Item 1. BUSINESS
General - ------- NewMil Bancorp, Inc., ("NewMil"), a Delaware corporation formed in 1987, is the registered bank holding company for New Milford Savings Bank ("the Bank"), a wholly-owned subsidiary. NewMil's activity is currently limited to the holding of the Bank's outstanding capital stock and the Bank is NewMil's only subsidiary and its primary investment. NewMil's net income is presently derived from the business of the Bank. Future establishment or acquisition of subsidiaries by NewMil is possible. Nevertheless, it is expected that the Bank will account for most of NewMil's net income in the foreseeable future.
The Bank, which was organized in 1858, is a Connecticut chartered and Federal Deposit Insurance Corporation ("FDIC") insured savings bank headquartered in New Milford, Connecticut. The Bank's principal business consists of attracting deposits from the public and using such deposits, with other funds, to make various types of loans and investments. The Bank offers both consumer and commercial deposit accounts, including checking accounts, interest bearing "NOW" accounts, money market accounts, certificates of deposit, savings accounts and Individual Retirement Accounts. The Bank offers 24-Hour banking through automated teller machines in ten branches.
The Bank offers a broad range of mortgage and consumer loans to the residents of its service area including residential mortgages, home equity credit lines and loans, installment loans and collateral loans. The Bank sells some of the residential mortgages that it originates on a servicing released basis. The Bank offers a broad range of mortgage and commercial loans to the companies and small businesses of its service area including lines of credit, term loans, Small Business Administration ("SBA") loans, commercial real estate mortgages, and construction and development mortgages. In addition, the Bank offers services including money orders, travelers' checks and safe deposit boxes. Although empowered, the Bank is not currently offering trust services.
NewMil's results of operations are significantly affected by general economic and competitive conditions, the real estate market, changes in interest rates, government policies and actions of regulatory authorities. Should the general economic climate stall, or reverse, NewMil's operations could be negatively impacted by adverse economic conditions.
Market Area and Competition - ---------------------------
The Bank conducts its business through fourteen offices located in Litchfield, Fairfield and New Haven Counties. The Bank's service area, which has a population of approximately 300,000, enjoys a balance of manufacturing, trade, and service employment and is home to a number of Fortune 500 companies. Although the Bank's primary market area is Litchfield and northern Fairfield counties, the Bank has depositors and borrowers that live outside of these areas.
The Bank faces strong competition in attracting and retaining deposits and in making mortgage and other loans. Its most direct competition for deposits has historically come from other savings banks, commercial banks and savings and loan associations located in its market area. Although the Bank expects this continuing competition to have an effect upon the cost of funds, it does not anticipate any substantial adverse effect on maintaining the current deposit base. The Bank is competitive within its market area in the various deposit products it offers to depositors. Due to this fact, management feels they have the ability to maintain the deposit base. The Bank does not rely upon any individual, group or entity for a significant portion of its deposits.
The Bank's competition for real estate loans comes primarily from mortgage banking companies, savings banks, savings and loan associations, commercial banks, insurance companies, and other institutional lenders. The Bank competes for loan originations primarily through the interest rates and loan fees it charges and the efficiency and quality of services it offers borrowers, real estate brokers and builders. Factors which affect competition include, among others, the general availability of funds and credit, general and local economic conditions, current interest rate levels and volatility in the mortgage markets.
Congress passed legislation in 1994 providing for a phase-in of full interstate branching. Connecticut law has since 1990 provided for full interstate banking and, more recently, has adopted legislation allowing interstate branching, subject to certain limitations. A number of out of state institutions, almost all larger and with greater financial resources then the Bank, have begun operations in Connecticut in recent years. This has increased competitiveness in NewMil's market areas. NewMil may consider expansion within or outside of Connecticut provided appropriate opportunities and conditions exist.
Distribution of Assets, Liabilities and Stockholders' Equity; Interest - ---------------------------------------------------------------------- Rates and Interest Differential - ------------------------------- For tables and discussion of the average balances, interest rates and interest differential of NewMil for the years 1999, 1998 and 1997, see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations" on pages 13 through 15. For tables and discussion of an analysis of the effect on net interest income of volume and rate changes on NewMil for 1999 over 1998 and 1998 over 1997, see "Management's Discussion and Analysis of Financial condition and Results of Operations - Results of Operations" on pages 15 and 16. In this analysis, the change due to volume was calculated as the change in average balance multiplied by the prior year's weighted average rate, the change in rate was calculated as the change in average rate multiplied by the prior year's average balance, and the change in rate/volume was calculated as the change in average rate multiplied by the change in average balance. Principal amounts of non-accruing loans have been included in the average loan balances used to determine the rate earned on loans. Interest income on non-accruing loans is included in income only to the extent that cash payments have been received.
Securities - ---------- For information concerning NewMil's securities portfolio activities see "Management's Discussion and Analysis of Financial Condition and Results of Operations" under the captions "Results of Operations" on pages 13 through 20, "Financial Condition" on pages 22 through 27 and "Note 2 - - Securities" on pages 42 through 44.
Lending Activities - ------------------ The Bank offers a broad range of mortgage and consumer loans to the residents of its service area including residential mortgages, home equity credit lines and loans, installment loans and collateral loans. The Bank also offers a broad range of mortgage and commercial loans to the companies and small businesses of its service area including lines of credit, term loans, SBA loans, commercial real estate mortgages, and construction and development mortgages.
One-to-Four Family Residential Mortgage Loans: The Bank offers a variety of fixed and adjustable rate loans, including adjustable rate loans that have fixed rates for an initial period ranging from 1 to 10 years and adjust annually thereafter. The Bank offers amortization periods of up to 30 years. The Bank's adjustable rate loans generally have a limit on the maximum rate change per interest rate adjustment of 2.0% to 3.0%, and have limits on the total interest rate adjustments during the life of a loan ranging from 4.0% to 6.0%, depending on the initial rate and type of loan. The Bank's adjustable rate loans include loans whose interest rate adjustments are based on U.S. Treasury constant maturity indices and other indices.
The Bank's initial rates on adjustable rate mortgage loans are offered at levels which are intended to be competitive within the Bank's service area and which are frequently at a discount from fully indexed contractual rates. The Bank charges origination fees ranging from no fee to several percent, depending on the initial rate and type of loan. Adjustable rate mortgage loans allow the Bank to maintain a degree of rate sensitivity, though the extent of this sensitivity is limited by the repricing intervals and caps contained in each loan type.
The Bank's residential mortgage loans are underwritten based on the borrower's income in accordance with secondary market or investor standards. In evaluating a potential residential mortgage borrower, the Bank considers a number of factors, including the creditworthiness of the borrower, the capacity of the borrower to repay the loan, an appraisal of the property to be mortgaged and a review of the loan to value ratio.
Much of the residential mortgage loans that the Bank originates are originated for sale to generate fee income. All such loans are sold on a servicing released basis. The Bank has not sold loans on a servicing retained basis since 1994.
Collateral and Installment Loans: The Bank makes collateral and installment loans, including home equity lines of credit, home equity loans, automobile and other personal loans. While the Bank offers fixed rates on its consumer loans and home equity loans, its home equity lines of credit are generally offered at or a spread over the Prime Rate. Home equity loans and lines of credit have risks similar to those associated with residential mortgages discussed above.
Commercial Mortgage and Multi-Family Mortgage Loans: The Bank also makes loans collateralized by mortgages on commercial and multi-family residential properties. Commercial and multi-family loans are offered on an adjustable rate basis, generally with a daily repricing frequency and with the interest adjustment tied to the Prime Rate. Loans may also be structured with fixed rate terms ranging from 1 to 5 years.
Loans collateralized by commercial properties, including multi-family residential properties, can involve greater credit risks than one- to four-family residential mortgage loans. The commercial real estate business is cyclical and subject to downturns, over-building, fluctuations in market value and local economic conditions. Typically, such loans are substantially larger than one- to four-family residential mortgage loans. Because repayment is often dependent on the cash flow of a successfully operated or managed property, repayment of such loans may be more susceptible to adverse conditions in the real estate market or the economy generally than is the case with residential mortgages.
Construction Loans: The Bank also makes construction loans to individuals and professional builders for the purpose of constructing 1-to-4 family residential properties, either as a primary residence or for investment or resale.
Commercial and Industrial Loans: The Bank offers unsecured commercial business loans, generally adjustable-rate loans with the adjustment of interest based on the Prime Rate plus a spread. The Bank believes it has been conservative in its underwriting standards for this market with the goal of obtaining quality loans for the portfolio. The Bank also offers SBA and other Government guaranteed loans. The Bank's loan products are targeted for, and tailored to the needs of, the local business and professional community in the Bank's market area.
For further discussion of the composition and quality of the loan portfolio see "Management's Discussion and Analysis of Financial Condition and Results of Operations" under the caption and "Financial Condition - Loans" on pages 24 and 25.
For information on the reduction in interest income associated with non-accrual loans for the year ended June 30, 1999 see "Note 4 - Non-Performing Assets" on page 45. For discussion of the Bank's policy for placing loans on non-accrual status refer to "Note 1 - Summary of Significant Accounting Policies - Loans" on pages 40 and 41. For information concerning loan portfolio composition and concentrations see "Management's Discussion and Analysis of Financial Condition and Results of Operations" under the caption "Financial Condition" on pages 22 through 27.
Summary of Loan Loss Experience - ------------------------------- For a discussion of the factors considered by management in determining the provision for loan losses, see "Management's Discussion and Analysis of Financial Condition and Results of Operations" under the caption "Results of Operations - Provision and Allowance for Loan Losses" on pages 16 through 18.
Deposits - -------- For a table on the average balances and rates on deposits, see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Results of Operations" on pages 13 through 15.
Certificate of deposits with balances of $100,000 and greater amounted to $14,654,000 and $16,477,000 at June 30, 1999 and 1998, respectively. The Bank generally attracts deposits from its market area and uses those deposits to fund lending and investment activities. The Bank has no brokered deposits.
Return on Equity and Assets - --------------------------- For selected statistical information required by this item see "Selected Financial Data" on pages 10 and 11.
Short-term Borrowings - --------------------- For the information required by this item see "Note 6 - Short Term Borrowed Funds" on page 46.
Supervision and Regulation - -------------------------- Federal Bank Holding Company Regulation: NewMil is registered under, and is subject to, the Bank Holding Company Act of 1956, as amended. This Act limits the types of companies which NewMil may acquire or organize and the activities in which it or they may engage. In general, NewMil and the Bank are prohibited from engaging in or acquiring direct or indirect control of any corporation engaged in non-banking activities unless such activities are so closely related to banking as to be a proper incident thereto. In addition, NewMil must obtain the prior approval of the Board of Governors of the Federal Reserve System to acquire control of any bank; to acquire, with certain exceptions, more than 5 percent of the outstanding voting stock of any other corporation; or, to merge or consolidate with another bank holding company. As a result of such laws and regulation, NewMil is restricted as to the types of business activities it may conduct and the Bank is subject to limitations on, among others, the types of loans and the amount of loans it may make to any one borrower.
