of certain individual loans for impairment.
The formula-based approach evaluates groups of loans
to determine the allocation appropriate within each portfolio segment. Individual loans within the real estate
(residential, commercial, construction, and home equity), commercial and
consumer (indirect auto and other consumer) loan portfolio segments are assigned
internal risk ratings to group them with other loans possessing similar credit
risk characteristics. The level of
reserve apportionable to each group of risk-rated loans is then determined by
management applying a loss factor that estimates the amount of probable loss in
each category. The assigned loss factor
for each risk rating is a formula based assessment of historical loss data,
portfolio characteristics, economic trends, overall market conditions, past
experience, and management’s subjective analysis of considerations of probable
loan loss based on these factors.
Allocations for loan categories are then determined by applying loss
factors that represent management’s estimate of inherent losses in those
categories to the appropriate loan balances outstanding.
The other method used to allocate the reserve for loan
losses entails the assignment of reserve amounts to individual loans on the
basis of loan impairment. Certain loans
are evaluated individually and are judged to be impaired when management
believes it is probable that the Company will not collect all of the
contractual interest and principal payments as scheduled in the loan
agreement. Under this method loans are
selected for evaluation based on a change in internal risk rating, occurrence
of delinquency, loan classification or non-accrual status. An identifiable reserve amount is allocated
to an individual loan when such loan has been deemed impaired and when the
amount of a probable loss is estimable on the basis of fair value of
collateral, present value of anticipated future cash flows or the loans
observable fair market price. Loans
with an identifiable reserve and the amount of such reserve totaled $6,177,002
and $2,465,765 at December 31, 2001, respectively.
A portion of the reserve for loan loss is not
allocated to any specific segment of the loan portfolio. This unallocated reserve is maintained for
two primary reasons; there exists an inherent subjectivity and imprecision to
the analytical processes employed and the prevailing business environment, as
it is affected by changing economic conditions and various external factors,
which may impact the portfolio in ways currently unforeseen. Moreover, management has identified certain
risk factors, which could impact the degree of loss sustained within the
portfolio. These include: market risk
factors, such as the effects of economic variability on the entire portfolio,
and unique portfolio risk factors that are inherent characteristics of the
Company’s loan portfolio. Market risk
factors may consist of changes to general economic and business conditions that
may impact the Company’s loan portfolio customer base in terms of ability to
repay and that may result in changes in value of underlying collateral. Unique portfolio risk factors may include
industry concentration or covariant industry concentrations, geographic
concentrations, or trends that may exacerbate losses resulting from economic
events which the Company may not be able to fully diversify out of its
portfolio. Management, therefore, has
established and maintains an unallocated reserve for loan losses. The amount of this unallocated reserve was
$2.4 million at December 31, 2001, compared to $2.2 million at December 31,
2000.
As of December 31, 2001, the reserve for loan losses
totaled $29.5 million as compared to $25.1 million at December 31, 2000. Based on the processes described above,
management believes that the level of the reserve for loan losses at December
31, 2001 is adequate.
Investment Activities
The primary objectives of the investment portfolio are
to achieve a competitive rate of return over a reasonable period of time and to
provide liquidity. In view of the
Banks’ lending capacity and generally
higher rates of return on loans, management prefers lending activities as its
primary source of revenue with the securities portfolio serving a secondary
role. The investment portfolio, however, is expected to continue to represent a
meaningful (not less than 10%) portion
of total assets.
The current investment strategy has emphasized the
purchase of U.S. Government and agency
obligations and corporate bonds generally maturing or callable within two to
five years. The investment policy
permits investments in mortgage-backed investments which typically have longer
weighted average lives.
At December 31, 2001, the Company had $467.2 million,
or 14.0% of total assets, in securities consisting primarily of U.S. Government and agency obligations ($263.2
million), corporate bonds ($89.5 million), mortgage-backed investments ($50.9
million), and marketable equity securities ($17.2 million). Also included in investments is $40.8
million in restricted equity securities, $40.4 million of which is in the stock
of the FHLB. To avail itself of services offered by that organization, in
particular the ability to borrow funds, the Banks are required to invest in the
stock of the FHLB in an amount determined on the basis of their residential
mortgage loans and borrowings from the FHLB. The stock is redeemable at par and
earns dividends at the discretion of the FHLB.
Statement of Financial Accounting Standards (SFAS) No.
115 requires the Company to designate its securities as either held to
maturity, available for sale or trading depending on management’s intent at the
time of purchase. As of December 31,
2001, $405.8 million, or 86.9% of the portfolio, was classified as available
for sale, $20.6 million, or 4.4% of the portfolio was classified as held to
maturity and $40.8 million, or 8.7% of the portfolio was invested in restricted
equity securities. As of December 31,
2001, the net unrealized gain on securities classified as available for sale
was $5.9 million, consisting of net unrealized gains of $2.1 million on
marketable equity securities and $3.8 million on debt securities.
The Company’s investment policy requires that
corporate bonds be rated “A” or better at the time of purchase. Due to a subsequent adjustment in credit
rating, the portfolio of corporate bonds included one issue with a carrying
value of $1.8 million at December 31, 2001 which was rated below investment
grade. The issuer of such bond is
neither in default as to the payment of interest nor has declared
bankruptcy. This bond traded at 89.2%
of par value at December 31, 2001. In
the opinion of management, no writedown in carrying value was required at
December 31, 2001.
The following table sets forth a summary of the
Company’s investment securities at the dates indicated:
The following table sets forth the book value,
fully-taxable weighted average yield and contractual maturities of investment securities as of December 31,
2001:
Sources of Funds
General. The Banks use deposits, repayments and
prepayments of loans, proceeds from sales of loans and securities and proceeds
from maturing securities, borrowings and cash flows generated by operations to
fund its lending, investing and general operations. Deposits have historically represented the Banks’ primary source
of funds. Since the Company’s initial
public offering in November 1998 it has relied to a greater extent on
borrowings to fund the growth in the loan portfolio.
Deposits. The Banks offer a variety of deposit
accounts with a range of interest rates and other terms. The accounts include passbook savings
accounts, NOW accounts (checking), demand deposit accounts, money market
deposit accounts, club accounts and certificates of deposit. The Banks also
offer IRA, Roth/IRA, Education IRA, Simple IRA
and SEP accounts. The FDIC
insures deposits up to certain limits (generally, $100,000 per depositor). The DIF fully insures amounts in excess of
such limits.
At December 31, 2001, deposits of $2,192.4 million
were comprised of $180.9 million of non-interest-bearing checking accounts and
$2,011.5 million of interest-bearing deposit accounts, of which $992.1 million
were certificates of deposit. Of the
total of certificates of deposit at December 31, 2001, $792.0 million, or 79.8%
were scheduled to mature within one year.
Based on the monitoring of historical trends, the current pricing
strategy for deposits and the general avoidance of brokered deposits, management believes that the Banks will retain a significant portion of their
certificate of deposit accounts upon maturity.
Deposit flows are influenced greatly by economic
conditions, the general level of interest rates and the relative attractiveness
of competing deposit and investment alternatives. Nantucket Bank’s deposit flows are also affected by the seasonal
economy of its market. In recent years,
the strength of the stock market has adversely affected deposit flows within
the banking industry as some customers have opted to place a greater portion of
their funds in instruments, such as mutual funds, not directly offered by the
Banks (other than through Compass’s contractual relationship with INVEST
Financial Corporation (INVEST) and Nantucket Bank’s Investment Services
Division), rather than in deposit accounts which they perceived to have less
attractive returns. The recent decline
in the stock market may make some investors more inclined to seek less risky
alternatives such as insured deposit accounts.
Compass has generally experienced steady deposit
inflows in recent years, primarily
influenced by regional bank consolidations, competitive pricing and its strong
community bank image. Compass’s
strategy has been to grow deposit levels through targeted promotions, branch
expansion and renovation (three new branches and a new main office were opened
in 2000 and one new branch as well as two major renovations were completed in
2001) and bank acquisition. Due to the
seasonal tourist-related economies on Cape Cod, Martha’s Vineyard and
Nantucket, the Banks’ deposits generally peak during the summer months.
Compass maintains a “call center” with extended hours,
staffed with 12 individuals trained to answer telephone inquiries about
customer accounts and about Compass’s various products and services. Compass also utilizes a 24-hour automated
touch-tone telephone voice response system, which allows customers to obtain
information about their accounts, to make account transfers, to pay bills and
to receive information about Compass’s products and services. Compass offers several relationship-based
checking account products, entitled Flagship Checking, Compass 50 Checking and
Preferred Checking which offer packages
of select benefits. Services to
commercial customers also include a Sweep Account, Simple IRA accounts, a
touch-tone telephone electronic tax filing service, merchant credit card
services, and web-based cash management products.
Compass uses direct mail and customer service
personnel at each of its branches and at its main office to solicit deposits
and advertises its deposits through the print media, on billboards, through its
website (www.compassbank.com) and through radio and television. Compass also offers its on-line banking
services, including a bill payment service, over the Internet. Nantucket Bank also offers a 24-hour
automated touch-tone telephone voice response system, merchant credit card
services and on-line banking, with a bill payment service, over the Internet.
The following table sets forth certain information
regarding the distribution of the average balance of deposit accounts and the
weighted average interest rate on each category of deposits during the periods
indicated:
Certificates of deposit of $100,000 or more
outstanding as of December 31, 2001 are scheduled to mature as follows (in
thousands):
Borrowings. The Banks borrow funds from the FHLB to
partially finance their loan and other funding needs. FHLB loans are collateralized by a blanket-type pledge on the Banks’
FHLB stock, first mortgages on residential property and securities issued,
insured or guaranteed by the U.S. Government and its agencies, including
mortgage-backed securities. The FHLB
charges a fixed rate of interest on its loans.
The maximum amount that the FHLB will loan varies based on the FHLB’s
policies. At December 31, 2001, Compass
and Nantucket Bank had approximately $411.9 million and $59.2 million,
respectively, in available borrowing capacity with the FHLB that is contingent
upon the purchase of additional FHLB stock.
Short-term borrowings include funds drawn under the
Banks’ lines of credit with the FHLB, securities sold under agreements to
repurchase and funds held in connection with the U.S. Treasury’s tax and loan
note program.
The following table sets forth certain information
regarding borrowed funds during the periods indicated:
Subsidiaries
In addition to its 100% ownership of the common stock
of Compass and Nantucket Bank, the Company directly owns 100% of Lighthouse
Securities Corporation and, through its bank subsidiaries, six other
corporations. At December 31, 2001, a summary of the Company’s and the Banks’
subsidiaries, all of which are Massachusetts corporations, was as follows:
Lighthouse
Securities Corporation. Lighthouse
Securities Corporation (“Lighthouse”) was established in 1998 as a
Massachusetts securities corporation and, as such, is authorized to engage in
buying, selling and holding investment securities on its own behalf and not as
a broker. The income earned on
Lighthouse’s investment securities is subject to a significantly lower rate of
state tax than that assessed on pretax income earned by the Banks. At December 31, 2001, Lighthouse had total
assets of $1.0 million, consisting primarily of cash maintained at Compass.
Sandwich
Securities Corporation.
Sandwich Securities Corporation (“Sandwich Corporation”) is a
wholly-owned subsidiary of Compass established in 1993 as a Massachusetts securities
corporation. Sandwich Corporation
engages exclusively in buying, selling and holding investment securities on its
own behalf and not as a broker. The
income earned on Sandwich Corporation’s investment securities is subject to a
significantly lower rate of state tax than that assessed on pretax income
earned by the Banks. At December 31,
2001, Sandwich Corporation had total assets of $128.3 million, consisting
primarily of investment securities.
Sextant
Securities Corporation.
Sextant Securities Corporation (“SSC”) is a wholly-owned subsidiary of
Compass established in 1995 as a Massachusetts securities corporation. SSC engages exclusively in buying, selling
and holding investment securities on its own behalf and not as a broker. The income earned on SSC’s investment
securities is subject to a significantly lower rate of state tax than that
assessed on pretax income earned by the Banks.
At December 31, 2001, SSC had total assets of $85.8 million, consisting
primarily of investment securities.
Compass
Preferred Capital Corporation. Compass Preferred Capital Corporation (“Compass Preferred”) is a
subsidiary of Compass. It was
established in 1998 to engage in real estate business activities (including the
acquisition and holding of securities and real estate loans) that enable it to
be taxed as a “real estate investment trust” under federal and Massachusetts
tax laws. Compass Preferred had total
assets of $673.8 million at December 31, 2001, of which $544.5 million were
mortgage loans originated by Compass and $120.3 million was cash maintained at
Compass.
The
Sextant Corporation.
The Sextant Corporation (“Sextant”) is a wholly-owned subsidiary of
Compass originally formed to purchase equipment on behalf of Compass for tax
favored purposes. Sextant has also
engaged in limited real estate development activities. At December 31, 2001, Sextant had total
assets of $2.0 million.
The
1855 Corporation. The
1855 Corporation (“1855 Corporation”) is a wholly-owned subsidiary of Compass
established in 1971 as a Massachusetts corporation. 1855 Corporation is principally engaged in the acquisition and
holding of real estate used for banking purposes. At December 31, 2001, 1855
Corporation had total assets of $1.6
million, of which $1.2 million consisted of real estate used for banking
purposes.
N.
Realty Corp. N.
Realty Corp. (“NRC”) is a subsidiary of Nantucket Bank established in 1998 to
engage in real estate business activities (including the acquisition and
holding of securities and real estate loans) that enable it to be taxed as a
real estate investment trust under federal and Massachusetts tax laws. NRC had
total assets of $170.3 million at
December 31 2001, of which $142.0 million were mortgage loans originated by
Nantucket Bank.
Supervision and Regulation
As Massachusetts-chartered stock savings banks,
Compass and Nantucket Bank are subject to regulation by the Massachusetts
Division of Banks (the “Division”) and the FDIC. The Banks are required to file reports with, and are periodically
examined by, the FDIC and the Division concerning their activities and
financial condition and must obtain regulatory approvals prior to entering into
certain transactions, including, but not limited to, mergers with or
acquisitions of other financial institutions.
The Banks are members of the FHLB and are subject to certain limited
regulation by the FRB. Seacoast
Financial, as a bank holding company, is subject to regulation by the FRB and
is required to file reports with the FRB.
