ITEM 1. BUSINESS
GENERAL
First Essex Bancorp, Inc.
The Company is a Delaware corporation whose primary activity is to act
as the parent holding company for wholly-owned First Essex Bank (the “Bank”), a
state-chartered savings bank. The
Company is also the sole owner of two other subsidiaries, First Essex Capital
Trust I and First Essex Capital Statutory Trust II, formed for the sole purpose
of issuing trust preferred securities.
On December 30, 1996, Finest Financial Corp. (“Finest”), the parent
holding company of Pelham Bank and Trust Company (“Pelham”), a New Hampshire
chartered bank, was merged into the Company in a transaction that was accounted
for as a purchase. Pelham was
simultaneously merged into the Bank.
The purchase price was composed of 1,353,998 shares of common stock issued
at a price of $11.50 per share and a
total cash outlay of $16.3 million. Included
in the total acquisition cost was approximately $1.4 million of capitalized
costs incurred in connection with the acquisition. This transaction was accounted for as a purchase and,
accordingly, the consolidated statement of operations includes the results of
Finest’s operations since the acquisition.
First Essex Bank
The Bank was originally founded under a Massachusetts legislative
charter issued in 1847. On December 1,
1993, First Essex Savings Bank converted to a federal savings bank with a charter
issued by the Office of Thrift Supervision (the “OTS”) under the name of First
Essex Bank, FSB. The purpose of the
conversion was to enable the Bank to operate branches in two states, which, in
1993, was permitted only to federal savings banks. On the same day First Essex Savings Bank of New Hampshire was
merged into First Essex Bank, FSB. As
stated above, the Bank merged with Pelham on December 30, 1996.
In November 2000, the Bank filed applications with the appropriate
federal and state regulatory agencies to convert its charter from a federal
savings bank back to a Massachusetts state-chartered savings bank;
Massachusetts-chartered banks are now permitted to operate branches in more
than one state. In February 2001, the
Bank received all necessary approvals and completed the conversion on March 31,
2001. The conversion to a
state-chartered savings bank provides the Bank more flexibility to continue its
emphasis on higher yielding commercial and consumer lending.
At December 31, 2001, the Bank had total assets of $1.6 billion. The Bank is principally engaged in the
business of attracting deposits from the general public and investing in
residential mortgage, construction, commercial real estate, commercial and
consumer loans. The Bank also makes
investments in various investment securities to provide a source of interest
and dividend income. The Bank currently
maintains 20 full-service banking offices at various locations throughout its
market area. Deposits at First Essex
Bank are insured up to the applicable limits by the Federal Deposit Insurance
Corporation (the “FDIC”) and deposits in excess of FDIC limits are fully
insured by the additional coverage provided by the Depositors Insurance Fund of
Massachusetts.
MARKET
AREA
First Essex’s market area is centered approximately 25 miles north of
Boston at the intersection of two major highways: Interstate Route 93, the
major north-south roadway connecting Boston with the northern Boston suburban
communities and New Hampshire, and Interstate Route 495. The Bank’s principal executive offices are
located in Andover, Massachusetts, and its main banking office and two of its
branches are located in Lawrence, Massachusetts. Other branches are in the surrounding communities of Andover,
North Andover, Haverhill, Lowell and Methuen, Massachusetts and Concord,
Hillsboro, Londonderry, Manchester, Pelham, Salem and Windham, New Hampshire.
CURRENT MARKET CONDITIONS
The New England region, including those portions of northeastern
Massachusetts and southern New Hampshire that constitute First Essex’s market
area, continues to experience growth, albeit at a slower pace than in the
recent past.
Loan demand to finance new and existing home sales has remained strong
for the last seven years. Refinancing
activity, aided by low interest rates, remained strong during 2001 and should
continue early in 2002. Commercial
loans to small and mid-size businesses in the area increased but the growth
reflected the subdued economic conditions.
In the commercial real estate market, refinancing and repositioning
opportunities for permanent financing replaced much of the construction lending
opportunities. Competition among
lenders for all types of loans remains intense.
Automobile sales continued to show signs of weakness through the first
half of 2001, however signs of improvement were evident in the last
quarter. The market for light aircraft
displayed similar signs of weakness throughout much of 2001 but posted a strong
turnaround in the fourth quarter. The
retrenchment that took place in the stock market during 2000 combined with the
economic uncertainty and international tensions as a result of the events of
September 11th, led to a decline in consumer confidence.
REGULATION
General
The Office of Thrift Supervision (“OTS”) is the primary regulator of
the Company. The Company must file
reports with the OTS concerning activities and financial condition, in addition
to obtaining regulatory approvals prior to entering into certain transactions
such as mergers or acquisitions.
Periodic examinations are conducted by the OTS to test the Company’s and
the Bank’s compliance with various regulatory requirements. The Company, as a thrift holding company, is
also required to file certain reports with, and otherwise comply with the rules
and regulations of the OTS and the Securities and Exchange Commission (“SEC”)
under the federal securities laws.
Upon the Bank’s March 2001 conversion to a state-chartered savings
bank, the Massachusetts Commissioner of Banks
(the “Commissioner”) and the FDIC have become the Bank’s primary
regulators. The Bank elected, pursuant
to Section 10(1) of the Home Owners’ Loan Act (“HOLA”), to be treated as a
savings association for holding company regulatory purposes. As a result, the OTS remains the primary
regulator of the Company.
As a state-chartered savings bank, the Bank is subject to regulation
and examination by the Commissioner and to various Massachusetts statutes and
regulations, which govern, among other things, investment powers (including
lending authority), deposit activities, borrowings, maintenance of surplus and
reserve accounts, distribution of earnings, and payment of dividends. The Commissioner’s approval is required to establish
or close branches, merge with other banks, issue stock and undertake many other
activities. As a state-chartered
savings bank, the Bank is also subject to regulation, examination and
supervision of the FDIC. The Bank’s
deposits are insured up to applicable limits by the Bank Insurance Fund (“BIF”)
of the FDIC, and all deposits in excess of the FDIC limits are insured in full
by the additional coverage provided by the Depositors Insurance Fund (“DIF”).
The Bank is also a member of the Federal Home Loan Bank (“FHLB”)
system, which provides a central credit facility primarily for member
institutions.
Business Activities
The activities of state-charted savings banks are governed by state law
and in certain respects, the Federal Deposit Insurance Act (the “FDI
Act”). The FDI Act was amended by the
Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”). FDICIA, among other things, requires that
federal banking regulators intervene promptly when a depository institution
experiences financial difficulties, mandates the establishment of a risk-based
deposit insurance assessment system and requires the imposition of numerous
additional safety and soundness operational standards and restrictions. FDICIA contains provisions affecting numerous
aspects of the operations of savings banks and empowers the FDIC, among other
agencies, to promulgate regulations implementing its provision.
Qualified
Thrift Lender Test
The Bank continues to be subject to the Qualified Thrift Lender Test by
virtue of the Bank’s election, under Section 10(1) of the HOLA, to continue to
be treated as a savings association for holding company regulatory purposes.
The HOLA requires savings institutions to meet a qualified thrift
lender (“QTL”) test. Under the QTL
test, as modified by FDICIA, a savings association is required to maintain at
least 65% of its “portfolio assets” (total assets less (i) specified liquid
assets up to 20% of total assets, (ii) intangibles, including goodwill, and
(iii) the value of property used to conduct the association’s business) in
certain “qualified thrift investments” (primarily residential mortgages and
related investments, including certain mortgage-backed securities) on a monthly
basis in 9 out of every 12 months.
Limitations on Capital Distributions
by the Bank
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 exceeds net income for that year combined with the retained net
income of the preceding two years.
The OTS has similar rules applicable to capital distributions of
savings institutions, and such rules apply to state-chartered institutions,
such as the Bank, that are subsidiaries of savings and loan holding
companies. A savings institution must
file an application for OTS approval of a capital distribution if either (1)
the total capital distributions for the applicable calendar year exceed the sum
of the institution’s net income for that year to date plus the institution’s
retained net income for the preceding two years, (2) the institution would not
be at least adequately capitalized following the distribution, (3) the
distribution would violate any applicable statute, regulation, agreement or
OTS-imposed condition, or (4) the institution is not eligible for expedited
treatment of its filings. If an
application is not required to be filed, savings institutions which are a
subsidiary of a holding company, as well as certain other institutions, must
still file a notice with the OTS at least 30 days before the board of directors
declares a dividend or approves a capital distribution from the savings
institution to its holding company parent.
Interstate
Branching
The Interstate Banking and Branching Act, effective June 1, 1997,
authorized banks to merge across state lines, thereby creating interstate
branches. Each state, prior to the
effective date, was afforded the opportunity to “opt out” of this provision,
thereby prohibiting interstate branching within that state. Neither Massachusetts nor New Hampshire, the
states in which the Company’s banking offices are located, has “opted out” of
interstate branching. In addition,
under the Interstate Banking and Branching Act, a bank can open new branches in
a state in which it does not already have banking operations if such state
enacts a law permitting such de novo branching. Neither Massachusetts nor New Hampshire has adopted legislation
permitting de novo interstate branching, although Massachusetts (but not New
Hampshire) permits the acquisition of existing branches by an out-of-state bank
or bank holding company.
Capital Requirements
The Bank is subject to various regulatory capital requirements
administered by the FDIC. Failure to
meet minimum capital requirements can initiate certain mandatory, and possibly
additional discretionary, actions by regulators that, if undertaken, could have
a direct material effect on the Bank’s, and in turn, the Company’s financial
statements. Under capital adequacy
guidelines and the regulatory framework for prompt corrective action, the Bank
must meet specific capital guidelines that involve quantitative measures of its
assets, liabilities, and certain off-balance-sheet items as calculated under
regulatory accounting practices. The
Bank’s capital amounts and classification are also subject to quantitative
judgements by the regulators about the components of capital, risk weightings
of assets, and other factors.
Quantitative measures are established by regulation regarding minimum
amounts and ratios of total and Tier I capital (as defined in the regulations)
to risk-weighted assets (as defined), and of Tier I capital (as defined) to
average assets (as defined). Management
believes, as of December 31, 2001, that the Bank meets all capital adequacy
requirements to which it is subject.
As of December 31, 2001, the most recent notification received from the
FDIC categorized the Bank as well capitalized under the regulatory framework
for prompt corrective action. To be
categorized as well capitalized the Bank must maintain the total risk-based,
Tier I risk-based and Tier I adjusted asset ratios. There are no conditions or events since that notification that
management believes have changed the institution’s category.
The Company may not declare or pay cash dividends on its shares of
common stock if the effect thereof would cause stockholder’s equity to be
reduced below applicable capital maintenance requirements or if such
declaration and payment would otherwise violate regulatory requirements.
The capital ratios discussed above, along with the Bank’s actual
capital amounts and ratios are presented in a table within Note 16 to the
Consolidated Financial Statements included in Item 8 - “Financial Statements
and Supplementary Data” of this report.
Insurance of Deposit Accounts
As required by FDICIA, in 1993, the FDIC established a risk-based
assessment system for insured depository institutions that takes into account
the risks attributable to different categories and concentrations of assets and
liabilities, the likely amounts of any loss, and the revenue needs of the
insurance fund.
Insurance of deposits may be terminated by the FDIC after notice and
hearing, upon finding by the FDIC that the Bank has engaged in unsafe or
unsound practices, is in an unsafe or unsound condition to continue operations,
or has violated any applicable law, rule, regulation, order or condition
imposed by, or written agreement with, the FDIC. Additionally, if insurance termination proceedings are initiated
against the Bank, the FDIC temporarily may suspend insurance on new deposits
received under certain circumstances.
Management is not aware of any activity or condition, which could result
in a termination of its deposit insurance.
Deposits are insured up to the applicable limits by the FDIC and
deposits in excess of FDIC limits are fully insured by the additional coverage
provided contractually by the Depositors Insurance Fund of Massachusetts.
Federal Reserve System
The Federal Reserve Board regulations require financial institutions to
maintain noninterest earning reserves against their transactions accounts
(primarily NOW and regular checking accounts).
Due to required reserves needing to be maintained in the form of either
vault cash, a noninterest bearing account at a Federal Reserve Bank or a
pass-through account as defined by the Federal Reserve Board, the effect of
this reserve requirement is to reduce the Bank’s interest-earning assets.
Holding Company Regulations
The Company is a nondiversified unitary savings and loan holding
company within the meaning of the HOLA.
As such, the Company has registered with the OTS and is subject to OTS
regulations, examinations, supervision and reporting requirements. As a unitary savings and loan holding
company, the Company generally will not be restricted under existing laws as to
the types of business activities in which it may engage, provided that the Bank
continues to be a QTL. The HOLA requires the Company to obtain regulatory
approvals prior to entering into certain transactions such as mergers with or
acquisitions of other institutions or holding companies.
LENDING
ACTIVITIES
General
At December 31, 2001, the loan portfolio, before deducting the
allowance for loan losses, totaled $1,053 million, which represented 66.1% of
total assets and an increase of $82.8 million over the prior year. See Item 7 - “Management’s Discussion and
Analysis of Financial Condition and Results of Operations - Allowance for Loan
Losses.”
Due to the Company’s continued emphasis on higher yielding commercial
and consumer loans, these categories increased by $116.5 million in 2001,
offset by a $33.8 million decrease in residential real estate loans. First Essex originates residential first
mortgage loans, commercial real estate loans, construction loans, consumer
loans, commercial loans and aircraft loans.
See Item 7 - “Management’s Discussion and Analysis of Financial
Condition and Results of Operations - Financial Condition.”
