10-Q 1 enterprise_10q.txt FORM 10Q U.S. Securities and Exchange Commission Washington, D.C. 20549 Form 10-Q [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2002 [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from _____________ to _______________ Commission File Number 0-21021 Enterprise Bancorp, Inc. (Exact name of registrant as specified in its charter) Massachusetts 04-3308902 (State or other jurisdiction (IRS Employer of incorporation or organization) Identification No.) 222 Merrimack Street, Lowell, Massachusetts, 01852 (Address of principal executive offices) (Zip code) (978) 459-9000 (Registrant's telephone number) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ..X.... No...... Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: November 13, 2002 Common Stock - Par Value $0.01, 3,523,416 shares outstanding ENTERPRISE BANCORP, INC. INDEX Page Number Cover Page 1 Index 2 PART I FINANCIAL INFORMATION Item 1 Financial Statements Consolidated Balance Sheets -September 30, 2002 and December 31, 2001 3 Consolidated Statements of Income - Three and nine months ended September 30, 2002 and 2001 4 Consolidated Statement of Changes in Stockholders' Equity - 5 Nine months ended September 30, 2002 Consolidated Statements of Cash Flows - Nine months ended September 30, 2002 and 2001 6 Notes to Consolidated Financial Statements 7 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations 11 Item 3 Quantitative and Qualitative Disclosures About Market Risk 24 Item 4 Disclosure Controls and Procedures 24 PART II OTHER INFORMATION Item 1 Legal Proceedings 25 Item 2 Changes in Securities and Use of Proceeds 25 Item 3 Defaults upon Senior Securities 25 Item 4 Submission of Matters to a Vote of Security Holders 25 Item 5 Other Information 25 - Item 6 Exhibits and Reports on Form 8-K 25 Signature Page 26 Officer Certification 27 SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS This report contains certain"forward-looking statements" including statements concerning plans, objectives, future events or performance and assumptions and other statements that are other than statements of historical fact. Enterprise Bancorp, Inc. (the "company") wishes to caution readers that the following important factors, among others, may adversely affect the company's future results and could cause the company's results for subsequent periods to differ materially from those expressed in any forward-looking statement made herein: (i) the effect of unforeseen changes in interest rates; (ii) the effect of changes in the business cycle and downturns in the local, regional or national economies, including unanticipated deterioration in the local real estate market; (iii) changes in asset quality and unanticipated increases in the company's reserve for loan losses; (iv) the effect on the company's competitive position within its market area of the increasing competition from larger regional and out-of-state banking organizations as well as non-bank providers of various financial services; (v) the effect of technological changes and unanticipated technology-related expenses; (vi) the effect of unforeseen changes in consumer spending; (vii) the effect of changes in laws and regulations that apply to the company's business and operations and unanticipated increases in the company's regulatory compliance costs; (viii) unanticipated increases in employee compensation and benefit expenses; and (ix) the effect of changes in accounting, auditing or other standards, policies and practices, as may be adopted or established by the regulatory agencies, the Financial Accounting Standards Board or the Public Company Accounting Oversight Board. ENTERPRISE BANCORP, INC. Consolidated Balance Sheets September 30, 2002 and December 31, 2001 (Dollars in thousands) Sept. 30, 2002 Dec. 31, 2001 (Unaudited) -------------- ----------- Assets Cash and equivalents: Cash and due from banks $ 34,566 $ 31,361 Daily federal funds sold 29,160 6,500 ----------- ----------- Total cash and cash equivalents 63,726 37,861 ----------- ----------- Investment securities at fair value 220,890 197,060 Loans, less allowance for loan losses of $9,276 at September 30, 2002 and $8,547 at December 31, 2001 396,811 367,780 Premises and equipment 12,981 12,136 Accrued interest receivable 3,453 3,586 Deferred income taxes, net 1,789 2,034 Prepaid expenses and other assets 3,576 2,990 Income taxes receivable 125 301 Core deposit intangible, net of amortization 1,040 1,140 Goodwill, net of amortization 5,656 5,656 ----------- ----------- Total assets $ 710,047 $ 630,544 =========== =========== Liabilities, Trust Preferred Securities and Stockholders' Equity Deposits $ 642,606 $ 526,953 Short-term borrowings 1,267 44,449 Escrow deposits of borrowers 1,361 931 Accrued expenses and other liabilities 5,101 4,185 Accrued interest payable 576 805 ----------- ----------- Total liabilities 650,911 577,323 ----------- ----------- Commitments and contingencies Trust preferred securities $ 10,500 $ 10,500 Stockholders' equity: Preferred stock, $0.01 per value; 1,000,000 shares Authorized; no shares issued 0 0 Common stock $0.01 par value; 10,000,000 shares authorized; 3,522,941 and 3,461,999 shares issued and outstanding at September 30, 2002 and December 31, 2001, respectively 35 35 Additional paid-in capital 19,565 18,654 Retained earnings 24,182 20,715 Accumulated other comprehensive income 4,854 3,317 ----------- ----------- Total stockholders' equity 48,636 42,721 ----------- ----------- Total liabilities, trust preferred securities and stockholders' equity $ 710,047 $ 630,544 =========== =========== See the accompanying notes to the consolidated financial statements ENTERPRISE BANCORP, INC. Consolidated Statements of Income Three and nine months ended September 30, 2002 and 2001 (unaudited)
Three Months Ended Nine Months Ended September 30, September 30, ------------------------------ ----------------------------- (Dollars in thousands, except per share data) 2002 2001 2002 2001 ------------ ------------- ------------ -------------- Interest and dividend income: Loans $ 7,146 $ 7,360 $ 21,141 $ 21,521 Investment securities 2,650 3,046 7,881 9,036 Federal funds sold 104 223 170 754 ------------ ------------- ------------ -------------- Total interest income 9,900 10,629 29,192 31,311 ------------ ------------- ------------ -------------- Interest expense: Deposits 2,463 2,897 7,160 9,164 Short-term borrowed funds 21 624 310 2,076 ------------ ------------- ------------ -------------- Total interest expense 2,484 3,521 7,470 11,240 ------------ ------------- ------------ -------------- Net interest income 7,416 7,108 21,722 20,071 Provision for loan losses 278 850 1,048 1,480 ------------ ------------- ------------ -------------- Net interest income after 7,138 6,258 20,674 18,591 provision for loan losses ------------ ------------- ------------ -------------- Non-interest income: Investment management and trust service fees 445 453 1,484 1,418 Deposit service fees 460 369 1,355 1,091 Net gains on sales of investment securities 476 350 1,341 761 Gains on sales of loans 109 101 292 252 Other income 231 199 637 611 ------------ ------------- ------------ ------------- Total non-interest income 1,721 1,472 5,109 4,133 ------------ ------------- ------------ ------------- Non-interest expense: Salaries and employee benefits 3,664 3,432 10,812 9,901 Occupancy expenses 1,254 1,052 3,603 2,989 Advertising and public relations 177 64 519 299 Audit, legal and other professional fees 358 123 828 429 Trust professional and custodial expenses 170 137 548 497 Office and data processing supplies 113 86 329 342 Trust preferred expense 290 290 869 869 Core deposit intangible amortization expense 33 33 100 100 Goodwill amortization expense 0 165 0 493 Other operating expenses 595 667 1,861 1,846 ------------ ------------- ------------ ------------- Total non-interest expense 6,654 6,049 19,469 17,765 ------------ ------------- ------------ -------------- Income before income taxes 2,205 1,681 6,314 4,960 Income tax expense 604 430 1,699 1,325 ------------ ------------- ------------ -------------- Net income $ 1,601 $ 1,251 $ 4,615 $ 3,634 ============ ============= ============ ============== Basic earnings per share $ 0.45 $ 0.36 $ 1.32 $ 1.06 ============ ============= ============ ============== Diluted earnings per share $ 0.44 $ 0.35 $ 1.28 $ 1.03 ============ ============= ============ ============== Basic weighted average common shares outstanding 3,522,603 3,452,065 3,485,067 3,424,709 ============ ============= ============ ============== Diluted weighted average common shares outstanding 3,637,165 3,545,329 3,602,242 3,515,621 ============ ============= ============ ==============
See the accompanying notes to the consolidated financial statements ENTERPRISE BANCORP, INC. Consolidated Statement of Changes in Stockholders' Equity Nine months ended September 30, 2002 (unaudited)
(Dollars in thousands) Common Stock Additional Comprehensive Income Total -------------------- Paid-in Retained ----------------------- Stockholders' Shares Amount Capital Earnings Period Accumulated Equity ----------- -------- ------------- --------- ------- ----------- ------------- Balance at December 31, 2001 3,461,999 $ 35 $ 18,654 $ 20,715 $ 3,317 $ 42,721 Comprehensive income Net Income 4,615 4,615 4,615 Unrealized appreciation on securities, Net of reclassification 1,537 1,537 1,537 ------- Total comprehensive income 6,152 ======= Common stock dividend * (1,148) (1,148) Common stock issued, dividend reinvestment plan * 42,717 778 778 Stock options exercised 18,225 133 133 ---------- -------- ---------- --------- -------- --------- Balance at September 30, 2002 3,522,941 $ 35 $ 19,565 $ 24,182 $ 4,854 $ 48,636 ========== ======== ========== ========= ======== ========= Disclosure of reclassification amount: Gross unrealized appreciation arising during this period $ 3,670 Tax expense (1,248) ------- Unrealized holding appreciation, net of tax 2,422 ------- Less: reclassification adjustment for net gains included in net income (net of $456 tax) 885 ------- Net unrealized appreciation on securities $ 1,537