Massachusetts Bank
Regulation
General.
Compass and Nantucket
Bank are subject to supervision, regulation and examination by the Division and
are subject to various Massachusetts statutes and regulations which govern,
among other things, investment powers, lending and deposit-taking activities,
borrowings, maintenance of surplus and reserve accounts, distribution of
earnings and payment of dividends. In
addition, the Banks are subject to Massachusetts consumer protection and civil
rights laws and regulations. The
Commissioner’s approval is required for a Massachusetts bank to establish or
close branches, merge with other banks, organize a holding company, issue
stock, engage in insurance agency activities and undertake certain other
activities.
In response to a Massachusetts law enacted in 1996,
the Commissioner adopted rules that generally give Massachusetts banks powers
equivalent to those of national banks.
The Commissioner also has adopted procedures reducing regulatory burdens
and expense and expediting branching by well-capitalized and well-managed
banks.
DIF. All Massachusetts-chartered savings banks
are required to be members of the DIF, a corporation that insures savings bank
deposits not covered by federal deposit insurance. The DIF is authorized to charge an annual assessment of up to
1/16th of 1% of a savings bank’s deposits.
Insurance of
Accounts and Regulation by the FDIC
As an insurer, the FDIC charges deposit insurance
premiums and is authorized to conduct examinations of and to require reporting
by FDIC-insured institutions. It also
may prohibit any FDIC-insured institution from engaging in any activity that
the FDIC determines by regulation or order to pose a risk to the insurance
fund. The FDIC also has the authority
to initiate enforcement actions against banks, after giving the Commissioner an
opportunity to take such action.
Regulatory Capital
Requirements
The Banks are
required to maintain certain levels of regulatory capital in relation to
risk-weighted assets. The ratio of such
regulatory capital to risk-weighted assets is referred to as the “risk-based
capital ratio.” Risk-based capital
ratios are determined by allocating assets and specified off-balance sheet
items to four risk-weighted categories ranging from 0% to 100%, with higher
levels of capital being required for the categories perceived as representing
greater risk.
These guidelines divide a bank’s capital into two
tiers. The first tier (“Tier 1”)
includes common equity, retained earnings, certain non-cumulative perpetual
preferred stock (including trust preferred securities, to a maximum of 25% of Tier 1 capital) and minority interests in
equity accounts of consolidated subsidiaries, less goodwill and other
intangible assets (except mortgage servicing rights and purchased credit card
relationships subject to certain limitations).
Supplementary (“Tier 2”) capital includes, among other items, cumulative
perpetual and long-term limited-life preferred stock, mandatory convertible securities,
certain hybrid capital instruments, term subordinated debt and the allowance
for loan losses, subject to certain
limitations, less required deductions. Banks are required to maintain a total
risk-based capital ratio equal to at least 8% of risk-weighted assets, and at
least half of such capital must be Tier 1 capital.
In addition, the FDIC has established regulations
prescribing a minimum Tier 1”leverage ratio”
(Tier 1 capital to adjusted average total assets as specified in the
regulations). These regulations provide
for a minimum Tier 1 leverage ratio of 3% plus an additional cushion of at
least 100 to 200 basis points. The FDIC
may, however, set higher leverage and risk-based capital requirements for
individual institutions when particular circumstances warrant.
International bank supervisory organizations,
principally the Basel Committee on Banking Supervision, currently are
considering changes to the risk-based capital adequacy framework which
ultimately could affect the FDIC’s guidelines concerning capital adequacy.
Limitations on
Dividends and Other Capital Distributions
The FDIC has the authority to use its enforcement
powers to prohibit a bank from paying dividends if, in its opinion, the payment
of dividends would constitute an unsafe or unsound practice. Federal law also prohibits the payment of
dividends by a bank that would result in the bank failing to meet its
applicable capital requirements on a pro forma basis. Massachusetts law also restricts a bank from declaring a dividend
which would reduce its capital below (i) the amount required to be maintained
by state and federal law and regulations or (ii) the amount of their
liquidation account established in connection with the conversion from mutual to stock form. In addition, Massachusetts law requires the
Commissioner’s approval if the total of dividends declared by a bank in any
calendar year exceed net income for that year combined with the retained net
income of the preceding two years.
Prompt Corrective
Action
The federal banking agencies have promulgated
regulations to implement a system of prompt corrective action required by
federal law. Under the regulations, a
bank is deemed to be: (i) “well capitalized” if it has total risk-based capital
of 10% or more, has a Tier 1 risk-based capital ratio of 6% or more, has a Tier
1 leverage ratio of 5% or more and is not subject to any written capital order
or directive; (ii) “adequately capitalized” if it has a total risk-based
capital ratio of 8% or more, a Tier 1 risk-based capital ratio of 4% or more
and Tier 1 leverage ratio of 4% or more (3% under certain circumstances) and
does not meet the definition of “well capitalized”; (iii) “undercapitalized” if
it has a total risk-based capital ratio that is less than 8%, a Tier 1
risk-based capital ratio that is less than 4% or a Tier 1 leverage ratio that is less than 4% (3% under certain
circumstances); (iv) “significantly undercapitalized” if it has a total
risk-based capital ratio that is less than 6%, a Tier 1 risk-based capital
ratio that is less than 3% or a Tier 1 leverage ratio that is less than 3%; and
(v) “critically undercapitalized” if it has a ratio of tangible equity to total
assets that is equal to or less than 2%.
Based on the foregoing, Compass and Nantucket Bank are
currently classified as “well capitalized” banks.
Holding Company
Regulation
General. Seacoast Financial, as a bank holding
company, is subject to comprehensive regulation and regular examinations by the
FRB. The FRB also has extensive
enforcement authority over bank holding companies, including, among other
things, the ability to assess civil money penalties, to issue cease and desist
or removal orders and to require that a holding company divest subsidiaries
(including its bank subsidiaries). In
general, enforcement actions may be initiated for violations of law and
regulations and unsafe or unsound practices.
Seacoast Financial is subject to capital adequacy
guidelines for bank holding companies (on a consolidated basis) which are
substantially similar to those of the FDIC for the Banks.
Under FRB policy, a bank holding company must serve as
a source of strength for its subsidiary banks.
Under this policy, the FRB may require, and has required in the past, a
holding company to contribute additional capital to an undercapitalized
subsidiary bank.
Seacoast Financial must obtain Massachusetts Board of
Bank Incorporation and FRB approval before: (i) acquiring, directly or
indirectly, ownership or control of any voting shares of another bank or bank
holding company if, after such acquisition, it would own or control more than
5% of such shares (unless it already owns or controls the majority of such
shares); (ii) acquiring all or substantially all of the assets of another bank
or bank holding company; or (iii) merging or consolidating with another bank
holding company.
The BHCA also prohibits a bank holding company, with
certain exceptions, from acquiring direct or indirect ownership or control of more
than 5% of the voting shares of any company which is not a bank or bank holding
company, or from engaging directly or indirectly in activities other than those
of banking, managing or controlling banks, or providing services for its
subsidiaries.
Dividends. FRB policy specifies that a bank holding
company should pay cash dividends only to the extent that the holding company’s
net income for the past year is sufficient to cover both the cash dividends and
a rate of earning retention that is consistent with the holding company’s
capital needs, asset quality and overall financial condition. Under the prompt corrective action
regulations adopted by the FRB, the FRB may prohibit a bank holding company from
paying any dividends if any of the holding company’s bank subsidiaries is
classified as “undercapitalized.”
Bank holding companies are required to give the FRB
prior written notice of any purchase or redemption of its outstanding equity
securities if the gross consideration for the purchase or redemption, when
combined with the net consideration paid for all such purchases or redemptions
during the preceding 12 months, is equal to 10% or more of the consolidated net
worth of the bank holding company. The
FRB may disapprove such a purchase or redemption if it determines that the
proposal would constitute an unsafe or unsound practice or would violate any
law, regulation, FRB order or any condition imposed by, or written agreement
with, the FRB.
This notification requirement does not apply to any
bank holding company that meets the well-capitalized standard for banks, is
“well managed” within the meaning of the FRB regulations and is not subject to
any unresolved supervisory issues.
Financial
Services Modernization.
In November 1999, the Gramm-Leach-Bliley Act (“Gramm-Leach”), which
significantly altered banking laws in the United States, became law. Gramm-Leach permits combinations among
banks, securities firms and insurance companies. Under Gramm-Leach, bank holding companies are permitted to offer
their customers virtually any type of financial service that is financial in
nature or incidental thereto, including banking, securities underwriting,
insurance (both underwriting and agency) and merchant banking.
In order to engage in these new financial activities,
a bank holding company must qualify and register with the FRB as a “financial
holding company” by demonstrating that each of its bank subsidiaries is “well
capitalized,” “well managed” and has at least a “satisfactory” rating under the
Community Reinvestment Act of 1977, as amended (“CRA”).
A “financial subsidiary”of a national or state bank
may engage in the new financial activities authorized by Gramm-Leach except for
insurance or annuity underwriting, insurance company portfolio investments,
real estate investment and development and merchant banking , which must be
conducted by a financial holding company.
In order for a financial subsidiary of a national or state bank to
engage in the new financial activities, Gramm-Leach requires that each of the
parent bank (and its sister-bank affiliates) be well capitalized and well
managed; that the aggregate consolidated assets of all of the bank’s financial
subsidiaries not exceed the lesser of 45% of its consolidated total assets or
$50 billion; that the bank must have at least a satisfactory CRA rating; and,
if the bank is one of the 100 largest national banks, it meet certain financial
rating or other comparable requirements.
Gramm-Leach established a system of functional
regulation, under which the federal banking agencies will regulate the banking
activities of financial holding companies and banks’ financial subsidiaries,
the U.S. Securities and Exchange Commission will regulate their securities
activities and state insurance regulators will regulate their insurance
activities. Gramm-Leach also provides
new protections against the transfer and use by financial institutions of
consumers’ nonpublic, personal information.
Although the Company meets the qualifications for
electing to become a financial holding company under Gramm-Leach, the Company
has elected to retain its pre-Gramm-Leach status for the present time.
Federal Reserve
System
The FRB requires all depository institutions to
maintain noninterest-bearing reserves at specified levels against their
transaction accounts (primarily depositor checking and NOW accounts). Banks are authorized to borrow from the
FRB’s “discount window,” but FRB regulations require banks to exhaust other
reasonable alternative sources of funds, including FHLB borrowings, before
borrowing from the FRB.
Federal Home Loan
Bank System
The Banks are members of the FHLB, which is one of 12
regional Federal Home Loan Banks that administer the home financing credit
function of savings institutions. Each
Federal Home Loan Bank serves as a central bank for members within its
region. It makes loans to members
(i.e., advances) in accordance with policies and procedures established by the
board of directors of each Federal Home Loan Bank. All advances are required to be fully secured by sufficient
collateral as determined by the FHLB.
As members, the Banks are required to purchase and maintain stock in the
FHLB. At December 31, 2001, the Banks
owned $40.4 million of FHLB stock.
Personnel
As of December 31, 2001, the Banks had 618 full-time
employees and 129 part-time employees.
None of the Banks’ employees are
represented by a labor union and management considers its relationship with its
employees to be good.
Item 2.
Item 2. Properties
At December 31, 2001, the Company conducted business
through 42 full-service branches, two seasonal high school offices, 7 remote
ATMs and the corporate headquarters.
In July 2000, the Company completed construction of
its new corporate headquarters and main banking office in downtown New
Bedford. The cost of construction of
this five story office building with
147,000 square feet of space was $21.5 million, including land acquisition and
site work as well as all furniture and equipment. The Company estimates that it currently is utilizing
approximately 70% of the building capacity with the remainder earmarked for
future expansion of business.
In the Greater New Bedford market, Compass operates
ten full-service branches, including seven branches in the City of New Bedford
(six of which are owned by Compass or a subsidiary while the other is operated
under a land lease), one owned branch in Fairhaven and one leased branch in
each of Mattapoisett and Dartmouth.
Compass’s corporate headquarters are also located in the City of New
Bedford. Two of Compass’s remote ATMs
and one of its limited service high school branches are also located in the
City of New Bedford.
In the Greater Fall River market, Compass operates
seven full-service branches, including one owned and one leased branch in the
City of Fall River, one leased branch in Assonet and owned branches in each of
Seekonk (subject to a land lease), Somerset, Swansea and Westport. One of Compass’s remote ATMs is also located
in the City of Fall River, as is one of Compass’s limited service high school
branches.
In the Greater Plymouth market, Compass operates six
full-service branches, including two owned and two leased branches in Plymouth
and a leased branch in Carver. Compass
also leases a non-branch mortgage office in Lakeville, located in the Greater
Plymouth market.
In the Martha’s Vineyard market, Compass operates five
full-service branches, including one owned and one leased branch in Edgartown,
and owned branches in each of Chilmark, Vineyard Haven and Oak Bluffs. One of Compass’s remote ATMs is located on
Martha’s Vineyard in West Tisbury.
In the Cape Cod market, Compass operates twelve
full-service branches, including two leased offices in Sandwich, leased offices
in Buzzards Bay, South Yarmouth and Wareham, and owned offices in Pocasset,
Falmouth, Hyannis (two), Chatham, Dennis and Orleans.
In the Nantucket market, Nantucket Bank operates three
full-service branches all of which are owned.
In addition, Nantucket Bank leases office space.
See Note 5 of the Notes to Consolidated Financial
Statements included herein for additional information.
Item 3.
Item 3. Legal Proceedings
The Company is not involved in any pending legal proceedings
other than routine legal proceedings occurring in the ordinary course of
business. Management believes that
those routine proceedings involve, in the aggregate, amounts which are
immaterial to the consolidated financial condition and results of operations of
the Company.
Item 4.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
PART II
Item 5.
Item 5. Market for Registrant’s Common Equity and Related Stockholder
Matters
Seacoast Financial’s
common stock is traded on the Nasdaq National Market System under the symbol
“SCFS”. At March 15, 2002, there were
24,238,886 shares of common stock outstanding and 5,635 shareholders of record. This does not reflect the number of persons
or entities who hold their stock in nominee or street name through various
brokerage firms. As of that date, the
closing sales price, as reported by Nasdaq, was $19.39.
