-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, ALAdBspTeO/QB87qjIHC02frGie29TVZTmETgUzqj+BQUeq+5k9v9oGLLgUkUoPl vx3mi/TrHIqRHb3Q3eqv+w== 0000915656-98-000023.txt : 19980401 0000915656-98-000023.hdr.sgml : 19980401 ACCESSION NUMBER: 0000915656-98-000023 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19971231 FILED AS OF DATE: 19980331 SROS: NASD FILER: COMPANY DATA: COMPANY CONFORMED NAME: NSS BANCORP INC CENTRAL INDEX KEY: 0001042806 STANDARD INDUSTRIAL CLASSIFICATION: SAVINGS INSTITUTIONS, NOT FEDERALLY CHARTERED [6036] IRS NUMBER: 061485317 STATE OF INCORPORATION: CT FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 000-22937 FILM NUMBER: 98584237 BUSINESS ADDRESS: STREET 1: 48 WALL ST CITY: NORWALK STATE: CT ZIP: 06852 BUSINESS PHONE: 2038384545 MAIL ADDRESS: STREET 1: NSS BANCORP INC STREET 2: P O BOX 28 CITY: NORWALK STATE: CT ZIP: 06852 10-K 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-K (Mark One) [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 1997 OR 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 0-22937 NSS BANCORP, INC. (Exact name of registrant as specified in its charter) Connecticut 06-1485317 (State or other jurisdiction of incorporation (I.R.S. Employer or organization) Identification No.) 48 Wall Street, Norwalk, Connecticut (Address of principal executive offices) 06852 (203) 838-4545 (Zip Code) (Registrant's telephone #) Securities registered pursuant to Section 12(b) of the Act: Not Applicable Securities registered pursuant to Section 12(g) of the Act: Common Stock, par value $.01 per share (Title of Class) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No Indicate by check mark if disclosure of delinquent filers pursuant to item 405 of regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in part III of this Form 10-K or any amendment to this Form 10-K. [X] Based upon the market price of the registrant's common stock as of February 28, 1998, the aggregate market value of the voting stock held by non-affiliates of the registrant is $68,509,055. * Indicate the number of shares outstanding of each of the issuer's classes of common stock, as the latest practicable date. Class: Common Stock, par value $.01 per share Outstanding at February 28, 1998: 2,421,071 shares DOCUMENTS INCORPORATED BY REFERENCE: Parts I and II: Portions of the Annual Report to Shareholders for the year ended December 31, 1997. Part III: Portions of the definitive proxy statement for the Annual Meeting of Shareholders to be held May 27, 1998. * Solely for purposes of this calculation, all executive officers and directors of the registrant are considered affiliates. Excludes all other shareholders beneficially owning more than 5% of the registrant's common stock. PART I. ITEM 1. BUSINESS General On October 1, 1997 NSS Bancorp, Inc. ("Bancorp") became the holding company for Norwalk Savings Society (the "Bank") (collectively, the "Company"). The formation of the holding company was approved at the Bank's annual meeting on May 20, 1997. Each of the outstanding shares of the Bank's common stock was automatically converted and exchanged into one share of the Bancorp's common stock. Bancorp's principal asset consists of all of the outstanding shares of the Bank. Historically, the principal business of the Bank has been attracting deposits from the general public, extending loans to individuals in the community for the purchase or construction of one-to-four family residences, making consumer installment loans, investing in securities, and providing typical consumer banking services. During the early 1980's, the Bank also began to emphasize loans secured by multi-family (e.g., five or more units) and commercial real estate, as well as construction loans, land acquisition and development loans and, to a lesser extent, commercial business, consumer and other loans. As a result, the Bank experienced dramatic growth as assets increased from $185 million in 1980 to $509 million in 1988. As the local and regional economies deteriorated in 1989, the Bank experienced increasing levels of problem loans and losses primarily resulting from delinquencies in commercial real estate, construction and land acquisition and development loans. From 1990 to 1995, the Bank devoted a significant portion of its resources to resolving problems associated with high levels of non-performing assets, including sales of OREO, loan restructurings and development for sale of a number of residential subdivisions and condominiums held as OREO. During that period, the Bank limited multi-family, commercial real estate, and construction lending to borrowers purchasing OREO from the Bank and to borrowers refinancing or restructuring currently