The following table sets forth information concerning First Essex’s
loan portfolio, including mortgage loans held for sale, at the dates
indicated. The balances shown in the
table are net of unadvanced funds and unearned discounts and fees. Required disclosure regarding maturity distribution
is shown on pages 29 and 30.
Residential Mortgage Loans
The Bank originates residential first mortgage loans in its market
area. At December 31, 2001, the
residential mortgage loan portfolio was $86.2 million, representing 8.2% of the
loan portfolio. The Bank’s residential
first mortgage loan products consists of six-month, one-year, three-year,
five-year and seven-year adjustable-rate mortgages and fixed-rate mortgages,
having terms of 15 to 30 years. Most of
the residential mortgage loans originated by the bank are sold in the secondary
market. See Item 7a - “Quantitative and
Qualitative Disclosures about Market Risk
- Asset/Liability Management.”
Commercial Real Estate Loans
The Bank also holds loans secured by commercial real estate, such as
manufacturing, retail, apartment and office buildings. At December 31, 2001, the commercial real
estate loan portfolio had an outstanding balance of $161.9 million,
representing 15.4% of the Bank’s loan portfolio.
Generally, commercial real estate loans in the portfolio have been made
to finance the acquisition or retention of income producing properties. The current policy of the Company is to
limit commercial real estate loans primarily to properties in eastern
Massachusetts and southern New Hampshire.
Commercial real estate loans generally reprice over periods ranging
from six months to five years based on a published prime rate or other index.
Construction Loans
Construction loans are primarily made to developers and builders for
the construction of commercial and single-family properties. Construction loans have generally been made
with maturities of one year or less and a price based on a published prime
rate, subject to renewal or extension by the Bank. Additionally, loans are made to qualified individuals for
construction of single-family owner-occupied homes that convert to permanent
mortgages upon completion of construction.
At December 31, 2001, the Bank’s construction loan portfolio had an
outstanding balance of $70.8 million, representing 6.7% of the loan portfolio.
Owner-Occupied Commercial Real Estate
Loans
Owner-occupied commercial real estate loans are extensions of credit to
commercial borrowers for the construction or purchase of business space,
primarily for the borrower’s own use, or loans to commercial borrowers for
operating purposes in which the Bank has taken real estate occupied by the
borrower as collateral. In these
instances, the cash flow of the borrower’s business is the primary source of
repayment. At December 31, 2001, this
portfolio had total outstandings of $74.8 million representing 7.1% of the
Bank’s loan portfolio.
Commercial Loans
At December 31, 2001, the portfolio of commercial loans totaled $120.1
million, representing 11.4% of the loan portfolio. The Bank offers secured and unsecured demand loans, time loans,
term loans, lines of credit and working capital loans, which are short term or
have adjustable rates. Commercial loans
are originated by the Bank’s commercial lending officers, who are supported by
a credit, processing and documentation staff.
Aircraft Loans
The Bank has an expanding market in aircraft lending, which totaled
$196.5 million or 18.7% of the loan portfolio at December 31, 2001. The Bank offers fixed and variable rate
loans to commercial and consumer customers.
Terms typically range from 12 to 20 years with a maximum loan amount of
$2 million.
Consumer Loans
Consumer loans totaled $342.8 million or 32.5% of the loan portfolio at
December 31, 2001. This portfolio
consists of automobile loans, fully or partially secured personal loans, second
mortgage loans, home equity loans and unsecured personal loans. Automobile loans include dealer indirect
loans totaling $287.3 million as well as loans originating directly in retail
branches. The Bank offers variable rate
home equity lines of credit called “First Line Equity Credit”. This product consists of a line of credit,
secured by a second mortgage on residential property, with a monthly adjustable
interest rate at a margin above a published prime rate.
Risks Associated with Commercial Real
Estate, Commercial, Owner-Occupied Commercial Real Estate and
Construction Loans
Commercial real estate and commercial lending involve significant
additional risks compared with one-to-four family residential mortgage lending,
and, therefore, typically account for a disproportionate share of delinquent
loans and real estate owned through foreclosure. Such lending generally involves larger loan balances to single
borrowers or groups of related borrowers than does residential lending, and
repayment of the loan depends in part on the underlying business and financial
condition of the borrower and is more susceptible to adverse future
developments. If the cash flow from
income-producing property is reduced (for example, because leases are not
obtained or renewed), the
borrower’s ability to repay the loan may be materially impaired. These risks can be significantly affected by
considerations of supply and demand in the market for office, manufacturing and
retail space and by general economic conditions. As a result, commercial real estate and commercial loans are
likely to be subject, to a greater extent than residential property loans, to
adverse conditions in the economy generally.
Construction loans are, in general, subject to the same risks as
commercial real estate loans, but involve additional risks as well. Such additional risks are due to
uncertainties inherent in estimating construction costs, delays arising from
labor problems, shortages of material, uncertain marketability of a complete
project and other unpredictable contingencies that make it relatively difficult
to determine accurately the total loan funds required to complete a project or
the value of the completed project.
Construction loan funds are advanced on the security of the project
under construction, which is of uncertain value prior to the completion of
construction. When a construction
project encounters cost overruns, marketing or other problems, it may become
necessary, in order to sustain the project and preserve collateral values, for
the lender to advance additional funds and to extend the maturity of its
loan. In a declining market, there is
no assurance that this strategy will successfully enable the lender to recover
outstanding loan amounts and interest due. Moreover, foreclosing on such
properties results in administrative expense and substantial delays in recovery
of outstanding loan amounts and provides no assurance that the lender will
recover all monies due to it, either by developing the property, subject to
regulatory limitations and to the attendant risks of development, or by selling
the property to another developer.
Residential Loan Servicing and Sales
of Loans
The Bank generally writes residential mortgage loans to meet the
requirements for sale in the secondary market.
From time to time, the Bank sells residential mortgage loans and
residential loan servicing. Such loan
sales represent a potential source of liquidity to meet lending demands and
deposit flows. See Item 7 - “Management’s
Discussion and Analysis of Financial Condition and Results of Operation - Asset/Liability
Management.”
At December 31, 2001, the Bank’s residential loan servicing portfolio
totaled $2.1 million.
NONPERFORMING
ASSETS
General
Nonperforming assets consist of nonaccruing loans (including impaired
and restructured loans) and foreclosed property. For further information
regarding the impairment of loans see “Provision for Loan Losses” included in
Item 7 - “Management’s Discussion and Analysis of Financial Condition and
Results of Operations”.
Nonaccruing
Loans
It is the general practice of the Bank to discontinue accrual of
interest on loans for which payment of interest or principal is 90 days or more
past due and such other loans where collection of interest and principal is
doubtful. All previously accrued but
uncollected interest is reversed against current period income when a loan is
placed on nonaccrual status. At
December 31, 2001, the Bank’s nonaccruing loans totaled $4.2 million,
representing an increase of $1.6 million or 59.4% from $2.6 million at December
31, 2000. This increase is due
primarily to the addition of a single commercial credit in the non-accrual loan
category. For further information
regarding the Bank’s nonaccruing loans, see Item 7 - “Management’s Discussion
and Analysis of Financial Condition and Results of Operations - Financial
Condition - Non-Performing Assets.”
Restructured Loans
These are loans on which concessions have been made in light of the
debtor’s financial difficulty with the objective of maximizing recovery. At December 31, 2001 and December 31, 2000,
the Bank had no restructured loans.
Restructured loans are nonperforming assets and would be included in the
totals for nonaccrual loans. For
further information regarding restructured loans, see Item 7 - “Management’s
Discussion and Analysis of Financial Condition and Results of Operations -
Financial Condition - Nonperforming Assets.”
Foreclosed Property
Foreclosed property at December 31, 2001 totaled $417,000 compared to
$3,000 at December 31, 2000. Foreclosed property consists of real or tangible
property that collateralized a loan prior to foreclosure or repossession. These
assets are carried at the lower of cost or the estimated net realizable values. Any decreases in value prior to sale are
charged to operations.
For further information regarding the Bank’s foreclosed property, see
Item 7 - “Management’s Discussion and Analysis of Financial Condition and
Results of Operations - Financial Condition - Nonperforming Assets.”
INVESTMENT
ACTIVITIES
The Company maintains an investment portfolio to provide a source of
interest and dividend income and potential source of liquidity to meet lending
demands and deposit flows. At December
31, 2001, the investment portfolio, consisting of short-term investments,
investment securities, mortgage-backed securities, stock in the Federal Home
Loan Bank of Boston and stock of the Savings Bank Life Insurance Company of
Massachusetts, totaled $427.0 million, or 26.8% of total assets.
Interest and dividend income on the investment portfolio generated
24.3% of total interest and dividend income for the year ended December 31,
2001. See Item 7 - “Management’s
Discussion and Analysis of Financial Condition and Results of Operations -
Financial Condition - Investments” for further information regarding the
investment portfolio.
The Bank’s investment strategy seeks to provide liquidity and realize
current income while preserving principal.
The Bank will generally invest only in government or corporate bonds or
securities issued in the United States and will only purchase bonds which are
rated A or higher at the time of purchase.
DEPOSITS
The Bank offers a range of deposit accounts including regular and
passbook savings, NOW, money market and demand deposit accounts. The Bank offers a number of relationship
products that allow customers to combine balances in checking and savings
accounts in order to avoid service and maintenance fees, and obtain free
banking services. These relationship
products also include discounts on installment loans and bonus rates on
certificates of deposit. The Bank also
offers term deposit certificates ranging from 32 days to seven years. Interest rates on these certificates vary
according to the term selected. From
time to time, the Bank promotes various types of accounts with the intention of
changing the maturity schedule of its liabilities. See Item 7 - “Management’s Discussion and Analysis of Financial
Condition and Results of Operations - Deposits.”
The Bank offers its retail banking customers a wide range of deposit
services and the convenience of drive-up ATMs. The Bank is a member of the
NYCE™, EXCHANGE™, TX™, and CIRRUS™ networks.
These networks allow the Bank’s depositors access to their accounts
through ATMs at the Bank, other banks and locations nationwide and worldwide.
COMPETITION
The Bank faces competition both in originating loans and in attracting
deposits. Competition in originating
loans comes from a variety of sources, including, but not limited to, other
financial institutions, mortgage companies, insurance companies and consumer
and commercial finance companies. The
Bank competes for loans principally on the basis of interest rates and loan
fees, the types and terms of loans originated and the quality of service
provided to borrowers. In attracting
deposits, the primary competitors are other financial institutions and mutual
funds. The ability to attract and
retain deposits depends on the ability to provide investment opportunities that
satisfy the requirements of investors with respect to rate of return,
liquidity, risk, service, convenience and other factors.
The Bank competes for deposits on the basis of interest rates and by
offering convenient branch locations, extended business hours and an automated
teller network.
EMPLOYEES
At December 31, 2001, the Bank had 319 full time equivalent
employees. None of the employees of the
Bank are represented by a collective bargaining group and management considers
its relationship with its employees to be good.
ITEM 2.
ITEM 2. PROPERTIES
The following table sets forth certain information relating to
properties owned or used in banking activities at December 31, 2001:
(1) This
site also serves as a branch location.
(2) Includes
two contiguous buildings at 284 Essex Street and 286-288 Essex Street which
were acquired in 1972 and 1980, respectively, as well as an adjacent parking
lot at 7 Lawrence Street which was acquired in 1981.
(3) Building
is owned and the land is leased.
(4) Second
floor of building is subleased to a third party for a three year term,
commencing on November 1, 2000 and terminating on October 31, 2003. There is an option to renew for two
additional 3 year terms.
(5) Second
floor of building is subleased to a third party for a five year term,
commencing June 1, 2001 and terminating on May 31, 2006. There is an option to renew for one
additional 5 year term.
(6) 4,000
sf of an adjacent parking lot is leased for a twenty year term, commencing
September 1, 1996 and terminating on August 31, 2016.
(7) Rear
of building is subleased to a third party for a two year term, commencing January
1, 2000 and terminating on December 31, 2002.
(8) Lease
includes 8,750 sf adjacent lot used for drive up lanes.
Management believes that the Company’s existing facilities are adequate
for the conduct of its business.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company is involved in various legal proceedings incident to its
business, none of which are believed by management to be material to the
financial condition or operations of the Company.
ITEM
4.
ITEM
4. SUBMISSION OF MATTERS TO A VOTE OF
SECURITY HOLDERS
There were no matters submitted to a vote of the shareholders during
the fourth quarter of 2001.
PART II
ITEM
5.
ITEM
5. MARKET FOR THE REGISTRANT’S EQUITY
AND RELATED STOCKHOLDERS MATTERS
First Essex Bancorp, Inc. common stock is traded over-the-counter on
the Nasdaq National Market System under the symbol FESX.
At December 31, 2001, there were 7,533,744 shares outstanding and
approximately 1,100 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.
The price information regarding the Company’s common stock in the
following table is based on high and low closing sale prices.
The only funds available to the Company for the payment of dividends
are cash and cash equivalents held at the holding company level, dividends from
the Bank and borrowings. In addition,
bank regulatory authorities generally restrict the amounts available for the
payment of dividends by the Bank to the Company to the net profit of the Bank
for that year, see Item 1 - “Business - Regulation - Limitation on Capital
Distributions”. The Federal Reserve Act
also restricts the Bank in lending or advancing funds to the Company unless
such loans are collateralized by specific obligations, and limits
collateralized loans to 10% of the Bank’s capital stock and surplus.
The Bank is prohibited from paying cash dividends, to the extent that
any such payment would reduce its capital below required regulatory capital
levels or would impair the liquidation account established in connection with
its conversion from mutual to stock form.