High and low sales prices
and dividends declared, stated on a per share basis, are as follows:
The Company’s Board of
Directors reviews the payment of dividends on a quarterly basis. The declaration of dividends is dependent
upon a number of factors, including capital requirements, regulatory
considerations, the financial condition and operating results of bank subsidiaries
and general economic conditions. Based
on its assessment of these factors, the Board of Directors may elect to either
pay the same dividend as the previous quarter or to increase, decrease or omit
the dividend.
The Company initiated the
payment of a dividend in the third quarter of 1999 and has increased the
dividend rate by $.01 per share semi-annually since then. While there can be no assurance that it will
continue to do so, the Company expects that dividends which are comparable in
relation to net income as those currently being paid will continue to be paid
in the foreseeable future.
Item 6.
Item 6. Selected Consolidated Financial Data
The selected consolidated
financial data are derived in part from, and should be read in conjunction
with, the Company’s consolidated financial statements and notes thereto
presented elsewhere herein.
(1) In January 1999,
the Board of Directors voted to change the Company’s year-end to December
31. Selected consolidated financial
data for the two month transition period ended December 31, 1998 is not
presented herein.
(2) Loans are comprised
of gross loan balances, less unearned discounts, loans held for sale and net unadvanced funds on loans plus net
deferred loan origination costs and fees.
(3) Asset Quality
Ratios and Regulatory Capital Ratios are end-of-period ratios. With the exception of end-of-period ratios,
all ratios are based on average daily balances during the periods indicated.
(4) The net interest
rate spread represents the difference between the fully-taxable weighted
average yield on average interest-earning assets and the weighted average cost
of average interest-bearing liabilities.
(5) The net interest
margin represents net interest income (fully taxable equivalent) as a
percentage of average interest-earning assets.
(6) The efficiency
ratio represents the ratio of noninterest expenses (excluding amortization of
intangible assets) to the sum of net interest income and noninterest income
(excluding gains on pension plan termination and settlement).
(7) Non-performing
loans consist of all nonaccrual loans and restructured loans.
(8) Diluted earnings
and cash dividends per share and the dividend payout ratio are inapplicable for
periods prior to the Company’s mutual to stock conversion in November 1998.
Item 7.
Item 7. Management’s Discussion and Analysis of Financial Condition and
Results of Operations
Forward-Looking Statements
This Form 10-K contains
certain “forward-looking statements” within the meaning of Section 21E of the
Securities Exchange Act of 1934. When
used in this report, the words or phrases, “will likely result,” “are expected to,” “will continue,” “is
anticipated,” “estimate,” “believe,” or similar expressions are intended to
identify such forward-looking statements.
Actual results could differ materially from those anticipated in the
forward-looking statements. Important
factors that might cause such a difference include, among other things, general
economic conditions, particularly the real estate market, in the Company’s
primary market area, credit risk management, asset/liability management,
changes in government regulation and supervision, changes in interest rates,
the availability of and costs associated with sources of liquidity and
increased competition and bank consolidations in the Company’s market area.
The Company does not
undertake, and specifically disclaims any obligation, to publicly release the
result of any revisions which may be made to any forward-looking statements to
reflect the occurrence of anticipated events or circumstances after the date of
such statements.
General
The Company’s results of
operations depend primarily on its net interest income, which is the difference
between the income earned on its loan and securities portfolios and its cost of
funds, consisting of the interest paid on deposits and borrowings. Results of operations are also affected by
the provision for loan losses, as well as noninterest income and expenses. Noninterest income consists principally of
deposit and other banking fees.
Noninterest expenses consist principally of employee compensation and
benefits, occupancy, data processing, marketing and professional services
costs. Results of operations are also
significantly affected by general economic and competitive conditions and
changes in interest rates as well as government policies and actions of
regulatory authorities.
Critical Accounting Policies
Management’s discussion
and analysis of the Company’s financial condition are based on the consolidated
financial statements which are prepared in accordance with accounting
principles generally accepted in the United States. The preparation of such financial statements requires management
to make estimates and assumptions that affect the reported amounts of assets,
liabilities, revenues and expenses and related disclosure of contingent assets
and liabilities. On an ongoing basis,
management evaluates its estimates, including those related to the allowance
for loan losses. Management bases its
estimates on historical experience and on various other assumptions that are
believed to be reasonable under the circumstances, the results of which form
the basis in making judgments about the carrying values of assets that are not
readily apparent from other sources.
Actual results could differ from the amount derived from management’s
estimates and assumptions under different assumptions or conditions.
Management believes the
allowance for loan losses is a critical accounting policy that requires the
most significant estimates and assumptions used in the preparation of the
consolidated financial statements. The
allowance for loan losses is based on management’s evaluation of the level of
the allowance required in relation to the estimated loss exposure in the loan
portfolio. Management believes the
allowance for loan losses is a significant estimate and therefore regularly
evaluates it for adequacy by taking into consideration factors such as prior
loan loss experience, the character and size of the loan portfolio, business
and economic conditions and management’s estimation of future losses. The use of different estimates or
assumptions could produce different provisions for loan losses. Refer to the discussion of Allowance for
Loan Losses in the Business Section and Notes 1 and 4 of the Notes to
Consolidated Financial Statements for a detailed description of management’s
estimation process and methodology related to the allowance for loan losses.
In June 2001, the
Financial Accounting Standards Board (FASB) issued SFAS No. 141, “Business
Combinations,” which is effective for transactions initiated after June 30,
2001. Under SFAS No. 141, all business
combinations must be accounted for using the purchase method of accounting; use
of the pooling-of-interests method is no longer permitted. In addition, this Statement requires that
certain intangible assets acquired in a business combination be recognized apart
from goodwill. Under the transition
provisions of SFAS No. 141, no change in the amount of the purchase price
assigned to the assets acquired and liabilities assumed in a business
combination completed before July 1, 2001 and accounted for by the purchase
method shall occur except for certain identified intangible assets which were
separately recognized at the time of the transaction.
Also in June 2001, the
FASB issued SFAS No. 142, “Goodwill and Other Intangible Assets,” which is
effective for fiscal years beginning after December 15, 2001. Under prior accounting standards, goodwill
resulting from a business combination is amortized against income over its
estimated useful life. Under SFAS No.
142, goodwill is generally no longer amortized as an expense after 2001, but
instead is reviewed and tested for impairment using a fair value methodology
prescribed in this Statement. Goodwill
will be tested for impairment at least annually, or more frequently as a result
of an event or change in circumstances (for example, recurring operating losses
by an acquired entity) that would indicate an impairment adjustment may be
necessary. Based on its assessment of
the current economic environment, management does not anticipate an impairment
adjustment to the goodwill reflected in the consolidated balance sheet set
forth in the Consolidated Financial Statements due to the adoption of SFAS No
142.
A significant effect of adopting SFAS No. 141 and No.
142 is that the Company will no longer amortize the goodwill balance of $33.9
million, which will have the effect of reducing goodwill amortization by $2.4
million in 2002 and increasing net income.
Refer to Note 1 of the
Notes to Consolidated Financial Statement for additional information about SFAS
141 and 142.
Acquisition of Home Port
On December 31, 2000, the
Company completed its acquisition of Home Port and its bank subsidiary,
Nantucket Bank, in a transaction accounted for under the purchase method of
accounting. Accordingly, the
consolidated assets and liabilities of Home Port as of December 31, 2000 have
been reflected in the Company’s consolidated balance sheet at that date at
their respective fair values. Home
Port’s results of operations have been included in the Company’s consolidated
statements of income from the date of acquisition.
Comparison of Financial Condition at
December 31, 2001 and 2000
Total assets increased by
$456.7 million, or 15.8%, from $2,890.8 million at December 31, 2000 to
$3,347.5 million at December 31, 2001.
This growth was due to a $207.2 million, or an 8.9% increase in net
loans and, to a lesser extent, increases in federal funds sold ($87.0 million)
and investment securities ($159.6 million).
The combined increase in federal funds sold and investment securities during
2001 amounted to nearly $250 million and is mainly attributable to two
factors. First, deposit growth during
the second half of the year, particularly the third quarter, totaled $142.6
million. This unusually high level of
growth is considered by management to be primarily caused by the decline in the
stock market in the wake of an economic slowdown and the acts of terrorism
against the United States occurring in September 2001. Second, the Company’s borrowings from the
Federal Home Loan Bank (FHLB) exceeded its actual funding needs as management
considered the rates being offered to be favorable. At December 31, 2001, the Company’s weighted average rate on its
outstanding FHLB advances was 5.31% compared to 6.05% at December 31, 2000.
The loan portfolio,
excluding loans held for sale, increased in 2001 due primarily to increases in
residential mortgage loans ($99.0 million),
indirect auto loans ($78.4 million) and commercial and commercial real
estate loans ($29.3 million). The
growth in residential mortgage loans largely reflects the lower interest rate
environment which prevailed throughout the year. This factor was partially offset when Compass decided to sell
some of its current production of 15 year fixed rate mortgage loans in the
secondary market. Such sales began in
the fourth quarter and amounted to $43.9 million in 2001. Compass continues to expand its network of
automobile dealers throughout Eastern Massachusetts in order to grow its
portfolio of indirect auto loans and expects to continue its geographic
expansion into Southern New Hampshire
in 2002. During 2001, Compass
originated $364.7 million of indirect loans and increased its portfolio of such
loans by $78.4 million, or 15.0%. The
Company’s commercial loan portfolios, including both commercial real estate
loans and commercial and industrial loans increased 6.9% during 2001 and
represented 17.6% of loans at December 31, 2001 compared to 17.9% at December
31, 2000. The moderate growth in
commercial lending in 2001 reflects the impact of the current economic slowdown
and the competition for creditworthy customers. The Company’s growth in commercial lending was primarily with
existing customers.
Deposits at December 31,
2001 were $2,192.4 million, an increase of $202.8 million, or 10.2%, compared
to $1,989.6 million at December 31, 2000, due to an increase in core
deposits. Core deposit account balances
increased by $227.2 million, or 23.4%, during 2001 which was generally
attributable to expansion of the branch network (including deposits of $24
million assumed from another bank in December 2001), the shift in balances from
certificates of deposit caused by the lower interest rates offered in 2001 and
the migration of funds from the stock market in the wake of an economic slowdown
and the acts of terrorism against the United States occurring in September
2001.
Borrowed funds were
$823.3 million at December 31, 2001 compared to $590.3 million at December 31,
2000, an increase of $233.0 million, or 39.5%.
During the year ended December 31, 2001, Compass increased its net
borrowings from the Federal Home Loan Bank in order to partially fund loan and
liquidity growth. Management believes
that it will continue to rely on Federal Home Loan Bank borrowings in 2002 to
partially fund anticipated loan growth.
The increase in
stockholders’ equity of $17.5 million to $305.7 million at December 31, 2001
resulted from net income of $31.0 million for the year then ended which was
partially offset by cash dividends ($8.1 million) and stock repurchases ($10.5
million). During 1999 and 2000, the
Company announced three stock repurchase programs, the most recent of which was
approved in July 2000, aggregating 3,486,212 shares. As of December 31, 2001, 3,027,000 shares had been
repurchased. Management anticipates
repurchasing the remaining 459,212 shares during 2002 and initiating a new
repurchase program.
Comparison of Financial Condition at
December 31, 2000 and 1999
Total assets increased by
$768.0 million, or 36.2%, from $2,122.8 million at December 31, 1999 to
$2,890.8 million at December 31, 2000, of which $378.7 million was due to the
acquisition of Home Port. The remaining
increase in assets of $389.3 million was due to a $339.4 million, or 19.4%
increase in loans and, to a lesser extent, increases in cash and due from banks
($28.1 million) and banking premises and equipment ($15.8 million). Asset growth was funded primarily by a
$199.3 million, or 63.3% increase in borrowings and a $242.9 million, or 16.0%,
increase in deposits.
Exclusive of Home Port,
the increase in loans occurred primarily in Compass’s indirect auto and
residential mortgage loan portfolios.
From December 31, 1999 to December 31, 2000, indirect auto loans (net of
unearned discounts) increased by $99.5 million, or 23.6%. This growth is primarily attributable to the
generally favorable economic conditions which prevailed during the period and
the continued geographic expansion of Compass’s network of participating dealers. Residential mortgage loans increased by
$154.4 million, or 17.2%, during
2000. Because of the higher interest
rates which prevailed in 2000, Compass originated $219.9 million of residential
mortgage loans in 2000, a 32.1% decrease compared to 1999. The net growth in residential mortgage loans
was also affected by the strategy to retain fixed rate mortgage loan
originations in the loan portfolio.
Exclusive of Home Port,
deposits at December 31, 2000 were $1,758.5 million, an increase of $242.9 million,
or 16.0%, compared to $1,515.6 million
at December 31, 1999, due largely to an increase in certificates of deposit of
$193.9 million during the period. This increase was fueled by the introduction
and promotion, in February 2000, of a 7 month certificate at 6.30% and, to a
lesser extent, the promotion of 9 and 18 month certificates of deposit during
the second quarter. Core deposit
account balances increased by $49.0 million, or 6.3%, during the year ended December
31, 2000. This growth was generally
attributable to the promotion of a free checking account product, partially
offset by the shift in funds to higher yielding certificates of deposit. Management believes that the bank
consolidation and divestitures which occurred in the Compass market area during
2000 as a result of the Fleet/Bank Boston merger have contributed to the growth
in deposits and continue to offer Compass an opportunity to increase
its deposits.
As discussed later herein, the market opportunity created by this merger
also increased the level of interest rates for time deposits as numerous banks
in the local market attempted to attract new customers affected by the merger.
Exclusive of Home Port,
borrowed funds were $513.9 million at December 31, 2000 compared to $314.6 million
at December 31, 1999, an increase of
$199.3 million, or 63.3%. During
the year ended December 31, 2000, Compass increased its net borrowings from the
Federal Home Loan Bank in order to partially fund loan growth as well as the
Home Port acquisition ($69 million).
The increase in
stockholders’ equity of $14.2 million to $288.2 million at December 31, 2000
resulted from net income of $23.9 million for the year then ended which was
partially offset by cash dividends ($6.3 million) and stock repurchases ($8.7
million). During 1999 and 2000, the
Company announced three stock repurchase programs, the most recent of which was
approved in July 2000, aggregating 3,486,212 shares. As of December 31, 2000, 2,359,775 shares had been repurchased.