outstanding loans. In 1996 the Bank defined its market area as southern Fairfield County and embarked on a program of expanding its business products and services as well as continuing to provide a full range of personal banking products and services. As part of this program, the Bank sold two branch offices in northern Fairfield County, and in July 1996, acquired certain assets and assumed essentially all of the liabilities of Fairfield First Bank & Trust Company ("FFB&T") in an FDIC-assisted transaction. This acquisition provided the Bank with a significant physical presence in the eastern part of the county and FFB&T's back office operation allowed the Bank to provide merchant banking and other business-related services. In 1997 it was determined that the Bank's goal would best be served by continued geographic expansion and broadening its products and services. The Bank opened a full service branch office in Darien in May 1997. To expand its business relationships, the Bank initiated several new products such as the commercial deposit sweep account and the commercial checking line of credit. Both the Darien branch and the Fairfield branch are staffed to allow for a dual focus to ensure that each segment of the Bank's customer base is properly served. In October 1997 the Bank formed Bancorp, a holding company, that will allow the Company to expand or enter into other financial service activities, capitalizing on its newly acquired business customer base and affording it the opportunity to expand its services to its existing consumer relationships. This reemphasis has not changed the Company's strong commitment to the communities where its business and consumer customers live and work. The principal sources of funds for the Bank's activities are deposit accounts, amortization and prepayment of loans, borrowings from the Federal Home Loan Bank (FHLB) and funds provided from operations. The Bank's principal sources of income are interest on loans and mortgage-backed securities, and interest and dividends on investments. In recent years, the Bank also has realized income from the sale of loans and mortgage- backed and investment securities. To a lesser extent, the Bank realizes other non-interest income, including income from service charges on deposit accounts and credit card fees. Market Area and Competition The Bank has eight banking offices located in Norwalk, Wilton, Westport, Georgetown, Fairfield and Darien. All of the Bank's office facilities and its primary market area are located in Fairfield County, Connecticut. The State of Connecticut is reported to be the wealthiest state in the United States, and Fairfield County among the wealthiest counties in terms of per capita income. Fairfield County is located in the southwestern corner of Connecticut in close proximity to New York City. At December 31, 1997, the unemployment rate for the Norwalk metropolitan area was 3.0% compared to 4.6% for the State of Connecticut as a whole. Fairfield County has a diversified mix of industry groups, including manufacturing, service, government and corporate offices. Fairfield County is the location for numerous headquarters of Fortune 500 industrial service companies. Fairfield County's industrial economy includes the manufacture of helicopters and other aircraft, sophisticated electronics, missile parts, clothing and precision instrumentation. In addition to the headquarters of large corporations, Fairfield County is the home for an increasing number of small businesses as well as a large number of research and development laboratories, which take advantage of the County's convenient location, access to investment capital and sales opportunities, and a highly educated labor force. As of December 31, 1997, the latest date for which information is available, the Bank ranked as the third largest depository institution headquartered in Fairfield County. In addition, the Bank ranked 11th out of 183 mortgage lenders in Fairfield County based on the number of mortgages originated in 1997. Intense competition exists in all major lines of business in which the Bank is presently engaged. The Bank's market area has a significant number of financial institutions, with offices of commercial banks, thrift institutions and credit unions in Fairfield County alone; in addition, due to its proximity and the number of commuters traveling to New York City, the Bank also faces intense and varied competition for loans and deposits with financial institutions headquartered in New York, many of which have, or have indicated plans to have, offices in Fairfield County. Recent federal legislation expanding interstate banking options may cause this type of competition to