See Item 1. “Business -
Regulation - Limitation on Capital Distributions” and Note 16 to the
consolidated financial statements included in response to Item 8 - “Financial
Statements and Supplementary Data” of this report for further discussion.
The payment of dividends by the Bank could carry significant adverse
tax consequences. To the extent that
distributions by the Bank to the holding company exceed the Bank’s current and
accumulated earnings and profits (as computed for federal income tax purposes
for taxable years beginning after December 31, 1951), those distributions would
be treated for tax purposes as first being made out of the Bank’s bad debt
reserve. In that case, the Bank would
have federal taxable income equal to approximately one and one-half times the
amount of the actual shareholder distribution that is treated as made out of
the Bank’s bad debt reserves.
ITEM
6.
ITEM
6. SELECTED FINANCIAL DATA
(1) Includes
loans for sale.
(2) Investment
securities include U.S. government and agency obligations, mortgage-based
securities, other bonds and obligations, stock in the Federal Home Loan Bank of
Boston and stock in the Savings Bank Life Insurance Company.
ITEM
7.
ITEM
7. MANAGEMENT’S DISCUSSION AND ANALYSIS
OF FINANCIAL
CONDITION
AND RESULTS OF OPERATIONS
RESULTS
OF OPERATIONS
General
The results of operations of the Company consist primarily of the
results of operations of the Bank, which is the Company’s principal
subsidiary. Net income for the year
ended December 31, 2001 totaled $16.9 million (or $2.18 per diluted share)
compared to $14.5 million (or $1.90 per diluted share) for the same period in
2000, an increase of 16.5% or $2.4 million.
The improvement was primarily due to increases in net interest income
and noninterest income, partially offset by higher provisions for loan losses
and increases in noninterest expenses.
Analysis of Average Yields Earned and
Rates Paid
The following table presents an analysis of average yields earned and
rates paid for the years indicated:
(1) Loans on a non-accrued status and loans held for sale are included
in the average balance.
(2) Net interest income before provision for loan losses divided by
average interest earning assets.
Rate/Volume Analysis
The following table presents, for the periods indicated, the changes in
interest and dividend income and the changes in interest expense attributable
to changes in interest rates and changes in the volume of interest earning
assets and interest bearing liabilities.
The change attributable to both volume and rate has been allocated
proportionally to the two categories.
Net Interest Income
Net interest income increased by $6.9 million to $58.6 million for the
year ended December 31, 2001, representing a 13.4% increase from $51.6 million
in 2000. The increase in net interest
income was due primarily to an increase in outstanding loans, combined with an
increase in the net yield on average earning assets.
Net interest income increased by $5.1 million to $51.6 million for the
year ended December 31, 2000, representing a 10.9% increase from $46.6 million
in 1999. The increase in net interest
income was due primarily to a volume increase in outstanding loans, combined
with an increase in the net yield on average earning assets.
Interest and Dividend Income
Interest and dividend income increased by $4.0 million (3.6%) to $115.6
million for the year ended December 31, 2001 from $111.6 million for the year
ended December 31, 2000. This increase
was primarily due to a $137.8 million or 10.1% increase in average earning
assets from $1,368.6 million in 2000 to $1,506.4 million in 2001. Offsetting this increase was a decrease in
the average yield on earning assets to 7.68% for the year ended December 31,
2001 as compared to 8.15% for the comparable period of 2000.
Interest and dividend income increased by $14.9 million (15.4%) to
$111.6 million for the year ended December 31, 2000 from $96.7 million for the
year ended December 31, 1999. This
increase was due to a $114.2 million or 9.1% increase in average earning assets
from $1,254.5 million in 1999 to $1,368.6 million in 2000 as well as an
increase in the average yield on earning assets, which was 8.15% for the year
ended December 31, 2000 as compared to 7.71% for the comparable period of 1999.
Interest Expense
Interest expense decreased $2.9 million or 4.8% to $57.1 million for
the year ended December 31, 2001 from $60.0 million in 2000. This decrease is attributable to a decrease
of 52 basis points in the average cost of funds from 4.89% in 2000 to 4.37% in
2001, offset by an increase in average interest bearing liabilities of $80.3
million during 2001.
Interest expense increased $9.8 million or 19.5% to $60.0 million for
the year ended December 31, 2000 from $50.2 million in 1999. The increase is primarily attributable to an
increase of $102.5 million in the average balance of deposits combined with an
increase of 42 basis points in the average cost of funds from 4.47% in 1999 to
4.89% in 2000.
Provision for Loan Losses
Losses on loans are provided for under the accrual method of
accounting. The determination of the
adequacy of the allowance for loan losses is based upon management’s assessment
of risk elements in the portfolio, factors affecting loan quality and
assumptions about the economic environment in which the Company operates. The process includes identification and
analysis of loss potential in various portfolio segments utilizing a credit
risk grading process and specific reviews and evaluations of significant
individual problem credits. In
addition, management reviews overall portfolio quality through an analysis of
current levels and trends in charge-off, delinquency and nonaccruing loan data,
collateral values, economic conditions and their effect on borrowers, and the
overall-banking environment. See
“Financial Condition - Allowance for Loan Losses”. Ultimate losses may vary significantly from the current estimates. Losses on loans, including impaired loans, are charged against
the allowance when management believes the collectability of principal is
doubtful.
Provisions for loan losses totaled $5.1 million, $3.7 million, and $2.4
million for the years ended December 31, 2001, 2000 and 1999 respectively. The increase in the provision for loan
losses for 2001 compared to 2000 was primarily due to $1.0 million of
charge-offs on two unrelated commercial credits, and to provide for the growth
in the loan portfolio. Provisions
result from management’s continuing internal review of the loan portfolio as
well as its judgment as to the adequacy of the reserves in light of the
condition of the regional real estate market and the economy generally. As a result of increased loans, there is an
expectation that the Bank will continue to find it necessary to make provisions
for loan losses in the future. See
“Financial Condition - Non-Performing Assets”.
The Bank’s total allowance for loan losses was $12.8 million or 304.3%
of non-accruing loans at December 31, 2001 compared to $12.7 million or 483.5%
at December 31, 2000 and $11.3 million or 331.1% at December 31, 1999.
Noninterest Income
Noninterest income consists of net gains from sales of securities, net
gains from sales of loans and loan servicing rights, fee and other noninterest
income.
Noninterest income increased $1.1 million (13.6%) to $8.9 million for
the year ended December 31, 2001 compared to $7.8 million in 2000. The increase is primarily attributable to an
increase in fee income associated with loans and deposits.
Noninterest income increased $1.7 million (28.2%) to $7.8 million for
the year ended December 31, 2000 compared to $6.1 million in 1999. The primary reasons for the increase are
increases in fee income and to a lesser extent income from bank owned life
insurance policies purchased during the third quarter of 1999.
Noninterest Expenses
Noninterest expenses increased by $2.0 million (6.4%) to $33.8 million
for the year ended December 31, 2001 compared to $31.7 million in 2000. The majority of this increase is
attributable to higher salary and benefit costs.
Salaries and employee benefits increased by $1.5 million (9.7%) to
$16.9 million for the year ended December 31, 2001 from $15.4 million in
2000. Salaries increased $1.3 million
or 8.9% while benefits and other personnel costs increased $245 thousand or
18.5% as compared to 2000. At December
31, 2001 the Bank had 319 full-time equivalent
employees as compared to 311 at December 31, 2000. The increase in benefit costs are primarily
due to higher pension costs and medical insurance premiums.
All other operating expenses increased $552,000 (3.4%) to $16.9 million
for the year ended December 31, 2001 as compared to $16.3 million in 2000.
Minority interest expense increased $722,000 or 83.2% to $1.6 million
in 2001 as compared to $868,000 in 2000 attributable to the issuance of $15
million in additional trust preferred securities during the third quarter of
2001.
Noninterest expenses increased by $1.7 million (5.6%) to $31.7 million
for the year ended December 31, 2000 compared to $30.1 million in 1999. The majority of this increase is attributable
to higher salary and benefit costs.
Salaries and employee benefits increased by $1.4 million (9.9%) to
$15.4 million for the year ended December 31, 2000 from $14.1 million in 1999
and $13.0 million in 1998. The
increases were primarily attributable to higher salary and benefit costs,
including $600 thousand related to a change in the estimate of certain pension
benefits in the fourth quarter of 2000.
Income Taxes
The provision for income taxes amounted to $10.1 million in 2001
compared to provisions of $8.7 million and $7.5 million recorded in 2000 and
1999, respectively. The effective tax
rate in 2001 is comparable to the effective tax rates for 2000 and 1999. The effective rate differs from the
statutory rate primarily as a result of the amortization of goodwill and state
taxes.
FINANCIAL
CONDITION
Total assets increased by $71.4 million or 4.7% to $1.6 billion at
December 31, 2001 compared to $1.5 billion at
December 31, 2000.
Loans
At December 31, 2001, the loan portfolio, excluding the allowance for
loan losses, and including mortgage loans held-for-sale, was $1,053 million,
representing 66.1% of total assets.
This is an increase of $82.8 million or 8.5% when compared to $970.4
million or 63.8% of total assets at December 31, 2000. See Item 1 - “Business - Lending Activities
- General” for a table setting forth the composition of the loan portfolio of
the Bank at the end of each of the past five years.
Nonperforming Assets
Nonperforming assets consist of nonaccruing and restructured loans (including
impaired loans), and foreclosed property. Nonperforming assets totaled $4.6
million at December 31, 2001, compared to $2.6 million at December 31, 2000 and
$3.9 million at December 31, 1999.
The Bank’s general practice is to discontinue the accrual of interest
on loans (including impaired loans) for which payment of interest or principal
is ninety days or more past due or for such other loans as considered necessary
by management if collection of interest and principal is doubtful. When a loan is placed on nonaccrual status,
all previously accrued but uncollected interest is reversed against current
period interest income.
There were no restructured loans at December 31, 2001 and 2000 compared
to a recorded investment in restructured loans of $303,000 for the year ended December 31, 1999.
The amount of interest that would have been earned had the nonaccrual
and restructured loans performed in accordance with original terms and
conditions was $458,000, $103,000 and $164,000 for the years ended December 31,
2001, 2000 and 1999, respectively.
Foreclosed property at December 31, 2001 totaled $417,000 compared to
$3,000 at December 31, 2000, and primarily consisted of repossessed
automobiles.
At December 31, 2001, the recorded investment in loans that are
considered to be impaired totaled $948,000 with a related allowance for loan
losses of $181,000. The average
recorded investment in impaired loans during 2001 was approximately $225,000.
The following table shows the composition of nonperforming assets for
the five years ended December 31, 2001:
The following table summarizes the activity of foreclosed property
during the year ended December 31, 2001:
Allowance for Loan Losses
The allowance for loan losses is maintained at a level determined by
management to be adequate to provide for probable losses inherent in the loan
portfolio. The allowance for loan
losses is maintained through the provision for loan losses, which is a charge
to operations. The potential for loss
in the portfolio reflects the risks and uncertainties inherent in the extension
of credit.
The determination of the adequacy of the allowance for loan losses is
based upon management’s assessment of risk elements in the portfolio, factors
affecting loan quality and assumptions about the economic environment in which
the Company operates. The process
includes identification and analysis of loss potential in various portfolio
segments
utilizing a credit risk grading process and specific reviews and
evaluations of significant individual problem credits. In addition, management reviews overall
portfolio quality through an analysis of current levels and trends in
charge-off, delinquency and nonaccruing loan data, collateral values, economic
conditions and their effect on borrowers, and the overall-banking environment. These reviews are of necessity dependent
upon estimates, appraisals and judgements, which may change quickly because of
changing economic conditions and the Company’s perception as to how these
factors may affect the financial condition of debtors.
The methodology for assessing the appropriateness of the allowance
consists of a review of the following key elements:
• a formula allowance for the various loan
portfolio classifications,
• a valuation allowance for loans
identified as impaired, and
• a nonspecific allowance.
The formula allowance is a percentage-based reflection of historical
loss experience and assigns required allowance allocations by loan
classification based on an estimated percentage of all outstanding loan
balances. The formula allowance employs
a risk-rating model that grades loans based on general characteristics of
credit quality and relative risk. As
credit quality becomes more suspect, so-called “watch list” loans, the risk
rating and allocation percentage increase.
The sum of these allocations comprise the Company’s “formula” or
“general” allowance.
The Company also has “valuation” allowances for impaired loans. Loans are evaluated for impairment by
measuring the net present value of the expected future cash flows using the
loan’s original effective interest rate, or looking at the fair value of the
collateral if the loan is collateral dependent. When the difference between the net present value of a loan (of
fair value of the collateral if the loan is collateral dependent) is lower than
the recorded investment of the loan, the difference is reflected with a
resulting “valuation” allowance.
In addition to the formula and valuation components, there is a
nonspecific allowance component that takes into consideration the imprecise
nature of the loan loss estimation process and various other factors as
discussed below. Based on the Company’s
credit policy, this component consists of an amount that is approximately 20%
to 30% of the total of the formula and valuation allowances in recognition of
the inherent subjectivity and imprecise nature of the loan loss estimation
process. This component’s adequacy is
also based upon management’s evaluation of various factors, the effects of
which are not directly measured in determining the formula and valuation allowances. The evaluation of the inherent loss
resulting from these factors involves a higher degree of uncertainty because
they are not identified with specific problem credits or portfolio segments. The factors evaluated in connection with the
nonspecific allowance include the following:
• then-existing
general economic and business conditions affecting the Company’s key lending
areas,
• credit
quality trends, including trends in nonperforming loans expected to result from
existing conditions,
• collateral
values,
• loan
volumes and concentrations,
• seasoning
of the loan portfolio,
• specific
industry conditions within portfolio segments,
• recent
loss experience in particular segments of the portfolio,
• duration
of the current business cycle,
• bank
regulatory examination results, and
• findings
of our internal credit examiners.