Results of Operations
Net
Interest Income
The Company’s operating
performance is highly dependent upon the level of net interest income. General economic conditions, corporate
strategies, asset/liability management, interest rates and the policies of
regulatory authorities all have a significant impact on the level of net
interest income achieved. During the
period 1999 to 2001, the Company’s net interest income increased from $74.4 to
$102.9 million, an increase of $28.5 million, or 38.3%. This achievement has been primarily
attributable to the growth in the loan portfolio.
The following table
presents average balances, interest income and expense and yields earned or
rates paid on the major categories of assets and liabilities for the years
indicated.
(1) Average balances include unrealized gains on
securities available for sale. Equity
securities include marketable equity securities and restricted equity
securities.
(2) Loans on non-accrual status are included in
the average balances.
(3) Short-term borrowings include immaterial
balances of other borrowings.
(4) Interest rate spread represents the difference
between the fully-taxable yield on interest-earning assets and the cost of
interest-bearing liabilities.
(5) Net interest margin represents net interest
income (fully-taxable equivalent) divided
by average interest-earning assets. The
tax equivalent adjustment in 2001 was $280,000. In prior years, the amount was immaterial.
Rate/Volume
Analysis. The
following table presents the extent to which changes in interest rates and
changes in volume of interest-earning assets and interest-bearing liabilities
have affected the Company’s interest income and interest expense during the
periods indicated. Information is
provided in each category with respect to: (i) changes attributable to changes
in volume (changes in volume multiplied by prior rate); (ii) changes
attributable to changes in rate (changes in rate multiplied by prior volume);
and (iii) the net change (change in rate times change in volume). The net change has been allocated
proportionately to the changes due to volume and the changes due to rate.
Comparison
Of Operating Results for the Years Ended December 31, 2001 and 2000
As previously
noted, the acquisition of Home Port on December 31, 2000 had a significant
impact on changes in the components of the Company’s consolidated statements of
income for the years ended December 31, 2001 and 2000. The following table segregates Nantucket
Bank’s impact on such changes (in thousands):
The remaining discussion,
unless otherwise indicated, addresses the net changes presented above, which
exclude the impact due to the acquisition of Nantucket Bank.
Interest
Income. Interest
income for the year ended December 31, 2001 was $190.0 million compared to
$166.4 million for the year ended December 31, 2000, an increase of $23.6
million, or 14.2%. The increase in
interest income resulted from growth in average interest-earning assets of
$423.2 million, or 19.2%, partially offset by a decrease in the overall yield
on interest-earning assets of 30 basis points in the 2001 period. The principal areas of growth in average
balances were related to real estate loans (up $181.2 million, or 13.7%) and
indirect auto loans (up $92.2 million, or 19.2%). Most of the real estate loan growth resulted from increased
originations and retention in portfolio, until September 2001, of residential
mortgage loans. The increase in
indirect auto loans resulted from the continued geographic expansion of the
network of participating dealers.
Interest
Expense. Interest
expense for the year ended December 31, 2001 was $98.4 million compared to
$86.3 million for the year ended December 31, 2000, an increase of $12.0
million or 13.9%. This increase
resulted from a higher average balance of interest-bearing liabilities (up
$384.1 million, or 20.3%), partially offset by a 24 basis points decrease in
the cost of funds from 4.56% in 2000 to 4.32% in 2001. Average interest-bearing deposit balances
increased $168.5 million, or 11.1%, during 2001 compared to 2000.
Interest expense on
borrowed funds increased $9.7 million in the year ended December 31, 2001 due
to a $215.7 million increase in the
average balance of such funds, partially offset by a 59 basis points decrease
in the average rate paid on borrowed funds to 5.53% in the 2001 period.
The decrease of 24 basis
points in the cost of funds in 2001 reflected the series of reductions in
interest rates initiated by the Federal Reserve Board in 2001 and the repricing
of nearly 90% of certificates of deposit outstanding at December 31, 2000 in
2001 (particularly in the second half of the year). The cost of funds is expected to decrease again in 2002 as certificates
of deposit with a weighted average rate of 4.02% and FHLB advances with a
weighted average rate of 5.16% are scheduled to mature during the year and be
replaced at lower rates.
Provision
for Loan Losses. The
Company provides for loan losses in order to maintain the allowance for loan
losses at a level that management believes is adequate to absorb future
charge-offs of loans deemed uncollectible.
In determining the appropriate level of the allowance for loan losses,
management considers past and anticipated loss experience, evaluations of
underlying collateral, prevailing economic conditions, the nature and volume of
the loan portfolio and the levels of nonperforming and other classified
loans. The amount of the allowance is
based on estimates and ultimate losses
may vary from such estimates.
Management assesses the allowance for loan losses on a quarterly basis
and provides for loan losses monthly in order to maintain the adequacy of the
allowance.
Compass provided $6.0
million for loan losses in the year ended December 31, 2001 compared to $4.8
million in the year ended December 31,
2000. The increase of $1.2 million in
2001 was primarily attributable to both growth in the loan portfolio and an
increase in non-performing loans. The
total allowance (including Nantucket Bank) of $29.5 million at December 31,
2001 represented 1.15% of total loans compared to 1.06% at December 31, 2000. At December 31, 2001, the allowance for loan
losses as a percentage of non-performing loans was 220.1% compared to 410.7% at
December 31, 2000. The Company
experienced a gradual increase in non-performing loans during 2001 from $6.1
million at December 31, 2000 to $13.4 million at December 31, 2001, or .52% of
total loans. The increase in
non-performing loans was primarily attributable to several commercial credits
affected by the current economic slowdown and does not appear to be reflective
of a more pervasive adverse trend in the economy of southeastern Massachusetts. Management has committed additional
personnel resources to the credit administration and collection functions in
the past two years to monitor its growing loan portfolio. With the continuing uncertainty in the
economy in 2002, the Company may experience an increase in its non-performing
loans but believes that the resources are in place to appropriately address
potential problem loans as they arise.
Noninterest
Income. Total
noninterest income was $14.1 million for the year ended December 31, 2001
compared to $10.0 million in the same period of 2000. Included in noninterest income in 2001 is a $1.5 million gain on
the settlement of Compass’s pension plan.
Exclusive of this non-recurring item, noninterest income increased $2.6
million, or 25.9%. This increase was
principally caused by gains on loan sales ($1.0 million), checking account
related income ($820,000) and ATM/Debit card usage ($670,000).
Noninterest
Expense. Noninterest
expense increased by $6.6 million from $49.1 million for the year ended
December 31, 2000 to $55.7 million for the year ended December 31, 2001. Exclusive of a non-recurring item related to
the acquisition of Sandwich Bancorp, Inc. recognized in 2000, noninterest expense
increased $6.3 million, or 12.7%, in 2001.
This increase reflected increases in salaries and employee benefits
($2.5 million), occupancy and equipment ($1.1 million), data processing
($638,000), marketing ($242,000), professional services ($940,000) and other
noninterest expense ($928,000).
Salaries and employee
benefits increased $2.5 million, or 9.5%, in 2001 due primarily to increases in
staffing ($1.0 million) necessitated by franchise expansion (first full year
for 2 branches and one new branch opened in 2001) and the start-up of Compass’s
private banking initiative, salary increases averaging 4.5% ($722,000), an
increase in ESOP expense due to the Company’s higher stock price in 2001
($256,000), increases in employee-related insurance costs ($222,000) and an
increase in 401(k) expense ($109,000).
Occupancy and equipment
expenses increased $1.1 million , or 16.3%, in 2001. This increase was primarily due to higher costs associated with
the new corporate offices which opened during the third quarter of 2000 and new
branches in Dennis, Seekonk and Mattapoisett, as well as higher utility costs
caused by increases in usage and rates charged by service providers.
Data processing expenses
increased $638,000, or 12.8%, in 2001
due primarily to volume-related services such as item processing and ATM
usage. These increases were partially
offset by a rate decrease received from the Company’s core processing service
provider.
Marketing expenses
increased $242,000, or 9.1% in 2001.
This increase was attributable to production and media costs for television
commercials, partially offset by decreases in promotions, print advertising and
direct marketing.
Professional services
expenses increased $940,000, or 53.4%, in 2001. This increase reflects consulting and legal fees associated with
the start-up of Compass’s private banking initiative and other legal and
consulting services primarily related to analysis of business expansion
opportunities.
Other noninterest expense
increased by $928,000, or 14.5%, in 2001.
This increase reflects primarily volume-related items such as printing,
postage and telephone costs as well as the increased use of security personnel
in the branches during the fourth quarter.
Income
Taxes. The effective tax rate (including Nantucket Bank) in
2001 was 35.1% compared to 34.3% in 2000.
In 2001, the Company completed an analysis addressing the impact of a
recent Tax Court decision on the deductibility of certain merger-related costs
incurred in connection with the acquisition of Sandwich Bancorp, Inc. in
1998. Based on this analysis, the
provision for income taxes was reduced by $479,000. Exclusive of this non-recurring item, the effective tax rate in
2001 was 36.1%. This increase from 2000
reflected the impact of nondeductible goodwill amortization resulting from the
Home Port acquisition.
Comparison of Operating Results for
the Years Ended December 31, 2000 and 1999
Overview Net income was $23.9 million, or $1.01 per
diluted share, in 2000 compared to $24.5 million, or $.97 per diluted share in
1999. Included in net income for 1999
was a curtailment gain on the pending termination of Compass’s defined benefit
pension plan which, after taxes, amounted to $856,000, or $.03 per diluted
share. Exclusive of this non-recurring
item, net income and earnings per share increased by 1.1% and 7.4%,
respectively. Due primarily to an
increase in average interest-earning assets of $313.6 million, or 16.6%, net
interest income increased by $5.7 million, or 7.6%, from $74.4 million in 1999
to $80.1 million in 2000. Offsetting
this increase in net interest income was an increase of $2.8 million in the
provision for loan losses and an increase of $4.6 million in noninterest
expense. The Company’s effective tax
rate declined to 34.0% in 2000 from 35.3% in 1999.
Interest
Income. Interest
income was $166.4 million in 2000, compared to $138.0 million in 1999, an
increase of $28.4 million, or
20.6%. This increase in interest income
resulted from the growth in average
interest-earning assets of $313.6 million and an increase in the yield on
interest-earning assets of 25 basis points
from 7.29% in 1999 to 7.54% in 2000.
A significant portion of the increase in average interest-earning assets
was attributable to the indirect auto loan portfolio, which increased from
$373.1 million in 1999 to $479.1 million in 2000, and the mortgage loan
portfolio, which increased from $1,121.7 million to $1,327.0 million for those
years, respectively. The increase in
the yield on interest-earning assets reflects the series of rate increases
initiated by the Federal Reserve Board beginning in June 1999 and continuing
into 2000.
Interest
Expense. Interest
expense increased by $22.8 million, or 35.9%, from $63.5 million in 1999 to
$86.3 million in 2000. The increase
resulted from a $319.2 million increase
in average interest-bearing liabilities and a 53 basis point increase in the
average rate paid on such liabilities.
Total average interest-bearing deposits increased by $126.3
million, with most of the increase
occurring in higher cost certificates of deposit. Because of the level of loan growth, Compass increased its
advances from the FHLB with the average amount of such borrowings outstanding
increasing by $190.2 million from $147.5 million in 1999 to $337.7 million in
2000.
The increase in the cost
of funds on interest-bearing liabilities reflects the series of rate increases
initiated by the Federal Reserve Board beginning in June 1999 and continuing
into 2000 as well as the greater utilization of higher cost certificates of
deposit and FHLB advances as a funding source.
The incremental increase of 28 basis points in the cost of funds over
the yield on interest-earning assets reflects the faster repricing
characteristics of Compass’s interest-bearing liabilities as compared to its
interest-earning assets and the competitive pricing for certificates of
deposits in 2000.
Provision
for Loan Losses. The
provision for loan losses increased by $2.8 million from $2.0 million in 1999 to $4.8 million in 2000. This increase was primarily attributable to
the growth in the loan portfolio as internal indicators of credit quality
continue to be positive. The total
allowance of $25.1 million at December 31, 2000 represented 1.06% of total
loans, an increase from .96% at December 31, 1999. At December 31, 2000, the allowance for loan losses as a
percentage of non-performing loans was
410.7% compared to 293.5% at December 31, 1999.
Noninterest
Income. Total
noninterest income was $10.0 million in 2000 and 1999. Included in noninterest income in 1999 was a
$1.5 million gain on termination of Compass’s pension plan. Exclusive of this non-recurring item,
noninterest income increased $1.5 million, or 17.2%, in 2000. This increase was principally caused by increases
in loan fees, ATM/Debit card usage and checking account related fees. Such increases more than offset a decrease
of $186,000 in gains on sales of investment securities and loans.
Noninterest
Expense. Noninterest
expense increased by $4.6 million, or 10.2%, from $44.5 million for the year
ended December 31, 1999 to $49.1 million for the year ended December 31,
2000. Of this increase, $4.1
million related to salaries and
employee benefits, which rose 18.4% to $26.5 million in 2000. This
increase is due to annual wage adjustments and increases in staffing
necessitated by franchise expansion ($1.9 million), a full year of cost
associated with the restricted stock awards granted in July 1999 ($725,000),
employment taxes ($272,000), employee-related insurance costs ($413,000) and
the cost of a new sales incentive program for retail branch personnel
($187,000). In addition, the amount
accrued for Compass’s management incentive plan increased $795,000 in 2000 partially
due to reduced expense in 1999 resulting from utilization of amounts accrued
but not paid during the two month transition period ended December 31,
1998. These increases were partially
offset by a net savings of $183,000 due to changes made in September 1999 to
Compass’s employee retirement plans.
Occupancy and equipment
expenses increased $752,000, or 12.9%, to $6.6 million for the year ended
December 31, 2000. This increase was
primarily due to an increase in depreciation and utility costs attributable to the
completion of Compass’s new corporate offices and the opening of new branches
in New Bedford, Seekonk and Mattapoisett.
In addition, non-recurring moving and storage costs of $205,000 were
incurred in connection with the relocation to the new corporate offices.
Data processing expenses
increased $517,000, or 11.5%, to $5.0 million for the year ended December 31,
2000. This increase was primarily due
to expansion of the ATM network on Cape Cod and volume-related core processing
costs due to increases in loans and deposits.