increase. The Bank faces additional competition for deposits from short-term money market funds and other securities funds offered by brokerage firms and other financial institutions as well as significant competition for retail products from insurance companies. Lending Activities General. Historically the Bank, like most other savings institutions, concentrated its lending activities on the origination of loans secured by first mortgage liens for the purchase or refinancing of one-to-four family residential properties. Through the 1980's, in an effort to diversify its loan portfolio and originate higher yielding adjustable rate loans, the Bank expanded its lending activities to include a significant volume of permanent and construction financing of a wide variety of real estate properties, including residential subdivision developments, condominium developments, land and various types of commercial properties. The Bank also emphasized various home equity, home improvement, commercial business and consumer loan products. However, following a sharp downturn in the New England real estate markets in the late 1980's and early 1990's, a significant portion of the Bank's real estate loans became non-performing. The Bank has refocused its lending activities on maintaining and expanding its market presence as a one-to-four family residential lender and on maintaining current banking relationships with borrowers that have good credit histories with the Bank. The Bank is also engaged in lending activities to facilitate the sale of OREO, the refinancing and restructuring of non-performing and other loans, and has expanded home equity, home improvement and direct consumer lending including credit card accounts as a result of the FFB&T transaction in 1996. In 1995 the Bank resumed commercial and commercial real estate lending on a conservative basis; a commercial lending department was established and experienced commercial lenders have been hired to underwrite and service commercial mortgages, working capital and equipment loans, and lines of credit for small and medium size businesses within the Bank's market area. Loan Portfolio Composition. The following table sets forth, at the dates indicated, information concerning the Bank's loan portfolio in dollar amounts and in percentages, by type of loan.
At December 31, 1997 % 1996 % 1995 % (Dollars in thousands) Real Estate Loans: One-to-four family adjustable rate $278,231 64.37% $257,459 61.48% $231,168 64.13% One-to-four family fixed rate 64,510 14.92 77,160 18.42 56,360 15.63 Multi-family 5,398 1.25 7,450 1.78 8,902 2.47 Commercial real estate 55,124 12.75 46,272 11.05 44,914 12.46 Land 640 .15 828 0.20 1,290 0.36 Construction 2,942 .68 1,227 0.29 1,617 0.45 Total 406,845 94.12 390,396 93.22 344,251 95.50 Other Loans: Commercial business 7,587 1.75 8,425 2.01 1,485 0.41 Home equity lines of credit 7,632 1.76 7,127 1.70 5,698 1.58 Home improvement and second mortgages 2,852 .66 2,568 0.61 3,422 0.95 Passbook 1,508 .35 1,510 0.36 1,634 0.45 Credit Cards 1,409 .33 991 0.24 - - Other consumer 4,436 1.03 7,801 1.86 3,985 1.11 Total 25,424 5.88 28,422 6.78 16,224 4.50 Total Loans (before net items) 432,269 100.00% 418,818 100.00% 360,475 100.00% Deduct: Deferred loan fees 625 718 509 Allowance for credit losses 5,832 7,334 4,170 Total 6,457 8,052 4,679 Loans, net $425,812 $410,766 $355,796
At December 31, 1994* % 1993* % (Dollars in thousands) Real Estate Loans: One-to-four family adjustable rate $180,275 62.07% $150,333 55.82% One-to-four family fixed rate 42,840 14.75 39,124 14.53 Multi-family 8,605 2.96 8,391 3.12 Commercial real estate 41,367 14.24 50,259 18.66 Land 1,806 0.62 2,338 0.87 Construction 987 0.35 3,505 1.30 Total 275,880 94.99 253,950 94.30 Other Loans: Commercial business 30 0.01 30 0.01 Home equity lines of credit 6,570 2.25 7,340 2.73 Home improvement and second mortgages 4,392 1.51 4,727 1.76 Passbook 1,761 0.62 1,788 0.66 Credit Cards - - - - Other consumer 1,783 0.62 1,465 0.54 Total 14,536 5.01 15,350 5.70 Total Loans (before net items) 290,416 100.00% 269,300 100.00% Deduct: Deferred loan fees 704 587 Allowance for credit losses 4,827 2,532 Total 5,531 3,119 Loans, net $284,885 $266,181
*Includes assets originally disclosed as in-substance foreclosures, under then current accounting pronouncements, for the years ended December 31, 1994 and 1993. Maturity of Loan Portfolio. The following table sets forth certain information at December 31, 1997 regarding the dollar amount of loans maturing in the Bank's loan portfolio. Demand loans and loans having no stated schedule of repayments and no stated maturity are reported as due within one year. Loan amounts are net of non-accruing loans.