When an evaluation of these conditions signifies a change in the level
of risk, the Company adjusts the formula allowance. Periodic credit reviews enable further adjustment to the
allowance through the risk rating of loans and identification of loans
requiring a valuation allowance. In
addition, the formula model is designed to be self-correcting by taking into
account recent loss experience.
The annual provision for loan losses is set based on the aforementioned
factors. The allowance to loans ratio
of 1.21% at December 31, 2001 was below the Company’s peer group’s average
allowance ratio of 1.30% (1). Although
the Company realized total loan growth of $82.8 million or 8.5% during 2001,
there were no significant changes in loan concentrations, loan quality or loan
terms during the period. Estimation
methods and assumptions affecting the allowance for loan losses remained
unchanged from those used in prior periods.
There was no significant reallocation of the allowance for loan losses
among the various segments of the portfolio.
The following table summarizes the activity in the allowance for loan
losses for the five years ended December 31, 2001:
(1) Based on the
most recently available peer group data as of September 30, 2001.
* Includes loans
held for sale.
Investments
At December 31, 2001, the Company’s investment portfolio, consisting of
short-term investments, investment securities, mortgage-backed securities,
Federal Home Loan Bank (“FHLB”) stock and Savings Bank Life Insurance Company
of Massachusetts stock, totaled $427.0 million or 26.8% of assets, compared to
$456.3 million or 30.0% of assets at December 31, 2000. The portfolio included U.S. government and
agency obligations having a book value of $71.6 million and mortgage-backed
securities with a book value of $328.9 million. Interest and dividend income on the Company’s investment
portfolio, which amounted to $28.1 million, generated 24.3% of total interest
and dividend income for the year ended December 31, 2001.
To identify and control risks associated with the investment portfolio,
the Company has established policies and procedures, which include stop loss limits
and stress testing on a periodic basis.
During the second quarter of 1998, the Company reclassified to
available-for-sale all securities previously classified as held-to-maturity. This reclassification was the result of an
analysis of the strategic alternatives for the securities portfolio. Under Securities and Exchange Commission
guidelines, this reclassification prohibits the Company from classifying
securities as held-to-maturity for a
period of at least two years.
The Company does not have any investments in off-balance-sheet
financial instruments, except as noted in Note 11 to the consolidated financial
statements included in response to Item 8 - “Financial Statements and
Supplementary Data” of this report.
The following table sets forth the composition of the investment
portfolio for the years indicated:
For further information regarding the Company’s investment portfolio,
including information regarding amortized cost and fair value as of December 31,
2001, see notes 1, 3 and 19 to the Company’s consolidated financial statements
included in response to Item 8 hereof.
Set forth below is a breakdown of yields and contractual maturities for
the amortized cost of indicated investment
securities at December 31, 2001:
Deposits
Deposits have historically been the Bank’s primary source of funds for
lending and investment activities.
Deposit flows vary significantly and are influenced by prevailing
interest rates, market conditions, economic conditions and competition. At December 31, 2001 the Bank had total
deposits of $1,217.2 million, representing a net increase of $89.6 million or
8.0% compared to $1,127.5 million at December 31, 2000.
While deposit flows are unpredictable by nature, the Bank attempts to
manage its deposits through selective pricing.
Due to the uncertainty of market conditions, it is not possible for the
Bank to predict how aggressively it will compete for deposits in the future or
the likely effect of any such decision on deposit levels, interest expense and
net interest income.
The following table sets forth the composition of average deposits and
rates for the years indicated:
Borrowed Funds
The primary source of the Bank’s borrowings is the Federal Home Loan
Bank (“FHLB”). The Bank also utilizes
other short-term borrowings, generally with maturities of less than three months,
as an additional source of funds. These
other short-term borrowings are secured by U.S. government and agency
securities. Borrowings are an
alternative source of funds compared to deposits and totaled $206.3 million at
December 31, 2001 compared to $267.4 million and $269.0 million at December 31,
2000 and 1999, respectively. Although
the loan portfolio has continued to show growth during 2001 and 2000, the need
to borrow funds was diminished by the continued growth in deposits and the
decrease in the investment portfolio.
The following table summarizes the maximum and average amounts of
borrowings outstanding, the majority of which are short term, during 2001, 2000
and 1999 together with the weighted average interest rates thereon:
ITEM
7A.
ITEM
7A. QUANTITATIVE AND QUALITATIVE
DISCLOSURES ABOUT MARKET RISK
ASSET/LIABILITY
MANAGEMENT
The Bank’s asset/liability management strategy is designed to increase
net interest income and provide adequate earnings in expected future interest
rate environments. As part of this
strategy, a balance is sought between the repricing characteristics of its earning
assets and funding sources while maximizing the spread between interest income
and expense. The Bank adjusts the level
of its liquid assets and the mix of its loans and investments based on
management’s judgment as to the quality of specific investment opportunities
and the relative attractiveness of their maturities and yields.
In order to achieve a better repricing balance between its assets and
liabilities, the Bank continued to originate and hold in portfolio adjustable
rate residential mortgage loans. The
Bank generally writes substantially all newly originated fixed rate residential
loans to meet the requirements for sale in the secondary market. During 2001, the Bank originated $90.0
million and sold $87.6 million of these residential loans. As a result of this strategy, residential
loans decreased by $33.8 million during the year.
The Bank’s commercial real estate, construction, consumer, aircraft and
commercial business lending programs also provide opportunities to better match
the interest rate sensitivity of its loan portfolio and liabilities due to the
adjustable rate or short term characteristics of these types of loans. These types of loans increased by $116.5
million during the year. Total loans increased by $82.8 million during the
year.
During 2001, funds provided by a $38.8 million decrease in investments
and an $89.6 million increase in deposits were used to fund the growth in the
loan portfolio and to repay borrowings, which decreased by $61.1 million.
As stated above, deposits increased by $89.6 million in 2001. The Bank maintains an aggressive marketing
campaign for savings and time deposit products, which resulted in the increase
in the balances of these products during 2001.
It is management’s opinion that interest rates will continue to exhibit
volatility. With this in mind, the Bank
will continue to follow a strategy that seeks to achieve a balance in the
repricing characteristics of its assets and liabilities and provide adequate
earnings in a variety of interest rate environments.
MARKET
RISK
Market risk is the risk of loss in a financial instrument arising from
adverse changes in market rates/prices such as interest rates, foreign currency
exchange rates, commodity prices and equity prices. The Company’s primary market risk exposure is interest rate
risk. The ongoing monitoring and
management of this risk is an important component of the Company’s
asset/liability management process which is governed by policies established by
its Board of Directors that are reviewed and approved annually. The Board of Directors delegates
responsibility for carrying out the asset/liability management policies to the
Asset/Liability Committee (“ALCO”). In
this capacity ALCO develops guidelines and strategies impacting the Company’s
asset/liability management related activities based upon estimated market risk
sensitivity, policy limits and overall market interest rate levels/trends.
Interest Rate Risk
Interest rate risk represents the sensitivity of earnings to changes in
market interest rates. As interest
rates change, the interest income and expense streams associated with the
Company’s financial instruments also change thereby impacting net interest
income (NII), the primary component of the Company’s earnings. ALCO utilizes the results of a detailed and
dynamic simulation model to quantify the estimated exposure of NII to sustained
interest rate changes. While ALCO
routinely monitors simulated NII sensitivity over a rolling two-year horizon,
it also utilizes additional tools to monitor potential longer-term interest
rate risk.
The simulation model captures the impact of changing interest rates and
the interest income received and interest expense paid on all assets and liabilities
reflected on the Company’s balance sheet.
This sensitivity analysis is compared to ALCO policy limits which
specify a maximum tolerance level for NII exposure over a one year horizon,
assuming no balance sheet growth, given both a 200 basis point (bp) upward and
downward shift in interest rates. A
parallel and pro rata shift in rates over a 12-month period is assumed. The following reflects the Company’s NII
sensitivity analysis as of December 31, 2001, which are well within ALCO policy
limits:
The preceding sensitivity analysis does not represent a Company
forecast and should not be relied upon as being indicative of expected
operating results. These hypothetical
estimates are based upon numerous assumptions including: the nature and timing
of interest rate levels including yield curve shape, prepayments on loan and
securities, deposit decay rates, pricing decisions on loans and deposits,
reinvestment/replacement of asset and liability cashflows, and others. While assumptions are developed based upon
current economic and local market conditions, the Company cannot make any
assurances as to the predictive nature of these assumptions including how a
customer preferences of competitor influences might change.
Also, as market conditions vary from those assumed in the sensitivity
analysis, actual results will also differ due to: prepayment/refinancing levels
likely deviating from those assumed, the varying impact of interest rate change
caps or floors on adjustable rate assets, the potential effect of changing debt
service levels on customers with adjustable rate loans, depositor early
withdrawals and product preference changes, and other internal/external
variables. Furthermore, the sensitivity
analysis does not reflect actions that ALCO might take in responding to or
anticipating changes in interest rates.
The following table sets forth the maturity and repricing information
relating to sensitive assets and liabilities at December 31, 2001. Fixed-rate investment securities, fixed rate
mortgage-backed investments, fixed rate loans, loans held for sale, short-term
investments, and other earning assets are shown in the table in the time period
corresponding to computed principal amortization based on their respective contractual
maturity. Adjustable rate investment
securities, adjustable rate mortgage-backed investments, and adjustable rate
loans are allocated to the period in which the rates are next adjusted. The table reflects an “expected” prepayment
assumption on residential loans and mortgage-backed investments. Certificates of deposit and borrowed funds
are shown in the table in the time period based on their respective contractual
maturity. Money market deposit accounts
and anniversary savings accounts are not subject to contractual interest rate
adjustments, however, these products are generally more interest rate sensitive
and are assumed to reprice within the 1-180 day time period. Regular savings and NOW accounts (“other
deposits”) are assumed to reprice within the 5 years + period. These deposit products are not subject to
contractual interest rate adjustments either, however, the Bank believes that these
deposits are less interest rate sensitive over long periods of time.
The following table reflects the scheduled maturities of selected loans
at December 31, 2001:
A summary of the above
categories of loans due after one year as to the rate variability follows
(dollars in thousands):
LIQUIDITY
AND CAPITAL RESOURCES
The Bank’s principal sources of liquidity are customer deposits,
borrowings from the FHLB, other short-term borrowings, scheduled amortization
and prepayments of loan principal, cash flow from operations, maturities and
prepayments of various investments and loan sales.
Management believes it is prudent to maintain an investment portfolio
that not only provides a source of income, but also provides a potential source
of liquidity to meet lending demand and deposit flows. The Bank adjusts the level of its liquid
assets and the mix of its loans and investments based upon management’s
judgment as to the quality of specific investment opportunities and the
relative attractiveness of their maturities and yields. At December 31, 2001, short-term
investments, bonds and obligations and mortgage-backed investments totaled
$427.0 million, 25.3% of which either matures or is estimated to be prepaid
within one year. At December 31, 2000,
short-term investments, bonds and obligations and mortgage backed investments
totaled $456.3 million, 18.1% of which matured or were estimated to be prepaid
within one year.
At December 31, 2001, the Bank had total outstanding borrowings of
$206.3 million, 17.3% of which matures within one year. At year-end 2000, the Bank had outstanding
borrowings of $267.4 million, 99% of which matured within one year.
At December 31, 2001, the Bank had outstanding commitments to originate
loans and unused balances on existing loans totaling $166.7 million, compared
to $163.8 million in 2000. Management
believes the sources of liquidity previously
discussed are sufficient to meet its commitments.
Net cash provided by operating activities totaled $25.7 million in 2001
compared to net cash provided of $11.5 million in 2000. The increase in net cash provided was
primarily due to an increase in tax liabilities, a decrease in accrued interest
receivable and an increase in net income, offset by an increase in cash used
for residential loan sale activities.
Net cash provided by operating activities totaled $11.5 million in 2000
compared to $25.8 million provided in 1999.
Net income was $14.5 million compared to net income of $12.7 million for
the respective periods. Provisions for
loan losses recorded in 2000 totaled $3.7 million compared to $2.4 million in
1999.
Net cash used in investing activities totaled $39.9 million for the
year ended December 31, 2001 compared to $147.2 million in 2000 and net cash
used of $205.3 million in 1999. The
2001 decrease in net cash used in investing activities compared to 2000 was
primarily attributable to a reduction in loan originations and purchases, an
increase in proceeds from maturities
and principal payments of available for sale securities, offset by an increase
in purchases of available for sale securities.
The 2000 decrease in net cash used in investing activities compared to
1999 was primarily attributable to a reduction of purchases in investment
securities partially offset by increased loan originations and purchases, and a
reduction in proceeds from the sales, maturities and principal repayments of
available for sale securities.
Net cash provided by financing activities totaled $39.6 million for the
year ended December 31, 2001 compared to net cash provided of $122.9 million in
2000, and net cash provided of $130.7 million in 1999. The decrease in 2001 compared to 2000 is
primarily attributable to net decreases in deposits and borrowings, offset by
an increase in proceeds from the issuance of trust preferred securities. Net cash provided by financing activities
also decreased in 2000 when compared to 1999.
This decrease is primarily attributable to decreased net borrowing
activity, offset by increases in net deposits and proceeds from the issuance of
trust preferred securities.
As of December 31, 2001, the Bank is in compliance with and exceeds
Federal regulatory capital requirements.