Federal Reserve System: NewMil is required by the Board of Governors of the Federal Reserve System to maintain cash reserves against its deposits. After exhausting all other sources of funds, NewMil may request to borrow from the Federal Reserve. Bank holding companies registered with the FRB are, among other things, restricted from making direct investments in real estate. Both NewMil and the Bank are subject to extensive supervision and regulation, which focus on, among other things, the protection of depositors' funds.
The Federal Reserve System also regulates the national supply of bank credit in order to influence general economic conditions. These policies have a significant influence on overall growth and distribution of loans, investments and deposits, and affect the interest rates charged on loans or paid for deposits.
Fluctuations in interest rates, which may result from government fiscal policies and the monetary policies of the Federal Reserve System, have a strong impact on the income derived from loans and securities, and interest paid on deposits. While NewMil and its subsidiary strive to anticipate changes and adjust their strategies for such changes, the level of earnings can be materially affected by economic circumstances beyond their control.
NewMil and the Bank are subject to minimum capital requirements established, respectively, by the FRB and the FDIC. For information on these capital requirements and NewMil and the Bank's capital ratios see "Management's Discussion and Analysis of Financial Condition and Results of Operations - Capital Resources" on page 30 and Note 9 to the Financial Statements - Shareholders Equity under Capital Requirements.
Connecticut Banking Law and FDIC Regulation: The Bank is a state chartered savings bank organized under the Banking Law of the State of Connecticut. Deposits are insured by the FDIC and FDIC insurance premiums are assessed on the Bank's deposit base on a semi-annual basis at variable rates dependent upon the Bank's capital rating and other safety and soundness considerations. The Bank is subject to regulation, examination and supervision by the Connecticut Banking Department and the FDIC. Both the Connecticut Banking Department and the FDIC issue regulations and require the filing of reports describing the activities and financial condition of the banks under their jurisdiction. Each agency conducts periodic examinations to test safety, soundness and compliance with various regulatory requirements and generally supervises the operations of such banks.
Employees - --------- The Bank had 130 full-time and 20 part-time employees at June 30, 1999. Management considers the Bank's relationship with its employees to be good. The Bank's employees are not represented by any collective bargaining groups.
Subsidiaries - ------------ The Bank is NewMil's only subsidiary and accounts for 100% of NewMil's income for the current fiscal year. At June 30, 1999, the Bank had three wholly-owned subsidiaries, NMSB Mortgage Company, Asset Recovery Management Company and New Mil Asset Company. NMSB Mortgage Company is a passive investment company ("PIC") that holds loans collateralized by real estate originated or purchased by the Bank. Income of the PIC and its dividends to NewMil are exempt from the Connecticut Corporate Business Tax. Asset Recovery Management Company and New Mil Asset Company were both formed to hold and develop certain foreclosed real estate.
Item 2.
Item 2. PROPERTIES The Bank conducts its business at its main office, located at 19 Main Street, New Milford, Connecticut, and through 14 branches located in Litchfield, Fairfield and New Haven Counties. In May 1999 the Bank closed its Winsted branch location and sold the branch deposits to American Bank, Waterbury, Connecticut. The Bank owns its main office and seven of its branches. The remaining six locations are leased by the Bank. The following table sets forth certain information regarding the Bank's branch offices, as of June 30, 1999.
Item 3.
Item 3. LEGAL PROCEEDINGS
There are no legal proceedings pending against NewMil or the Bank or any of their properties, other than ordinary routine litigation incidental to the Company's business.
Item 4.
Item 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
During the fourth quarter of 1999, no matter was submitted to a vote of the shareholders of NewMil.
PART II
Item 5.
Item 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
For the information required by this item see "Quarterly Financial Data (unaudited)" on pages 57 and 58. For a discussion of NewMil's dividend policy and restrictions on dividends see "Management Discussion and Analysis of Financial Condition and Results of Operations" under the caption "Dividend Restrictions" on page 30.
Item 6.
Item 6. SELECTED FINANCIAL DATA
The following table sets forth NewMil's consolidated financial and other data at the dates and for the periods indicated. This data has been derived from NewMil's audited consolidated financial statements.
Item 7.
Item 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
BUSINESS
NewMil Bancorp, Inc. ("NewMil"), a Delaware corporation, is a bank holding company for New Milford Savings Bank ("Bank"), a Connecticut-chartered and Federal Deposit Insurance Corporation ("FDIC") insured savings bank headquartered in New Milford, Connecticut. NewMil's principal business consists of the business of the Bank. The Bank is engaged in customary banking activities, including general deposit taking and lending activities, and conducts its business from fourteen offices in Litchfield, Fairfield and New Haven Counties. NewMil and the Bank were formed in 1987 and 1858, respectively.
OVERVIEW
NewMil earned net income of $3,032,000, or $.76 per share, for the year ended June 30, 1999, compared with net income of $2,989,000, or $0.74 per share, for fiscal year 1998. Net income for the 1999 fiscal year included the effect of both a change in accounting principals, resulting from the adoption of SFAS 133, and an extraordinary item, resulting from the prepayment of Federal Home Loan Bank advances. Income before the effect of the accounting change and extraordinary item was $3,281,000, or $.82 per share, for the year ended June 30, 1999, compared with net income of $2,989,000, or $0.74 per share, for fiscal year 1998.
Excluding the effect of the accounting change and extraordinary item NewMil's income grew 9.8% in 1999, reflecting improved core earnings, driven by higher net interest income and non-interest income, and a lower loan loss provision, partly offset by increased operating expenses. Similarly, earnings per share before the effect of the accounting change and extraordinary item increased 10.8%, reflecting both the growth in net income and share repurchase activity.
Effective October 1, 1998 NewMil adopted the provisions of SFAS 133 (Accounting for Derivative Instruments and Hedging Activities). NewMil took advantage of the provisions of SFAS 133 by reclassifying securities totaling $21 million from held-to-maturity to available-for-sale, and then sold those securities. NewMil realized a loss, net of tax, of $162,000 on the transfer and sale of these securities. This loss has been reported separately in net income as the cumulative effect of adopting SFAS 133. The securities were previously carried below cost as held-to-maturity, and an unrealized loss, net of taxes, of $654,000 against these securities had been included in shareholders' equity prior to their sale.
NewMil used the proceeds from the sale of the securities to prepay $22.5 million of Federal Home Loan Bank fixed rate advances. NewMil incurred a prepayment fee, net of taxes, of $87,000 that has been reported in net income as an extraordinary item for this early extinguishment of debt.
During 1999 NewMil formed a Passive Investment Company ("PIC") and changed its tax year to a calendar year basis to take advantage of recent changes in Connecticut tax statutes. The Connecticut statute, effective January 1, 1999, allows NewMil to transfer loans collateralized by real estate into the PIC. Income of the PIC and its dividends to NewMil became exempt from the Connecticut Corporation Business Tax. Effective January 1, 1999, NewMil's combined Federal and State effective tax rate is 34%, compared with an effective rate of 40.27% (prior to the deferred tax asset write-off, discussed below), for the first two quarters of the fiscal year. The formation of the PIC required NewMil to establish a valuation allowance against its existing deferred State tax assets that are no longer expected to be realized in future years. Accordingly, NewMil's income tax provision for the year ended June 30, 1999 includes a charge of $266,000.
Over the past five years NewMil has achieved a steady improvement in core earnings. This is attributed to a continuing strategy which includes refining both the mix and the quality of NewMil's earning assets, increasing non-interest income, controlling operating expenses, and reducing non-performing assets.
The following discussion and analysis of NewMil's consolidated results of operations should be read in conjunction with the Consolidated Financial Statements and footnotes.
RESULTS OF OPERATIONS
Comparison Between 1999 and 1998
Analysis of Net Interest and Dividend Income - --------------------------------------------
Net interest income increased $190,000, or 1.5%, to $12,649,000 in 1999. This resulted from growth of $18.0 million, or 5.4%, in average earning assets, driven by an increase in average loans of $21.8 million, or 12.8%. The net interest margin declined 14 basis points, to 3.64% from 3.78%. This decrease was due mostly to the effects of lower market interest rates during 1999 as compared with 1998, and to changes in balance sheet mix. The following table sets forth the components of NewMil's net interest income and yields on average interest-earning assets and interest-bearing funds for each of the past three years.
Net interest and dividend income represents the difference between interest and dividends earned on loans and securities and interest paid on deposits and borrowings. The level of net interest income is a function of volume, rates and mix of both earning assets and interest-bearing liabilities. Net interest income can be adversely affected by changes in interest rate levels as determined by NewMil's "gap" position, measured by the differences between the volume of assets and liabilities that are subject to repricing within different future time periods.
Interest Income - --------------- Total interest and dividend income decreased $199,000, or 0.8%, to $24.5 million in 1999. Loan income increased $421,000, or 2.8%, as a result of higher loan volume offset by lower average yield. Average loans increased $21.8 million, or 12.8%, to $192.1 million in 1999 as compared with 1998. The decrease in average loan yield, down 78 basis points, was mostly due to lower yields on loans originated during 1999 coupled with the downward repricing of adjustable rate loans and changes in portfolio mix. Most of the growth has been in residential mortgage loans that have lower yields relative to commercial loans. Investment income decreased $620,000, or 6.4%, in 1999 as a result of lower average volume coupled with a slightly lower average yield. Average securities decreased $3.8 million, or 2.4%. The decrease in average investment yield, down 25 basis points, was due to lower reinvestment yields during 1999 and changes in portfolio mix.
Interest Expense - ---------------- Interest expense decreased $389,000, or 3.2%, to $11.8 million in 1999 primarily as a result of changes in the deposit mix offset in part by higher average borrowings. Deposit expense decreased $551,000, or 5.1%, as a result of a decline in deposit rates and a favorable change in deposit mix, partially offset by interest-bearing deposit growth of $12.4 million, or 4.6%. The average cost of interest-bearing deposits declined by 37 basis points to 3.66%. Deposit growth occurred in all deposit categories, except higher cost certificates of deposit. NOW accounts increased $4.1 million, or 14.0%, money market accounts increased $5.7 million, or 9.1% and savings accounts increased $7.5 million, or 18.2%, while certificates of deposits decreased $4.8 million, or 3.5%. Borrowings expense increased $162,000, primarily as a result of an increase in borrowings in late 1998 to fund securities purchases.
Provision and Allowance for Loan Losses - ---------------------------------------
NewMil provided $100,000 for loan losses in 1999, down from $250,000 in 1998 and $400,000 in 1997. The reduction in NewMil's provision over the past three years is due principally to an ongoing improvement in loan quality as evidenced by the steady reduction in non-performing loans over the past five years, offset in part by loan portfolio growth. During 1999 non-performing loans decreased $153,000, or 11.1%, to $1.2 million at June 30, 1999 and, as a result, the reserve coverage to non-performing loans increased to 403.6%. Past due performing loans (accruing loans 30-89 days past due) also decreased in 1999 and at June 30, 1999 represented 1.3% of gross loans. The decrease in the ratio of the allowance for loan losses to total gross loans during 1999, to 2.3% at June 30, 1999 compared to 3.0% at June 30, 1998, is due to loan portfolio growth of $47.2 million, or 28.1% during 1999. Loan growth has been primarily concentrated in residential mortgage loans that have a relatively low risk profile. NewMil remains adequately reserved both against total loans and non-performing loans. For a discussion on loan quality see "Asset Quality and Portfolio Risk".