*Dividends declared were $0.33 per share, totaling $1,148,000. The dividend was split between cash of $370,000, which was paid on June 28, 2002, and 42,717 shares valued at $778,000, which were issued on June 28, 2002 pursuant to the Company's dividend reinvestment plan. See the accompanying notes to the consolidated financial statements ENTERPRISE BANCORP, INC. Consolidated Statements of Cash Flows Nine months ended September 30, 2002 and 2001 (unaudited) (Dollars in thousands) September 30, September 30, 2002 2001 ------------ ------------ Cash flows from operating activities: Net income $ 4,615 $ 3,634 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 1,048 1,480 Depreciation and amortization 2,168 1,696 Amortization of intangible assets 100 593 Net gains on sales of investments (1,341) (761) Gains on sale of loans (292) (252) (Increase) decrease in: Loans held for sale (2,445) 282 Accrued interest receivable 133 341 Prepaid expenses and other assets (586) (251) Deferred income taxes (547) - Income taxes receivable 176 185 Increase (decrease) in: Accrued expenses and other liabilities 843 143 Accrued interest payable (156) (209) ------------ ------------ Net cash provided by operating activities 3,716 6,881 ------------ ------------ Cash flows from investing activities: Proceeds from maturities, calls and paydowns of investment securities 33,628 31,348 Proceeds from sales of investment securities 42,075 14,409 Purchase of investment securities (96,133) (69,243) Net increase in loans (27,342) (51,692) Additions to premises and equipment, net (2,743) (2,301) ------------ ------------ Net cash used in investing activities (50,515) (77,479) ------------ ------------ Cash flows from financing activities: Net increase in deposits, including escrow deposits 116,083 40,884 Net increase (decrease) in short-term borrowings (43,182) 12,367 Common stock dividends (1,148) (981) Common stock issued- dividend reinvestment plan 778 650 Common stock issued- employee stock options 133 38 ------------ ------------ Net cash provided by financing activities 72,664 52,958 ------------ ------------ Net increase/(decrease) in cash and cash equivalents 25,865 (17,640) Cash and cash equivalents at beginning of period 37,861 54,105 ------------ ------------ Cash and cash equivalents at end of period $ 63,726 $ 36,465 ============ ============ Supplemental financial data: Cash paid for: Interest expense $ 7,699 $ 11,449 Income taxes 2,069 1,200 See the accompanying notes to the consolidated financial statements ENTERPRISE BANCORP, INC. Notes to Consolidated Financial Statements (1) Organization of Holding Company Enterprise Bancorp, Inc. (the "company") is a Massachusetts corporation, which was organized on February 29, 1996, at the direction of Enterprise Bank and Trust Company, a Massachusetts trust company (the "bank"), for the purpose of becoming the holding company for the bank. (2) Basis of Presentation The accompanying unaudited consolidated financial statements should be read in conjunction with the company's December 31, 2001 audited consolidated financial statements and notes thereto. Interim results are not necessarily indicative of results to be expected for the entire year. Intercompany balances and transactions have been eliminated in the consolidated financial statements of Enterprise Bancorp, Inc. and its consolidated subsidiaries Enterprise Bank and Trust Company and Enterprise (MA) Capital Trust I. In preparing the consolidated financial statements, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and revenues and expenses for the period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to change relate to the determination of the allowance for loan losses. In the opinion of management, the accompanying consolidated financial statements reflect all necessary adjustments consisting of normal recurring accruals for a fair presentation. (3) Earnings Per Share Basic earnings per share are calculated by dividing net income by the year-to-date weighted average number of common shares that were outstanding for the period. Diluted earnings per share reflect the effect on weighted average shares outstanding of the number of additional shares outstanding if dilutive stock options were converted into common stock using the treasury stock method. The increase in average dilutive shares, using the treasury stock method, for the diluted earnings per share calculation were 114,562 and 93,264 for the quarters ended September 30, 2002 and September 30, 2001, respectively, and 117,175 and 90,912 for the nine months ended September 30, 2002 and September 30, 2001, respectively. (4) Dividend Reinvestment Plan The company maintains a Dividend Reinvestment Plan (the "DRP"). The DRP enables stockholders, at their discretion, to elect to reinvest dividends paid on their outstanding shares of company common stock by purchasing additional shares of company common stock from the company. The stockholders utilized the DRP to reinvest $778,000 of the dividends paid by the company into 42,717 shares of the company's common stock in 2002. (5) Intangible Assets On July 21, 2000 the bank acquired two Fleet National Bank branch offices. The excess of cost over the fair market value of assets acquired and liabilities assumed of approximately $7.9 million was allocated to core deposit intangible assets and goodwill, which were valued at $1.3 million and $6.6 million, respectively, at the acquisition date. See Note 6 to the Consolidated Financial Statements for further discussion regarding the accounting for intangible assets. (6) Accounting Rule Changes In July 2001, the Financial Accounting Standards Board ("FASB") issued Statements of Financial Accounting Standards ("SFAS") No. 141, "Business Combinations," and SFAS No. 142, "Goodwill and Intangible Assets." SFAS No. 141 requires that all business combinations initiated after September 30, 2001 be accounted for using the purchase method of accounting, and prohibits the use of the pooling-of-interests method for such transactions. The new standard also requires that goodwill acquired in such business combinations be measured using the definition included in APB Opinion No. 16, "Business Combinations" and initially recognized as an asset in the financial statements. The new standard also requires intangible assets acquired in any such business combination to be recognized as an asset apart from goodwill if they meet certain criteria. SFAS No. 142 applies to all goodwill and intangible assets acquired in a business combination. Under the new standard, all goodwill, including goodwill acquired before initial application of the standard, should not be amortized but should be tested for impairment at least annually at the reporting unit level, as defined in the standard. Intangible assets other than goodwill should be amortized over their useful lives and reviewed for impairment in accordance with SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of." Within six months of initial application of the new standard, a transitional impairment test must be performed on all goodwill. Any impairment loss recognized as a result of the transitional impairment test should be reported as a change in accounting principle before the end of the year of adoption. The company adopted the new standard on January 1, 2002. During 2001, the company reported that the adoption of SFAS No. 142 was expected to increase annual net income by approximately $450,000 over the remaining amortization period ending in June 2010. However, subsequent to the company's disclosure but prior to formal adoption on January 1, 2002, the FASB clarified that goodwill as defined in SFAS No. 142 did not include the excess of amounts paid over net liabilities assumed in a bank or thrift branch acquisition and such amounts should continue to be accounted for in accordance with SFAS No. 72, "Accounting for Certain Acquisitions of Banking or Thrift Institutions." Consequently, goodwill continued to be amortized over a ten-year life and adoption of SFAS No. 142 was expected to have no impact on the consolidated financial statements of the company. In October 2002, the FASB issued SFAS No. 147, "Acquisition of Certain Financial Institutions." SFAS 147 states that the excess of amounts paid over the fair value of the assets acquired and liabilities assumed in a bank or thrift branch acquisition does represent goodwill, and should be accounted for under SFAS 142, and not under SFAS No. 72. Upon adoption of SFAS 147, the excess paid over the fair value of the assets acquired and net liabilities assumed in a business combination is required to be reclassified to goodwill, and any amortization expense recognized in 2002 must be reversed. The FASB permitted adoption of SFAS 147 as of September 30, 2002, and the company has adopted this new standard as of that date. The consolidated financial statements contained herein reflect these reclassifications retroactive to January 1, 2002. Adoption of SFAS 147 is expected to increase the company's annual net income by approximately $435,000, net of taxes. However, an annual impairment test is required, with any resulting decline in the value of the goodwill associated with the prior branch acquisition being charged as an expense on the income statement and a reduction of such goodwill on the balance sheet. Financial institutions which adopt SFAS 147 are required to restate previously issued financial statements as if the standard were in place for the institution upon adoption of SFAS 142 on January 1, 2002. The following schedule is a reconcilement of the impact of goodwill amortization on the company's net income and earnings per share for the periods listed below:
Three Months Ended Nine Months Ended March June 30, September 30, September 30, (Dollars in thousands, except per share data) 31, 2002 2002 2002 2002 ------------ --------- ------------ ---------------- Reported : Net income $ 1,381 $ 1,416 $ 1,492 $ 4,289 Diluted earnings per share $ 0.39 $ 0.39 $ 0.41 $ 1.19 Goodwill amortization, net of taxes $ 108 $ 109 $ 109 $ 326 Diluted earnings per share $ 0.03 $ 0.03 $ 0.03 $ 0.09 Restated: Net income $ 1,489 $ 1,525 $ 1,601 $ 4,615 Diluted earnings per share $ 0.42 $ 0.42 $ 0.44 $ 1.28
The following adjusted financial information reflects the retroactive application of SFAS 147 for the three and nine months ended September 30, 2002 and for the same periods in 2001 had the standard been applicable in 2001:
Three Months Ended Nine Months Ended September 30, September 30, ------------------ --------------------- (Dollars in thousands, except per share data) 2002 2001 2002 2001 -------- -------- -------- --------- Net income before goodwill amortization $ 1,601 $ 1,251 $ 4,615 $ 3,634 Goodwill amortization, net of tax - 109 - 326 -------- -------- -------- --------- Adjusted net income $ 1,601 $ 1,360 $ 4,615 $ 3,960 -------- -------- -------- --------- Earnings per share: Basic: Net income before goodwill amortization $ 0.45 $ 0.36 $ 1.32 $ 1.06 Goodwill amortization, net of tax - 0.03 - 0.10 -------- -------- -------- --------- Adjusted net income $ 0.45 $ 0.39 $ 1.32 $ 1.16 -------- -------- -------- --------- Diluted: Net income before goodwill amortization $ 0.44 $ 0.35 $ 1.28 $ 1.03 Goodwill amortization, net of tax - 0.03 - 0.09 -------- -------- -------- --------- Adjusted net income $ 0.44 $ 0.38 $ 1.28 $ 1.12 -------- -------- -------- ---------
(7) Reclassification Certain fiscal 2001 information has been reclassified to conform to the 2002 presentation. (8) Massachusetts Department of Revenue - Notice of Assessment Enterprise Realty Trust, Inc. ("ERT") is a real estate investment trust, which is 99.9% owned by the bank. The bank has received a Notice of Assessment ("NOA") dated October 19, 2002 from the Commonwealth of Massachusetts Department of Revenue ("DOR"), pursuant to which the DOR has assessed the bank for additional state taxes plus interest totaling an aggregate amount of $1,096,000 for the tax years ended December 31, 1999 and 2000. The NOA is based upon the DOR's contention that any income received by the bank in the form of dividends from ERT is fully taxable under applicable Massachusetts tax laws. This position is in conflict with the position taken by the bank that it is authorized under the express provisions of the applicable Massachusetts statute to exclude 95% of all dividends received by the bank from ERT in calculating the bank's taxable income for Massachusetts state tax purposes. If the position that has been taken by the DOR were also applied to the bank's tax year ended December 31, 2001, and the nine months ended September 30, 2002, then the bank would be subject on such basis to additional Massachusetts income tax for such periods totaling approximately $1,145,000 and $928,000, respectively. To the company's knowledge, the bank is one of approximately forty banking institutions located in Massachusetts that has received an NOA of this type. The company believes that it has complied fully with the applicable Massachusetts tax laws in deducting 95% of the dividends received by the bank from ERT in calculating the bank's taxable income for Massachusetts tax purposes. Accordingly, no provision has been made in the company's financial statements for the amounts that the DOR has assessed for the tax years ended December 31, 1999 and 2000 or for any additional amounts that may be assessed for any future periods, including without limitation the tax year ended December 31, 2001, and the nine months ended September 30, 2002. The company intends to dispute the DOR's assessment of additional taxes and interest contained in the NOA and to pursue all available means to defend its current position regarding the bank's payment of Massachusetts income taxes. ITEM 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations Capital Resources The company's actual capital amounts and capital adequacy ratios are presented in the table below. The bank's capital amounts and ratios do not differ materially from the amounts and ratios presented.
Minimum Capital Minimum Capital for Capital to be Actual Adequacy Purposes Well Capitalized ------------------------- ----------------------- ----------------------- (Dollars in thousands) Amount Ratio Amount Ratio Amount Ratio ------------ --------- ------------ --------- ------------ --------- As of September 30, 2002: Total Capital (to risk weighted assets) $ 53,581 11.35% $ 37,763 8.00% $ 47,203 10.00% Tier 1 Capital (to risk weighted assets) $ 47,639 10.09% $ 18,881 4.00% $ 28,322 6.00% Tier 1 Capital (to average assets)* $ 47,639 7.18% $ 26,522 4.00% $ 33,153 5.00%
* For the bank to qualify as "well capitalized", it must maintain a leverage capital ratio (Tier 1 capital to average assets) of at least 5%. This requirement does not apply to the company and is reflected merely for informational purposes with respect to the bank. Balance Sheet Total Assets At September 30, 2002, total assets increased by $79.5 million, or 12.6 %, since December 31, 2001. The increase was primarily attributable to increases of $22.6 million, or 348.6%, in daily federal funds sold, $23.8 million, or 12.1%, in investment securities at fair value, and $29.0 million, or 7.9%, in net loans (i.e., loans after the allowance for loan losses). The increase in assets was funded primarily by growth in deposits of $115.7 million, offset by a decrease in short-term borrowings and repurchase agreements of $43.2 million. During the fourth quarter of 2001, the bank began to transition the investment portion of the bank's commercial sweep accounts from overnight repurchase agreements secured by municipal securities held by the bank to money market mutual funds managed by Federated Investors, Inc. ("Federated"). The balances transferred to Federated do not represent obligations of the bank. This transition from overnight repurchase agreements to Federated mutual funds continued during the first five months of 2002 and was completed in mid-May. Under this arrangement, management believes that commercial customers will benefit from enhanced interest rate options on sweep accounts, while retaining a conservative investment option of the highest quality and safety. Without this transition to Federated, the bank would have had growth in assets and deposits plus repurchase agreements of 17.8% and 18.3%, respectively, at September 30, 2002 as compared to December 31, 2001. Investments At September 30, 2002 all of the company's investment securities were classified as available-for-sale and carried at fair value. The net unrealized appreciation at September 30, 2002 was $7.3 million compared to $5.0 million at December 31, 20901. The net unrealized appreciation or depreciation, as the case may be, in the portfolio fluctuates as interest rates rise and fall. Due to the fixed rate nature of the company's investment portfolio, as rates rise the value of the portfolio declines, and as rates fall the value of the portfolio rises. Unrealized appreciation on the investment portfolio will decrease as the securities approach maturity. The unrealized appreciation will only be realized if the securities are sold. The Company may expand its investment activities to include a limited amount of equity securities in the future. All such equity investment activities would be undertaken in accordance with applicable regulatory limitations. Loans Total loans, before the allowance for loan losses, were $406.1 million, or 57.2% of total assets, at September 30, 2002, compared to $376.3 million, or 59.7% of total assets, at December 31, 2001. The increase in total gross loans of $29.8 million at September 30, 2002 compared to December 31, 2001, was primarily attributed to originations of commercial real estate and industrial loans offset by a reduction in residential mortgages, due to the sale of fixed rate mortgage loans originated throughout the year. Deposits and Borrowings Total deposits, including escrow deposits of borrowers, increased $116.1 million, or 21.9%, during the first nine months of 2002, to $644.0 million at September 30, 2002 compared to $527.9 million at December 31, 2001. The increase consists of growth of $79.5 million in money market and savings deposits, and a $33.3 million increase in demand deposit and interest bearing checking accounts. The growth in deposits is primarily attributable to increased market penetration and strong sales efforts, and consumers seeking alternatives to the stock market. Short-term borrowings, consisting of securities sold under agreements to repurchase and Federal Home Loan Bank ("FHLB") borrowings, decreased by $43.2 million, or 97.2%, to $1.3 million at September 30, 2002. The decrease was attributable to the bank's continued transition during the first five months of 2002 of the investment portion of the bank's commercial sweep accounts from overnight repurchase agreements secured by municipal securities held by the bank to money market mutual funds managed by Federated. The company had $470,000 in borrowings outstanding from the FHLB at both September 30, 2002 and December 31, 2001. Non-performing Assets/Loan Loss Experience The following table sets forth non-performing assets at the dates indicated:
September 30, December 31, September 30, (Dollars in thousands) 2002 2001 2001 ---------- ----------- ------------- Non-accrual loans $ 1,959 $ 1,874 $ 833 Accruing loans > 90 days past due 1 1 3 -------- ----------- ------------- Total non-performing loans 1,960 1,875 836 Other real estate owned - - - -------- ----------- ------------- Total non-performing assets $ 1,960 $ 1,875 $ 836 ======== =========== ============= Non-performing loans: Loans outstanding 0.48% 0.50% 0.23% ======== =========== ============= Non-performing assets: Total assets 0.28% 0.30% 0.13% ======== =========== ============= Delinquent loans 30-89 days past due: Loans 0.14% 0.30% 0.56% ======== =========== =============
Total non-performing loans increased by $1.1 million from September 30, 2001 to September 30, 2002 and by $.08 million from December 31, 2001 to September 30, 2002, and the ratio of non-performing loans to total loans (i.e., loans before the allowance for loan losses) increased from 0.23% to 0.48% and decreased from 0.50% to 0.48% over the same respective periods. The ratio of delinquent loans (30 - 89 days past due) to total loans decreased from 0.56% at September 30, 2001 to 0.30% at December 31, 2001 and decreased from 0.30% to 0.14% from December 31, 2001 to September 30, 2002. The increase from September 30, 2001 through September 30, 2002 was primarily attributable to a weakened economy, which began in 2001 and has continued through the first nine months of 2002. The increase in the ratio of non-performing loans to loans outstanding is offset by an increase in the ratio of the allowance for loan losses to loans outstanding to 2.28% at September 30, 2002 from 2.11% at September 30, 2001. The bank's level of non-performing assets is largely a function of economic conditions and the overall banking environment. Continuing adverse conditions within the bank's market area, as well as any other adverse changes in local, regional or national economic conditions, could negatively impact the bank's level of non-performing assets in the future, despite prudent loan underwriting. The following table summarizes the activity in the allowance for loan losses for the periods indicated: Nine months ended September 30, -------------------------------------- (Dollars in thousands) 2002 2001 ---------------- ---------------- Balance at beginning of year $ 8,547 $ 6,220 Loans charged off Commercial 428 37 Commercial real estate - - Construction - - Residential real estate - - Home equity - - Consumer 10 41 ---------------- ---------------- 438 78 ---------------- ---------------- Recoveries on loans charged off Commercial 107 25 Commercial real estate - Construction - Residential real estate 2 20 Home equity - Other 10 17 ---------------- ---------------- 119 62 ---------------- ---------------- Net loans charged off (319) (16) Provision charged to operations 1,048 1,480 ---------------- ---------------- Balance at September 30 $ 9,276 $ 7,684 ================ ================ Annualized net loans charged off: Average loans outstanding (0.11%) (0.01%) ================ ================ Allowance for loan losses: Loans outstanding 2.28% 2.11% ================ ================ Allowance for loan losses: Non-performing loans 473.27% 919.13% ================ ================ The ratio of allowance for loan losses to non-performing loans decreased from 919.13% at September 30, 2001 to 473.27% at September 30, 2002 due to the increase of $1.1 million in non-performing loans, offset by an increase of $1.6 million in the allowance for loan losses. During the nine months ended September 30, 2002, the bank added approximately $1.0 million to the allowance for loan losses compared to $1.5 million for the same period in 2001. The 2001 provision reflected management's decision, in the third quarter of that year, to increase the allowance for loan losses in light of the economic uncertainty during the period, especially after September 11, 2001. Management has continued to provide for loan losses in 2002 due to the increase in the level of non-performing loans, the growth in the loan portfolio, and the continuing economic uncertainty. Management regularly reviews the level of non-accrual loans, levels of charge-offs and recoveries, levels of loans outstanding, and known and inherent risks in the nature of the loan portfolio. Management also analyzes the adequacy of the allowance for loan losses on a quarterly basis. See "Results of Operations - Provision for loan losses." Results of Operations Nine Months Ended September 30, 2002 vs. Nine Months Ended September 30, 2001 The company reported net income of $4,615,000 for the nine months ended September 30, 2002, versus $3,634,000 for the nine months ended September 30, 2001, an increase of $981,000, or 27.0%. The company had basic earnings per common share of $1.32 and $1.06, and diluted earnings per common share of $1.28 and $1.03 for the nine months ended September 30, 2002 and September 30, 2001, respectively. As previously noted, the 2002 period includes an adjustment for the adoption of SFAS 147 effective January 1,2002. The adjustment increased net income for the nine months ended September 30, 2002 by $326,000, net of taxes. Excluding this adjustment, net income for the 2002 period increased by $655,000, or 18.0%, as compared to the 2001 period. The following table highlights changes, which affected the company's earnings for the periods indicated:
Nine months ended September 30, -------------------------------- (Dollars in thousands) 2002 2001 --------- --------- Average assets (1) $ 644,106 $ 596,112 Average deposits and short-term borrowings 587,231 544,861 Average investment securities and federal funds sold (1) 204,694 220,875 Average loans, net of deferred loan fees 391,509 330,612 Net interest income 21,722 20,071 Provision for loan losses 1,048 1,480 Net gains on sales of investment securities 1,341 761 Tax expense 1,699 1,325 Average loans: Average deposits and borrowings 66.67% 60.68% Non-interest expense: Average assets (2) 4.04% 3.98% Non-interest income: Average assets (2) (3) 0.78% 0.76% Average tax equivalent rate earned on interest earning assets 6.69% 7.74% Average rate paid on interest bearing deposits and short-term borrowings 2.09% 3.39% Average rate paid on total deposits and borrowings 1.70% 2.76% Net interest margin (tax equivalent basis) 5.01% 5.01%
(1) Excludes the effect of SFAS No. 115 (2) Ratios have been annualized based on number of days for the period (3) Excludes net gain on sale of investment securities Net Interest Income The company's net interest income was $21,722,000 for the nine months ended September 30, 2002, an increase of $1,651,000, or 8.2%, from $20,071,000 for the nine months ended September 30, 2001. Interest income decreased by $2,119,000 for the nine months ended September 30, 2002 to $29,192,000 compared to $31,311,000 for the same period ended September 30, 2001. This decrease resulted from a decrease in the average tax equivalent yield on interest earning assets of 105 basis points to 6.69% for the nine months ended September 30, 2002 compared to 7.74% for the same period ended September 30, 2001, offset by an increase in the average balance of interest earning assets of $44.7 million or 8.1% to $596.2 million for the nine months ended September 30, 2002 compared to $551.5 million for the nine months ended September 30, 2001. For the nine months ended September 30, 2002, the average loan balance increased by $60.9 million, or 18.4%, and the average investment securities and federal funds sold balance decreased by $16.2 million, or 7.3%, compared to the same period ended September 30, 2001. The average rate earned on loans declined by 148 basis points to 7.22% for the nine months ended September 30, 2002, from 8.70% for the same period ended September 30, 2001, while the average tax equivalent yield on investment securities and federal funds sold decreased by 63 basis points to 5.67% for the nine months ended September 30, 2002, from 6.30% for the same period ended September 30, 2001. Interest expense for the nine months ended September 30, 2002 was $7,470,000 compared to $11,240,000 for the same period ended September 30, 2001, a decrease of $3,770,000 or 33.5%. This decrease resulted from a reduction in the average interest rate paid on interest bearing liabilities of 130 basis points to 2.09% for the nine months ended September 30, 2002, compared to 3.39% for the same period ended September 30, 2001, offset by an increase in the average balance of interest-bearing deposits and short-term borrowings of $34.7 million, or 7.8%, to $477.4 million for the nine months ended September 30, 2002, as compared to $442.7 million for the same period ended September 30, 2001. The average interest rate paid on savings, checking