The minimum standards are (i) a total risk-based capital ratio of 8%,
(ii) a Tier I risk-based capital ratio of 4% or (iii) a Tier I leverage capital
ratio of 4%.
IMPACT
OF INFLATION
The financial statements and related data presented herein have been
prepared in accordance with generally accepted accounting principles which
require measurements of financial position and operating results in terms of
historical dollars without considering changes in the relative purchasing power
of money over time due to inflation.
An important concept in understanding the effect of inflation on
financial institutions is the distinction between monetary and nonmonetary
items. In a stable environment,
monetary items are those assets and liabilities that are or will be converted
into a fixed amount of dollars regardless of changes in prices. Examples of monetary items include cash,
investment securities, loans, deposits and borrowings. Nonmonetary items are those assets and
liabilities that gain or lose general purchasing power as a result of the
relationships between specific prices for the items and price change levels.
Examples of nonmonetary items include premises and equipment and real estate in
foreclosure. If real estate values
decrease sharply, the deflationary impact of changing prices of real estate
securing loans foreclosed upon could significantly affect a financial
institution’s performance.
Additionally, interest rates do not necessarily move in the same
direction, or in the same magnitude, as the prices of goods and services as
measured by the consumer price index.
In a volatile interest rate environment, liquidity and the management of
the maturity structure of assets and liabilities are critical in maintaining
acceptable profitability levels.
ITEM
8.
ITEM
8. FINANCIAL STATEMENTS AND
SUPPLEMENTARY DATA
REPORT
OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors and Stockholders of
FIRST ESSEX BANCORP, INC.:
We have audited the accompanying consolidated balance sheets of First
Essex Bancorp, Inc. and subsidiaries (the “Company”) as of December 31, 2001
and 2000, and the related consolidated statements of operations, stockholders’
equity and cash flows for each of the three years in the period ended December
31, 2001. These financial statements are the responsibility of the Company’s
management. Our responsibility is to
express an opinion on these 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 consolidated 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 financial statements referred to above present
fairly, in all material respects, the financial position of First Essex
Bancorp, Inc. and subsidiaries as of December 31, 2001 and 2000, and the
results of their operations and their cash flows for each of the three years in
the period ended December 31, 2001, in conformity with accounting principles
generally accepted in the United States.
ARTHUR ANDERSEN LLP
Boston, Massachusetts
January 18, 2002
FIRST
ESSEX BANCORP, INC.
CONSOLIDATED
BALANCE SHEETS
The accompanying
notes are an integral part of these consolidated financial statements.
FIRST
ESSEX BANCORP, INC.
CONSOLIDATED
STATEMENTS OF OPERATIONS
The accompanying notes are an integral part of these consolidated
financial statements.
FIRST
ESSEX BANCORP, INC.
CONSOLIDATED
STATEMENTS OF STOCKHOLDERS’ EQUITY
The accompanying notes are an integral part of these consolidated
financial statements.
FIRST
ESSEX BANCORP, INC.
CONSOLIDATED
STATEMENTS OF CASH FLOWS
The accompanying notes are an integral part of these consolidated
financial statements.
FIRST
ESSEX BANCORP, INC.
NOTES TO
CONSOLIDATED FINANCIAL STATEMENTS
December
31, 2001
1.
SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
PRINCIPLES
OF CONSOLIDATION
The consolidated financial statements include the accounts of First
Essex Bancorp, Inc. (“the Company”), and its
subsidiaries, First Essex Bank, (“the Bank”), First Essex Capital Trust
I and First Essex Capital Statutory Trust II.
All significant intercompany balances have been eliminated in
consolidation.
USE OF
ESTIMATES IN PREPARATION OF FINANCIAL STATEMENTS
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosures of contingent assets and liabilities as of the date of the
financial statements and the reported amounts of income and expenses during the
reporting periods. Operating results in
the future could vary from the amounts derived from management’s estimates and
assumptions.
INVESTMENT
SECURITIES
Investments in debt securities may be classified as held-to maturity
and measured at amortized cost only if the Company has the positive intent and
ability to hold such securities to maturity.
Investments in debt securities that are not classified as
held-to-maturity and equity securities that have readily determinable fair
values are classified as trading securities or available-for-sale
securities. Trading securities are
investments purchased and held principally for the purpose of selling in the
near term; available-for-sale securities are investments not classified as
trading or held-to-maturity. Unrealized
holding gains and losses for trading securities are included in earnings;
unrealized holding gains and losses for available-for-sale securities are
reported in comprehensive income and as a separate component of stockholders’
equity.
Declines in the fair value of held to maturity and available for sale
securities below their cost that are deemed to be other than temporary are
reflected in earnings as realized losses.
The Company evaluates individual securities that have fair values below
cost for six months or longer to determine if the decline in fair value is
other than temporary.
Dividend and interest income, including amortization of premiums and
discounts, is included in earnings for all categories of investment
securities. Discounts and premiums
related to debt securities are amortized using a method that approximates the
level-yield method, adjusted for estimated prepayments in the case of
mortgage-backed securities. Realized gains and losses on security transactions
are computed using the specific identification method.
LOANS
RECEIVABLE
Loans are stated at the amount of unpaid principal, net of the
allowance for loan losses, unearned discounts and unearned net loan origination
fees. Loan origination fees, discounts
and certain direct loan origination costs are deferred and amortized as an
adjustment to the related loan yield over the contractual life of the
loan. When loans are sold or fully
repaid, the unamortized fees, discounts and costs are recognized in income.
Interest on loans is included in income as earned based upon interest
rates applied to unpaid principal.
Interest is not accrued on loans 90 days or greater past due or on other
loans when management believes collection is doubtful. Loans considered impaired, as defined below,
are nonaccruing. When a loan is placed
on nonaccrual status, all interest previously accrued is reversed against
current-period interest income.
A loan is impaired when, based on current information and events, it is
probable that the Bank will be unable to collect all amounts due in accordance
with the contractual terms of the loan agreement. All loans are individually evaluated for impairment, except for
smaller balance homogeneous residential and consumer loans which are evaluated
in aggregate, according to the Bank’s normal loan review process, including
overall credit evaluation, nonaccrual status and payment experience. Loans identified as impaired are further
evaluated to determine the estimated extent of impairment.
Impaired loans are measured based on the present value of expected
future cash flows discounted at each loan’s effective interest rate or, as a
practical expedient, at each loan’s observable market price or the fair value
of the collateral if the loan is collateral-dependent. For collateral-based loans, the extent of
impairment is the shortfall, if any, between the collateral value, less costs
to dispose of such collateral, and the carrying value of the loan.
The allowance for loan losses is based on management’s estimate of the
amount required to reflect the risks in the loan portfolio, based on
circumstances and conditions known or anticipated at each reporting date. The methodology for assessing the appropriateness
of the allowance consists of a review of the following three key elements:
• a formula allowance for the various loan
portfolio classifications,
• a valuation allowance for loans identified
as impaired, and
• a nonspecific allowance.
The formula allowance is a percentage-based reflection of historical
loss experience and assigns required allowance allocations by loan
classification based on an estimated percentage of all outstanding loan
balances. The formula allowance employs
a risk-rating model that grades loans based on general characteristics of
credit quality and relative risk. As
credit quality becomes more suspect, so-called “watch list” loans, the risk
rating and allocation percentage increase.
The sum of these allocations comprise the Company’s “formula” or
“general” allowance.
The Company also has “valuation” allowances for impaired loans. When impaired loans are evaluated, if the
difference between the net present value of the impaired loan (or fair value of
the collateral if the loan is collateral-dependent) is lower than the recorded
investment of the loan, the shortfall is reflected with a resulting “valuation”
allowance.
In addition to the formula and valuation components, there is a
nonspecific allowance component that takes into consideration the imprecise
nature of the loan loss estimation process and various other factors as
discussed below. Based on the Company’s
credit policy, this component consists of an amount that is approximately 20%
to 30% of the total of the formula and valuation allowances in recognition of
the inherent subjectivity and imprecise nature of the loan loss estimation
process. It is further adjusted for
qualitative factors including, among others, general economic and business
conditions, credit quality trends, loan volumes and concentrations and specific
industry conditions within portfolio segments.
There are inherent uncertainties with respect to the final outcome of
loans and nonperforming loans. Because
of these inherent uncertainties, actual losses may differ from the amounts
reflected in these consolidated financial statements. Factors considered in
evaluating the adequacy of the allowance include previous loss experience,
current economic conditions and their effect on borrowers, the performance of
individual loans in relation to contract terms, and the estimated fair values
of underlying collateral. Losses are
charged against the allowance when management believes the collectability of
principal is doubtful.
Key elements of the above estimates, including assumptions used in
independent appraisals, are dependent upon the economic conditions prevailing
at the time of the estimates.
Accordingly, uncertainty exists as to the final outcome of certain of
the valuation judgements as a result of economic conditions in the region. The inherent uncertainties in the
assumptions relative to projected sales prices or rental rates may result in
the ultimate realization of amounts on certain loans that are significantly
different from the amounts reflected in these consolidated financial
statements.
MORTGAGE
SERVICING ACTIVITIES
The transfer of financial assets in which the Company surrenders
control over those financial assets is accounted for as a sale to the extent
that consideration other than beneficial interests in the transferred assets is
received in exchange. Each time the
Company undertakes an obligation to service financial assets it recognizes
either a servicing asset or a servicing liability for that contract, unless it
securitizes the asset, retains all of the securities, and classifies them as
debt securities held-to-maturity.
Servicing assets are evaluated for impairment based upon the fair value
of the rights as compared to amortized cost.
Impairment is determined by stratifying rights by predominant
characteristics, such as interest rates and terms. Fair value is determined using prices for similar assets with
similar characteristics, when available, or based upon discounted cash flows
using market-based assumptions.
Impairment is recognized through a valuation allowance for an individual
stratum, to the extent that fair value is less than the capitalized amount for
the stratum.
During the second quarter of 2000, the Company sold all of its
capitalized mortgage servicing rights, and recorded a gain of $28,000. Amortization of these rights totaled $0,
$9,000 and $27,000 for the years ended December 31, 2001, 2000 and 1999,
respectively.
Mortgage loans held-for-sale are carried at the lower of aggregate cost
or fair value. Gains and losses on
sales of mortgage loans are recognized at the time of sale.
FORECLOSED
PROPERTY
Collateral acquired through foreclosure is recorded at the lower of
cost or fair value, less estimated costs to sell, at the time of
acquisition. The excess, if any, of the
loan balance over the fair value of the property at the time of transfer from
loans to foreclosed property is charged to the allowance for loan losses. Subsequent impairments in the fair value of
foreclosed property are charged to expense in the period incurred. Net operating income or expense related to
foreclosed property is included in noninterest expense in the accompanying
consolidated statements of operations. Because of current market conditions,
there are inherent uncertainties in the assumptions with respect to the
estimated fair value of foreclosed property.
Because of these inherent uncertainties, the amount ultimately realized
on foreclosed property may differ from the amounts reflected in the
consolidated financial statements.
CASH AND
CASH EQUIVALENTS
Cash and cash equivalents consist of cash on hand, amounts due from
banks, interest-bearing deposits, federal funds sold and investments with
original maturities of less than three months.
BANK PREMISES AND EQUIPMENT
Real estate held for banking purposes, leasehold improvements and
furniture and fixtures are stated at cost, less accumulated depreciation and
amortization. Depreciation is computed
principally on the straight-line method over estimated service lives. Amortization of leasehold improvements is
computed on the straight-line method over the shorter of the estimated useful
lives of the assets or related lease term.
Expenditure for maintenance, repairs and renewals of minor items are
charged to expense as incurred.
Bank premises and equipment are reviewed for impairment whenever events
or changes in circumstances indicate that the carrying amount of an asset may
not be recoverable. Based on its
review, the Company does not believe that any material impairments of its
long-lived assets have occurred.
Long-lived assets to be disposed of are reported at the lower of the
carrying amounts or fair value less cost to sell.
INTANGIBLE ASSETS
Intangible assets, comprised of goodwill and a core deposit premium,
represent the excess of the purchase price over the fair value of net assets
acquired in the acquisition of Finest Financial Corp. in 1996 and the 1998
branch acquisition. Goodwill is being
amortized on a straight-line basis over 15 and 20 years, respectively. The core deposit premium is being amortized
over an eight-year period on an accelerated basis. The Company periodically evaluates the realizability of intangible
assets based on expectations of nondiscounted future cash flows of the related
acquired entity and branches. If the
sum of the nondiscounted future cash flows is less than the carrying amount of
the intangible asset, the Company would recognize an impairment loss. At December 31, 2001, the Company has not
recorded any impairment of its intangible assets.
In July 2001, the FASB issued SFAS No. 141, “Business
Combinations”. SFAS No. 141 eliminates
the pooling of interests method of accounting for business combinations and
requires that the purchase method of accounting be used for all business
combinations. Goodwill and certain
intangible assets will remain on the balance sheet and not be amortized. On an annual basis, and when there is reason
to suspect that their values have been diminished or impaired, these assets
must be tested for impairment, and write-downs may be necessary. This statement is effective for business
combinations initiated after July 1, 2001.
In July 2001, the FASB issued SFAS No. 142, “Goodwill and Other
Intangible Assets”. SFAS No. 142
changes the accounting for goodwill from an amortization method to an
impairment-only approach. Amortization
of goodwill, including goodwill recorded in past business combinations, will
cease upon adoption of this statement.
The Company is required to implement SFAS No. 142 on January 1, 2002.