After One After Year through Five Years Within Five through After Amount One Year Years Ten Years Ten Years (In thousands) Real estate loans: One-to-four family adjustable rate $276,020 $ 1,320 $ 1,702 $ 1,861 $271,137 One-to-four family fixed rate 64,599 250 2,224 10,469 51,656 All other loans secured by real estate 71,240 5,668 16,728 20,531 28,313 All other loans 15,563 7,100 6,053 2,300 110 Total $427,422 $14,338 $26,707 $35,161 $351,216
The following table sets forth the dollar amount of all loans maturing or repricing after December 31, 1998 by fixed or adjustable interest rates.
Fixed Rates Adjustable Rates (In thousands) Real estate loans: One-to-four family $63,472 $18,556 All other loans secured by real estate 23,759 9,303 All other loans 6,621 306 Total $93,852 $28,165
Loan Portfolio Activity. The following table shows loan origination, sale and repayment activity of the Bank at and during the periods indicated.
At or For the Year Ended December 31, 1997 1996 1995 (In thousands) Loans at beginning of period (before net items) $418,818 $360,475 $290,416 Add: Loans originated: Real estate loans: One-to-four family adjustable rate 60,694 102,109 78,624 One-to-four family fixed rate 16,538 23,574 18,116 Multi-family - - - Commercial real estate 24,863 12,355 8,617 Land 58 58 525 Construction 4,328 7,516 4,784 Other loans: Commercial business 3,890 2,995 1,965 Home improvement and second mortgage 5,729 6,334 520 Passbook 1,156 1,132 726 Other consumer 2,433 5,911 1,424 Total loans originated 119,689 161,984 115,301 Loans Purchased - 13,724 - Less: Loans sold 13,156 45,319 1,296 Loans securitized - - 4,361 Loan repayments 84,473 67,800 37,462 Total loans sold, securitized and repaid 97,629 113,119 43,119 Less: Charged-off 2,155 2,488 1,799 Net transfers to OREO 1,143 1,758 324 Transfers to loans held-for-sale 5,311 - - Total loans charged-off and transfers 8,609 4,246 2,123 Net increase in loans 13,451 58,343 70,059 Loans at end of period $432,269 $418,818 $360,475
One-to-Four Family Residential Lending. The Bank continues to focus on the origination of loans secured primarily by first mortgage liens on existing one-to-four family residences, offering a variety of fixed and variable-rate mortgage loan products. At December 31, 1997, $342.7 million, or 79.3%, of the Bank's total loan portfolio consisted of one-to-four family mortgage loans, substantially all of which are conventional loans (i.e., loans that are neither insured by the Federal Housing Administration ("FHA") nor partially guaranteed by the Veterans Administration (the "VA")). The Bank actively solicits one-to-four family residential mortgage loan applications through its branch banking offices, as well as its team of loan originators, who will complete residential loan applications "off-site" throughout the Bank's market area. In addition, the Bank periodically conducts first-time home buyer seminars in an effort to develop residential loan applications and promote the Bank's community reinvestment. The Bank's practice is to generally originate single-family residential loans which qualify for sale to FNMA and FHLMC underwriting standards. In addition, the Bank has entered into agreements with several conduits whereby these institutions will purchase loans at a pre-determined price and on a pre-approved basis. This relationship allows the Bank to make mortgage loans that do not conform to the Bank's asset/liability management strategy. All of the Bank's rights and interest in such loans, including, in some instances, the right to service the loan, are thereby transferred to the purchasers. The Bank earns an origination fee on such loans. The Bank presently originates both fixed-rate and adjustable-rate mortgage loans with loan terms of 10, 15, 30 and 40 years. Adjustable-rate mortgage loans have interest rates that adjust at annual intervals based upon an index tied to the average yield on U. S. Treasury securities adjusted to a constant maturity of one year. These loans typically provide that the amount of any increase or decrease in the interest rate is limited to two percentage points per adjustment period and is limited to an aggregate of seven percentage points by which the rate can increase or decrease over the life of the loan. The Bank also originates, on a limited basis, self-insured residential loans with a maximum L.T.V. of 90% as well as limited documentation loans. Borrower demand for adjustable-rate versus fixed-rate mortgage loans is a function of the level of interest rates, expectations as to future changes in interest rates, and pricing differences between fixed-rate mortgage loans and adjustable-rate mortgage loans. The relative amount of fixed-rate