and money market deposit accounts decreased 70 basis points for the nine months ended September 30, 2002 compared to the same period ended September 30, 2001, while the average balance of such deposit accounts increased by $72.7 million, or 32.0%, to $299.5 million for the nine months ended September 30, 2002 as compared to $226.8 million for the same period ended September 30, 2001. The average interest rate on time deposits decreased by 166 basis points for the nine months ended September 30, 2002 compared to the same period ended September 30, 2001. The average balance on time deposits increased by $9.2 million, or 6.3%, to $155.7 million for the nine months ended September 30, 2002 as compared to $146.5 million for the same period ended September 30, 2001. The average interest rate on short-term borrowings, consisting of term repurchase agreements and commercial sweep accounts utilizing overnight repurchase agreements secured by municipal securities held by the bank (together, "repurchase agreements") and FHLB borrowings, decreased to 1.86%, for the nine months ended September 30, 2002, compared to 4.00% for the nine months ended September 30, 2001. The average balance of short-term borrowings for the nine months ended September 30, 2002 decreased by $47.1 million, or 67.9%, to $22.2 million as compared to $69.4 million for the nine months ended September 30, 2001. The 214 basis point decrease in average rate paid on short-term borrowings resulted from decreases in market rates, while the decrease in average balance was attributable to the transition, described above, of the bank's commercial sweep accounts from overnight repurchase agreements to Federated money market mutual funds. Net interest margin remained at 5.01% for the nine months ended September 30, 2002 as compared to the same period ended September 30, 2001, primarily due to the decrease in the interest rate environment offset by the increase in average balances. The following table sets forth, among other things, the extent to which changes in interest rates and changes in the average balances of interest earning assets and interest bearing liabilities affected interest income and expense during the nine months ended September 30, 2002 and September 30, 2001, respectively. For each category of interest earning assets and interest bearing liabilities, information is provided on changes attributable to: (1) volume (change in average portfolio balance multiplied by prior year average rate); (2) interest rate (change in average interest rate multiplied by prior year average balance); and (3) rate and volume (the remaining difference). The company manages its earning assets by fully using available capital resources within what management believes are prudent credit and leverage parameters. Loans, investment securities, and federal funds sold comprise the company's earning assets. AVERAGE BALANCES, INTEREST AND AVERAGE INTEREST RATES
Nine Months Ended Nine Months Ended September 30, 2002 September 30, 2001 Changes due to ------------------------------ ---------------------------- ------------------------------ (Dollars in thousands) Average Yield/ Average Yield/ Rate/ Balance Interest Rates (3) Balance Interest Rates (3) Total Volume Rate Volume ------- -------- ----------- -------- ------- --------- ----- ------- ------- ------ Assets: Loans (1) (2) $391,509 $ 21,141 7.22% $330,612 $21,521 8.70 $ (380) $3,963 $(3,659) $(684) Investment securities & federal funds sold (3)(5) 204,694 8,051 5.67% 220,875 9,790 6.30 (1,739) (765) (1,043) 69 -------- -------- -------- ------- ------- ------ -------- ------ Total interest earnings assets 596,203 29,192 6.69% 551,487 31,311 7.74 (2,119) 3,198 (4,702) (615) -------- ------- ------- ------ ------- ------ Other assets (4)(5) 47,903 44,625 -------- -------- Total assets (5) $644,106 $596,112 ======== ======== Liabilities and stockholders' equity: Savings/PIC/MMDA $299,490 3,034 1.35% $226,829 3,470 2.05 (436) 1,114 (1,188) (362) Time deposits 155,682 4,126 3.54% 146,507 5,694 5.20 (1,568) 357 (1,819) (106) Short-term borrowings 22,231 310 1.86% 69,361 2,076 4.00 (1,766) (1,410) (1,110) 754 -------- -------- -------- ----- ------- ------ ------- ------ Total interest-bearing deposits and borrowings 477,403 7,470 2.09% 442,697 11,240 3.39 (3,770) 61 (4,117) 286 ------- -------- -------- ------ ------- ------ ------- ------ Net interest rate spread (3) 4.60% 4.35 Non-interest bearing deposits 109,828 - 102,164 - -------- -------- -------- ------ Total deposits and borrowings 587,231 7,470 1.70% 544,861 11,240 2.76 Other liabilities 4,696 4,422 -------- -------- Total liabilities 591,927 549,283 Trust preferred securities 10,500 10,500 Stockholders' equity (5) 41,679 36,329 -------- -------- Total liabilities, trust preferred Securities and stockholders' equity (5) $644,106 $596,112 ======== ======== Net interest Income $ 21,722 $20,071 $ 1,651 3,137 $ (585) $(901) ======== ======= ======= ====== ======= ===== Net interest margin 5.01% 5.01
(1) Average loans include non-accrual loans. (2) Average loans are net of average deferred loan fees. (3) Average investment balances are presented at average amortized cost and average yields are presented on a tax equivalent basis. The tax equivalent effect was $659 and $639 for the periods ended September 30, 2002 and September 30, 2001, respectively (4) Other assets include cash and due from banks, accrued interest receivable, allowance for loan losses, intangible assets, and other miscellaneous assets. (5) Excludes the effect of SFAS No. 115 Provision for Loan Losses The provision for loan losses amounted to $1,048,000 and $1,480,000 for the nine months ended September 30, 2002 and September 30, 2001, respectively. The 2001 provision reflected management's decision, in the third quarter of that year, to increase the allowance for loan losses in light of the economic uncertainty during the period, especially after September 11, 2001. The provision reflects real estate values and economic conditions in New England and in Greater Lowell, in particular, the level of non-accrual loans, levels of charge-offs and recoveries, levels of outstanding loans, known and inherent risks in the nature of the loan portfolio and management's assessment of current risk. There have been no material changes to the company's allowance for loan loss methodology used to estimate loan loss exposure as reported in the company's Annual Report on Form 10-K for the year ended December 31, 2001. The provision for loan losses is a significant factor in the company's operating results. Non-Interest Income Investment management and trust service fees increased by $66,000, or 4.7%, for the nine months ended September 30, 2002 compared to the same period in 2001. The increase was primarily due to one-time fees of $76,000, booked in the first quarter of 2002 for estate settlements offset by a reduction in investment commission and fees. Excluding these one-time fees, investment management and trust service fees would have decreased by $10,000, or 0.7%, for the nine months ended September 30, 2002 compared to the same period in 2001. Average investment services and trust assets under management (excluding the commercial sweep balances held in Federated mutual funds) decreased $15.0 million, or 5.1%, to $277.5 million for the nine months ended September 30, 2002 from $292.5 million for the same period in 2001. Deposit service fees increased by $264,000, or 24.2%, for the nine months ended September 30, 2002, compared to the nine months ended September 30, 2001, due primarily to an increase in the average balance on savings, checking and money market accounts of $72.7 million, or 32.0%, for the nine months ended September 30, 2002 compared to the same period in 2001. The fee increase was also due to a reduction in the earnings credit posted to business checking accounts, which offsets the service charges assessed by the bank. Net gain on sale of investment securities amounted to $1,341,000 and $761,000 for the nine months ended September 30, 2002 and September 30, 2001, respectively. These net gains resulted from management's decision to take advantage of certain investment opportunities and asset/liability repositioning. Gain on sale of loans increased by $40,000 to $292,000 for the nine months ended September 30, 2002, compared to the nine months ended September 30, 2001, due to increased fixed rate residential mortgage production resulting from a declining interest rate environment. Other income for the nine months ended September 30, 2002, was $637,000 compared to $611,000 for the nine months ended September 30, 2001. This increase of $26,000 was primarily attributable to an increase in processing income earned on the Federated sweep product and an increase in insurance commission, offset by a reduction of the earnings credit on account balances related to sales of third party bank checks, due to the decline in market rates. Non-Interest Expenses Salaries and benefits expense totaled $10,812,000 for the nine months ended September 30, 2002, compared to $9,901,000 for the nine months ended September 30, 2001, an increase of $911,000 or 9.2%. This increase was primarily due to the salary and related benefits of new employees hired to support the Company's growth and strategic initiatives, as well as annual increases. Occupancy expense amounted to $3,603,000 for the nine months ended September 30, 2002, compared to $2,989,000 for the nine months ended September 30, 2001, an increase of $614,000 or 20.5%. The