The Bank determines its allowance and provisions for loan losses based upon a detailed evaluation of the loan portfolio through a process which considers numerous factors, including estimated credit losses based upon internal and external portfolio reviews, delinquency levels and trends, estimates of the current value of underlying collateral, concentrations, portfolio volume and mix, changes in lending policy, historical loan loss experience, current economic conditions and examinations performed by regulatory authorities. Determining the level of the allowance at any given period is difficult, particularly during deteriorating or uncertain economic periods. Management must make estimates using assumptions and information which is often subjective and changing rapidly. The review of the loan portfolio is a continuing event in the light of a changing economy and the dynamics of the banking and regulatory environment. In management's judgement the allowance for loan losses at June 30, 1999, is adequate. Should the economic climate deteriorate, borrowers could experience difficulty and the level of non-performing loans, charge-offs and delinquencies could rise and require increased provisions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's allowance for loan losses. Such agencies could require the Bank to recognize additions to the allowance based on their judgements of information available to them at the time of their examination. The Bank was examined by the FDIC, in August 1998 and no additions to the allowance were requested as a result of this examination.
Non-Interest Income - ------------------- Non-interest income increased $570,000 or 19.9%, to $3,434,000 in 1999. This increase is attributable to gains on sales of OREO in 1999 and security losses in 1998, offset by a gain on the sale of a non-performing loan in 1998. The principal categories of non-interest income are as follows:
The increase in service charges on deposit accounts in 1999 reflects increased transaction volume, resulting from growth in demand deposit and NOW accounts and increased debit card transactions volume. The increase in gains from sales of residential mortgage loans resulted from loan sales of $28.0 million in 1999 compared with $25.8 million in 1998. Secondary market loan sales are generally pre-arranged on a loan by loan basis prior to origination and loans are sold service-released.
The net securities losses in 1998 were realized on securities sales of $44.2 million and included a loss of $103,000 from the sale of a collateralized mortgage obligation ("CMO") that was classified as held-to-maturity. In October 1997 NewMil engaged a financial securities consultant to analyze this CMO. Based on this review NewMil determined that it was highly probable that NewMil would likely receive substantially less than the contractual interest on this CMO and that the CMO could experience a significant decline in market value. NewMil concluded that these and other changes in circumstances surrounding this CMO were isolated, non-recurring, and highly unusual, and could not have been reasonably anticipated. The significant increase in OREO gains in 1999 resulted from the sale of two OREO properties and the sale of the Bank's interest in a partnership formed several years ago to develop an OREO property into a residential subdivision. In 1998 NewMil realized a gain of $778,000 from the sale of its largest remaining non-performing loan. The gain resulted from the sale of the loan to a buyer whose intended use of the property added significant value which was not anticipated. The decrease in loan servicing fees in 1999 resulted from run-off in the mortgage servicing portfolio, which at June 30, 1999 totaled $20.2 million, down from $24.8 million at June 30, 1998. The Bank has sold its mortgage loans on a servicing released basis since 1994.
Operating Expenses - ------------------ Operating expenses increased $518,000, or 5.2%, in 1999. The principal categories of operating expenses are as follows:
The increase in salaries in 1999 was due primarily to annual salary increases, overtime related to the conversion of the Bank's core data processing systems to a new in-house system, higher loan origination and sales commissions, and higher incentive compensation awards. Employee benefits expense increased as a result of taxes and other benefits related to the increase in salaries, and due to increased medical claims from the Bank's partially self insured plan. These increases were partially offset by net income related to the Bank's curtailed pension plan. The decrease in occupancy and equipment expense is primarily due to reduced building maintenance expense in 1999 and the write-off, in 1998, of obsolete computer equipment and related prepaid maintenance in preparation for the conversion of the Bank's core data processing systems to a new client server system. All other operating expenses, including marketing, shareholder relations, office expense and other, increased $100,000 or 4.6% in 1999. This increase is attributed principally to increased lending activity, various marketing promotions and other changes in operating activities.
Income Taxes - ------------ Net income for 1999 included an income tax provision of $2,264,000, for an effective tax rate of 40.8%, as compared with an income tax provision of $2,164,000, for an effective tax rate of 42.0%, for 1998.
On May 19, 1998 Connecticut legislation was passed which made sweeping changes to the corporation business tax treatment of banks and financial service companies. The new law permits banks to shelter certain mortgage income from the Connecticut corporation business tax through the use of a new special purpose entity called a "passive investment company" (PIC). In general, the PIC can earn mortgage interest income, and pay dividends to its parent company, free from the Connecticut corporation business tax. The legislation was effective for income years commencing on or after January 1, 1999.
NewMil formed a PIC and changed its tax year to a calendar year basis to take advantage of the Connecticut statute. Effective January 1, 1999 NewMil transferred mortgages into the PIC and income of the PIC and its dividends to NewMil became exempt from the Connecticut Corporation Business Tax. Effective January 1, 1999, NewMil's combined Federal and State effective tax rate became 34%, compared with an effective rate, during the first two quarters of the fiscal year, of 40.27% (prior to the deferred tax asset write-off, discussed below). The formation of the PIC has required NewMil to establish a valuation allowance against its existing deferred State tax assets that are no longer expected to be realized in future years. The provision for the year ended June 30, 1999 included a one-time charge of $266,000 related to the formation of the PIC, as discussed above.
For further information on income taxes see Note 7 of Notes to Consolidated Financial Statements.
Effect of Change in Accounting Principle and Extraordinary Item - --------------------------------------------------------------- Effective October 1, 1998 NewMil adopted the provisions of SFAS 133, reclassified securities totaling $21 million from held-to-maturity to available-for-sale, and then sold those securities. NewMil realized a loss, net of tax, of $162,000 on the transfer and sale of these securities. This loss has been reported separately in net income as the cumulative effect of adopting SFAS 133.
NewMil used the proceeds from the sale of the securities to prepay $22.5 million of Federal Home Loan Bank fixed rate advances. NewMil incurred a prepayment fee, net of taxes, of $87,000 that has been reported in net income as an extraordinary item.
Comparison between 1998 and 1997
Overview - -------- NewMil earned net income of $2,989,000 or $0.74 per share, for the year ended June 30, 1998, compared with net income of $2,602,000, or $0.63 per share, for fiscal year 1997. Net income grew 14.9% in 1998, reflecting significantly improved core earnings, driven by higher net interest income and non-interest income, and a lower provision for loan losses, offset in part by increased operating expenses. Earnings per share increased 17.5%, reflecting both the growth in net income and share repurchase activity.
Analysis of Net Interest Income - ------------------------------- Net interest income increased $524,000, or 4.4%, to $12,459,000 in 1998. This resulted from growth of $30.5 million, or 10.2%, in average earning assets, driven by an increase in average investments of $23.9 million, or 17.6% coupled with an increase in average loans of $6.6 million, or 4.0%. The net interest margin decreased by 20 basis points, to 3.78% from 3.98%.
Interest Income - --------------- Total interest and dividend income increased $1,804,000, or 7.9%, to $24.7 million in 1998. Loan income increased $404,000, or 2.8%, as a result of higher volume offset by slightly lower average yield. Average loans grew $6.6 million, or 4.0%, to $170.3 million in 1998 as compared with 1997. The decrease in the average loan yield, down 11 basis points, resulted primarily from lower yields on new loans originated during 1998. Investment income increased $1,400,000, or 17.0%, in 1998 as a result of higher average volume, offset in part by a slightly lower average yield. Average securities increased $23.9 million, or 17.6%, while average federal funds balances remained fairly constant. The decrease in average yield, down 3 basis points, resulted from in changes in portfolio mix and lower reinvestment yields.
Interest Expense - ---------------- Interest expense increased $1,208,000, or 11.7%, to $12.2 million in 1998 primarily as a result of deposit growth and higher average borrowings. Deposit expense increased $704,000, or 6.9%, as a result of an increase of $17.7 million, or 7.0%, in average interest-bearing deposits. The average cost of interest-bearing deposits remained unchanged at 4.03%. Deposit growth was realized in all deposit categories with the greatest concentration in certificates of deposit, which increased $9.2 million, and NOW accounts which increased $4.6 million. Interest expense on borrowings increased $576,000 primarily as a result of additional borrowings in 1998, including term advances at higher rates, to fund securities purchases.
Non-Interest Income - ------------------- Non-interest income increased $778,000, or 37.3%, to $2,864,000 in 1998. The principal categories of non-interest income are as follows:
The increase in service charges on deposit accounts in 1998 reflected increased transaction volume, resulting from growth in demand deposit and NOW accounts, fees from the Generation Gold Family Club introduced in 1998, and increased debit card transactions volume. The increase in gains from sales of residential mortgage loans resulted from loan sales of $25.8 million in 1998 compared with $9.6 million in 1997. The decrease in loan servicing fees in 1998 resulted from a decrease in the mortgage servicing portfolio, which at June 30, 1998 totaled $24.8 million, down from $28.8 million at June 30, 1997. Net securities losses in 1998 and 1997 were realized on security sales of $44.2 million and $23.3 million, respectively. In 1998 NewMil realized a gain of $778,000 from the sale of its largest remaining non-performing loan. The gain resulted from the sale of the loan to a buyer whose intended use of the property added significant value which was not anticipated. Gains on sales of OREO decreased as a result of less OREO and fewer sales. In 1998 and 1997 OREO proceeds from OREO sales were $1.3 million and $3.3 million, respectively.
Operating Expenses - ------------------ Operating expenses increased $787,000, or 8.6%, in 1998. In 1998 NewMil opened branch offices in Southbury and Norwalk, Connecticut, in July and October 1997, respectively. These offices added approximately $422,000 to operating expenses, principally compensation, occupancy and equipment expense. Other increases in 1998 included the write-off of obsolete equipment and prepaid maintenance in preparation for the conversion of the Bank's core data processing system to a new in-house system. These increases were offset in part by a significant reduction in professional and legal expense. The principal categories of operating expenses are as follows:
The increase in salaries in 1998 was due primarily to the two new branches and annual salary increases. Employee benefits expense increased as a result of additional health, taxes and other benefits related to the increased staffing levels and increased medical claims from the Bank's partially self insured plan. These increases were partly offset by net income related to the Bank's pension plan. The increase in occupancy expense was primarily related to the two new branches. Equipment expense for 1998 included $213,000 to write-off obsolete computer equipment and prepaid maintenance related to the Bank's legacy computer system. The Bank converted its core data processing system to a new client server system in November 1998. Professional, collection and OREO expense, which includes expenditures related to audit, accounting, legal, appraisal, property tax, insurance, other workout related expenses together with the negative provision for OREO losses, decreased $384,000 as a result, primarily, of a recovery of legal expenses related to a securities arbitration claim that was settled in 1998. The increase in insurance expense resulted from both increased FDIC insurance premiums related to deposit growth and increase in premiums relating to the new branches. All other operating expenses, including marketing, shareholder relations, office expense and other, increased $326,000 or 17.6% in 1998 due principally to increased lending activity, new branch locations, marketing promotions and other changes in operating activities.