Marketing expenses
increased $371,000, or 15.1%, to $2.8 million for the year ended December 31,
2000. Such increase was attributable to
various initiatives promoting the grand opening of Compass’s new main banking
office and corporate headquarters as
well as customer acquisition programs targeted at individuals and businesses
affected by the branch divestitures required by the Fleet/Bank Boston merger.
Other components of
noninterest expense decreased $1.2 million, or 12.7%, for the year ended
December 31, 2000. This decrease was
due primarily to the change between years in certain non-recurring items
associated with the merger with Sandwich Bank.
Income
Taxes. Total income
tax expense was $12.3 million in 2000 compared to $13.4 million in 1999. The effective tax rate was lower in 2000
(34.0%) than in 1999 (35.3%) primarily because of greater utilization of
non-bank subsidiaries that were taxed at a lower rate for state tax purposes,
an increase in tax-favored investment income and the reversal of reserves no
longer required.
Liquidity and Capital Resources
The Banks’ liquidity,
represented by cash and cash equivalents and debt securities is a product of
their operating, investing, and financing activities. The primary sources of funds are deposits, borrowings, principal
and interest payments on outstanding loans and mortgage-backed securities,
maturities of investment securities and funds provided from operations. While scheduled payments from the amortization
of loans and mortgage related securities and maturing investment securities are
relatively predictable sources of funds, deposit flows and loan prepayments are
greatly influenced by general interest rates and, in the case of deposits,
other instruments available to the public such as mutual funds and annuities.
As voluntary members of
the FHLB, Compass and Nantucket Bank are entitled to borrow an amount up to the
value of their qualified collateral that has not been pledged to others. Qualified collateral generally consists of
residential first mortgage loans, U.S. Government and agency securities and
funds on deposit at the FHLB. At
December 31, 2001, Compass and Nantucket Bank had $411.9 million and $59.2
million, respectively, in unused borrowing capacity that is contingent upon the
purchase of additional FHLB stock. Use
of this borrowing capacity may also be impacted by regulatory capital
requirements.
Liquidity management is
both a daily and long term function of business management. The measure of a bank’s liquidity is its
ability to meet its cash commitments at all times with available cash or by
conversion of other assets to cash at a reasonable price. At December 31, 2001, the Banks maintained
cash and due from banks, short-term investments and debt securities maturing
within one year of $289.8 million, or 8.66% of total assets. The Banks invest excess funds, if any, in
federal funds sold, which provides liquidity to meet lending and other cash
requirements.
At December 31, 2001, the
Banks had commitments to originate loans, unused outstanding lines of credit,
standby letters of credit and undisbursed proceeds of loans totaling $285.2
million. The Banks anticipate that they
will have sufficient funds available to meet their current loan
commitments. Certificates of deposit
maturing within one year from December 31, 2001 amounted to $792.0
million. The Banks expect that
substantially all maturing certificate accounts will be retained at maturity, although the percentage
retained may be below historical levels due to increased price competition for
these deposits.
The Company’s and the
Banks’ capital ratios at December 31, 2001 were as follows:
These ratios placed the
Company in excess of regulatory standards and the Banks in the “well capitalized”
category as set forth by the FDIC.
Impact of Inflation and Changing
Prices
The consolidated
financial statements and notes thereto presented herein have been prepared in
accordance with accounting principles generally accepted in the United States,
which require the measurement of financial position and operating results in
terms of historical dollar amounts without considering changes in the relative
purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of the
Company’s operations.
Unlike industrial
companies, nearly all of the Company’s assets and liabilities are monetary in
nature. As a result, interest rates
have a greater impact on its performance than do the effects of general levels
of inflation. Interest rates do not
necessarily move in the same direction or to the same extent as the prices of
goods and services.
Item 7a.
Item 7a. Quantitative and Qualitative
Disclosures about Market Risk
The chief market risk
factor affecting the financial condition and operating results of the Company
is interest rate risk. This risk is
managed by periodic evaluation of the interest rate risk inherent in certain balance
sheet accounts, determination of the level of risk considered appropriate given
capital and liquidity requirements, business strategy, performance objectives
and operating environment and maintenance of such risks within guidelines
approved by the Board of Directors.
Through such management, the Company seek to reduce the vulnerability of
net earnings to changes in interest rates.
The Banks’ Asset/Liability Committees, comprised of senior management,
are responsible for managing interest rate risk and reviewing with their Boards
of Directors on a quarterly basis their activities and strategies, the effect
of those strategies on operating results, the Banks’ interest rate risk
positions and the effect changes in interest rates would have on net interest
income. The extent of movement of
interest rates is an uncertainty that could have a negative impact on earnings.
The principal strategies
that the Company uses to manage interest rate risk include (i) emphasizing the
origination and retention of adjustable rate loans, origination of indirect
auto loans (Compass only) which have relatively short maturities and
origination of loans with maturities at least partially matched with those of
the deposits and borrowings funding the loans, (ii) investing in debt
securities with relatively short maturities and (iii) classifying a significant
portion of the investment portfolio as available for sale so as to provide
sufficient flexibility in liquidity management.
The Company and the Banks
quantify their interest rate risk exposure using a sophisticated simulation
model. Simulation analysis is used to
measure the exposure of net interest income to changes in interest rates over a
specified time horizon. Simulation analysis
involves projecting future interest income and expense under various rate scenarios. Internal guidelines on interest rate risk
specify that for every 100 basis points immediate shift in interest rates,
estimated net interest income over the next twelve months should decline by no
more than 5%.
In utilizing a 300 basis
point increase in rates in its simulation model, the full impact of annual rate
caps of 200 basis points common to most adjustable rate mortgage loan products
is considered. The rate shocks used
assume an instantaneous and parallel change in interest rates and that no
strategies are implemented in response to the change in rates. Prepayment speeds for loans are based on
published median dealer forecasts for each interest rate scenario.
The following table
reflects the estimated percentage exposure of the Company’s net interest income
for the 12 months following the date indicated assuming an immediate shift in
interest rates as set forth below:
For each one percentage
point change in net interest income in the 2001 projections, the effect on net
income would be $793,000, assuming a 36% tax rate.
(1) Due to the low interest rate environment in effect at December 31,
2001 (the average Federal Fund overnight rates were trading at 2.00%.) the
simulation model could only be rate shocked down 150 basis points.
Item 8.
Item 8. Financial Statements and Supplementary Data
Report of
Independent Public Accountants
Consolidated Balance Sheets
as of December 31, 2001 and 2000
Consolidated
Statements of Income for the Years Ended December 31, 2001, 2000 and 1999
Consolidated
Statements of Changes in Stockholders’ Equity for the Years Ended December
31, 2001, 2000 and 1999
Consolidated Statements
of Cash Flows for the Years Ended December 31, 2001, 2000 and 1999
Notes to
Consolidated Financial Statements
All schedules are omitted because they are not required or applicable,
or the required information is shown in the financial statements or notes
thereto.
REPORT
OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
Seacoast Financial Services Corporation:
We have audited the accompanying consolidated balance
sheets of Seacoast Financial Services Corporation and subsidiaries (the
Company) as of December 31, 2001 and 2000 and the related consolidated
statements of income, changes in stockholders’ equity and cash flows for each
of the years in the three year period ended December 31, 2001. These
consolidated financial statements are the responsibility of the Company’s
management. Our responsibility is to
express an opinion on these consolidated financial statements based on our
audits.
We conducted our audits in accordance with auditing
standards generally accepted in the United States. Those standards require that we plan and perform the audit to
obtain reasonable assurance about whether the financial statements are free of
material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the financial statements.
An audit also includes assessing the accounting principles used and
significant estimates made by management, as well as evaluating the overall
financial statement presentation. We
believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements
referred to above present fairly, in all material respects, the financial position
of Seacoast Financial Services Corporation and subsidiaries as of December 31,
2001 and 2000, and the results of their operations and their cash flows for
each of the years in the three year period ended December 31, 2001 in
conformity with accounting principles generally accepted in the United States.
ARTHUR ANDERSEN LLP
Boston, Massachusetts
January 22, 2002
SEACOAST
FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per
share amounts)
The accompanying notes
are an integral part of these consolidated financial statements.
SEACOAST
FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(Dollars in thousands, except per
share amounts)
The accompanying notes
are an integral part of these consolidated financial statements.
SEACOAST
FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
FOR THE
YEARS ENDED DECEMBER 31, 2001, 2000 AND 1999
The
accompanying notes are an integral part of these consolidated financial
statements.
SEACOAST
FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED
STATEMENTS OF CASH FLOWS
The accompanying notes
are an integral part of these consolidated financial statements.
SEACOAST
FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
The accompanying notes
are an integral part of these consolidated financial statements.
SEACOAST
FINANCIAL SERVICES CORPORATION AND SUBSIDIARIES
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER
31, 2001
(1) SUMMARY
OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation
The accompanying consolidated financial statements
include the accounts of Seacoast Financial Services Corporation and its
wholly-owned subsidiaries, Compass Bank for Savings (“Compass”), Nantucket Bank
and Lighthouse Securities Corporation (collectively referred to herein as “the
Company”). Compass and Nantucket Bank are collectively referred to herein as
“the Banks”. All significant
intercompany balances and transactions have been eliminated in consolidation.
The Company
and its subsidiaries are subject to regulation of, and periodic examination by,
the Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve Board,
among other agencies. All deposits of
the Banks are insured by the FDIC or the Depositors Insurance Fund, an excess
deposit insurer for Massachusetts-chartered savings banks.
The accompanying consolidated financial statements
have been prepared in conformity with accounting principles generally accepted
in the United States and general practice within the banking industry. In preparing the financial statements,
management is required to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets
and liabilities as of the date of the balance sheets and income and expenses
during the reporting periods. Actual
results could differ from those estimates.
Material estimates that are particularly susceptible to change relate to
the determination of the allowance for loan losses. The following is a description of the more significant accounting
policies.
Cash and Cash Equivalents
For purposes of reporting cash flows, cash and cash
equivalents include cash, amounts due from banks, federal funds sold and other
short-term investments having an original maturity of 90 days or less. Generally, federal funds are sold for
one-day periods.
Investment Securities
Debt securities that management has the positive
intent and ability to hold to maturity are classified as held-to-maturity and
reported at cost, adjusted for amortization of premiums and accretion of
discounts, both computed by a method that approximates the effective yield
method. Debt and equity securities that
are bought and held principally for the purpose of selling them in the near
term are classified as trading and reported at fair value, with unrealized
gains and losses included in earnings.
Debt and equity securities not classified as either held-to-maturity or
trading are classified as available-for-sale
and reported at fair value, with unrealized gains and losses excluded from
earnings and reported as a separate component of stockholders’ equity and
comprehensive income.
Restricted equity securities are reported at cost and
consist principally of the Banks’ investments in the stock of the Federal Home
Loan Bank of Boston.
Unrealized losses deemed to be other than temporary
declines in value are charged to operations.
When securities are sold, the adjusted cost of the specific securities
sold is used to compute gains or losses.
Loans, Deferred Costs and Fees
Loans are stated at the principal amounts outstanding,
adjusted by partial charge-offs, unearned discount and net deferred loan costs
and fees.
Unearned discount is recognized on the level-yield
method for discounted indirect auto loans.
All other interest on loans is recognized on a simple interest basis.
Since January 1, 1999 all indirect auto loans have been originated on a simple
interest basis. Accordingly, the
balance of unearned discount has declined significantly.
Deferred loan origination fees and certain deferred
loan origination costs are amortized over the contractual life of the related
loan using the level-yield method. At
December 31, 2001 and 2000, the Company had net deferred loan costs of
$13,566,000 and $12,137,000, respectively, including $15,311,000 and
$12,225,000, respectively, paid to auto dealers originating indirect auto loans. Amounts paid to auto dealers are generally
rebatable in the event of loan prepayment or default.
It is the practice of the Company to discontinue the
accrual of interest on loans, except consumer loans, which are in excess of 90 days past due or sooner if,
in the judgment of management, the ultimate collectibility of principal or
interest becomes doubtful. When a loan
is placed on nonaccrual status, previously accrued and uncollected interest is
reversed against interest on loans. Interest
income is subsequently recognized only to the extent cash payments are received. When there is doubt regarding the ultimate
collectibility of principal, all cash receipts thereafter are applied to reduce
the recorded investment in the loan.
Loans are classified as impaired when it is probable
that the Company will not be able to collect principal, interest and fees
according to the contractual terms of the loan agreement. Management considers the payment history,
net worth and earnings potential of a borrower, and the value and cash flow of
the collateral as factors to determine whether a loan will be paid in
accordance with its contractual terms.
The amount judged to be impaired is the difference between the present
value of the expected future cash flows discounted at the loan’s original
contractual effective interest rate and the net carrying amount of the
loan. If foreclosure on a
collateralized loan is probable, impairment is measured based on the fair value
of the collateral compared to the net carrying amount. If appropriate, a valuation reserve is
established to recognize the difference between the recorded investment and the
present value. Impaired loans are
charged off when management believes that the collectibility of the loan is
remote. The Banks consider nonaccrual
loans, except for smaller balance, homogeneous residential mortgage loans, and
troubled debt restructurings to be impaired.
Allowance for Loan Losses
The allowance for loan losses is maintained at a level
determined to be adequate by management to absorb future charge-offs of loans
deemed uncollectable. This allowance is
increased by provisions charged to operating expense and by recoveries on loans
previously charged off, and reduced by charge-offs on loans.
Arriving at an appropriate level of allowance for loan
losses necessarily involves a high degree of judgment. The allowance for loan losses is evaluated
on a regular basis by management and is based upon management’s systematic periodic review of the collectability
of the loans. Primary considerations in
this evaluation are prior loan loss experience, the character and size of the
loan portfolio, business and economic conditions and management’s estimation of
future losses. The Company evaluates
specific loan status reports on certain commercial and commercial real estate
loans rated “substandard” or worse in excess of a specified dollar amount. Estimated reserves for each of these credits is determined by reviewing current
collateral value, financial information, cash flow, payment history and trends
and other relevant facts surrounding the particular credit. The remaining commercial and commercial real
estate loans are provided for as
part of pools of similar loans based on a combination of historical loss
experience and qualitative adjustments.