increase was primarily due to depreciation of office renovations for operational support departments completed in 2001, ongoing enhancements to the company's computer systems in the current year, start-up costs associated with the bank's newest branch office, located at the end of the Lowell Connector, which opened on April 29, 2002, and increases generally in real estate taxes, bank insurance and common area maintenance fees for the bank's leased office space. Advertising and public relations expenses increased by $220,000, or 73.6%, for the nine months ended September 30, 2002 compared to the same period in 2001. The increase was due to expenditures, in the early part of this year, related to the opening of the bank's Lowell Connector office in April, increases in advertising expenditures for the commercial lending division, as well as advertising and public relations initiatives undertaken on behalf of the trust division. Audit, legal and other professional expenses increased by $399,000, or 93.0%, for the nine months ended September 30, 2002 compared to the same period in 2001. The increase was primarily due to increased consulting expenses related to technology initiatives undertaken in the first nine months of the year, as well as increased compliance and internal audit related expenses associated with the bank's growth in 2002. The 2002 expenses also reflect estimated legal and audit related expenses related to the company's dispute of the Massachusetts Department of Revenue's Notice of Assessment of additional taxes and interest, as discussed in Note 8 of the Consolidated Financial Statements. Trust professional and custodial expenses increased by $51,000, or 10.3%, for the nine months ended September 30, 2002 compared to the same period in 2001. The increase was primarily due to an increase in custodial and advisory fees paid to third parties. Office and data processing supplies expense decreased by $13,000, or 3.8%, for the nine months ended September 30, 2002 compared to the same period in 2001. The decrease was primarily due to timing differences of the expenditures. Trust preferred expense was $869,000 for the nine months ended September 30, 2002 and September 30, 2001. The expense consists of interest costs and the amortization of deferred underwriting costs from the trust preferred securities issued on March 23, 2000. Amortization of core deposit intangible assets was $100,000 for the nine months ended September 30, 2002 and September 30, 2001. The expense relates to the amortization of intangible assets resulting from the acquisition of two branches from Fleet National Bank on July 21, 2000. These intangible assets are being amortized on a straight-line basis over ten years. Goodwill amortization expense was $0 for the nine months ended September 30, 2002, compared to $493,000 for the same period in 2001. The current period reflects the restatement of amortization expense in accordance with SFAS 147, as discussed in Note 6 of the Consolidated Financial Statements. Other operating expenses were $1,861,000 and $1,846,000 for the nine months ended September 30, 2002 and September 30, 2001, respectively. The increase of $15,000, or 0.8%, for the 2002 period consisted of increased expenses for correspondent bank service charges, training expenses and expenses related to loan workouts, offset by reductions in telephone and ATM supplies and security expenses due to the timing differences of the expenditures. Income Tax Expense Income tax expense and the effective tax rate for the nine months ended September 30, 2002 and September 30, 2001 were $1,699,000 and 26.9% and $1,325,000 and 26.7%, respectively. Results of Operations Three Months Ended September 30, 2002 vs. Three Months Ended September 30, 2001 The company reported net income of $1,601,000 for the three months ended September 30, 2002, versus $1,251,000 for the three months ended September 30, 2001, an increase of $350,000 or 28.0%. The company had basic earnings per common share of $0.45 and $0.36 and diluted earnings per common share of $0.44 and $0.35 for the three months ended September 30, 2002 and September 30, 2001, respectively. As previously noted, the 2002 period includes an adjustment for the adoption of SFAS 147 effective January 1,2002. The adjustment increased net income for the three months ended September 30, 2002 by $109,000, net of taxes. Excluding this adjustment, net income for the 2002 period increased by $241,000, or 19.3%, as compared to the 2001 period. The following table highlights changes, which affected the company's earnings for the periods indicated:
Three months ended September 30 ------------------------------- (Dollars in thousands) 2002 2001 -------------- ------------ Average assets (1) $ 669,750 $ 621,768 Average deposits and short-term borrowings 611,451 569,209 Average investment securities and federal funds sold (1) 221,728 228,516 Average loans, net of deferred loan fees 400,108 347,957 Net interest income 7,416 7,108 Provision for loan losses 278 850 Net gains on sales of investment securities 476 350 Tax expense 604 430 Average loans: Average deposits and borrowings 65.44% 61.13% Non-interest expense: Average assets (2) 3.94% 3.86% Non-interest income: Average assets (2)(3) 0.74% 0.72% Average tax equivalent rate earned on interest earning assets 6.47% 7.49% Average rate paid on interest bearing deposits and short-term borrowings 1.98% 3.01% Average rate paid on total deposits and borrowings 1.61% 2.45% Net interest margin (tax equivalent basis) 4.88% 5.07%
(1) Excludes the effect of SFAS No. 115 (2) Ratios have been annualized based on number of days for the period (3) Excludes net gain on sale of investment securities Net Interest Income The company's net interest income was $7,416,000 for the three months ended September 30, 2002, an increase of $308,000, or 4.3%, from $7,108,000 for the three months ended September 30, 2001. Interest income decreased by $729,000 for the three months ended September 30, 2002 and was $9,900,000 compared to $10,629,000 for the same period ended September 30, 2001. This decrease resulted primarily from a decrease in the average tax equivalent yield on interest earning assets of 102 basis points to 6.47% for the three months ended September 30, 2002 compared to 7.49% for the same period ended September 30, 2001, offset by an increase in the average balance of interest earning assets of $45.4 million, or 7.9%, to $621.8 million for the three months ended September 30, 2002 compared to $576.5 million for the three months ended September 30, 2001. For the three months ended September 30, 2002, the average loan balance increased by $52.2 million, or 15.0%, and the average investment securities and federal funds sold balance decreased by $6.8 million, or 3.0%, compared to the same period ended September 30, 2001. The average rate earned on loans declined by 130 basis points to 7.09% for the three months ended September 30, 2002, from 8.39% for the same period ended September 30, 2001, while the average tax equivalent yield on investment securities and federal funds sold decreased by 77 basis points to 5.35% for the three months ended September 30, 2002 from 6.12% for the same period ended September 30, 2001. Interest expense for the three months ended September 30, 2002 was $2,484,000 compared to $3,521,000 for the same period in 2001. The decrease resulted primarily from a decrease in the average interest rate paid on interest bearing liabilities of 103 basis points to 1.98% for the three months ended September 30, 2002 compared to 3.01% for the same period in 2001, offset by an increase in the average balance of interest-bearing deposits and short-term borrowings of $34.6 million, or 7.5%, to $498.2 million for the three months ended September 30, 2002, compared to $463.6 million for the same period in 2001he average interest rate on savings, checking and money market deposit accounts decreased by 46 basis points for the three months ended September 30, 2002 compared to the same period ended September 30, 2001, due to lower market rates, while the average balance of such deposit accounts increased by $93.0 million, or 37.7%, to $340.0 million for the three months ended September 30, 2002 as compared to $247.0 million for the same period ended September 30, 2001. The average interest rate on time deposits decreased by 156 basis points for the three months ended September 30, 2002 compared to the same period ended September 30, 2001. The average balance on time deposits increased by $11.4 million, or 7.9%, to $155.0 million for the three months ended September 30, 2002 as compared to $143.7 million for the same period ended September 30, 2001. The average interest rate on short-term borrowings, consisting of repurchase agreements and FHLB borrowings, decreased 72 basis points to 2.68% for the three months ended September 30, 2002, compared to 3.40% for the three months ended September 30, 2001. The average balance of short-term borrowings for the three months ended September 30, 2002 decreased by $69.8 million, or 95.7%, to $3.1 million as compared to $72.9 million for the three months ended September 30, 2001. The 72 basis point decrease in average rate paid on short-term borrowings resulted primarily from decreases in market rates, while the decrease in average balance was attributable to the transition of the bank's commercial sweep accounts from overnight repurchase agreements to Federated money market mutual funds. Net interest margin decreased to 4.88% for the three months ended September 30, 2002 from 5.07% for the same period ended September 30, 2001, primarily due to the 103 basis point decrease in the average rate on interest bearing liabilities, offset by the 102 basis point decrease in tax equivalent yield on interest earning assets, and the $45.4 million increase in the average balance of interest earning assets, offset by the $34.6 million increase in the average balance of interest bearing liabilities. The following table sets forth, among other things, the extent to which changes in interest rates and changes in the average balances of interest earning assets and interest bearing liabilities affected interest income and expense during the three months ended September 30, 2002 and September 30, 2001, respectively. For each category of interest earning assets and interest bearing liabilities, information is provided on changes attributable to: (1) volume (change in average portfolio balance multiplied by prior year average rate); (2) interest rate (change in average interest rate multiplied by prior year average balance); and (3) rate and volume (the remaining difference). The company manages its earning assets by fully using available capital resources within what management believes are prudent credit and leverage parameters. Loans, investment securities, and federal funds sold comprise the company's earning assets. AVERAGE BALANCES, INTEREST AND AVERAGE INTEREST RATES