On October 17, 2001, the FASB issued Action Alert No. 01-37. This Action Alert reports the conclusion
reached by the FASB regarding the application of SFAS No. 141 and SFAS No. 142
with respect to the accounting for goodwill in bank branch acquisitions. The conclusion set forth in the Action Alert
states that paragraph 5 of SFAS No. 72, “Accounting for Certain Acquisitions of
Banking or Thrift Institutions”, “applies to all acquisitions of financial
institutions (or branches thereof) whether “troubled” or not, in which the fair
value of the liabilities assumed exceeds the fair value of tangible and
intangible assets acquired.”
The Company is assessing the impact of the adoption of SFAS No. 141 and
SFAS No. 142 in view of the Action Alert.
Based upon the conclusion set forth in the Action Alert, the Company
currently anticipates that it will be required to continue to amortize goodwill
totaling approximately $3.8 million which is attributable to the Company’s 1998
acquisition of five bank branches, unless the FASB issues further guidance with
respect to accounting for bank branch acquisitions. Upon adoption of this Statement, the Company will cease amortizing
approximately $7.9 million of goodwill, which will reduce annual amortization
by approximately $785 thousand.
The Action Alert also states that the FASB will reconsider its new
guidance during future deliberations.
The conclusion reached by the FASB regarding the need to continue
amortization of an unidentifiable intangible asset, therefore, may be
overturned at a later date. The
Company, however, can give no assurance that the FASB will vary from its
current position.
INCOME TAXES
The Company records income taxes under the liability method. Under this method, deferred tax assets and
liabilities are established for the temporary differences between the
accounting basis and the tax basis of the Company’s assets and
liabilities. Deferred taxes are
measured using enacted tax rates that are expected to be in effect when the
amounts related to such temporary differences are realized or settled. The Company’s deferred tax asset is reviewed
quarterly and adjustments are recognized in the provision for income taxes
based on management’s judgments relating to realizability.
OTHER ASSETS
Other assets include a $20.0 million long term fixed rate certificate
of deposit with the FHLB and $15 million of Bank owned life insurance (“BOLI”)
policies at December 31, 2001. The
certificate of deposit was purchased at a discount and this discount is
accreted to income quarterly resulting in carrying amounts of $17.7 million and
$17.6 million at December 31, 2001 and 2000, respectively. BOLI policies provide life insurance on the
lives of certain employees. The Company
is the beneficiary of the insurance.
Increases in the cash value of the policies, as well as insurance
proceeds received, are recorded in other income, and are not subject to income
taxes if certain conditions are met.
BOLI carrying values totaled $17.3 million and $16.3 million at December
31, 2001 and 2000, respectively.
EARNINGS PER SHARE
Basic EPS amounts have been computed by dividing reported earnings
available to common shareholders by the weighted average number of common
shares outstanding during the year.
Dilutive EPS amounts have been computed using the weighted average
number of common shares and the dilutive potential common shares (stock options
outstanding) outstanding during the year using the treasury stock method. Included in diluted EPS are 329,369,
194,274, and 174,275 dilutive potential common shares for 2001, 2000 and 1999,
respectively. Excluded from diluted earnings per share were options to purchase
266,400, and 494,544, shares in 2000 and 1999, respectively. These shares were excluded as the exercise
price was greater than the average market price of the common shares during the
respective years.
COMPREHENSIVE INCOME
Comprehensive income is the total of net income and all non-owner
related changes in a company’s equity including, among other things, unrealized
gains and losses on investment securities classified as
available-for-sale. Other comprehensive
income refers to revenues, expenses, gains, and losses that under generally
accepted accounting principles are included in comprehensive income but
excluded from net income. Gains on
investment securities that were realized and included in net income of the
current period that also had been included in other comprehensive income as
unrealized holding gains and losses in the period in which they arose are
deducted or added back through other comprehensive income of the period in
which they are included in net income to avoid including them in comprehensive
income twice.
RECLASSIFICATIONS
Certain reclassifications have been made to the 2000 and 1999
consolidated financial statements to conform to the 2001
presentation.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board (“FASB”) issued
Statement of Financial Accounting Standards (“SFAS”) No. 133, “Accounting for
Derivative Instruments and Hedging Activities”. The statement establishes
accounting and reporting standards requiring that every derivative instrument
(including certain derivative instruments embedded in other contracts) be
recorded on the balance sheet as either an asset or liability measured at its
fair value. The statement requires that
changes in the derivative’s fair value be recognized currently in earnings
unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative’s
gains and losses to offset related results on the hedged item in the income
statement, and requires that a company must formally document, designate, and
assess the effectiveness of transactions that receive hedge accounting.
On June 15, 2000, the FASB issued SFAS No. 138, “Accounting for Certain
Derivative Instruments and Certain Hedging Activities, an Amendment of FASB
Statement No. 133.” The Statement addresses a limited number of issues causing
implementation difficulties for numerous entities that are required to
implement SFAS No. 133.
The Company adopted SFAS No. 133, as amended, in the first quarter of
2001. The adoption of SFAS No. 133 did
not have a material effect on the consolidated financial statements but could
have the effect of increasing the volatility in reported earnings and accumulated
other comprehensive income.
SFAS No. 140, “Accounting for Transfers and Servicing of Financial
Assets and Extinguishments of Liabilities,” was issued in September 2000. SFAS No. 140 is a replacement of SFAS No.
125, “Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities.” Most
of the provisions of SFAS No. 125 were carried forward to SFAS No. 140 without
reconsideration by the Financial Accounting Standards Board, and some were
changed only in minor ways. In issuing
SFAS No. 140, the FASB included issues and decisions that had been addressed
and determined since the original publication of SFAS No. 125. SFAS No. 140 is effective for transfers
after March 31, 2001. The adoption of
SFAS No. 140 did not have a significant impact on the financial position or
results of operations of the Company.
In June 2001, the FASB issued SFAS No. 143, “Accounting for Asset
Retirement Obligations”. This statement
addresses financial accounting and reporting for obligations associated with
the retirement of tangible long-lived assets, and the associated asset
retirement costs. This statement is
effective for financial statements issued for fiscal years beginning after June
15, 2002. Management does not expect the adoption of SFAS No. 143 to have a
significant impact on the financial position or results of operations of the
Company.
In August 2001, the FASB issued SFAS No. 144, “Accounting for the
Impairment or Disposal of Long-Lived Assets”, which supersedes SFAS No. 121 and
portions of APB Opinion No. 30. This
statement addresses the recognition of an impairment loss for long-lived assets
to be held and used, or disposed of by sale or otherwise. This statement is effective for financial
statements issued for fiscal years beginning after December 15, 2001, and
interim periods within those fiscal years.
Management does not expect the adoption of SFAS No. 144 to have a
significant impact on the financial position or results of operations of the
Company.
2. BUSINESS SEGMENTS
Operating segments are components of an enterprise, which are evaluated
regularly by the chief operating decision-maker in deciding how to allocate
resources and in assessing performance.
The Company’s chief operating decision-maker is the Chief Executive
Officer and Chairman of the Board of the Company. The Company has identified its reportable operating business
segment as Community Banking, based on the products and services provided to
its customers.
The Company’s community banking business segment consists of commercial
banking and retail banking. The
community banking segment is managed as a single strategic unit and derives its
revenues from a wide range of banking services, including lending activities,
and the acceptance of demand, savings and time deposits.
Nonreportable 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. The nonreportable segment represents the
holding company financial information (Note 20) and its non-banking subsidiaries
First Essex Capital Trust I and First Essex Capital Statutory Trust II.
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 investments in
subsidiaries.
3. INVESTMENT SECURITIES
Investment securities at December 31, 2001 and 2000 are as follows:
At December 31, 2001 and 2000, U.S. government obligations and
mortgage-backed securities with amortized costs of $61,480,000 and fair values
of $62,296,000 were pledged to collateralize certain borrowings and deposit
accounts.
For the year ended December 31, 2001, there were no realized gains or
losses from the sale of investment securities available for sale. For the year ended December 31, 2000, there
were realized gross losses of $18,000 from the sale of investment securities
available-for-sale. For the year ended
December 31, 1999 there were realized gains before taxes from the sale of
investment securities of approximately $54,000.
The following table shows the maturity distribution of the amortized
cost of the Company’s investment securities at December 31, 2001:
The following table shows the maturity distribution of the fair value
of the Company’s investment securities at December 31, 2001:
(1) Maturities of mortgage-backed securities are based on contractual
maturities with scheduled amortization based on expected prepayments. Actual maturities will differ from
contractual maturities due to prepayments.
4. LOANS
Major classifications of loans at December 31, 2001 and 2000 follow:
The Company’s lending activities are conducted principally in eastern
Massachusetts and southern New Hampshire.
The Company originates single family and multifamily residential loans,
commercial real estate loans, commercial loans, aircraft loans, automobile
loans and a variety of consumer loans.
In addition, the Company originates loans for the construction of
residential homes, multifamily properties, commercial real estate properties
and land development.
A significant portion of the loans originated by the Company are
collateralized by real estate. The
ability and willingness of the single family residential and consumer borrowers
to honor their repayment commitments are generally dependent on the level of
overall economic activity within the geographic areas and real estate
values. The ability and willingness of
commercial real estate, commercial and construction loan borrowers to honor
their repayment commitments are generally dependent on the health of the real
estate economic sector in the borrowers’ geographic areas, the borrowers’
financial condition and the economy in general.
A summary of changes in the allowance for loan losses for the years
ended December 31, 2001, 2000 and 1999 follows:
The Company considers a loan impaired if it is 90 days or more past due
as to principal or interest, or if management’s credit risk assessment
determines that it is probable that principal or interest will not be collected
as contractually scheduled. In
addition, loans that are restructured at market rates and comparable to loans
with similar risks are considered impaired only in the year of the
restructuring, so long as they continue to perform according to the
restructured terms. Excluded from the
impaired category, but otherwise considered nonaccruing loans, are small
balance homogeneous loans that are ninety days or more past due. Small balance homogeneous loans include
residential mortgage loans, residential construction loans to individuals
(excluding builder construction loans) and consumer loans. The Company
evaluates a loan’s level of impairment by measuring the net present value of
the expected future cash flows using the loan’s original effective interest
rate, or considering the fair value of the collateral if the loan is collateral
dependent. When the difference between
the net present value of the impaired loan (or fair value of the collateral if
the loan is collateral dependent) is lower than the recorded investment of the
loan, the difference is provided to expense with a resulting valuation
allowance.
The following table indicates the recorded investment in nonperforming
assets and the related valuation allowance for
impaired loans:
(1) The valuation allowance for impaired loans
is included in the allowance for loan losses on the balance sheet.
The average recorded investment in impaired loans was approximately
$225,000 in 2001, $394,000 in 2000 and $1.3 million in 1999. Interest income recognized on impaired
loans, using the cash basis of income recognition, amounted to approximately
$57,000 for the year ended December 31, 2001 compared to $123,000 in 2000 and
$96,000 in 1999.
The amount of interest that would have been earned had the nonaccrual
and restructured loans performed in accordance with original terms and
conditions was $458,000, $103,000 and $164,000 for the years ended December 31,
2001, 2000 and 1999, respectively.
The maximum amount of aggregate loans to directors, executive officers
and principal stockholders for the year ended December 31, 2001 was less than
5% of stockholders’ equity.
At December 31, 2001 and 2000, the Bank was servicing loans sold to
various other banks and entities on a nonrecourse basis (except as discussed in
Note 11), in the amounts of $14,588,000 and $13,307,000, respectively. The amount of loans sold and serviced for
others is not included in loans receivable.
5. BANK PREMISES AND EQUIPMENT
A summary of bank premises and equipment at December 31, 2001 and 2000
follows:
Depreciation and amortization expense was $1,922,000, $1,781,000, and
$2,082,000, for 2001, 2000 and 1999, respectively.
6. DEPOSITS
A summary of deposits at December 31, 2001 and 2000 follows:
The following is a summary of original maturities of time deposits as
of December 31, 2001:
At December 31, 2001, 2000 and 1999, outstanding certificates of
deposits in denominations of $100,000 and over had maturities as follows:
7. BORROWED FUNDS
Borrowed funds at December 31, 2001 and 2000 are summarized below:
Total lines of credit available under both short-term and long-term
borrowings from the FHLB are dependent upon the amount of FHLB stock owned and
other assets available as collateral.
Total credit available was $362,551,000, of which $192,060,000 was
unused at December 31, 2001. The
advances from the FHLB are secured by all FHLB stock (book value of $12,771,000
at December 31, 2001 and 2000) and a pledge of certain assets as collateral.
Other short-term borrowings outstanding at December 31, 2001 mature in three
months or less with an average interest rate of 1.71% and are secured by
certain U.S government and agency securities.
8. COMPANY - OBLIGATED MANDATORILY
REDEEMABLE TRUST PREFERRED SECURITIES
On March 23, 2000, the Company organized a wholly-owned Delaware
business trust which issued $10 million face amount of the trust’s 10.875%
Fixed Rate Capital Trust Pass-Through Securities (“Capital Securities”)
scheduled to mature in 2030 to a private investor. Simultaneously, the trust used the proceeds of that sale to
purchase $10 million principal amount of the Company’s 10.875% Fixed Rate
Junior Subordinated Deferrable Interest Debentures due 2030 (“Subordinated
Debt”). Both the Capital Securities and
the Subordinated Debt are callable by the Company at any time after 10 years
from the issue date. The Subordinated
Debt is an unsecured obligation of the Company and is junior in right of
payment to all present and future senior indebtedness of the Company. The Capital Securities are guaranteed by the
Company on a subordinated basis. The
Company used the net proceeds of approximately $9.7 million for general
corporate purposes, including the repurchase of shares of the Company’s
outstanding common stock.