Income Taxes - ------------ Net income for 1998 included an income tax provision of $2,164,000, for an effective tax rate of 42.0%, as compared with an income tax provision of $1,886,000, with a similar effective tax rate of 42.0%, for 1997.
FINANCIAL CONDITION
During 1999 total assets declined $15.5 million, or 4.2%, to $352.1 million at June 30, 1999. This was due to a sale of securities and repayment of borrowings with the proceeds. Net loans increased by $47.2 million, or 29.0%, to $210.0 million at June 30, 1999, while securities decreased $44.1 million, or 27.2%, and federal funds sold decreased $22.0 million, or 87.4%. On the liability side, deposits grew $6.2 million, or 2.1%, while borrowings decreased $22.5 million, to $15.0 million at June 30, 1999. Non-performing assets decreased $115,000, or 6.8%, to $1.6 million, and represent only 0.45% of assets at June 30, 1999. Book value per share increased 3.8% to $9.04 at June 30, 1999, after cash dividends of $0.35, representing a 43.8% payout ratio. At June 30, 1999 tier 1 leverage and total risk-based capital ratios were 9.53% and 19.40%, respectively, and NewMil was "well capitalized" as defined by the Federal Reserve Board.
Securities - ---------- During 1999 securities declined $44.1 million, or 27.2%, to $118.2 million at June 30, 1999, while federal funds sold decreased $22.0 million, to $3.6 million. These reductions were used to fund loan growth and repay borrowings during 1999. The principal categories of securities are as follows (including both available-for-sale and held-to-maturity):
The change in portfolio mix in 1999 resulted from portfolio run-off and the sale of certain collateralized mortgage obligations ("CMOs"), offset by new purchases of mortgage backed securities ("MBS") and municipal bonds.
NewMil took advantage of the one-time opportunity to reclassify securities from held-to-maturity to available-for-sale permitted with the adoption of SFAS 133 to restructure its securities portfolio. On adopting SFAS 133 effective October 1, 1998, NewMil reclassified certain securities totaling $21 million from held-to-maturity to available-for-sale, and then sold those securities. These securities consisted of floating rate CMOs that repriced off the Eleventh District Cost of Funds index. At September 30, 1998 these securities had been carried in the held-to-maturity category at $1,091,000 below cost, with a related unrealized loss, net of taxes, in shareholders equity. The unrealized loss was generated as a result of having transferred them from available-for-sale to held-to-maturity at which time they were transferred at their current market value, which was significantly below their amortized cost. The unrealized loss, at the date of transfer, was frozen and amortized as the related investments paid down. NewMil sold the securities during the quarter ended December 31, 1998 and realized a loss of only $274,000. This loss has been reported separately in net income, net of taxes, as the cumulative effect of adopting SFAS 133.
NewMil's securities portfolio consists of MBSs', CMOs', bank qualified municipal bonds and Federal Home Loan Bank stock. At June 30, 1999, 90.0% of the portfolio consisted of fixed rate securities, principally MBS and to a lesser extent, CMOs and municipal bonds. At June 30, 1999 total fixed rate securities had a projected weighted average duration and life of 3.8 years and 4.9 years, respectively, based on median projected prepayment speeds at current interest rates. At June 30, 1999 7.7% of the portfolio consisted of floating rate CMOs and MBSs, which generally reprice monthly based on pre-determined spreads to underlying index, subject to life-time caps and floors. The floating rate securities had a projected weighted average duration and life of 0.1 years and 3.1 years, respectively, based on median projected prepayment speeds at current interest rates. Floating rate MBSs are tied to the Eleventh District Cost of Funds index, while the floating rate CMOs are tied to several Treasury indices. The remaining 2.3% of the portfolio at June 30, 1999, was represented primarily by Federal Home Loan Bank stock.
At June 30, 1999, securities totaling $74.1 million, or 62.7%, were classified as available-for-sale and securities totaling $44.1 million, or 37.3%, were classified as held-to-maturity.
The composition, maturity distribution and weighted average yields of securities available-for-sale are as follows:
The composition, maturity distribution and weighted average yields of securities held-to-maturity are as follows:
Loans - ----- During 1999 net loans grew $47.2 million, or 29.0%, to $210.0 million at June 30, 1999. Loan originations and advances for portfolio, including $38.6 million of residential mortgage loans purchased, totaled $92.4 million for 1999, up 58.5% from $58.3 million in 1998. Loan repayments totaled $83.4 million for 1999, up from $61.6 million in 1998. The increase in loan repayments was due primarily to refinancings of residential mortgage loans caused by the low interest rate environment, and, to a lesser extent, related home equity lines of credit refinancing. Residential mortgage loans originated for sale increased by $2.2 million to $28.0 million, compared with $25.8 million in 1999. Loans originated for sale are sold on a servicing released basis.
The principal categories of the loan portfolio are as follows:
The Commercial Lending department specializes in lending to small and mid-size companies and professional practices and provides short-term and long-term financing, construction loans, commercial mortgages and property improvement loans. The department also works extensively with several government-assisted lending programs. The Residential Mortgage Department, in addition to traditional portfolio lending, originates loans for sale to the secondary market on a service-released basis, which enables the Bank to offer a very comprehensive residential mortgage product line. The department also offers home equity loans and lines of credit and consumer installment loans.
The following table sets forth information on the composition of NewMil's loan portfolio by loan type for each of the past five years:
The following tables reflect NewMil's loan portfolio maturity distribution as of June 30, 1999 (non-accrual loans have been presented in the after 5 years category):
The following table shows as of June 30, 1999 the amount of loans due after one year that have fixed interest rates and variable or adjustable interest rates:
Non-performing assets - --------------------- The following table sets forth non-performing assets for each of the last five years:
During 1999 non-performing assets decreased $115,000, or 6.8%, to $1.6 million at June 30, 1999, and represented only 0.45% of total assets. The low level of non-performing assets reflects NewMil's rigorous ongoing credit management process and favorable economic climate. The following table summarizes changes in non-performing assets during the past two years.
The following table details the composition of non-performing assets as of the periods presented.
Had non-accrual loans as of June 30, 1999 and 1998, been current in accordance with their original terms, gross interest income of $98,000 and $77,000 would have been recorded in net income for 1999 and 1998, respectively. The amount of interest on these loans that was included in income was $59,000 and $58,000 in 1999 and 1998, respectively. Accruing loans past due 90 days or more at June 30, 1999 consist of four residential mortgage loans, all of which are in the process of collection and where the collection of accrued interest is probable. NewMil pursues the resolution of all non-performing assets through restructurings, credit enhancements or collections. When collection procedures do not bring a loan into performing or restructured status, NewMil generally initiates action to foreclose the property or to acquire it by deed in lieu of foreclosure. NewMil actively markets all OREO and in 1999 sold $1.8 million of OREO from which net gains of $1.3 million were realized.
In addition to non-performing assets, at June 30, 1999 NewMil had $8,238,000 of performing classified loans that are considered potential problem loans. Although not impaired, performing classified loans, in the opinion of management, exhibit a higher than normal degree of risk and warrant monitoring due to various considerations, including (i) the degree of documentation supporting the borrower's current financial position, (ii) potential weaknesses in the borrowers' ability to service the loan, (iii) possible collateral value deficiency, and (iv) other risk factors such as geographic location, industry focus and negatively trending financial results. These deficiencies create some uncertainty, but not serious doubt, as to the borrowers' ability to comply with the loan repayment terms in the future. Management believes that reserves for these loans are adequate.
Deposits and borrowings - ----------------------- Deposits grew $6.2 million, or 2.1%, during 1999 to $300.1 million. Savings, Money Market and NOW accounts grew $14.7 million, or 10.5% and demand deposits grew $4.1 million, or 28.3%, while certificates of deposit decreased $12.6 million, or 9.1%. In May 1999 the Bank closed its Winsted Office and sold the $4.9 million branch deposits. The Bank received a $175,000 deposit premium which offset the branch closing expenses. NewMil has 14 branch offices located in Fairfield, Litchfield and New Haven Counties.
The following table shows the scheduled maturities of certificates of deposit with balances in excess of $100,000:
During 1999 NewMil sold certain securities and used the proceeds to reduce borrowings by $22.5 million to $15.0 million. Borrowings at June 30, 1999 consisted of Federal Home Loan Bank advances with terms ranging from twenty to forty-four months and fixed rates ranging from 5.91% to 6.02%. The borrowings are being used to match fund certain securities. Borrowings at June 30, 1998 had terms of twelve to sixty months and rates between 5.68% and 6.02%.
LIQUIDITY
NewMil manages its liquidity position to ensure that there is sufficient funding availability at all times to meet both anticipated and unanticipated deposit withdrawals, new loan originations, securities purchases and other operating cash outflows. The primary sources of liquidity are principal payments and maturities of securities and loans, short term borrowings through repurchase agreements and Federal Home Loan Bank advances, net deposit growth and funds provided by operations. Liquidity can also be provided through sales of loans and available-for-sale securities.
Operating activities in 1999 provided net cash flows of $5.6 million, up from $3.6 million in 1998. During 1999 investing activities used net cash of $3.4 million, principally for loan advances and purchases and net security purchases. Financing activities used net cash of $19.7 million, principally to repay borrowings, pay shareholder dividends and purchase treasury stock, offset by increased net deposits. Funds provided by operating activities coupled with $17.6 million decreased cash and cash equivalents, due primarily a decrease in federal funds sold, were utilized to fund investing and financing activities.
Operating activities in 1998 provided net cash flows of $3.6 million, up from $3.3 million in 1997. During 1998 investing activities used net cash of $39.2 million, principally for net security purchases. Financing activities provided net cash of $41.4 million, principally from increased deposits and borrowings, offset in part by dividends paid to shareholders and treasury stock purchases. Funds provided by operating and financing activities were utilized to fund investing activities and to increase cash and cash equivalents by $5.8 million.
At June 30, 1999, NewMil's liquidity ratio, as represented by cash, short-term available-for-sale securities, marketable assets, the ability to borrow against held-to-maturity securities and loans through unused FHLB and other short term borrowing capacity, of approximately $176.2 million, to net deposits and short term unsecured liabilities, was 62.0%, well in excess of NewMil's minimum guideline of 15%.
At June 30, 1999, NewMil had outstanding commitments to fund new loan originations of $6.1 million, construction mortgage commitments of $2.7 million and unused lines of credit of $23.9 million. These commitments will be met in the normal course of business. NewMil believes that its liquidity sources will continue to provide funding sufficient to support operating activities, loan originations and commitments, and deposit withdrawals.
ASSET/LIABILITY MANAGEMENT AND MARKET RISK
NewMil manages interest rate risk through an Asset Liability Committee comprised of senior management. The committee monitors exposure to interest rate risk on a quarterly basis using both a traditional gap analysis and simulation analysis. Traditional gap analysis identifies short and long term interest rate positions or exposure. Simulation analysis measures the amount of short term earnings at risk under both rising and falling rate scenarios.