Smaller balance, homogeneous loans, including residential real estate
loans and consumer loans, are evaluated as a group by applying estimated
charge-off and recovery percentages, based on historical experience and certain
qualitative factors, to the current outstanding balance in each loan category. Based on these analyses , the resulting
allowance is deemed adequate to absorb all probable credit losses in the
portfolio.
Although management uses available information to
establish the appropriate level of the allowance for loan losses, future
additions to the allowance may be necessary based on estimates that are
susceptible to change as a result of changes in economic conditions and other
factors. In addition, various
regulatory agencies, as an integral part of their examination process,
periodically review the Company’s allowance for loan losses. Such agencies may require the Company to
recognize adjustments to the allowance based on their judgments about
information available to them at the time of their examination. Changes
in estimates are provided currently in earnings.
Loan Sales and Servicing Rights
Loans held for sale are valued at the lower of the
recorded loan balance or market value.
The Company periodically enters into
forward commitments to sell loans for the purpose of reducing market risk
associated with the origination of loans for sale. Market value is
estimated based on outstanding investor commitments or, in the absence of such
commitments, current investor yield requirements.
The Company recognizes, as a separate asset, the right
to service mortgage loans for others.
The amount capitalized is based on an allocation of the cost of the loan
based on the total relative fair value of the loan and the servicing
right. The amortization of servicing
rights is recognized in proportion to estimated net servicing revenue and is recorded as a charge against loan
servicing fee income. The value of servicing
rights is periodically assessed for impairment based on the fair value of those
rights. In measuring for impairment,
servicing assets are stratified by interest rate, which is the predominant risk
characteristic affecting the prepayment of loans.
Included in other assets in the accompanying
consolidated balance sheets are mortgage servicing rights of
$1,329,000 and $1,170,000 at December 31, 2001 and 2000,
respectively. The Company recognized
$523,900 and $0 of mortgage servicing rights during December 31, 2001 and 2000,
respectively. Amortization expense was
$361,000, $180,000 and $390,000 for the years ended December 31, 2001, 2000 and
1999, respectively.
Banking Premises and Equipment
Land is stated at cost. Buildings, leasehold improvements and equipment are stated at
cost, less accumulated depreciation and amortization, computed on the
straight-line method over the estimated useful lives of the assets or the terms
of the leases, if shorter. Maintenance
and repairs are expensed when incurred; major expenditures for betterments are
capitalized and depreciated.
Interest incurred during construction of the Company’s
new corporate headquarters was capitalized based on Compass’s overall cost of
funds. During the years ended December
31, 2000 and 1999, interest of $268,000 and $107,000, respectively, was
capitalized.
Other Real Estate Owned
Other real estate owned (OREO) is composed of
properties acquired through foreclosure or receipt of a deed in lieu of
foreclosure. Foreclosed assets are
presumed to be held-for-sale and are recorded at the lower of the carrying value
of the related loan or the fair value of property, less estimated costs to
sell. The excess, if any, of the loan
balance over the fair value of the property at the time of transfer to OREO is
charged to the allowance for loan losses.
Subsequent write-downs of the carrying value of the foreclosed assets
are charged to expense. Costs relating
to the development and improvement of foreclosed assets are capitalized while
other costs are charged to expense. Such amounts have been insignificant during
the periods covered by this report.
Income Taxes
The Company utilizes the asset and liability method of
accounting for income taxes. Under this
method, deferred tax assets and liabilities are recognized for the future tax
consequences attributable to differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases.
Deferred tax assets and liabilities are measured using
enacted tax rates expected to apply to taxable income in the years in which
those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and
liabilities of a change in tax rates is recognized in income in the period that
includes the enactment date. Deferred tax assets are recognized subject to
management’s judgement that realization is more likely than not.
Goodwill and Intangible Assets
Through December 31, 2001, goodwill was amortized on a
straight-line basis over fifteen years.
Amortization amounted to $2.4 million in 2001. As discussed below under the caption “Recent Accounting
Pronouncements”, amortization of goodwill is generally no longer permitted
effective January 1, 2002.
The core deposit intangible asset is being amortized over
periods ranging from six to ten years using accelerated and straight-line
methods. Amortization expense was
$494,000, $542,000 and $619,000 for the years ended December 31, 2001, 2000 and
1999, respectively. The core deposit
intangible asset amounted to $2,370,000 and $1,333,000 at December 31, 2001 and
2000, respectively.
Goodwill and intangible assets are periodically
evaluated for impairment at least annually.
Stock-Based Compensation
Stock options issued to officers and directors are
accounted for in accordance with Accounting Principles Board Opinion No. 25,
“Accounting for Stock Issued to Employees” (APB No. 25) under which there is
generally no charge to earnings for stock option grants.
Earnings Per Share (EPS)
Basic EPS is computed by dividing net income by the
weighted average number of common shares outstanding for the period. Unallocated ESOP shares and unvested
restricted stock awards are not considered outstanding in computing basic
earnings per share. Diluted EPS
reflects the potential dilution that could occur if contracts to issue common
stock were exercised and has been computed after giving consideration to the
dilutive effect of stock options, stock awards and shares held in an employee
trust.
Comprehensive Income
The Company reports comprehensive income in accordance
with Financial Accounting Standards (SFAS) No. 130, “Reporting Comprehensive
Income.” This statement establishes
standards for reporting and displaying comprehensive income, which is defined
as all changes to equity except investments by and distributions to
stockholders. Net income is a component
of comprehensive income with all other components referred to in the aggregate
as “other comprehensive income.” As of
December 31, 2001 and 2000, the Company’s other comprehensive income consisted
of unrealized gains (losses) on securities classified as available-for-sale,
net of taxes of $2,740,000 and $3,221,000.
Included in net income are gains on the sale of investment securities,
net of taxes, of $64,000, $3,000 and $106,000 for the years ended December 31,
2001, 2000 and 1999, respectively, that had previously been classified with
other comprehensive income.
Reclassifications
Certain reclassifications have been made to the prior
year financial statements to conform to the 2001
presentation. Such reclassifications have no effect on
previously reported net income.
Recent Accounting Pronouncements
Effective January 1,
2001, the Company adopted SFAS No. 133, “Accounting for Derivative Instruments
and Hedging Activities,” as amended by SFAS Nos. 137 and 138 (collectively SFAS
No. 133). This standard establishes
accounting and reporting standards for derivative instruments and for hedging
activities. SFAS No. 133 requires all
derivatives, including certain derivative instruments embedded in other
contracts, to be recognized as assets or liabilities on the balance sheet and
measured at fair value. The adoption of
SFAS No. 133 did not have a material impact on the Company’s financial position
or results of operations.
In June 2001, the Financial Accounting Standards Board
(FASB) issued SFAS No. 141, “Business Combinations” which is effective for
transactions initiated after June 30, 2001.
Under SFAS No. 141, all business combinations must be accounted for
using the purchase method of accounting; use of the pooling-of-interests method
is no longer permitted. In addition,
this Statement requires that certain intangible assets acquired in a business
combination be recognized apart from goodwill.
Under the transition provisions of SFAS No. 141, no
change in the amount of the purchase price assigned to the assets acquired and
liabilities assumed in a business combination completed before July 1, 2001 and
accounted for by the purchase method shall occur except for certain identified
intangible assets which were separately recognized at the time of the
transaction. Management does not
believe that any reclassification of intangible assets recognized in connection
with the Company’s acquisition of Home Port Bancorp, Inc. (Home Port) in
December 2000 is required as a result of the application of SFAS No. 141.
In June 2001, the FASB also issued SFAS No. 142,
“Goodwill and Other Intangible Assets” which is effective for fiscal years
beginning after December 15, 2001.
Under prior accounting standards, goodwill resulting from a business
combination is amortized against income over its estimated useful life. Under
SFAS No. 142, goodwill is generally no longer amortized as an expense after
2001 but instead is reviewed and tested for impairment using a fair value
methodology prescribed in this Statement.
Goodwill will be tested for impairment at least annually or more
fequently as a result of an event or change in circumstances (e.g. recurring
operating losses by the acquired entity) that would indicate an impairment
adjustment may be necessary. Based on
its assessment of the current economic environment, management does not
anticipate an impairment adjustment to the goodwill reflected in the
accompanying consolidated balance sheet upon adoption of SFAS No. 142. The effect of adopting SFAS No. 141 and No.
142 will be the Company will cease amortizing the goodwill balance of $33.9
million which will have the effect of reducing goodwill amortization of $2.4
million in 2002.
(2) ACQUISITIONS
On December 31, 2000, the Company completed its
acquisition of Home Port for $68.2 million in cash, exclusive of one-time
transaction costs. Home Port was the
holding company for Nantucket Bank, a three branch savings bank located on
Nantucket Island, Massachusetts with total assets of approximately $341 million
at the date of acquisition. The assets
acquired included loans, investments, bank premises, equipment and other
assets. This transaction has been
accounted for under the purchase method of accounting. Based on an allocation of the purchase
price, goodwill from this acquisition totaled $36.3 million.
The results of operations of Home Port are not
reflected in the accompanying consolidated statements of operations prior to
2001. The Company’s pro forma
summarized results of operations for the years ended December 31, 2000 and
1999, assuming Home Port had been acquired as of January 1, 1999, are as
follows (in thousands):
Included in noninterest expense in the pro forma results
of operations for 2000 are certain acquisition-related costs incurred by Home
Port totaling $1,864,000 which, after the estimated tax effect, reduced the pro
forma net income and EPS by $1,655,000, or $.07 per share.
On December 15, 2001, Compass completed its assumption
of the deposit liabilities of Charter Bank’s Hyannis, Massachusetts branch
office for cash and an insignificant balance of deposit-related loans. Compass paid a deposit premium of 5% of the stated
balance of the assumed deposits of $24.0 million. Charter Bank closed this branch office and customer accounts were
transferred to an existing Compass branch office in Hyannis. The resulting core deposit intangible of
approximately $1.2 million is being amortized over 10 years on an accelerated
basis.
In connection with the Company’s acquisition of
Sandwich Bancorp, Inc. in 1998, estimated merger-related costs of $6.8 million
were expensed. During 2000, the Company
recognized, as a reduction of noninterest expense, approximately $400,000 due
to an overestimate of such costs.
(3) INVESTMENT
SECURITIES
The amortized cost and fair value of securities
available-for-sale at December 31, 2001 and 2000 are as follows:
The amortized cost and fair value of securities
held-to-maturity at December 31, 2001 and 2000 are as follows:
The maturity distribution of debt securities at
December 31, 2001 is as follows:
Mortgage-backed investments and collateralized
mortgage obligations are shown at their contractual maturity dates, but actual
maturities may differ as borrowers have the right to prepay obligations without
incurring prepayment penalties.
Proceeds from sales of investment securities and
related gains and losses for the years ended December 31, 2001, 2000, and 1999
(all classified as available-for-sale) were as follows:
At December 31, 2001, investment securities carried at
$54,900,000 were pledged to secure public deposits under the Treasury, Tax and
Loan program, deposits held by various municipalities and retail repurchase
agreements. In addition, investment
securities carried at $250,200,000 were pledged under a blanket lien to
partially secure the advances from the Federal Home Loan Bank (Note 8). Pledged investment securities are maintained
under the Company’s control.
(4) LOANS AND ALLOWANCE FOR LOAN LOSSES
The Company’s lending activities are conducted
principally in Southeastern Massachusetts, including the islands of Nantucket
and Martha’s Vineyard and, to a lesser extent, Eastern Massachusetts and Rhode
Island. A summary of the loan portfolio
follows:
Loans serviced for others on a non-recourse basis at
December 31, 2001 and 2000 amounted to $363,123,000 and $382,680,000,
respectively.
At December 31, 2001 and 2000, troubled debt
restructurings, all of which are
included in nonaccrual loans, totaled $755,500 and $936,400, respectively. There are no commitments to extend
additional credit on these loans.
Nonaccrual loans amounted to $13,408,000 and $6,107,000, at December 31,
2001 and 2000, respectively.
The following table presents information about
impaired loans:
For the year ended December 31, 1999, the average balance of impaired loans was $2,346,000
and the interest income recognized on impaired loans was $163,000.
In the ordinary course of business, the Company grants
loans to its executive officers, directors and related parties on substantially
the same terms as loans made to unrelated borrowers. Related party loan activity for the years ended December 31, 2001
and 2000 is as follows:
A summary of changes in the allowance for loan losses
follows:
Allocated reserves for loan losses are determined
using both a formula-based approach applied to groups of loans and an analysis
of certain individual loans for impairment.
The formula-based approach evaluates groups of loans
to determine the allocation appropriate within each portfolio segment. Individual loans within the real estate
(residential, commercial, construction, and home equity), commercial and
consumer (indirect auto and other consumer) loan portfolio segments are
assigned internal risk ratings to group them with other loans possessing
similar credit risk characteristics.
The level of reserve apportionable to each group of risk-rated loans is
then determined by management applying a loss factor that estimates the amount
of probable loss in each category. The
assigned loss factor for each risk rating is a formula based assessment of
historical loss data, portfolio characteristics, economic trends, overall
market conditions, past experience, and management’s subjective analysis of
considerations of probable loan loss based on these factors. Allocations for loan categories are then
determined by applying loss factors that represent management’s estimate of
inherent losses in those categories to the appropriate loan balances
outstanding.
The other method used to allocate the reserve for loan
losses entails the assignment of reserve amounts to individual loans on the a
basis of loan impairment. Certain loans
are evaluated individually and are judged to be impaired when management
believes it is probable that the Company will not collect all of the contractual
interest and principal payments as scheduled in the loan agreement. Under this method loans are selected for
evaluation based on a change in internal risk rating, occurrence of
delinquency, loan classification or non-accrual status. An identifiable reserve amount is allocated
to an individual loan when such loan has been deemed impaired and when the
amount of a probable loss is estimable on the basis of fair value of
collateral, present value of anticipated future cash flows or the loans observable
fair market price. Loans with an
identifiable reserve and the amount of such reserve totaled $6,177,002 and
$2,465,765 at December 31, 2001, respectively.