On July 31, 2001, the Company organized a wholly-owned Connecticut
statutory business trust which issued $15 million face amount of the trust’s
Floating Rate Capital Trust Pass-Through Securities (“2001 Trust Preferred
Securities”) to a private investor.
Simultaneously, the trust used the proceeds of that sale to purchase $15
million principal amount of the Company’s Floating Rate Junior Subordinated
Deferrable Interest Debentures due 2031 (“2001 Subordinated Debt”). Both the 2001 Trust Preferred Securities and
the 2001 Subordinated Debt are callable at any time after five years from the
issue date. The 2001 Subordinated Debt
is an unsecured obligation of the Company and is junior in right of payment to
all present and future senior indebtedness of the Company and is pari passu
with the 2000 Subordinated Debt. The
2001 Trust Preferred Securities are guaranteed by the Company on a subordinated
basis. The Company used the net
proceeds for general corporate purposes.
The Trust Preferred Securities are presented in the consolidated
balance sheets of the Company titled “Company-Obligated Mandatorily Redeemable
Trust Preferred Securities of Subsidiary Trust Holding Solely Junior
Subordinated Debentures of the Company.”
The Company records distributions payable on the Trust Preferred
Securities as a Minority Interest Expense in its consolidated statements of
income. The cost of issuance of the
2000 Trust Preferred Securities totaled $337 thousand and the cost of issuance
of the 2001 Trust Preferred Securities totaled $480 thousand. These costs are being accreted on the
effective interest rate method.
9. INCOME TAXES
The provision for income taxes for each of the three years in the
period ended December 31, 2001 consists of the following:
The difference between the total expected provision for income taxes
computed by applying the statutory federal income tax rate to income before
provision for income taxes and the recorded provision for income taxes for the
three years in the period ended December 31, 2001 follows:
In August of 1996, Congress passed the Small Business Job Protection
Act of 1996. Included in the bill was
the repeal of IRC Section 593, which allowed thrift institutions special
provisions in calculating bad debt deductions for income tax purposes. Thrift institutions are now viewed as
commercial banks for income tax purposes.
The repeal is effective for tax years after December 31, 1995.
One effect of this legislative change was to suspend the Bank’s bad
debt reserve for income tax purposes as of its base year (October 31,
1988). Any bad debt reserves in excess
of the base year amount is subject to recapture over a six-year time
period. The suspended (i.e. base year)
amount is subject to recapture upon the occurrence of certain events, such as a
complete or partial redemption of the Bank’s stock or if the Bank ceases to
qualify as a bank for income tax purposes.
At December 31, 2001, the Bank’s surplus includes approximately $7.7
million of bad debt reserves, representing the base year amount, for which
income taxes have not been provided.
Since the Bank does not intend to use the suspended bad debt reserve for
purposes other than to absorb the losses for which it was established, deferred
taxes in the amount of $3.2 million have not been recorded with respect to such
reserve
The components of the net deferred tax asset (included in other assets
in the accompanying consolidated balance sheet) at December 31, 2001 and 2000
follow:
10. PENSION BENEFITS
The Company has a defined benefit pension plan covering most
employees. Employees are eligible to
participate upon the attainment of age 21 and the completion of one year of
service. Benefits are based primarily
on years of service and employees’ final five-year average pay. Contributions by the Company are consistent
with the funding requirements of federal law and regulations. Pension plan assets consist primarily of
mutual funds, bonds and government securities.
The assumptions utilized include a discount rate of 7.0% at October 31,
2001, and 7.75% at October 31, 2000 and 1999, respectively. The rate on increase in future compensation
levels used in determining the actual present value of the projected benefit
obligation was 4.0% in 2001, 2000 and 1999.
The expected long-term rate of return on assets was 8.0% in 2001, 2000
and 1999.
The following table sets forth the changes in the plan’s benefit
obligations and assets together with the plan’s funded status and the amounts
recognized in the Company’s consolidated financial statements at December 31,
2001 and 2000 for the plan’s October 31 fiscal year end:
Net periodic pension benefit cost for the
years ended December 31, 2001, 2000 and 1999 included the following components:
The Company has no postretirement or postemployment benefit
arrangements other than pension benefits with its employees, except as stated
in Notes 11 and 14.
11. COMMITMENTS AND CONTINGENCIES
FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company is a 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,
held for purposes other than trading, include commitments to originate loans,
standby letters of credit, recourse arrangements on sold assets, unadvanced
portions of construction loans and forward commitments. The instruments involve, to varying degrees,
elements of credit and interest rate risk in excess of the amount recognized in
the accompanying consolidated balance sheets.
The contract or notional amounts of these 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, standby
letters of credit and recourse arrangements is represented by the contractual
amount of those instruments. The
Company uses the same credit policies in making commitments and conditional
obligations as it does for on-balance sheet instruments. For forward commitments, the contract or
notional amounts do not represent exposure to credit loss. The Company controls the credit risk of its
forward commitments through credit approvals, limits and monitoring procedures.
Financial instruments with off-balance sheet risk at December 31, 2001
and 2000 follow:
Commitments to originate loans are agreements to lend to customers
provided there are no violations of any conditions established in the contracts. Commitments generally have fixed expiration
dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected
to expire without being drawn upon, the total commitment amounts do not
necessarily represent future cash requirements. The Company evaluates each customer’s creditworthiness on a
case-by-case basis. The amount of
collateral obtained, if deemed necessary by the Company upon extension of
credit, is based upon management’s credit evaluation of the borrower.
Standby letters of credit are conditional commitments issued by the
Company to guarantee the performance by 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.
LEASE
COMMITMENTS
The Company has operating leases on twelve of its facilities. Most of the leases have renewal
options. Total rent expense under these
leases for 2001, 2000 and 1999 was $1,395,000, $1,302,000 and $1,039,000,
respectively.
The following is a schedule of future minimum lease payments, excluding
options, for operating leases (dollars in thousands):
EMPLOYMENT AND TERMINATION AGREEMENTS
The Company and the Bank has entered into employment agreements with
two executive officers. Each employment
agreement is for a three-year term, commencing on January 1, 1997 and is
extended daily until notice of non-renewal is given by either the officer or
the Company or the Bank. Under both of
the employment agreements, if the officer’s employment is terminated for any
reason other than for “cause”, as defined in the employment agreement, or if
the officer terminates his employment for “good reason”, as defined therein,
the officer will be entitled to receive a lump sum severance benefit equal to
three times the officer’s highest annual “Total Compensation,” as defined
therein, during the three preceding fiscal years as well as the continuation of
certain benefits for the remaining term of the employment agreement and a
pension adjustment as specified in the employment agreement.
In addition, the Company, the Bank and five officers (including the two
officers referred to above) have entered into special termination agreements
that provide for the payment, under certain circumstances, of a lump-sum amount
upon termination following a “Change of Control” as defined therein. The lump-sum amounts for three of these
officers are based on three times the officer’s current base salary and the
highest annual bonus paid during the three fiscal years preceding the
termination of employment. The lump-sum
amounts for the other two officers are based on two times such base salary and
highest bonus. Additionally, the first
three officers would continue to receive disability and medical benefits for
three years after such termination.
Also, the pensions of the officers who do not have employment contracts
would be credited with a number of additional years of accrual equal to the
multiple of base salary applicable to such officer’s severance benefits. In the case of such a termination, the two
officers with employment agreements could elect to receive (in lieu of any
benefits due under such officer’s special termination agreement) such
termination benefits as he may receive under his employment agreement.
The Company and the Bank have entered into an Executive Salary
Continuation Agreement (“SERP”) with the Company’s Chairman and Chief Executive
Officer. Under this agreement, the
officer would be entitled to certain payments following retirement at or after
age 62. Payments under the agreement
will equal 65% of the highest annual compensation (including bonuses) received
during any of the five years preceding retirement, reduced by a portion of
social security benefits payable as well as amounts payable pursuant to other
qualified defined benefit pension plans.
The agreement also provides for certain reduced payments if the
officer’s employment terminates before age 62, and for certain benefits in the
event of disability and upon death, under certain circumstances. The SERP provides for the funding of a Trust
by the Company in the event of a Change of Control, as defined therein, in an
amount necessary to fulfill the Company’s and the Bank’s obligations
thereunder.
The Company and the Bank have entered into an Executive Salary
Continuation Agreement (“SERP”) with the Company’s President and Chief
Operating Officer. Under this
agreement, the officer would be entitled to certain payments following
retirement at or after age 62. Payments
under the agreement will equal 65% of the average of the two highest annual
compensation amounts (including bonuses) received during any of the ten years
preceding retirement, reduced by a portion of social security benefits payable
as well as amounts payable pursuant to other qualified pension plans. The agreement also provides for certain
reduced payments if the officer’s employment terminates before age 62, and for
certain benefits in the event of disability and upon death, under certain
circumstances. The SERP provides for
the funding of a Trust by the Company in the event of a Change of Control, as
defined therein, in an amount necessary to fulfill the Company’s and the Bank’s
obligations thereunder.
The Company and the Bank have also entered into Benefit Enhancement
Plans (“BEP”) for three executive officers other than the Chairman and Chief
Executive Officer and President and Chief Operating Officer. Under the BEP, the Company agrees to provide
additional retirement benefits to compensate the officers for benefits that
otherwise would be lost due to the limitations imposed by the Internal Revenue
Code.
LEGAL PROCEEDINGS
The Company is involved in various legal proceedings incidental to its
business, none of which is believed by management, based on discussion with
legal counsel, to be material to the financial condition or operations of the
Company.
12. MANAGEMENT INCENTIVE COMPENSATION
PLAN
The Company has a Management Incentive Compensation Plan (the
“Incentive Plan”) as a means of recognizing achievement on the part of
individual officers and management as a whole.
In 2001, 2000 and 1999 the Company awarded $823,000, $752,000, and
$601,000, respectively, for bonuses in connection with the Incentive Plan.
13. STOCK PLANS
The Company has three stock plans.
The first was adopted in 1987 as a performance incentive for its
directors, officers, employees and other key persons (the “1987 Stock Option Plan”). The 1987 Stock Option Plan provided for the
granting of “Incentive Stock Options” and “Non-qualified Stock Options”. Options granted under the 1987 Stock Option
Plan have an exercise price per share equal to at least the fair market value
of a share of the Company’s common stock on the date the option is granted and
expire no later than 10 years after the date of grant. As of December 31, 2001, 265,557 shares are
reserved for issuance under this plan with respect to the current outstanding
options; no more options may be granted under this plan.
The second stock plan (the “1996 Stock Option Plan”) was assumed under
the terms of the agreement related to the Company’s purchase of Finest
Financial Corp. on December 30, 1996.
Non-qualified options totaling 114,465 shares have been granted under
this plan at an exercise price of $7.67 per share to two former officers of
Finest. During 1997, 26,415 options
were exercised. The remaining 88,050
options were vested and exercisable at December 31, 1999 and expire October 1,
2005. None of these options were
exercised during 2001, 2000 and 1999.
The weighted average estimated life of these outstanding options is 3.8
years. The estimated fair value of
these options totaling $438,400 was recorded as part of the acquisition price
and, accordingly, the pro forma compensation cost discussed below excludes the
effect of these options. No more
options may be granted under this plan.
The third stock plan (the “1997 Stock Incentive Plan”) was adopted in
1997 as a performance incentive for the Company’s directors, officers, and
employees. Incentive stock options,
non-qualified stock options, unrestricted stock awards, conditioned stock
awards, performance share awards and stock appreciation rights may be granted pursuant
to the 1997 Stock Incentive Plan.
Incentive stock options granted under the 1997 Stock Incentive Plan have
an exercise price per share equal to at least the fair market value of a share
of the Company’s common stock on the date the option is granted and expire no
later than 10 years after the date of grant.
The company has reserved 800,000 shares for issuance pursuant to awards
granted under the 1997 Stock Incentive Plan.
The Company accounts for stock options at intrinsic value with
disclosure of the effects of fair value accounting on net income and earnings
per share on a pro forma basis. Had
compensation costs for the stock option plans been determined using the fair
value method based upon the Modified Black-Scholes American option model, the
Company’s 2001, 2000 and 1999 net income and earnings per share from operations
would have been reduced to the following pro forma amounts (dollars in
thousands except per share amounts):
Pro
forma compensation cost may not be representative of that in future years.
The following table summarizes various facts and assumptions pertaining
to the 1987 Stock Option Plan and the 1997 Stock Incentive Plan for the year
ended December 31, 2001:
14. 401(k) PLAN
Under the 401(k) Plan (the “Plan”), eligible employees (“participants”)
may make contributions up to 15% of their compensation with certain
limitations. The Company may elect to
make basic matching contributions.
During 2001, 2000 and 1999, the Company made basic matching contributions
equal to 50% of the first 4% of each participant’s compensation, or a maximum
of 2%. Basic matching contributions for
2001, 2000 and 1999 amounted to $191,000, $170,000 and $156,000, respectively. The Plan also provides for discretionary
supplemental matching contributions. These contributions are allocated to
participants in the same manner as described above. There were no supplemental matching contributions in 2001, 2000
and 1999.
15. STOCKHOLDERS’ EQUITY
At the time of conversion to stock form, the Bank established a
liquidation account in the amount of $41,426,000 (unaudited). In accordance with Massachusetts statutes,
the liquidation account is maintained for the benefit of Eligible Account Holders
who continue to maintain their accounts in the Bank after the conversion. The liquidation account is reduced annually
to the extent that Eligible Account Holders have reduced their qualifying
deposits. Subsequent increases will not
restore an Eligible Account Holder’s interest in the liquidation account. In the event of a complete liquidation, each
Eligible Account Holder is entitled to receive a distribution from the
liquidation account in a proportionate amount to the current adjusted
qualifying balances for the account then held.