NewMil manages interest rate risk with the objective of maintaining a high and stable net interest margin under changing interest rate environments. Interest rate risk is measured using gap analysis, to identify short- medium- and long-term interest rate risk positions, and simulation analysis, to measure the amount of short-term earnings at risk under rising and falling interest rate scenarios. NewMil seeks to manage interest rate risk within limits approved by the Board of Directors.
The following table sets forth NewMil's interest rate sensitivity position, or gap position, at June 30, 1999, measured in terms of the volume of interest rate sensitive assets and liabilities that are subject to repricing in future time periods. For the purposes of this analysis, money market and savings deposits have been presented in the within 6 month category and NOW account deposits have been presented in the after 5 year category, although the interest rate elasticity of money market, savings and NOW deposits cannot be tied to any one time category. Non-accrual loans and overdrafts have been presented in the non-interest-bearing category. Significant variations may exist in the degree of interest rate sensitivity between individual asset and liability types within the repricing periods presented due to differences in their repricing elasticity relative to changes in the general level of interest rates.
At June 30, 1999, its one year cumulative gap was -$75.7 million, or 21.5% of assets. A liability sensitive gap implies that NewMil's net interest margin could be adversely affected by a sudden increase in interest rates.
NewMil simulates earnings at risk over a twelve month horizon by ramping interest rates +/-100 and +/-200 basis points from the current rate environment. During the year ended June 30, 1999 interest rates did not move +/-100 basis points from their current rates. NewMil's asset/liability management responds to changes in interest rates and market conditions. The simulation analysis incorporates numerous assumptions about balance sheet changes, including growth and product mix, product pricing and the behavior of interest rates. NewMil's policy is to ensure that the change in net income over the twelve month horizon within the +/-200 basis point band will not decrease by 20% or more. The following table indicates that the estimated percentage change in net income over the next twelve month forecast, for June 30, 1999 and 1998, horizon is within NewMil's tolerance limit.
Due to the numerous assumptions in the simulation analysis, actual results will differ from estimated results. Factors other than changes in interest rates could also impact net income. A significant factor in determining NewMil's ability to maintain its net interest margin in a changing interest rate environment is its ability to manage its core deposit rates. Essentially all of NewMil's deposit base is composed of local retail deposit accounts which tend to be somewhat less sensitive to moderate interest fluctuations than other funding sources and, therefore, provide a reasonably stable and cost-effective source of funds. The entry of new competitors into NewMil's market area may pressure NewMil to change its loan and deposit pricing which may negatively affect NewMil's net interest margin. NewMil structures its loan and securities portfolios to provide for portfolio repricing consistent with its interest rate risk objectives.
CAPITAL RESOURCES
During 1999 shareholders' equity decreased $274,000, or 0.8%, to $33.1 million, while book value per share increased 3.8% to $9.04 at June 30, 1999. The decrease in shareholders' equity resulted from treasury stock purchases of $2,110,000 and dividend payments of $1,328,000, offset by earnings of $3,032,000, a $73,000 decrease in the adjustment to shareholders equity for net unrealized holding losses on securities and $59,000 from the exercise of stock options.
In July 1996 NewMil announced its intention to repurchase up to 10% of its outstanding common stock in the open market and unsolicited negotiated transactions, including block purchases. In April and July 1999 NewMil announced its intention to buy additional shares of 100,000 and 50,000, respectively, under the same conditions. The purpose of the repurchase plan is to offset the future dilution from shares issued upon the exercise of stock options under NewMil's stock option plans, and for general corporate purposes. During 1999 NewMil repurchased 184,500 shares, or 4.5%, of its outstanding shares of common stock. As of June 30, 1999 NewMil had repurchased 406,989 shares of its outstanding common stock, under the July 1996 plan, and 71,811 shares of its outstanding common stock, under the April 1999 plan. This represents 94.4% of the total planned repurchases with total consideration of $5,012,000 being paid.
NewMil and the Bank are subject to minimum capital requirements established, respectively, by the Federal Reserve Board (the "FRB") and the FDIC. At June 30, 1999 NewMil's leverage capital ratio was 9.53% and its tier I and total risk-based capital ratios were 18.13% and 19.40%, respectively. At June 30, 1999 the Bank's leverage capital ratio was 9.40% and its tier I and total risk-based capital ratios were 18.46% and 19.73%, respectively. NewMil and the Bank are categorized as "well capitalized". A well capitalized institution, which is the highest capital category for an institution as defined by the Prompt Corrective Action regulations issued by the FDIC and the FRB, is one which maintains a total risk-based ratio of 10% or above, a tier I risk-based ratio of 6% or above and a leverage ratio of 5% or above, and is not subject to any written order, written agreement, capital directive, or prompt corrective action directive to meet and maintain a specific capital level.
Dividend Restrictions - --------------------- NewMil's ability to pay dividends to its shareholders is dependent on the Bank's ability to pay dividends to NewMil. There are certain restrictions on the payment of dividends by the Bank to NewMil. Under Connecticut law a bank is prohibited from declaring a cash dividend on its common stock except from its net profit for the current year and retained net profits for the preceding two years. Consequently, the maximum amount of dividends payable by the Bank to NewMil at June 30, 1999 is $1,064,000. In some instances, further restrictions on dividends may be imposed on NewMil by the FRB.
In October 1994 NewMil resumed dividend payments with the payment of a $0.02 quarterly cash dividend, following a four year lapse. In October 1995, 1996, 1997 and 1998 NewMil increased its quarterly cash dividend to $0.05, $0.06, $0.08 and $0.09, respectively. In July 1999 NewMil increased its quarterly dividend to $0.10. For 1999 total dividends of $0.35 per share were paid.
NewMil believes that the payment of cash dividends to its shareholders is appropriate, provided that such payment considers NewMil's capital needs, asset quality, and overall financial condition and does not adversely affect the financial stability of NewMil or the Bank. The continued payment of cash dividends by NewMil will be dependent on NewMil's future core earnings, financial condition and capital needs, regulatory restrictions, and other factors deemed relevant by the Board of Directors of NewMil.
IMPACT OF RECENT ACCOUNTING PRONOUNCEMENTS
There were no new accounting pronouncements which are expected to impact NewMil at this time.
YEAR 2000
Year 2000 Action Plan
In early 1997 NewMil developed its Year 2000 Action Plan (Plan) to ensure that its operating systems, and those of its outside vendors and suppliers, will function correctly in the year 2000 and beyond. During 1999 NewMil became compliant with its Year 2000 Plan. The Plan is managed by the Year 2000 Committee, comprised of representatives from each operational area of the Bank. The Plan has five phases: (1) awareness; (2) assessment; (3) renovation; (4) validation; and, (5) implementation.
The awareness phase included development of the Plan, conducting awareness meetings and communicating with all NewMil employees, attending Year 2000 seminars and attending a user group meeting for the Bank's legacy system vendor. The awareness phase was completed during 1997.
The assessment phase included the development of an inventory of all date sensitive systems, including in-house systems and those of the Bank's outside vendors and suppliers, a risk assessment of each element, and specific methodology to correct non-compliant systems. As of June 30, 1999 the assessment phase was completed for all items.
High criticality ratings were assigned to several systems, including the Bank's legacy computer systems, that had the potential to substantially impact the Bank's operation should they prove to be non-compliant.
The renovation phase addresses the bringing of systems into compliance, systems replacements and retirements. As of June 30, 1999 the renovation phase was completed for all items.
The validation phase addresses systems testing by the Bank and its outside vendors and suppliers alike. The Bank converted its in-house computer system in November 1998 from a legacy computer system to a client server relational database system. The Bank's new client server system has been certified Year 2000 compliant by the supplying vendor and the Bank verified compliance in early 1999. Several third party interfaces were scheduled for testing in early 1999 as well. All systems testing has been completed as of June 30, 1999.
The implementation phase addresses the roll out of Year 2000 compliant systems during 1998 and 1999. As of June 30, 1999 the implementation phase was completed for all items.
In addition, contingency plans have been developed for all systems with high criticality ratings. Testing of these contingency plans is proceeding according to plan and is expected to be completed by September 1999.
NewMil has completed an evaluation of its loan portfolio to identify credit risk arising from the potential failure of a borrower's operating or other systems as a consequence of the Year 2000. NewMil conducted mailings of a Year 2000 Questionnaire to all of its commercial borrowers and completed Year 2000 Risk to Bank assessment ratings for all commercial borrowers in early 1999.
Federal banking agencies are conducting supervisory reviews of all financial institutions Year 2000 readiness. In February 1998 the FDIC completed an assessment of the Bank's Year 2000 planning efforts. In September 1998 the FDIC conducted a supervisory review of the Bank's Year 2000 conversion effort. In March 1999 the FDIC and State of Connecticut completed their Year 2000 Readiness Phase II Assessment of the Bank.
Costs
The cost of Year 2000 compliance is expected to be minimal because the Bank converted its in-house data processing system to a new system which has been certified to be Year 2000 compliant. This cost has been capitalized and is being depreciated over the fixed assets useful lives. Based on current information, management believes that specific costs related to NewMil's Year 2000 systems issues will not have a material impact on the operations, cash flows or financial condition of NewMil.
Risks
Due to the general uncertainty inherent in the Year 2000 problem, resulting in part from the uncertainty of the Year 2000 readiness of third-party vendors and borrowers, NewMil is unable to determine at this time whether the consequences of Year 2000 failures, if any, will have a material impact on NewMil's results of operations, liquidity or financial condition. However, based on NewMil's high level of readiness and the readiness reported by all significant third party vendors, NewMil does not expect any significant disruption of service. The Year 2000 Action Plan is expected to significantly reduce NewMil's level of uncertainty about the Year 2000 problem and, in particular, about the Year 2000 readiness of its material vendors, suppliers and commercial borrowers. NewMil believes that, with the implementation of the new client server system and the completion of the Plan as scheduled, the possibility of significant interruptions of normal operations will be minimized.
IMPACT OF INFLATION AND CHANGING PRICES
NewMil's financial statements have been prepared in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, virtually all of the assets and liabilities of a financial institution are monetary in nature. As a result, interest rates have a more significant impact on a financial institution's performance than the effect of general levels of inflation. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services. Notwithstanding this, inflation can directly affect the value of loan collateral, in particular real estate. Sharp decreases in real estate prices have, in past years, resulted in significant loan losses and losses on real estate acquired. Inflation, or disinflation, could significantly affect NewMil's earnings in future periods.
Item 8.
Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT ACCOUNTANTS
The Board of Directors and Shareholders of NewMil Bancorp, Inc.
In our opinion, the accompanying consolidated balance sheets and the related consolidated statements of income, changes in shareholders' equity, and cash flows present fairly, in all material respects, the financial position of NewMil Bancorp, Inc. and its subsidiary at June 30, 1999 and 1998, and the results of their operations and their cash flows for each of the three years in the period ended June 30, 1999 in conformity with generally accepted accounting principles. These financial statements are the responsibility of NewMil's management; our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits of these statements in accordance with generally accepted auditing standards, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above.