A portion of the reserve for loan loss is not
allocated to any specific segment of the loan portfolio. This unallocated reserve is maintained for
two primary reasons; there exists an inherent subjectivity and imprecision to
the analytical processes employed and the prevailing business environment, as
it is affected by changing economic conditions and various external factors,
which may impact the portfolio in ways currently unforeseen. Moreover, management has identified certain
risk factors, which could impact the degree of loss sustained within the
portfolio. These include: market risk
factors, such as the effects of economic variability on the entire portfolio,
and unique portfolio risk factors that are inherent characteristics of the
Company’s loan portfolio. Market risk
factors may consist of changes to general economic and business conditions that
may impact the Company’s loan portfolio customer base in terms of ability to
repay and that may result in changes in value of underlying collateral. Unique portfolio risk factors may include
industry concentration or covariant industry concentrations, geographic
concentrations, or trends that may exacerbate losses resulting from economic
events which the Company may not be able to fully diversify out of its
portfolio. Management, therefore, has established
and maintains an unallocated reserve for loan losses. The amount of this unallocated reserve was $2.4 million at
December 31, 2001, compared to $2.2 million at December 31, 2000.
As of December 31, 2001, the reserve for loan losses
totaled $29.5 million as compared to $25.1 million at December 31, 2000. Based on the processes described above,
management believes that the level of the reserve for loan losses at December
31, 2001 is adequate.
(5) BANKING
PREMISES AND EQUIPMENT
A summary of banking premises and equipment follows:
Depreciation for the years ended December 31, 2001,
2000 and 1999,amounted to $4,082,000, $2,867,000 and $2,464,000, respectively,
and is included in occupancy and equipment expenses in the accompanying
consolidated statements of income.
During 2001, and 2000, the Company recognized net gains of $372,000 and
$329,000, respectively, upon the disposition of banking premises and equipment
caused by the relocation to its new corporate and banking offices which are included in other noninterest
income in the accompanying consolidated statements of income.
(6) DEPOSITS
A summary of deposit balances follows:
A summary of the maturity distribution of certificates
of deposit with weighted average interest rates follows:
(7) SHORT-TERM
BORROWINGS
A summary of short-term borrowings follows:
The weighted average interest rates on short-term
borrowings during the years ended December 31, 2001, 2000 and 1999, were 3.69%, 4.68% and 4.79% , respectively. The average
daily balance outstanding was $32,122 and $32,562 for 2001and 2000,
respectively. The maximum balance
outstanding at any month end was $37,464 and $57,637 for 2001 and 2000,
respectively.
The Company’s available lines of credit with the
Federal Home Loan Bank (FHLB) amounted to $42,500,000 at December 31,
2001. The interest on borrowings under
the lines of credit adjusts daily based on a formula. At December 31, 2001 and
2000, the Company had no advances outstanding under these lines.
(8) FEDERAL
HOME LOAN BANK ADVANCES
FHLB advances are collateralized by a blanket-type
pledge agreement on the Banks’ FHLB stock, certain qualified investment
securities, deposits at the FHLB and first mortgages on residential
property. As members of the FHLB, the
Banks are required to invest in stock of the FHLB at an amount equal to the
greater of 1% of their outstanding first mortgage residential loans, 3% of
total assets or 5% of their outstanding advances from the FHLB. When such stock is redeemed, the Banks will
receive from the FHLB an amount equal to the par value of the stock.
A summary of the maturity distribution of FHLB
advances (based on final maturity dates) with weighted average interest rates
follows:
At December 31, 2001, outstanding advances of
$402,000,000 are callable at the option of FHLB, of which $282,000,000 are
callable at December 31, 2001, $15,000,000 are initially callable in 2002,
$70,000,000 are initially callable in 2003 and $35,000,000 become initially
callable thereafter. The Company is
generally subject to a substantial penalty upon prepayment of FHLB advances.
(9) INCOME
TAXES
The components of the provision for income taxes and
the reconciliation between the statutory federal income tax rate and the
effective income tax rate for the years indicated, are as follows:
The Company’s net deferred tax asset consisted of the
following tax effects of temporary differences:
In August 1996, Congress passed legislation which
suspended the Banks’ bad debt reserve for income tax purposes as of their base
year (October 31, 1988). Any bad debt
reserve in excess of the base year amount is subject to recapture over a
six-year period. The suspended (i.e.,
base year) amount is subject to recapture only upon the occurrence of certain
events, such as excess distributions to stockholders or failure to qualify as a
bank for income tax purposes. Since the
Banks do not intend to use their suspended bad debt reserves for purposes other
than to absorb the losses for which they were established, deferred taxes in
the amount of $7,300,000 have not been recorded with respect to such reserves.
(10) COMMITMENTS
AND CONTINGENCIES
Pursuant to the terms of noncancellable leases, future
minimum annual rentals for both operating and capital leases at December 31,
2001 are as follows:
Certain leases contain renewal options the potential
impact of which is not included above.
Rent expense for the years ended December 31, 2001, 2000 and 1999
amounted to $884,000, $883,000 and $882,000, respectively, and is included in
occupancy and equipment expenses in the accompanying consolidated statements of
income.
Aggregate cash reserves (in the form of deposits with
the Federal Reserve Bank and vault cash) of $30.4 million were maintained to satisfy regulatory requirements at
December 31, 2001.
In the ordinary course of business, the Company is a
defendant in litigation matters.
Although there can be no assurance, management believes that, based on
its review of current litigation and discussion with legal counsel, the
ultimate resolution of these legal proceedings would not be likely to have a
material adverse impact on the Company’s financial position, results of
operations or liquidity.
(11) REGULATORY
CAPITAL REQUIREMENTS
The Company and the Banks are subject to various
regulatory capital requirements administered by the federal banking
agencies. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Banks
must meet specific capital guidelines that involve quantitative measures of
assets, liabilities and certain off-balance-sheet items as calculated under
regulatory accounting practices.
Quantitative measures established by regulation to
ensure capital adequacy require the Company and the Banks to maintain minimum
amounts and ratios (set forth in the following table) of total and Tier 1
capital (as defined in the regulations) to risk-weighted assets (as defined),
and of Tier 1 capital (as defined) to average assets (as defined). At December
31, 2001 and 2000, the Company and the Banks met all applicable regulatory
capital requirements.
As of December 31, 2001, the most recent notification
from the Federal Reserve Bank of Boston classified the Company’s capital as
satisfactory and the most recent notifications from the FDIC categorized the
Banks as well capitalized under the regulatory framework for prompt corrective
action. To be categorized as well
capitalized, an insured depository institution must maintain minimum total
capital (to risk weighted assets), Tier 1 capital (to risk weighted assets) and
Tier 1 leverage capital (to average assets) as set forth in the accompanying
table and not be subject to a directive, order, or written agreement to meet
and maintain specific capital levels.
There are no conditions or events since such notifications that
management believes would have changed these classifications. The
Company’s and the Banks’ actual capital amounts and ratios are as follows:
(12) RETIREMENT
AND OTHER BENEFIT PLANS
Pension Plans
Through October 31, 1999, Compass provided basic and
supplemental pension benefits for eligible employees through the Savings Bank’s
Employees Retirement Association Pension Plan (the Compass SBERA Plan). Benefits were based on an employee’s years
of service and annual compensation, as defined. Compass’s funding policy was to contribute annually the maximum
deductible amount for federal income tax purposes.
In September 1999, the Board of Directors voted to
freeze benefits under the Compass SBERA Plan effective October 31, 1999 and to
terminate this Plan on or about December 31, 1999. In connection therewith, the Compass SBERA Plan was also amended
to improve the benefit formula for current employees and permit payment of lump
sums. A curtailment gain of $1,472,000
was recognized in 1999 representing the difference between the estimated
benefit obligation and the accumulated benefit obligation at the effective date
of termination.
In October 2001, all obligations of the Compass SBERA
Plan were settled with excess assets of $300,000 returned to Compass. A gain of $1,504,000 was recognized in
connection with this settlement principally related to previously unrecognized
deferred gains.
Nantucket Bank provides pension benefits for its
employees through the SBERA Plan. This
Plan provides for benefits to be paid to eligible employees at retirement based
primarily upon their years of service with Nantucket Bank and compensation
level near retirement. Contributions to
this Plan equal the maximum deductible amount for tax purposes.
The following tables summarize the components of net
periodic pension cost and the funded status of each of the SBERA Plans for the plan years ended October
31 (in thousands):
(1) With plan assets
frozen at the time of termination, the expected rate of return for 2001 was
reduced to properly reflect the yield associated with current money market fund
rates.
Postretirement Benefits Other than
Pensions
Compass sponsors a postretirement life insurance plan
(the Life Insurance Plan) that primarily covers pre-1996 retirees and a
postretirement medical insurance plan that covers certain retirees of the
former Sandwich Bank. The Life
Insurance Plan generally provides lifetime coverage to retired employees equal
to their final annual rate of pay, but not more than $50,000, and to active
full time employees equal to three times the employee’s annual salary, but not
more than $350,000. Annual expense for
these plans has averaged $60,000 during the past three years. At December 31, 2001 and 2000, the accrued
liability was $567,000 and $568,000, respectively, while the accumulated
benefit obligation was $841,000 and $799,000, respectively, measured using a
7.00% discount rate.
Supplemental Retirement Benefits
Compass has entered into agreements with four officers
to provide supplemental retirement benefits based on 25% of the average of the
three highest years of compensation (salary and bonus) paid to the officer in
the ten years immediately preceding the officer’s retirement. A reduced benefit is payable if the officer
retires prior to age 65, but after age 55.
The present value of these future payments is being accrued over the
estimated remaining terms of employment.
The accrued supplemental retirement liability was $1,839,000 and
$1,697,000 at December 31, 2001 and 2000, respectively. The agreements are being funded through a
life insurance program with policy benefits accruing to Compass. The cash surrender value of the policies is
$1,918,000 and $1,726,000 at December 31, 2001 and 2000, respectively, and is
included in other assets in the accompanying consolidated balance sheets.
Compass has agreed to calculate each year the
additional amount that would need to be accrued in order to result in the
executive annually receiving 70% of the average of the three highest years of
the compensation paid to the officer in the ten years of employment immediately
preceding the officer’s retirement from a combination of Compass’s former
defined benefit plan, the 25% supplemental retirement benefit, Compass’s
contribution to the executive’s 401(k) plan, the ESOP, social security and any
supplemental funding. This amount, if
any, is added to the executive’s account under the deferred compensation plan.
Net expense for these supplemental retirement benefits
for the years ended December 31, 2001, 2000 and 1999, amounted to $309,000,
$276,000 and $206,000, respectively, and is included in salaries and employee
benefits in the accompanying consolidated statements of income.
Incentive Compensation Plan
Each of the Banks maintains a bonus plan providing for
awards based on a combination of corporate and individual performance
objectives being met, subject to the approval of the Board of Directors. Amounts charged to operations under the
bonus plans amounted to $1,753,000, $1,840,000 and $1,045,000 for the years
ended December 31, 2001, 2000 and 1999, respectively.
401(k) Plan
The Banks offer a 401(k) retirement savings plan for
employees. Participating employees may
generally contribute up to 15% of their W-2 compensation. The Banks match 50% of a participant’s
deferral contribution on the first 6% of the deferral amount subject to the
maximum allowable under federal regulations.
Since November 1999, the Compass plan has included a 3% automatic
contribution for all eligible participants.
Total 401(k) expense was $969,000, $809,000 and $437,000 for the years ended December 31,
2001, 2000 and 1999, respectively.
ESOP
In connection with its conversion from mutual-to-stock
form and initial public offering, the Company
established the Compass Bank for Savings Employee Stock Ownership Plan
(“ESOP”) which acquired 1,120,000 of the Company’s shares at a price of $10 per
share. The purchase of the shares by
the ESOP was funded by a loan of $11,200,000 from the Company. The loan is being repaid in 80 equal
quarterly installments with interest at a fixed rate of 7.75% and is secured by the unallocated shares of the
ESOP. The ESOP covers substantially all
of Compass’s employees who have attained the age of 21 and who have completed
at least 1,000 hours of service.
ESOP expense is based on the market value of the
Company’s common stock at the time shares are allocated to employees, which
differs from the $10 cost of those shares.
Such changes in market value impact the Company’s results of operations
but have no impact on total stockholders’ equity. ESOP expense for the years ended December 31, 2001, 2000 and 1999
amounted to $828,000, $572,000 and $585,000, respectively.
Other
The former Sandwich Bank, acquired in December 1998,
maintained certain employee and director benefit programs, including a
directors deferred compensation plan and supplemental executive retirement
plans, which have been discontinued.
Included in accrued expenses and other liabilities are $3,287,000, and
$3,283,000, at December 31, 2001 and 2000, respectively, for such plans.
(13) STOCK
INCENTIVE PLAN
In 1999, the Company adopted the 1999 Stock Incentive
Plan (the Stock Incentive Plan) for officers, employees and directors. The maximum number of shares of common stock
issuable under the Stock Incentive Plan is 1,960,000 (subject to adjustment
upon the occurrence of a stock dividend, stock split or similar change in
capitalization affecting the Company’s common stock). Of this number, up to 560,000 shares are issuable in connection
with “conditioned stock awards”. A
conditioned stock award is an award entitling the recipient to acquire, at no cost or for a purchase price to be
determined by the Compensation Committee, shares of common stock subject to
restrictions and conditions determined at the date of grant. Conditions may be based on continuing
employment and/or achievement of performance goals. The remaining 1,400,000 shares may be either incentive stock
options (as defined in the Internal Revenue Code) or options that do not so
qualify (non-qualified options).
Incentive stock options shall have an exercise price
that is not less than the fair market value of the Company’s stock at the date
of grant and shall not be exercisable more than ten years after the date of
grant. All incentive stock options and
non-qualified options shall vest and become exercisable based on the
determination of the Compensation Committee.
Stock options issued to date become exercisable at a rate of 20% per
year.
In July 1999, a conditioned stock award of 560,000 shares
was approved for a group of officers and directors. Under the terms of the award, there is no cost to the recipient
for the shares, which vest annually over a five year period conditioned on
continued employment with the Company.
Shares that do not vest are forfeited and are returned to the
Company. Upon the event of death, a
recipient’s shares become fully vested.
While the shares issued under this conditioned stock award are
outstanding, recipients have both voting and dividend rights in such shares.