16. REGULATORY CAPITAL REQUIREMENTS
The Bank is subject to regulatory capital requirements administered by
the FDIC. Failure to meet minimum
capital requirements can initiate certain mandatory, and possibly additional
discretionary, actions by regulators that, if undertaken, could have a direct
material effect on the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework
for prompt corrective action, the Bank must meet specific capital guidelines
that involve quantitative measures of the Bank’s assets, liabilities and
certain off-balance-sheet items as calculated under regulatory accounting
practices. The Bank’s capital amounts and classification are also subject to
qualitative judgment by the FDIC about components, risk weightings and other
factors.
Quantitative measures established by regulation to ensure capital
adequacy require the Bank to maintain minimum amounts and ratios (set forth in
the following table) of total and Tier I capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier I capital (as
defined) to average assets (as defined).
Management believes, as of December 31, 2001, that the Bank meets all
capital adequacy requirements to which it is subject.
As of December 31, 2001, the most recent notification from the FDIC
categorized the Bank as well capitalized under the regulatory framework for
prompt corrective action. To be
categorized as well capitalized the Bank must maintain minimum total
risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the
table. There are no conditions or
events since that notification that management is aware of that would have
changed the institution’s category.
The Bank may not declare or pay cash dividends on its shares of common
stock if the effect thereof would cause stockholders’ equity to be reduced
below applicable capital maintenance requirements or if such declaration and
payment would otherwise violate regulatory requirements.
The following table displays the Bank’s capital calculations as defined
under prompt corrective action for the periods indicated:
17. STOCK REPURCHASE PROGRAM
On January 8, 1998, the Company announced that its Board of Directors
had authorized the Company to repurchase up to 375,000 shares of its
outstanding common stock from time to time at prevailing market prices. During 1999 and 1998, the Company repurchased
56,800 shares and 110,500 shares, respectively. At December 31, 1999, there were approximately 207,700 shares
still authorized to be repurchased under this plan. On March 9, 2000, the Company’s Board of Directors authorized the
repurchase of additional shares of its common stock up to a total of 970,000
shares. For the years ended December
31, 2001 and 2000, the Company repurchased 0 and 276,000 shares, respectively.
18. PREFERRED STOCK
The Company’s Board of Directors has authorized a series of 100,000
shares of preferred stock designated as Series A Junior Participating
Cumulative Preferred Stock, par value $0.10 per share (“Series A Stock”) and
has declared a dividend distribution of one Preferred Stock Purchase Right (the
“Right”) for each outstanding share of the Company’s common stock.
Pursuant to the Company’s Shareholder Rights Plan, each Right entitles
the holder to purchase from the Company a unit consisting of one one-hundredth
of a share of Series A Stock, par value $0.10 per share, at an initial cash
exercise price of $28 per unit, subject to adjustment. The Rights are not exercisable and remain
attached to all outstanding shares of the Company’s common stock until the
earliest of (i) 10 days following a public announcement that a person or group
of affiliated or associated persons (an “Acquiring Person”) has acquired
beneficial ownership of 20% or more of the outstanding shares of the Company’s
common stock (the date of said announcement being referred to as the “Stock
Acquisition Date”), (ii) 10 business days following the commencement of a
tender offer or exchange offer that would result in a person or group becoming
an Acquiring Person or (iii) the declaration by the Company’s Board of
Directors that a person is an “Adverse Person,” as such term is defined in the
Company’s Shareholder Rights Plan.
In the event that a Stock Acquisition Date occurs or the Board
determines that a person is an Adverse Person, each holder of a Right will be
entitled to receive, upon exercise, that number of units of Series A Stock
having a fair value of two times the exercise price of the Right. In the event that, at any time following the
Stock Acquisition Date, (i) the Company is acquired in a merger or other
business combination transaction or (ii) 50% or more of the Company’s assets or
earning power is sold, each holder of a Right shall thereafter have a right to
receive, upon exercise, common stock of the acquiring company having a fair
value equal to two times the exercise price of the Right. The holders of Series A Stock would be
entitled to preferred rights with respect to dividends, voting and liquidation.
19. FAIR VALUE OF FINANCIAL
INSTRUMENTS
CASH AND CASH EQUIVALENTS
Cash and cash equivalents consists of cash on hand, amounts due from
banks, interest-bearing deposits, federal funds sold and investments with
original maturities of less than three months.
Cash and cash equivalents are recorded at cost, which approximates fair
value.
INVESTMENT SECURITIES
Fair values for investment securities, excluding Federal Home Loan Bank
(FHLB) and Savings Bank Life Insurance (SBLI) stock, are based on quoted market
prices, where available. If quoted
market prices are not available, fair values are based on quoted market prices
of comparable instruments. The carrying
values of FHLB and SBLI stock approximate fair value.
LOANS RECEIVABLE
For variable rate loans that reprice frequently and with no significant
change in credit risk, fair values are based on carrying values. The fair values for certain mortgage loans
(e.g., one-to-four family residential) are based on quoted market prices of
similar loans sold in conjunction with securitization transactions, adjusted
for differences in loan characteristics.
The fair values of other loans (e.g., commercial real estate and rental
property mortgage loans, commercial, industrial loans, and consumer loans) are
estimated using a discounted cash flow analysis, using interest rates currently
being offered for loans with similar terms to borrowers of similar credit
quality. The carrying amount of
mortgage loans held-for-sale and accrued interest approximates fair value.
OTHER EARNING ASSETS
Other earning assets consist of a long term fixed rate certificate of
deposit with the Federal Home Loan Bank of Boston. The fair value for this
certificate of deposit is estimated using a discounted cash flow calculation
that applies an interest rate currently being offered on a time deposit of
similar maturity.
DEPOSITS
The fair values disclosed for certain deposits (e.g., interest and
noninterest-bearing checking, passbook savings, and certain types of money
market accounts) are, by definition, equal to the amount payable on demand at
the reporting date (i.e., their carrying amounts). Fair values for fixed-rate certificates of deposit are estimated
using a discounted cash flow calculation that applies interest rates currently
being offered on a schedule of aggregated expected monthly maturities on time
deposits. The carrying amount of
accrued interest payable approximates fair value.
BORROWED FUNDS
The carrying amount of borrowings payable within 90 days approximates
fair value. Fair values of other
borrowings are estimated using discounted cash flow analyses based on the
Company’s current borrowing rates for similar types of borrowing
arrangements. The carrying value for
other short-term borrowings approximates fair value due to the short-term
nature of these instruments.
OFF-BALANCE SHEET INSTRUMENTS
The fair values of the Company’s off-balance sheet instruments (lending
commitments and letters of credit) are based on fees currently charged to enter
into similar agreements, taking into account the remaining terms of the
agreement and the counterparties’ credit standing.
At December 31, 2001 and 2000, the estimated fair value of
off-balance-sheet financial instruments, consisting primarily of loan
commitments, were not material.
ASSUMPTIONS
Fair value estimates are made at a specific point in time, based on
relevant market information about specific financial instruments. These estimates do not reflect any premium
or discount that could result from offering for sale at one time the Company’s
entire holdings of a particular financial instrument. Because no market exists for a significant portion of the
Company’s financial instruments, fair value estimates are based on judgments
regarding future expected loss experience, current economic conditions, risk
characteristics of various financial instruments, and other factors. These estimates are subjective in nature and
involve uncertainties and matters of significant judgment and, therefore,
cannot be determined with precision.
Changes in assumptions could significantly affect the estimates.
The estimated fair values of the Company’s financial instruments
follow:
20. CONDENSED PARENT COMPANY
FINANCIAL STATEMENTS-FIRST ESSEX BANCORP, INC.
Condensed financial statements of First Essex Bancorp, Inc. as of
December 31, 2001 and 2000 and for the years ended December 31, 2001, 2000 and
1999 follows:
21. RESTRICTIONS ON SUBSIDIARY BANK
LOANS, ADVANCES AND DIVIDENDS
The Federal Reserve Act restricts the Bank with respect to lending or
advancing funds to the Company unless such loans are collateralized by specific
obligations and limits collateralized loans to 10% of the Bank capital stock
and surplus. At December 31, 2001, no
amounts were available to be transferred from the Bank to the Company in the
form of loans or advances. In addition,
under the FDIC prompt corrective action regulations, which took effect on
December 19, 1992, the Bank generally would be prohibited from making any
capital distribution if, after the distribution, the Bank would have (i) a
total risk-based capital ratio of less than 8%, (ii) a Tier I risk-based
capital ratio of less than 4% or (iii) a Tier I core capital ratio of less than
3%.
22. QUARTERLY DATA (UNAUDITED)
A summary of quarterly financial data for the years ended December 31,
2001 and 2000 follows:
*For an explanation of the 2001 increase in the provision for loan
losses, See Item 7 - Management's Discussion and Analysis of Financial
Condition and Results of Operations - Provision for Loan Losses.
ITEM
9.
ITEM
9. CHANGES IN AND DISAGREEMENTS WITH
ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There were no changes in, or disagreements with, accountants on
accounting and financial disclosures.
PART III
ITEM 10.
ITEM 10. DIRECTORS
AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item will appear under the headings
“Information Regarding Directors and Nominees”, “Executive Officers” and
“Compliance with Section 16(a) of the Exchange Act” of the Company’s definitive
Proxy Statement for the Annual Meeting of Stockholders to be held May 2, 2002
to be filed with the Securities and Exchange Commission within 120 days after
December 31, 2001 (the Proxy Statement”), and is incorporated herein by
reference.
ITEM
11.
ITEM
11. EXECUTIVE COMPENSATION
The information required by this item will appear in the Proxy
Statement under the headings “Summary Compensation Table,” “Stock Options
Granted in Fiscal 2001,” “Aggregated Option/SAR Exercises in Last Fiscal Year
and FY-end Option/SAR Values,” “Pension Plan,” “Executive Salary Continuation
Agreement,” “Employment Contracts, Termination of Employment and Change in
Control Arrangements,” and “Compensation/Nominating Committee Interlocks and
Insider Participation” and is incorporated herein by reference.
ITEM
12.
ITEM
12. SECURITY OWNERSHIP OF CERTAIN
BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item will appear in the Proxy
Statement under the headings “Security Ownership of Certain Beneficial Owners
and Management” and is incorporated herein by reference.
ITEM
13.
ITEM
13. CERTAIN RELATIONSHIPS AND RELATED
TRANSACTIONS
The information required by this item will appear in the Proxy
Statement under the heading “Certain Transactions with Management and Others”
and is incorporated herein by reference.
PART IV
ITEM 14.
ITEM 14. EXHIBITS,
FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a) (1) Index
of Financial Statements:
The following financial statements appear in response
to Item 8 of this Report.
Reports of
Independent Public Accountants
Consolidated Balance
Sheets as of December 31, 2001 and 2000
Consolidated
Statements of Operations for the Years Ended December 31, 2001, 2000, and 1999
Consolidated
Statements of Stockholders’ Equity for the Years Ended December 31, 2001, 2000
and 1999
Consolidated
Statements of Cash Flows for the Years Ending December 31, 2001, 2000 and 1999
Notes to
Consolidated Financial Statements
(a) (2) Index
of Financial Statement Schedules:
The following financial statement schedules appear in
response to Item 8 of this report or as part of this Item 14:
Schedule
I - Indebtedness to Related Parties. This information required by this schedule
is not material and is
therefore omitted.
Schedule
II - Guarantees of Securities of other Issuers. Not applicable.
(b) Reports
on Form 8-K:
No reports on Form 8-K were filed by the registrant
during the fiscal quarter ended December 31, 2001.
(c) Exhibits:
(12) Statements Regarding Computation of
Ratios:
Not applicable, as First
Essex does not have any debt securities registered under Section 12 of the
Securities
Exchange Act of 1934.
(21) Subsidiaries of Registrant:
A list of subsidiaries of
the Company is attached hereto as Exhibit 21.
(23) Consent of Experts and Counsel:
Consent of Arthur
Andersen LLP is attached hereto as Exhibit 23.
(99) Letter from the Company to the SEC with
respect to representations received from
Arthur Andersen LLP is
attached hereto as Exhibit 99.
*Management contract or compensatory plan.
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.
FIRST
ESSEX BANCORP, INC.
Date: March 14, 2002
/s/ Leonard A. Wilson
Leonard A. Wilson
Chairman and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange
Act of 1934, this report has been signed by the following people on behalf of
the registrant in the capacities and on the dates indicated:
/s/ Leonard A. Wilson
Chairman and Chief Executive Officer
March 14, 2002
Leonard A. Wilson
(Principal Executive Officer)
/s/ William F. Burke
Chief Financial Officer
March 14, 2002
William F. Burke
(Principal Financial and Accounting Officer)
/s/ Thomas S. Barenboim
Director
March 14, 2002
Thomas S. Barenboim
/s/ Augustine J. Fabiani
Director
March 14, 2002
Augustine J. Fabiani
/s/ William Lane
Director
March 14, 2002
William L. Lane
/s/ Frank J. Leone, Jr.
Director
March 14, 2002
Frank J. Leone, Jr.
Director
Robert H. Pangione
/s/ Brian W. Thompson
Director
March 18, 2002
Brian W. Thompson
/s/ Walter W. Topham
Director
March 14, 2002
Walter W. Topham
/s/ Robert H. Watkinson
Director
March 14, 2002
Robert H. Watkinson