As discussed in Note 2 to the consolidated financial statements, NewMil changed its method of accounting for derivative financial instruments in 1999.
/s/ PricewaterhouseCoopers LLP Hartford, Connecticut July 20, 1999
NewMil Bancorp, Inc. and Subsidiary NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NewMil Bancorp, Inc. ("NewMil") is the bank holding company for New Milford Savings Bank (the "Bank"), a State chartered savings bank. NewMil's activity is currently limited to the holding of the Bank's outstanding capital stock and the Bank is the Company's only subsidiary and its primary investment. The Bank is a Connecticut chartered and Federal Deposit Insurance Corporation (the "FDIC") insured savings bank headquartered in New Milford, Connecticut. The Bank's principal business consists of attracting deposits from the public and using such deposits, with other funds, to make various types of loans and investments. The Bank conducts its business through 14 offices located in Litchfield, Fairfield and New Haven Counties. The accompanying consolidated financial statements have been prepared in conformity with generally accepted accounting principles. The following is a summary of significant accounting policies:
Principles of Consolidation
The consolidated financial statements include those of NewMil and its subsidiary after elimination of all intercompany accounts and transactions. Certain reclassifications have been made to prior years' amounts to conform with the 1999 financial presentation.
Basis of Financial Statement Presentation
The financial statements have been prepared in accordance with generally accepted accounting principles. In preparing the financial statements, management is required to make extensive use of estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the statement of condition, and revenues and expenses for the period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses and the valuation of OREO in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowance for loan losses and valuation of OREO, management obtains independent appraisals for significant properties.
NewMil's loans are generally collateralized by real estate located principally in Connecticut. In addition, substantially all OREO is located in Connecticut. Accordingly, the collectability of a substantial portion of the Company's loan portfolio and OREO through foreclosure is particularly susceptible to changes in market conditions.
While management uses available information to recognize losses on loans and OREO, future additions to the allowance or write-downs of OREO may be necessary based on changes in economic conditions, particularly in Connecticut. In addition, various regulatory agencies, as an integral part of their examination process, periodically review NewMil's allowance for loan losses and valuation of OREO. Such agencies may require NewMil to recognize additions to the allowance or write-downs based on their judgements of information available to them at the time of their examination.
Securities
Securities that may be sold as part of NewMil's asset/liability or liquidity management or in response to or in anticipation of changes in interest rates and resulting prepayment risk, or for other similar factors, are classified as available-for-sale and carried at their fair market value. Unrealized holding gains and losses on such securities are reported net of related taxes, if applicable, as a separate component of shareholders' equity. Securities that NewMil has the ability and positive intent to hold to maturity are classified as held-to-maturity and carried at amortized cost. Realized gains and losses on the sales of all securities are reported in earnings and computed using the specific identification cost basis. Securities that NewMil has transferred from available-for-sale to held-to-maturity are carried at the fair value at the time of transfer, adjusted for subsequent amortization or accretion and net of applicable taxes.
Loans
Loans are reported at their principal outstanding balance net of charge-offs, deferred loan origination fees and costs, and unamortized premiums or discounts on purchased loans. Loan origination and commitment fees and certain direct origination costs are deferred and recognized over the life of the related loan as an adjustment of yield, or taken into income when the related loan is sold.
Mortgage loans held-for-sale are valued at the lower of cost or market as determined by outstanding commitments from investors or current investor yield requirements calculated on the aggregate loan basis. Changes in the carrying value are reported in earnings as gains and losses on mortgage loans. Realized gains and losses on sales of mortgage loans are reported in earnings when the proceeds are received from investors.
The accrual of interest on loans is generally discontinued when principal or interest is past due by 90 days or more, or earlier when, in the opinion of management, full collection of principal or interest is unlikely unless such loans are well collateralized and in the process of collection. When a loan is placed on non-accrual status, interest previously accrued but not collected is charged against current income. Income on such loans is then recognized only to the extent that cash is received and future collection of principal is probable.
Loans are restored to accrual status when principal and interest payments are brought current and future payments are reasonably assured, following a sustained period of repayment performance by the borrower in accordance with the loan's contractual terms.
Troubled debt restructurings ("TDR") are renegotiated loans for which concessions, such as the reduction of interest rates, deferral of interest or principal payments, or partial forgiveness of principal and interest, have been granted due to a deterioration in a borrower's financial condition. Interest to be paid on a deferred or contingent basis is reported in earnings only as collected.
Allowance for Loan Losses
NewMil periodically reviews the allowance for loan losses in order to maintain the allowance at a level sufficient to absorb probable credit losses. NewMil's review is based upon a detailed evaluation of the loan portfolio through a process which considers numerous factors, including estimated credit losses based upon internal and external portfolio reviews, delinquency levels and trends, estimates of the current value of underlying collateral, concentrations, portfolio volume and mix, changes in lending policy, historical loan loss experience, current economic conditions and examinations performed by regulatory authorities. The allowance for loan losses is increased through charges to earnings in the form of a provision for loan losses. When a loan or portion of a loan is determined to be uncollectible, the portion deemed uncollectible is charged against the allowance and subsequent recoveries, if any, are credited to the allowance. While NewMil uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in regional economic conditions and related factors.
NewMil measures impaired loans based on the present value of the expected future cash flows discounted at the loan's effective interest rate, or the fair value of the collateral, less estimated selling costs, if the loan is collateral dependent and foreclosure is probable. NewMil recognizes impairment by creating a valuation allowance. A loan is impaired when, based on current information, it is probable that NewMil will be unable to collect all amounts due according to the contractual terms of the loan.
Smaller-balance homogeneous loans consisting of residential mortgages and consumer loans are evaluated for collectability by NewMil based on historical loss experience rather than on an individual loan-by-loan basis. Impaired loans are primarily commercial mortgages, collateralized by real estate.
Other Real Estate Owned
Real estate acquired through foreclosure, forgiveness of debt and in lieu of debt, are stated at the lower of cost (principally loan amount) or fair value minus estimated selling expenses. When a loan is reclassified as real estate acquired any excess of the loan balance over its fair value less estimated selling costs is charged against the allowance for loan losses. Costs relating to the subsequent development or improvement of a property are capitalized, to the extent realizable. Holding costs and any subsequent provisions to reduce the carrying value of a property to fair value minus estimated selling expenses are charged to earnings and classified as real estate acquired expense. Fair value is determined by current appraisal for collateral dependent loans.
Income Taxes
Deferred income taxes are provided for differences arising in the timing of income and expenses for financial reporting and for income tax purposes using the asset/liability method of accounting for income taxes. Deferred income taxes and tax benefits are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. NewMil provides deferred taxes for the estimated future tax effects attributable to temporary differences and carryforwards when realization is assured beyond a reasonable doubt.
Bank Premises and Equipment
Bank premises, furniture and equipment are carried at cost, less accumulated depreciation and amortization computed on the straight-line method over the estimated useful lives of the assets. Leasehold improvements are amortized on the straight-line basis over the shorter of the estimated useful lives of the improvements or the term of the related leases.
Statement of Cash Flows
For the purpose of the Consolidated Statements of Cash Flows, cash and cash equivalents include cash and due from banks, interest-bearing deposits at other financial institutions and overnight federal funds sold.
Computation of Earnings per Share
Effective December 31, 1997, NewMil adopted the provisions of Statement of Financial Accounting Standards No. 128, "Earnings per Share" (SFAS 128). SFAS 128 establishes standards for computing and presenting earnings per share ("EPS"). It replaces the presentation of primary EPS with a presentation of basic EPS. It also requires dual presentation of basic and diluted EPS on the face of the income statement for all entities with complex capital structures. This statement was effective for financial statements issued for periods ending after December 15, 1997 and has been applied for all periods presented.
Basic earnings per share is computed using the weighted-average common shares outstanding during the year. The computation of diluted earnings per share is similar to the computation of basic earnings per share except the denominator is increased to include the number of additional common shares that would have been outstanding if dilutive potential common shares had been issued. The shares used in the computations for the three years ended June 30, were as follows:
Segments of an Enterprise and Related Information
In June 1997, the FASB issued Statement of Financial Accounting Standards No. 131 "Disclosures about Segments of an Enterprise and Related Information" (SFAS 131). SFAS 131 requires public companies to report financial and descriptive information about operating segments in annual financial statements and requires selected information about operating segments to be reported in interim financial reports issued to shareholders. Operating segment financial information is required to be reported on the basis that it is used internally for evaluating segment performance and allocation of resources. SFAS 131 is effective for financial statements for periods beginning after December 15, 1997 and requires presentation of comparative information for prior periods presented. NewMil does not have any operating segments, as defined by SFAS 131, and therefore, has not disclosed the additional information.
NOTE 2 - SECURITIES
In June 1998, the FASB issued Statement of Financial Accounting Standards No. 133 (SFAS 133), "Accounting for Derivative Instruments and Hedging Activities". SFAS 133 was modified by SFAS 137 to make the standard effective for all fiscal years beginning after June 15, 2000 (July 1, 2000 for NewMil). SFAS 133 requires that all derivative instruments be recorded on the balance sheet at their fair value. Changes in the fair value of derivative instruments are recorded each period in current earnings or other comprehensive income, depending on whether a derivative is designated as part of a hedge transaction and, if it is, the type of hedge transaction. NewMil does not presently have any derivative or hedging instruments. NewMil has not had any derivative or hedging instruments in the past three years.
In 1999 NewMil adopted the provisions of SFAS 133 and under this provision reclassified securities totaling $21 million from held-to-maturity to available-for-sale, and then sold those securities. NewMil realized a loss, net of taxes, of $162,000 on the transfer and sale of these securities. This loss has been reported separately in net income as the cumulative effect of adopting SFAS 133. In past years these securities had experienced significant market price volatility. NewMil sold these securities to reduce it's exposure to market risk.
At September 30, 1998 these securities were carried in the held-to-maturity category at $1,091,000 below cost, with a related unrealized loss, net of taxes, in shareholders equity. The unrealized loss was generated as a result of having transferred them from available-for-sale to held-to-maturity at which time they were transferred at their then current market value, which was significantly below their amortized cost. The unrealized loss, at the date of transfer, was frozen and amortized as the related investments paid down.
During 1998 NewMil sold a collateralized mortgage obligation ("CMO") with an amortized cost of $7,428,000 which was classified as held-to-maturity and realized a loss of $103,000. NewMil had engaged a financial securities consultant to analyze this CMO. Based on this review NewMil determined that it was highly probable that NewMil would likely receive substantially less than the contractual interest on this CMO and that the CMO could experience a significant decline in market value. NewMil concluded that these and other changes in circumstances surrounding this CMO were isolated, non-recurring, and highly unusual, and could not have been reasonably anticipated.
At June 30, 1999 securities with a carrying value and market value aggregating approximately $786,000 and $746,000, respectively, were pledged as collateral against public funds.