Nine Months Ended September 30, Nine Months Ended 2002 September 30, 2001 Changes due to ------------------------------ ---------------------------- ------------------------------ (Dollars in thousands) Average Yield/ Average Yield/ Rate/ Balance Interest Rates (3) Balance Interest Rates (3) Total Volume Rate Volume ------- -------- ----------- -------- ------- --------- ----- ------- ------- ------ Assets: Loans (1) (2) $400,108 $ 7,146 7.09% $ 347,957 $7,360 8.39% $(214) $1,103 $(1,140) $ (177) Investment securities & federal funds sold (3)(5) 221,728 2,754 5.35% 228,516 3,269 6.12% (515) (104) (444) 33 -------- ------- --------- ------ ----- ------ ------- ------ Total interest earnings assets 621,836 9,900 6.47% 576,473 10,629 7.49% (729) 999 (1,584) (144) -------- ------- --------- ------ ----- ------ ------- ------ Other assets (4) (5) 47,914 45,295 -------- --------- Total assets (5) $669,750 $ 621,768 == ======== ========= Liabilities and stockholders' equity: Savings/PIC/MMDA $340,033 1,197 1.40% $ 247,009 1,159 1.86% 38 436 (286) (112) Time deposits 155,041 1,266 3.24% 143,676 1,738 4.80% (472) 138 (565) (45) Short-term borrowings 3,114 21 2.68% 72,907 624 3.40% (603) (598) (132) 127 -------- ------- --------- ------ ----- ------ ------- ------ Total interest-bearing deposits and borrowings 498,188 2,484 1.98% 463,592 3,521 3.01% (1,037) (24) (983) (30) -------- ------- --------- ------ ------ ------ ------- ------ Net interest rate spread (3) 4.49% 4.48% Non-interest bearing deposits 113,263 - 105,617 - -------- -------- --------- ------ Total deposits and borrowings 611,451 2,484 1.61% 569,209 3,521 2.45% Other liabilities 4,744 4,678 -------- --------- Total liabilities 573,887 Trust preferred securities 10,500 10,500 Stockholders' equity (5) 43,055 37,381 -------- --------- Total liabilities, trust preferred securities and stockholders' equity (5) $669,750 $621,768 ======== ========= Net interest Income $ 7,416 $ 7,108 $ 308 $1,023 $ (601) $(114) ======== ======= ====== ====== ======= ===== Net interest margin 4.88 % 5.07%
(1) Average loans include non-accrual loans. (2) Average loans are net of average deferred loan fees. (3) Average investment balances are presented at average amortized cost and average yields are presented on a tax equivalent basis. The tax equivalent effect was $214 and $228 for the periods ended September 30, 2002 and September 30, 2001, respectively (4) Other assets include cash and due from banks, accrued interest receivable, allowance for loan losses, intangible assets, and other miscellaneous assets. (5) Excludes the effect of SFAS No. 115 Provision for Loan Losses The provision for loan losses amounted to $278,000 and $850,000 for the three months ended September 30, 2002 and September 30, 2001, respectively. The 2001 provision reflected management's decision, in the third quarter of that year, to increase the allowance for loan losses in light of the economic uncertainty during the period, especially after September 11, 2001. The provision reflects real estate values and economic conditions in New England and in Greater Lowell, in particular, the level of non-accrual loans, levels of charge-offs and recoveries, levels of outstanding loans, known and inherent risks in the nature of the loan portfolio and management's assessment of current risk. There have been no material changes to the company's allowance for loan loss methodology used to estimate loan loss exposure as reported in the company's Annual Report on Form 10-K for the year ended December 31, 2001. The provision for loan losses is a significant factor in the company's operating results. Non-Interest Income Investment management and trust service fees decreased by $8,000, for the three months ended September 30, 2002 compared to the same period in 2001. The decrease was primarily due to decreases in investment commission and fees offset by a slight increases in trust income. Average investment services and trust assets under management (excluding the commercial sweep balances held in Federated mutual funds) decreased $15.4 million, to $266.5 million for the three months ended September 30, 2002 from $281.9 million for the same period in 2001. Deposit service fees increased by $91,000, or 24.7%, for the three months ended September 30, 2002, compared to the three months ended September 30, 2001, due primarily to an increase in the average balance on savings, checking and money market accounts of $93.0 million, or 37.7%, for the three months ended September 30, 2002 compared to the same period in 2001. The fee increase was also due to a reduction in the earnings credit posted to business checking accounts, which offsets the service charges assessed by the bank. Net gain on sale of investment securities amounted to $476,000 and $350,000 for the three months ended September 30, 2002 and September 30, 2001, respectively. These net gains resulted from management's decision to take advantage of certain investment opportunities and asset/liability repositioning. Gain on sale of loans increased by $8,000 to $109,000 for the three months ended September 30, 2002, compared to the three months ended September 30, 2001, due to increased fixed rate residential mortgage production resulting from a declining interest rate environment. Other income was $231,000, an increase of $32,000, or 16.1%, for the three months ended September 30, 2002 compared to the same period in 2001. The increase was primarily due to processing income earned on the Federated sweep product and increases in insurance commissions and ATM surcharges, offset by a decrease of the earnings credit on account balances related to sales of third party bank checks, due to the decline in market rates. Non-Interest Expenses Salaries and benefits expense totaled $3,664,000 for the three months ended September 30, 2002, compared to $3,432,000 for the three months ended September 30, 2001, an increase of $232,000 or 6.8%. This increase was primarily due to new hires, company growth, strategic initiatives implemented by the company, and annual pay increases. Occupancy expense was $1,254,000 for the three months ended September 30, 2002, compared to $1,052,000 for the three months ended September 30, 2001, an increase of $202,000 or 19.2%. The increase was primarily due to depreciation of office renovations for operational support departments completed in 2001, ongoing enhancements to the company's computer systems in the current year, start-up costs associated with the bank's newest branch office, which opened on April 29, 2002, and increases generally in real estate taxes, bank insurance, and common area maintenance fees for the bank's leased office space. Advertising and public relations expenses increased by $113,000 for the three months ended September 30, 2002 compared to the same period in 2001. The increase was primarily due to increases in advertising expenditures for the commercial lending division and public relations expenditures for the trust division. Audit, legal and other professional expenses increased by $235,000 for the three months ended September 30, 2002 compared to the same period in 2001. The increase was due to increased consulting expenses related to technology initiatives undertaken in 2002, as well as increased compliance and internal audit related expenses associated with the bank's growth in 2002. The 2002 expenses also reflect estimated legal and audit related expenses related to the company's dispute of the Massachusetts Department of Revenue's Notice of Assessment of additional taxes and interest, as discussed in Note 8 of the Consolidated Financial Statements. Trust professional and custodial expenses increased by $33,000, or 24.1%, for the three months ended September 30, 2002 compared to the same period in 2001. The increase was due to an increase in custodial fees. Office and data processing supplies expense increased by $27,000, or 31.4%, for the three months ended September 30, 2002 compared to the same period in 2001. The increase was primarily due to timing differences of the expenditures. Trust preferred expense was $290,000 