The total compensation cost of $6,370,000 for the
conditioned stock award was determined at the award date since both the number
of shares and price to be paid (zero) were known. The cost, adjusted for any forfeitures and accelerated vesting,
is being amortized ratably over five years when all risks of forfeiture have
passed. Forfeitures will be recognized
as a reduction of compensation cost in the period in which they occur. No forfeitures relating to the conditioned
stock awards have occurred since the award date. For the years ended December 31, 2001, 2000 and 1999, the Company
expensed $1,249,000, $1,362,000 and $637,000, respectively, in connection with
its conditioned stock award grants.
Stock option activity is as follows:
The range of per share prices for outstanding and
exercisable stock options at December 31, 2001 are as follows:
As disclosed in Note 1, the Company accounts for its
stock-based compensation plan in accordance with APB No. 25 and, under such
accounting rules, no compensation cost has been recognized in connection with
the granting of stock options.
Alternatively, FASB standards (SFAS No. 123) would permit a method under
which a compensation cost for all stock awards would be calculated and recognized
over the service period (generally equal to the vesting period). This compensation cost would be determined
in a manner prescribed by the FASB using option pricing models intended to
estimate the fair value of stock options at the grant date. Such alternative accounting would not have resulted
in additional compensation cost recorded for the conditioned stock awarded in
1999.
Had the Company applied SFAS No. 123 in accounting for
its stock option grants, net income and EPS (basic and diluted) would have been
reduced to the pro forma amounts indicated below (in thousands, except for per
share amounts):
The fair value of stock options is estimated on the
grant date using the Black-Scholes option pricing model with the following
valuation assumptions:
The weighted average fair value of stock options
granted in 2001, 2000 and 1999, based on the above assumptions, was $5.29,
$3.34 and $3.00 per share, respectively.
(14) FINANCIAL
INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company is party
to financial instruments with off-balance sheet risk in the normal
course of business to meet the financing needs of its customers. These
financial instruments include commitments to originate loans and standby
letters of credit. The instruments
involve, to varying degrees, elements of credit and interest rate risk in
excess of the amounts recognized in the accompanying consolidated balance
sheets. The contract amounts of those instruments reflect the extent of
involvement the Company has in particular classes of financial instruments.
The Company’s exposure to credit loss in the event of
nonperformance by the other party to the financial instrument for loan
commitments and standby letters of credit is represented by the contractual
amount of those instruments. The
Company uses the same credit policies in making commitments and conditional
obligations as they do for on-balance sheet instruments.
Off-balance sheet financial instruments whose contract
amounts present credit risk included the following:
Commitments to originate loans are agreements to lend
to a customer as long as there is no violation of any condition established in
the contract. Commitments generally
have fixed expiration dates or other termination clauses and may require
payment of a fee. Since some of the
commitments may expire without being drawn upon, the total commitment amounts
do not necessarily require future cash requirements. Management evaluates each customer’s creditworthiness on a
case-by-case basis. The amount of
collateral obtained upon extension of the credit is based on management’s
credit evaluation of the borrower.
Collateral held varies but may include accounts receivable, inventory,
property, plant and equipment and income-producing commercial real estate.
Standby letters of credit are conditional commitments
to guarantee performance of a customer to a third party. The credit risk involved in issuing letters
of credit is essentially the same as that involved in extending loan facilities
to customers. The collateral supporting
those commitments varies and may include real property, accounts receivable or
inventory.
(15) FAIR
VALUE OF FINANCIAL INSTRUMENTS
The reported fair values of financial instruments are
based on a variety of valuation techniques.
In some cases, fair values represent quoted market prices for identical
or comparable instruments. In other
cases, fair values have been estimated based on assumptions concerning the
amount and timing of estimated future cash flows, assumed discount rates
reflecting varying degrees of risk and future expected loss assumptions. These estimates involve a high degree of
judgment. The estimates do not reflect
any premium or discount that could result from offering significant holdings of
financial instruments at bulk sale. Tax
implications of unrealized gains and losses can also have a significant effect
on fair value of the financial instruments.
Changes in economic conditions may dramatically affect the fair value of
financial instruments.
The following methods and assumptions were used to
estimate the fair value of the Banks’ financial instruments:
For cash and due from banks and federal funds sold,
the carrying amount approximates fair value due to the short maturity of those
instruments.
The fair values of investment securities are based on
published market prices or quotations received from securities dealers.
The fair values of loans are estimated for loan
portfolios with similar financial characteristics. Loans are segregated by type, fixed- and adjustable-rate interest
terms and by performing and nonperforming status. The fair values of performing residential real estate loans are
estimated by discounting the anticipated future cash flows at rates currently
required by the secondary mortgage market for the purchase of similar
loans. For performing commercial real
estate loans and performing commercial loans, fair values are estimated by
discounting the anticipated future cash flows using estimated market discount
rates that reflect the credit and interest rate risk inherent in the loan as
determined by the loan’s terms and credit rating. For home equity loans and consumer loans, fair values are estimated by discounting the
anticipated cash flows using current interest rates.
The fair value of deposits does not include the value
of long-term relationships with depositors and does not reflect the value
associated with possessing this relatively inexpensive source of funds that may
be available for a considerable length of time. The reported fair value of deposits with no stated maturity is
equal to the amount payable on demand at the reporting date. The fair value of time deposits is estimated
by discounting the contractual future cash flows at rates currently offered for
time deposits with similar remaining maturities.
The fair value of FHLB advances is determined by
discounting the anticipated future cash payments using rates currently
available for advances with similar terms and remaining maturities. For other borrowings, the carrying amount
approximates fair value due to the short maturity of those instruments.
The fair value of commitments to originate loans is
estimated using the fees currently charged to enter into similar agreements,
taking into account the remaining terms of the agreements and the present
creditworthiness of the counterparties.
For fixed rate loan commitments, fair value also considers the
difference between current levels of interest rates and the committed
rates. The fair value of financial
standby letters of credit is based on fees currently charged for similar
agreements or on the estimated cost to terminate them or otherwise settle the
obligations with the counterparties.
The estimated fair value of all such commitments is insignificant.
Certain items are excluded from disclosure
requirements, including banking premises and equipment, the value of mortgage
servicing rights, the intangible value inherent in deposit relationships (i.e.
core deposits), leases and pension benefit obligations, among others. Accordingly, the aggregate fair value
amounts presented in the accompanying table do not include all data integral to
a full assessment of the Company’s financial position and the market value of
its net assets.
A summary of the estimated fair values of the
Company’s financial instruments follows:
(16) CONDENSED
PARENT COMPANY INFORMATION
The condensed unconsolidated financial statements of
the Parent Company follow:
(17) STOCKHOLDERS’
EQUITY
Stock Conversion
As part of the conversion from mutual to stock form in
1998 (the Conversion), the Company established a liquidation account in an
amount equal to its net worth as of May 31, 1998. The liquidation account is maintained for the benefit of eligible
account holders and supplemental eligible account holders who maintain their
accounts at Compass after the Conversion.
The liquidation account is reduced annually to the extent that such
account holders have reduced their qualifying deposits as of each anniversary
date. Subsequent increases do not
restore an account holder’s interest in the liquidation account. In the event of a complete liquidation, each
eligible account holder is entitled to receive balances for accounts then held.
Stock Repurchase Programs
In July 1999, the Board of Directors authorized the
Company to repurchase up to 1,000,000 shares in the open market to meet the
anticipated needs of stock awards and stock options issued in connection with
the Stock Incentive Plan. In October
1999 and July 2000, the Board of Directors, with the approval of the Commissioner
of Banks, authorized the Company to repurchase up to an additional 1,231,900
and 1,254,312 shares,
respectively, in the open
market. The Board of Directors
delegated to the discretion of senior management the authority to determine the
timing of the repurchase programs’ commencement, the timing of subsequent
repurchases and the prices at which repurchases will be made.
As of January 22, 2002, the Company had repurchased
3,027,000 shares of its common stock
under these programs at a total cost of $35.1 million, all of which shares had
been repurchased as of December 31, 2001.
Dividend Reinvestment and Stock
Purchase Plan
In October 1999, the Board of Directors authorized a
dividend reinvestment and stock purchase plan for up to 500,000 shares of common
stock. Stockholders owning 100 or more
shares are eligible to enroll and may reinvest part of all of their cash
dividends. Participants may also make
optional cash payments from $100 to a maximum of $5,000 per quarter to purchase additional shares of
common stock. This plan commenced upon
the Board’s declaration of the Company’s
quarterly cash dividend in January 2000. The Company has directed its agent to acquire shares in open
market transactions to meet the needs of this plan.
(18) BUSINESS
SEGMENT INFORMATION
The Company has identified its reportable segment as
“Community Banking” which consists of commercial and retail banking. The Company operates under two operating
segments which have similar economic characteristics, products and services,
distribution channels and regulatory environments. Accordingly, disaggregated segment information for each bank is
not presented. The community banking
segment derives its revenue from a wide range of banking services, including
investing and lending activities and acceptance of demand, savings and time
deposits, merchant credit card services as well as servicing loans for
investors. There is no major customer,
as defined, and the banks operate within a single geographic area (southeastern
Massachusetts, including the islands of Martha’s Vineyard and Nantucket).
Non-reportable operating segments of the Company’s
operations which do not have similar characteristics to the community banking
operations and do not meet the quantitative thresholds requiring disclosure,
are included in the Other category in the disclosure of business segments
below. These non-reportable segments
include the Parent Company (Note 16).
The accounting policies used in the disclosure of
business segments are the same as those described in the summary of significant
accounting policies (Note 1). The
consolidation adjustments reflect certain eliminations of intersegment revenue,
cash and the Parent Company investments in subsidiaries.
Reportable segment specific information and
reconciliation to consolidated financial information is as follows (in
thousands):
(19) SELECTED
QUARTERLY FINANCIAL DATA (UNAUDITED)
The following table summarizes the operating results on a quarterly
basis for the years ended December 31, 2001 and 2000.
(1) Refer to Note 12 regarding the termination of
the defined benefits plan.
(2) In the quarter ending December 31, 2001, the
Company recorded gains on the sale of mortgage loans of approximately
$1,024,000.
(3) In the quarter ending December 31, 2001,
salaries and benefits increased ($569,000), data processing increased
($276,000), advertising and marketing increased ($227,000) and other expenses
increased ($301,000).
(4) During the quarter ended December 31, 2000,
the Company reversed approximately $300,000 in tax reserves which were deemed
no longer required. During the quarter
ending March 31, 2001, the Company recorded a tax refund of $341,000 against
the tax provisions due on amended tax returns related to the Sandwich
acquisition.
Item 9.
Item 9. Changes in and Disagreements With Accountants on Accounting and
Financial Disclosure
None.
PART III
Item 10.
Item 10. Directors and Executive Officers of the Registrant
Information required by Item 10. of this Form is
incorporated by reference herein from the Company’s Proxy Statement relating to
the 2002 Annual Meeting of Stockholders of the Company.
Item 11.
Item 11. Executive Compensation
Information required by Item 11. of this Form is
incorporated by reference herein from the Company’s Proxy Statement relating to
the 2002 Annual Meeting of Stockholders of the Company.
Item 12.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Information required by Item 12. of this Form is
incorporated by reference herein from the Company’s Proxy Statement relating to
the 2002 Annual Meeting of Stockholders of the Company.
Item 13.
Item 13. Certain Relationships and Related Transactions
Information required by Item 13. of this Form is
incorporated by reference herein from the Company’s Proxy Statement related to
the 2002 Annual Meeting of Stockholders of the Company.
PART IV
Item 14.
Item 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K
(a) Contents:
1.
Financial Statements: All financial statements are
included in Item 8. of Part II to this report.
2.
Financial Statement Schedules: All financial
statement schedules have been omitted because they are either not required,
not applicable or are included in the consolidated financial statements or
related notes.
3.
Exhibits
3.1
Articles of Organization of Seacoast Financial
Services Corporation+++
3.2
By-Laws of Seacoast Financial Services
Corporation+++
Specimen certificate for the common stock of
Seacoast Financial Services Corporation++
10.1*
Form of Employment Agreement by and among Seacoast
Financial Services Corporation, Compass Bank for Savings and Kevin G.
Champagne+
10.2*
Form of Employment Agreement by and among Compass
Bank for Savings, Seacoast Financial Services Corporation and certain
Officers of Compass Bank for Savings+
10.3*
Form of Change in Control Agreements by and among
Seacoast Financial Services Corporation, Compass Bank for Savings, Kevin G.
Champagne and certain other Officers of Compass Bank for Savings+
10.4*
Form of Change in Control Agreement by and among
Seacoast Financial Services Corporation, Compass Bank for Savings and certain
Officers of Compass Bank for Savings +
10.5*
Form of Executive Salary Continuation Agreements
made and entered into by and between Compass Bank for Savings and Kevin G.
Champagne, Arthur W. Short, John D. Kelleher and Francis S. Mascianica and
forms of amendments thereto +
(b) Reports of Form 8-K:No reports were filed during the fourth
quarter.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of
the Securities Exchange Act of 1934, the Registrant has duly caused this report
to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities
Exchange Act of 1934, this report has been signed below by the following
persons on behalf of the Registrant and in the capacities and on the dates
indicated.
/s/ Kevin G.
Champagne
Kevin G. Champagne
President, Chief
Executive
Officer and Director
March 28, 2002
/s/ David P.
Cameron
David P. Cameron
Director
March 28, 2002
/s/ Howard
C. Dyer, Jr.
Howard C. Dyer, Jr.
Director
March 28, 2002
/s/ Mary F.
Hebditch
Mary F. Hebditch
Director
March 28, 2002
/s/ Glen F.
Johnson
Glen F. Johnson
Director
March 28, 2002
/s/ Thornton
P. Klaren, Jr.
Thornton P. Klaren, Jr.
Director
March 28, 2002
/s/ J. Louis
LeBlanc
J. Louis LeBlanc
Director
March 28, 2002
/s/ Frederic
D. Legate
Frederic D. Legate
Director
March 28, 2002
/s/ Reale J.
Lemieux
Reale J. Lemieux
Director
March 28, 2002
/s/ A.
William Munro
A. William Munro
Director
March 28, 2002
/s/ Philip
W. Read
Philip W. Read
Director
March 28, 2002
/s/ Carl
Ribeiro
Carl Ribeiro
Director
March 28, 2002
/s/ Joseph
H. Silverstein
Joseph H. Silverstein
Director
March 28, 2002
/s/ Gerald
H. Silvia
Gerald H. Silvia
Director
March 28, 2002