NOTE 3 - LOANS
NewMil's loans consist primarily of residential and commercial real estate loans located principally in western Connecticut, NewMil's service area. NewMil offers a broad range of loan and credit facilities to borrowers in its service area, including residential mortgage loans, commercial real estate loans, construction loans, working capital loans, and a variety of consumer loans, including home equity lines of credit, and installment and collateral loans. All residential and commercial mortgage loans are collateralized by first or second mortgages on real estate. The ability and willingness of borrowers to satisfy their loan obligations is dependent in large part upon the status of the regional economy and regional real estate market. Accordingly, the ultimate collectability of a substantial portion of the NewMil's loan portfolio and the recovery of a substantial portion of OREO is susceptible to changes in market conditions.
NOTE 4 - NON-PERFORMING ASSETS
NOTE 5 - BANK PREMISES AND EQUIPMENT
NOTE 6 - BORROWINGS
NewMil's borrowings consist of advances from the Federal Home Loan Bank of Boston and repurchase agreements with major brokerage firms that are primary dealers in government securities. Advances from the Federal Home Loan Bank of Boston at June 30, were as follows:
NewMil has a pre-approved line of credit of up to 2% of total assets with the Federal Home Loan Bank of Boston ("FHLBB") under the FHLBB's IDEAL Way Line of Credit Program. These advances are one-day variable rate loans with automatic rollover. Under an agreement with the FHLBB NewMil is required to maintain qualified collateral, as defined in the FHLBB's Statement of Credit Policy, free and clear of liens, pledges and encumbrances, as collateral for the advances and the pre-approved line of credit. NewMil maintains qualified collateral in excess of the amount required to support the outstanding advances and the pre-approved line of credit at June 30, 1999.
During 1999 NewMil used the proceeds from the sale of securities to prepay $22.5 million of Federal Home Loan Bank fixed rate advances. NewMil incurred a gross prepayment fee of $147,000. The effect on the net income of this prepayment fee was $87,000, net of taxes, and has been reported in net income as an extraordinary item for this early extinguishment of debt.
NOTE 7 - INCOME TAXES
NewMil provides deferred taxes for the estimated future tax effects attributable to temporary differences and carryforwards when realization is more likely than not. The components of the income tax provision were as follows:
The following is a reconciliation of the expected federal statutory tax to the income tax provision:
The components of NewMil's net deferred tax asset were as follows: (in thousands)
NewMil will only recognize a deferred tax asset when, based upon available evidence, realization is more likely than not. At June 30, 1999, NewMil recorded a valuation reserve of $143,000 and $485,000 against federal and state deferred tax assets, respectively, representing capital loss carryforwards which NewMil does not expect to utilize.
On May 19, 1998 Connecticut legislation was passed which made sweeping changes to the corporation business tax treatment of banks and financial service companies. The new law permits banks to shelter certain mortgage income from the Connecticut corporation business tax through the use of a new special purpose entity called a "passive investment company" (PIC). In general, the PIC can earn mortgage interest income, and pay dividends to its parent company, free from the Connecticut corporation business tax. The legislation was effective for income years commencing on or after January 1, 1999.
NewMil formed a PIC, NMSB Mortgage Company, and changed its tax year to a calendar year basis to take advantage of the Connecticut statute. Effective January 1, 1999 NewMil transferred mortgages into the PIC and income of the PIC and its dividends to NewMil became exempt from the Connecticut Corporation Business Tax. Effective January 1, 1999, NewMil's combined Federal and State effective tax rate became 34%, compared with an effective rate, during the first two quarters of the fiscal year, of 40.27% (prior to the deferred tax asset write-off, discussed below). The formation of the PIC required NewMil to establish a valuation allowance against its existing deferred State tax assets that are no longer expected to be realized in future years. Accordingly, NewMil's income tax provision for the year ended June 30, 1999 includes a charge of $266,000.
NOTE 8 - RETIREMENT PLANS
In February 1998, the FASB issued Statement of Financial Accounting Standards No. 132 (SFAS 132), "Employers' Disclosure about Pensions and Other Postretirement Benefits". SFAS 132 standardizes the disclosure requirements for pension and other postretirement benefits by requiring additional information to facilitate financial analysis and eliminate certain disclosures that are considered no longer useful. SFAS 132 supersedes the disclosure requirements of SFAS Nos. 87, 88 and 106. This Statement is effective for fiscal years beginning after December 15, 1997. Restatement of disclosures for earlier periods provided for comparative purposes is required unless the information is not readily available. NewMil adopted SFAS 132 as of July 1, 1998.
NewMil has a non-contributory defined benefit pension plan (the "Pension Plan") covering all eligible employees. Since September 1, 1993 benefit accruals have been suspended under the Pension Plan for all employees. The accrued benefits are primarily based on compensation and length of service. Pension Plan assets consist principally of cash, money market funds, bonds and equity securities. The funded status of the Pension Plan at March 31 was as follows:
No contributions were made to the Pension Plan in 1999, 1998 or 1997. NewMil has a supplemental pension plan which provides retirement benefits to a key employee who is not included in the Pension Plan.
NewMil has a 401(k) Savings Retirement Plan covering all eligible employees. Participants may contribute up to 15% of their compensation, subject to a maximum of $10,000 per year in 1999. NewMil contributes amounts equal to 50% of annual employee contributions up to 6% of participants' compensation. Employees are fully vested in NewMil's contributions after five years of service. NewMil contributed $79,196, $74,875 and $61,972 to the Plan in 1999, 1998 and 1997, respectively. This plan allows for NewMil to make non-contributory profit sharing contributions. No profit sharing contributions were made in 1999, 1998 or 1997.
NewMil provides post-retirement health benefits for current retirees and eligible employees. Post-retirement life insurance benefits are provided for employees that were eligible for retirement as of October 1, 1993 and current retirees. The cost of post-retirement health care benefits is shared by NewMil and the retiree, and benefits are based on deductible and coinsurance provisions. The post-retirement life insurance benefits are non-contributory, and benefits are based on a percentage of the base pay at retirement. Effective October 1, 1993 NewMil suspended certain post-retirement benefits and introduced a co-pay provision for new employees hired on or after October 1, 1993. NewMil does not advance-fund its post-retirement health care and life insurance benefit plan. Post-retirement expense for 1999, 1998 and 1997 was $60,000, $50,000 and $60,000, respectively.
NOTE 9 - SHAREHOLDERS' EQUITY
Capital Requirements - -------------------- The Bank is subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional and discretionary actions by the 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 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 judgments by the regulators 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 table below) of Tier 1 capital (as defined) to average assets (as defined) and total and Tier 1 capital (as defined) to risk-weighted assets (as defined). Management believes, as of June 30, 1999, that the Bank meets all capital adequacy requirements to which it is subject.
The Bank was classified, as of its most recent notification, as "well capitalized". At June 30, 1999, the Bank's actual regulatory capital position as compared to both the capital position as defined "For Capital Adequacy Purposes" and "To Be Well Capitalized Under Prompt Corrective Action Provisions" is as follows:
Restrictions on Subsidiary's Dividends and Payments - --------------------------------------------------- NewMil's ability to pay dividends is dependent on the Bank's ability to pay dividends to NewMil. There are certain restrictions on the payment of dividends and other payments by the Bank to NewMil. Under Connecticut law the Bank is prohibited from declaring a cash dividend on its common stock except from its net profit for the current year and retained net profits for the preceding two years. Consequently, the maximum amount of dividends payable by the Bank to NewMil at June 30, 1999 is $1,064,000. In some instances, further restrictions on dividends may be imposed on NewMil by the FRB.
In July 1996 NewMil announced its intention to repurchase up to 10% of its outstanding common stock in the open market and unsolicited negotiated transactions, including block purchases. In April and July 1999 NewMil announced its intention to buy additional shares of 100,000 and 50,000, respectively, under the same conditions. The purpose of the repurchase plan is to offset the future dilution from shares issued upon the exercise of stock options under NewMil's stock option plans, and for general corporate purposes. During 1999 NewMil repurchased 184,500 shares, or 4.5%, of its outstanding shares of common stock. As of June 30, 1999 NewMil had repurchased 406,989 shares of its outstanding common stock, under the July 1996 plan, and 71,811 shares of its outstanding common stock, under the April 1999 plan. This represents 94.4% of the total planned repurchases with total consideration of $5,012,000 being paid.
NOTE 10 - COMPREHENSIVE INCOME
Effective July 1, 1998, NewMil adopted the provisions of Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive Income" (SFAS 130). SFAS 130 establishes standards for reporting and display of comprehensive income and its components. Comprehensive income includes net income and any changes in equity from non-owner sources that are not recorded in the income statement (such as changes in net unrealized gains (losses) on securities). The purpose of reporting comprehensive income is to report a measure of all changes in equity of an enterprise that result from recognized transactions and other economic events of the period other than transactions with owners in their capacity as owners. NewMil's one source of other comprehensive income is the net unrealized gain (loss) on securities.
NOTE 11 - RELATED PARTY TRANSACTIONS
In the normal course of business the Bank has granted loans to executive officers, directors, principal shareholders and associates of the foregoing persons considered to be related parties. Changes in loans to executive officers, directors and their related associates are as follows (there are no loans to principal shareholders):
Note 1. Adjustment to exclude loans outstanding to persons who are no longer considered related parties, as well as to add loans previously outstanding to persons who became related parties during the year.
NOTE 12 - STOCK OPTIONS
NewMil's 1986 Stock Option and Incentive Plan ("1986 Plan") authorizes the granting of both incentive and non-incentive options and stock appreciation rights (SARs) to officers and other key employees by the Salary and Benefits Committee of the Board. The 1986 Plan provides for the granting of options to purchase shares of Common Stock for terms of up to 10 years at an exercise price not less than 85% of the fair market value of NewMil's stock on the date of the grant. The options are fully vested at the time of the grant. Changes in outstanding stock option and SARS were as follows:
Note 1. Includes 8,000 options with SARs.
All stock options outstanding as of June 30, 1999 were exercisable. As of June 30, 1999 options to purchase 76,548 shares of Common Stock were available to be granted under the 1986 Stock Option and Incentive Plan.
NewMil's 1992 Stock Option Plan for Outside Directors ("1992 Plan") provides for automatic grants of options to non-employee directors who were participants on the effective date of the plan and were reelected as non-employee directors. At the annual meeting in 1995 the plan was amended so that all non-employee directors would be granted 2,000 options at June 30th of each subsequent year. The 1992 Plan provides for the granting of options to purchase shares of Common Stock for terms of up to 10 years at an exercise price of not less than the fair market value (average of the bid and ask price) of NewMil's stock on the date of the grant. The options are fully vested at the time of the grant. Changes in outstanding stock options were as follows:
All stock options outstanding as of June 30, 1999 were exercisable. As of June 30, 1999 options to purchase 3,000 shares of Common Stock were available to be granted under the 1992 Stock Option Plan for Outside Directors.
Effective July 1, 1996 NewMil adopted Statement of Financial Accounting Standards No. 123 "Accounting for Stock-Based Compensation" (SFAS 123). As permitted by SFAS 123 NewMil has chosen to apply APB Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25) and related interpretations in accounting for its Plans. Accordingly, no compensation expense has been recognized for options granted under its Plans. Had compensation cost for the NewMil's Plans been determined based on the fair value at the grant dates for awards under the Plans consistent with the method of SFAS 123, NewMil's net income and diluted
earnings per share would have been reduced to the proforma amounts indicated below.