for the three months ended September 30, 2002 and September 30, 2001. The expense consists of interest costs and the amortization of deferred underwriting costs from the trust preferred securities issued on March 23, 2000. Amortization of core deposit intangible assets was $33,000 for the three months ended September 30, 2002 and September 30, 2001. The expense relates to the amortization of intangible assets resulting from the acquisition of two branches from Fleet National Bank on July 21, 2000. These intangible assets are being amortized on a straight-line basis over ten years. Goodwill amortization expense was $0 for the three months ended September 30, 2002, compared to $165,000 for the same period in 2001. The current period reflects the restatement of amortization expense in accordance with SFAS 147, as discussed in Note 6 of the Consolidated Financial Statements. Other operating expenses were $595,000 and $667,000 for the three months ended September 30, 2002 and September 30, 2001, respectively. The decrease of $72,000, or 10.8%, for the 2002 period is attributable to decreases in charitable contributions, telephone and security expenditures due primarily to timing differences of the expenditures in 2002, and the recovery of approximately $10,000 in previously charged off uncollected checks, offset by increases in bank service charges and loan workout expenses. Income Tax Expense Income tax expense and the effective tax rate for the three months ended September 30, 2002 and September 30, 2001 were $604,000 and 27.4% and $430,000 and 25.6%, respectively. The effective rate for the three months ended September 30, 2001 was low due to an adjustment in income tax estimates during the period. The effective rate for the three months ended September 30, 2002, of 27.4%, is consistent with the nine month effective rates of 26.9% and 26.7%, for the periods ended September 30, 2002 and 2001, respectively. ITEM 3 - Quantitative and Qualitative Disclosures About Market Risk The company's primary market risk is interest rate risk, specifically, changes in the interest rate environment. The bank's investment committee is responsible for establishing policy guidelines on acceptable exposure to interest rate risk and liquidity. The investment committee is comprised of certain members of the Board of Directors and certain members of senior management. The primary objectives of the bank's asset/liability policy is to monitor, evaluate and control the bank's interest rate risk, as a whole, within certain tolerance levels while ensuring adequate liquidity and adequate capital. The investment committee establishes and monitors guidelines for the net interest margin sensitivity, equity to capital ratios, liquidity, FHLB borrowing capacity and loan to deposit ratio. These asset/liability strategies are reviewed regularly by management and presented and discussed with the investment committee on at least a quarterly basis. The bank's asset/liability strategies may be revised periodically based on changes in interest rate levels, general economic conditions, competition in the marketplace, the current position of the bank, anticipated growth of the bank and other factors. One of the principal factors in maintaining planned levels of net interest income is the ability to design effective strategies to manage the impact of changes in interest rates on future net interest income. The balancing of changes in interest income from interest earning assets and interest expense of interest bearing liabilities is accomplished through the asset/liability management program. The bank's simulation model analyzes various interest rate scenarios. Variations in the interest rate environment affect numerous factors, including prepayment speeds, reinvestment rates, maturities of investments (due to call provisions), and interest rates on various asset and liability accounts. The investment committee periodically reviews the guidelines or restrictions contained in the bank's asset/liability policy and adjusts them accordingly. The bank's current asset/liability policy is designed to limit the impact on net interest income to 7.5% in the 12-month period following the date of the analysis, in a rising and falling rate shock analysis of 100 and 200 basis points. Management believes there have been no material changes in the interest rate risk reported in the company's Annual Report on Form 10-K for the year ended December 31, 2001. ITEM 4 - Controls and Procedures Evaluation of Controls and Procedures The company maintains a set of disclosure controls and procedures and internal controls designed to ensure that the information required to be disclosed in reports that it files or submits to the Securities and Exchange Commission (the "SEC") under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), is recorded, processed, summarized and reported within the time periods specified in the SEC's rules and forms. Within 90 days prior to the date of the company's filing of this report, the company carried out an evaluation, under the supervision and with the participation of the company's management, including its chief executive officer and chief financial officer, of the effectiveness of the design and operation of the company's disclosure controls and procedures pursuant to Exchange Act Rule 13a-14. Based upon that evaluation, the company's chief executive officer and chief financial officer concluded that the company's disclosure controls and procedures are effective in timely alerting them to material information relating to the company (including its consolidated subsidiaries) required to be included in the company's periodic SEC filings. Changes in Controls and Procedures Subsequent to the date of management's evaluation referred to above, there have been no significant changes in the company's internal controls or in other factors that could significantly affect such internal controls, nor were any corrective actions required with regard to any significant deficiencies or material weaknesses with respect to such internal controls. PART II OTHER INFORMATION Item 1 Legal Proceedings As described in further detail in footnote No. 8 of the Consolidated Financial Statements included in Item 1 of Part I of this report, set forth at page 9 above, the bank has received a Notice of Assessment ("NOA") from the Commonwealth of Massachusetts Department of Revenue ("DOR"), pursuant to which the DOR has assessed the bank for additional state taxes and interest in connection with the bank's operation of a real estate investment trust subsidiary. The company intends to dispute the DOR's assessment of additional taxes and interest contained in the NOA and to pursue all available means to defend its current position regarding the bank's payment of Massachusetts income taxes. Item 2 Changes in Securities and Use of Proceeds Not Applicable Item 3 Defaults upon Senior Securities Not Applicable Item 4 Submission of Matters to a Vote of Security Holders Not Applicable Item 5 Other Information In addition to the certifications included in this report below, the company's chief executive officer and chief financial officer have submitted to the SEC on the date hereof the certification required pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. Item 6 Exhibits and Reports on Form 8-K Not Applicable SIGNATURES Pursuant to the requirements of the Securities and Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. ENTERPRISE BANCORP, INC. DATE: November 14, 2002 By:/s/John P. Clancy, Jr. ------------------------------------------- John P. Clancy, Jr. Treasurer (Principal Financial Officer) CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER UNDER SECURITIES EXCHANGE ACT RULES 13a-14 AND 15d-14 I, John P. Clancy, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Enterprise Bancorp, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a -14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 14, 2002 /s/John P. Clancy, Jr. ----------------------------------- John P. Clancy, Jr. Treasurer (Principal Financial Officer) CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER UNDER SECURITIES EXCHANGE ACT RULES 13a-14 AND 15d-14 I, George L. Duncan, certify that: 1. I have reviewed this quarterly report on Form 10-Q of Enterprise Bancorp, Inc.; 2. Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; 3. Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report; 4. The registrant's other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a -14 and 15d-14) for the registrant and we have: a) designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) evaluated the effectiveness of the registrant's disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the "Evaluation Date"); and c) presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date; 5. The registrant's other certifying officers and I have disclosed, based on our most recent evaluation, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent function): a) all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant's ability to record, process, summarize and report financial data and have identified for the registrant's auditors any material weaknesses in internal controls; and b) any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal controls; and 6. The registrant's other certifying officers and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses. Date: November 14, 2002 /s/George L. Duncan -------------------------------------------- George L. Duncan Chairman & CEO (Principal Executive Officer)