The fair value of each option grant was estimated on the date of grant using the Roll-Geske Model for pricing American call options with dividends, with the following weighted average assumptions used for grants:
NOTE 13 - COMMITMENTS AND CONTINGENT LIABILITIES
In the normal course of business there are various commitments and contingent liabilities outstanding pertaining to the purchase and sale of securities and the granting of loans and lines of credit which are not reflected in the accompanying financial statements. At June 30, 1999 NewMil had commitments under outstanding construction mortgages of $2,697,000, unused lines of credit of $23,879,000 and outstanding commitments to fund loans of $6,104,000. At June 30, 1998 NewMil had commitments under outstanding construction mortgages of $1,501,000, unused lines of credit of $19,268,000 and outstanding commitments to fund loans of $7,254,000. NewMil does not anticipate any material losses as a result of these transactions. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. NewMil's exposure to credit loss in the event of non-performance by the other party to the commitment is represented by the contractual amount of the instrument. The exposure to credit loss is limited by evaluating the customer's credit worthiness on a case-by-case basis and by obtaining collateral if deemed necessary. Collateral held generally includes residential and commercial properties. NewMil generally requires an initial loan to value ratio of no greater than 80% when real estate collateralizes a loan commitment.
NewMil and its subsidiaries are defendants in proceedings arising out of, and incidental to, activities conducted in the normal course of business. In the opinion of management, resolutions of these matters will not have a material effect on NewMil's financial condition, results of operations or cash flows.
NewMil leases facilities under operating leases which expire at various dates through 2004. The leases have varying renewal options, generally require a fixed annual rent, and provide that real estate taxes, insurance, and maintenance are to be paid by NewMil. Rent expense totaled $253,234, $232,240 and $167,041 for 1999, 1998 and 1997, respectively. Future minimum lease payments at June 30, 1999 are as follows:
NOTE 14 - ESTIMATED FAIR VALUES OF FINANCIAL INSTRUMENTS
Statement of Financial Accounting Standards No. 107 "Disclosures About Fair Value of Financial Instruments" (SFAS 107), requires NewMil to disclose fair value information for certain of its financial instruments, including loans, securities, deposits, borrowings and other such instruments. Quoted market prices are not available for a significant portion of NewMil's financial instruments and, as a result, the fair values presented may not be indicative of net realizable or liquidation values. Fair values are estimates derived using present value or other valuation techniques and are based on judgements regarding future expected loss experience, current economic conditions, risk characteristics, and other factors. In addition, fair value estimates are based on market conditions and information about the financial instrument at a specific point in time. Fair value estimates are based on existing on- and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Such items include mortgage servicing, core deposit intangibles and other customer relationships, premises and equipment, foreclosed real estate and income taxes. In addition, the tax ramifications relating to the realization of the unrealized gains and losses may have a significant effect on fair value estimates and have not been considered in the estimates.
The following is a summary of the methodologies and assumptions used to estimate the fair value of NewMil's financial instruments pursuant to SFAS 107.
Cash, cash equivalents and other: The fair value of cash and due from banks, deposits with banks, federal funds sold, accrued interest receivable, securities sold under repurchase agreements and accrued interest payable, is considered to approximate the book value due to their short-term nature and negligible credit losses.
Securities: Fair value of securities available-for-sale and held-for-sale were determined by secondary market and independent broker quotations.
Loans: Fair values for residential mortgage and consumer installment loans were estimated by discounting cash flows, adjusted for prepayments. The discount rates used for residential mortgages were secondary market yields for residential mortgage loans, net of servicing and adjusted for risk. The discount rates used for consumer installment loans were current rates offered by NewMil. Fair values for commercial loans were estimated by assessing credit risk and interest rate risk. Such loans were valued by discounting estimated future cash flows at a rate that incorporates both interest and credit risk.
Deposit liabilities: The fair value for demand, savings and certain money market deposits is equal to the amount payable on demand at the balance sheet date which is equal to the carrying value. The fair value of certificates of deposit was estimated by discounting cash flows using rates currently offered by NewMil for deposits of similar remaining maturities.
Borrowings: The fair value for borrowings was estimated by discounting cash flows using rates currently offered by lenders for borrowings of similar remaining maturities.
NOTE 15 - NEWMIL BANCORP, INC. (parent company only) FINANCIAL INFORMATION
The unconsolidated balance sheets of NewMil Bancorp, Inc. at June 30, and its statements of income and cash flows for each of the years ended June 30, are presented as follows:
NOTE 16 - QUARTERLY FINANCIAL DATA (Unaudited)
Item 9.
Item 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
There were no disagreements on accounting and financial disclosures between NewMil and its independent accountants for which a Form 8-K was required to be filed during the two most recent fiscal years or for the period from June 30, 1999 to the date hereof.
PART III
Item 10.
Item 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The information required by this item appears on pages 5 through 7 of NewMil's Proxy Statement dated September 27, 1999 for the 1999 Annual Meeting of Shareholders, under the captions "Nominees for Election for a Three Year Term" and "Directors Continuing in Office". Such information is incorporated herein by reference and made a part hereof.
Item 11.
Item 11. EXECUTIVE COMPENSATION
The information required by this item appears on pages 7 through 14 of NewMil's Proxy Statement dated September 27, 1999 for the 1999 Annual Meeting of Shareholders, under the captions: "Executive Compensation"; "Employee Benefit Plans"; "Report of the Board on Executive Compensation"; and "Performance Graph". Such information is incorporated herein by reference and made a part hereof.
Item 12.
Item 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT
The information required by this item appears on pages 5 through 7 of NewMil's Proxy Statement dated September 27, 1999 for the 1999 Annual Meeting of Shareholders, under the caption "Nominees for Election for a Three Year Term" and "Directors Continuing in Office". Such information is incorporated herein by reference and made a part hereof.
Item 13.
Item 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item appears on page 14 of NewMil's Proxy Statement dated September 27, 1999 for the 1999 Annual Meeting of Shareholders, under the caption "Transactions with Management and Others". Such information is incorporated herein by reference and made a part hereof.
PART IV
Item 14.
Item 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K
(a) The following documents are filed as exhibits to this report and appear on the pages indicated. Financial Statements -------------------- None.
(b) Reports on Form 8-K ------------------- None.
(c) Exhibits -------- The following documents are filed as Exhibit to this Form 10-K, as required by Item 601 of Regulation S-K.
Exhibit No. Description
3.1 Certificate of Incorporation of NewMil (incorporated by reference to Exhibit 3.1 to NewMil's Registration Statement on Form S-4 (No. 33-10693) filed on December 9, 1986) 3.1.1 Amendment to Certificate of Incorporation of NewMil increasing authorized shares of common stock from 6,000,000 to 20,000,000 (incorporated by reference to the Registrant's 1994 Proxy Statement dated September 23, 1994, page A-1). 3.2 Bylaws of NewMil (incorporated by reference to Exhibit 3.2 to NewMil's Registration Statement on Form S-4 (No. 33-10693) filed on December 9, 1986) 4.1 Instruments Defining Rights of Security Holders (Included in Exhibits 3.1 and 3.2) 10.1 The New Milford Savings Bank 1986 Stock Option and Incentive Plan (incorporated by reference to Exhibit 10.1 to the Company's Registration Statement on Form S-4 (No. 33-10693) filed on December 9, 1986) 10.2 The New Milford Savings Bank 1986 Stock Option and Incentive Plan Incentive Stock Option Agreement and Non-Qualified Stock Option Agreement (incorporated by reference to the Registrant's 1988 Form 10-K). 10.3 1992 Stock Option Plan For Outside Directors of NewMil Bancorp, Inc. (incorporated by reference to the Registrant's 1992 Proxy Statement dated September 22, 1992, pages 17 through 20). 10.5 Rights Agreement between NewMil Bancorp, Inc. and American Stock Transfer and Trust Company as Rights Agent dated as of July 19, 1994 concerning NewMil Bancorp's shareholder rights plan of same date (incorporated by reference to the Registrant's 1994 Form 10-K). 10.6 The NewMil Bancorp, Inc. Amended and Restated 1986 Stock Option and Incentive Plan (incorporated by reference to the Registrant's 1995 Proxy Statement dated September 20, 1995, pages A-1 to A-11). 10.7 Employment agreement between New Milford Savings Bank and its President and CEO, Francis J. Wiatr, as of March 31, 1994 (incorporated by reference to the Registrant's 1995 Form 10-K). 10.8 Dividend reinvestment plan for NewMil Bancorp's shareholders (incorporated by reference to the Registrant's 1996 Form 10-K). 10.9 Change in control agreements between New Milford Savings Bank and management (Messrs. Grant, McMahon and Shannon; Ms. Farrell)(incorporated by reference to the Registrant's 1996 Form 10-K). 10.10 The Amended and Restated 1992 Stock Option Plan for Outside Directors of NewMil Bancorp, Inc. (incorporated by reference to the Registrant's 1995 Proxy Statement dated September 20, 1995, pages B-1 to B-4). 10.12 The Amended 1986 Stock Option and Incentive Plan (extending term until 2005 and increasing shares to 525,000), approved by shareholders October 1997. 10.13 First and Second Amendments to Employment Agreement of Francis J. Wiatr, as of August 1998. 10.14 Amendment to Bylaws of NewMil. 11.1 Statement regarding Computation of Net Income Per Common Share. 23.0 Consent of PricewaterhouseCoopers LLP. 20.1 Proxy Statement dated September 27, 1999 for the Annual Meeting of Shareholders, of NewMil Bancorp, Inc. 21.1 Subsidiaries of the Registrant.
(d) Financial Statement Schedules -----------------------------
No financial statement schedules are required to be filed as Exhibits pursuant to Item 14(d).
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.
NEWMIL BANCORP, INC. /s/ Francis J. Wiatr Francis J. Wiatr Chairman of the Board, President and Chief Executive Officer September 16, 1999
Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated, on the dates indicated below.
/s/ Willis H. Barton, Jr. Willis H. Barton, Jr. Director September 16, 1999
/s/ Herbert E. Bullock Herbert E. Bullock Director September 16, 1999
/s/ Joseph Carlson II Joseph Carlson II Director September 16, 1999
/s/ Laurie G. Gonthier Laurie G. Gonthier Director September 16, 1999
/s/ Dr. John V. Haxo Dr. John V. Haxo Director September 16, 1999
/s/ Robert J. McCarthy Robert J. McCarthy Director September 16, 1999
/s/ Betty F. Pacocha Betty F Pacocha Director and Secretary September 16, 1999
/s/ Suzanne L. Powers Suzanne L. Powers Director September 16, 1999
/s/ Francis J. Wiatr Francis J. Wiatr Chairman of the Board, President and Chief Executive Officer September 16, 1999
/s/ Mary C. Williams Mary C. Williams Director September 16, 1999
/s/ B. Ian McMahon B. Ian McMahon Chief Financial Officer and Chief Accounting Officer September 16, 1999