and adjustable-rate residential loans that are originated at any time is therefore largely determined by market and financial conditions. At December 31, 1997, $64.5 million, or 14.9%, of the Bank's one-to-four family residential loan portfolio consisted of loans which provide for fixed rates of interest. Although these loans generally provide for repayment of principal over a fixed period of 10, 15 or 30 years, it is the Bank's experience that because of prepayments and due-on-sale clauses, such loans generally remain outstanding for a substantially shorter period of time. Adjustable-rate loans tend to decrease the risks to the Bank's net interest income associated with changes in interest rates, but involve credit risk, primarily because as interest rates rise, the payment by the borrower rises to the extent permitted by the terms of the loan, thereby increasing the potential for default. At the same time, the marketability of the underlying property may be adversely affected by higher interest rates. The Bank offers introductory rates on its adjustable-rate residential mortgage loans, which are lower than the fully indexed rate on adjustable-rate loans but are competitive with other lenders in the Bank's market. The Bank typically underwrites the ability of borrowers to service the one year adjustable-rate mortgage loans at the fully indexed rate or at rates acceptable to the secondary markets. The Bank's general practice is to lend up to 80% of the appraised value of the property securing a one-to-four family residential loan. Under certain circumstances, the Bank will lend up to 95% of the appraised value. Except as to certain loans to facilitate the sale of residential subdivision OREO, to the extent that a loan exceeds 80% of the appraised value of the property, the borrower generally must obtain private mortgage insurance on the portion of the principal amount of the loan that exceeds 80%, which effectively reduces the loss exposure to an 80% loan-to-value ratio or less. The Bank offers self-insured residential mortgage loans to a maximum L.T.V. of 90%. The Bank will, under certain circumstances, lend up to 95% of appraised value to facilitate the sale of residential OREO and up to 85% for the sale of non-residential OREO. Appraisals on property securing the Bank's one-to-four family residential loans are made by both independent appraisers and by the Bank's licensed, in-house appraisal staff. The Bank's policy also requires that appraisals be performed in accordance with applicable federal and state laws and regulations. Borrowers also must obtain hazard insurance prior to closing and, when required by the United States Department of Housing and Urban Development, flood insurance. The Bank generally has required borrowers to advance funds, with each monthly payment of principal and interest, to a loan escrow account from which the Bank makes disbursements for items such as real estate taxes as they become due. Multi-Family, Commercial Real Estate, Land and Construction Lending. The Bank originates loans secured by multi-family and commercial real estate located primarily within the Bank's market area. The Bank also originates land acquisition and development loans, as well as construction loans for one-to-four family, multi-family and commercial real estate projects. These loan programs reflected efforts to diversify the type of property securing loans in the Bank's portfolio and to increase the sensitivity of the loan portfolio to changes in interest rates by originating loans with adjustable rates tied to indices more reflective of actual market rates. Additionally, such loans generally have higher fees and interest rates than comparable one-to-four family residential real estate loans. The Bank also originated fixed rate commercial mortgages generally matched by FHLB advances of like terms. At December 31, 1997, $5.4 million, or 1.3%, of the Bank's total loan portfolio consisted of loans secured by multi-family properties. Multi-family loans are comprised primarily of loans secured by income producing properties with five to 10 residential units. At December 31, 1997, $55.1 million, or 12.8%, of the Bank's total loan portfolio consisted of loans secured by commercial real estate. Also at December 31, 1997, $2.9 million, or 0.7% of the Bank's total loan portfolio were construction loans, the majority of which were for construction of one-to-four family residential units. Land loans to acquire and develop real estate at December 31, 1997 amounted to $640,000 or 0.2% of the Bank's total loan portfolio. Most of the Bank's land loans were for residential real estate development projects, and, to a lesser extent, commercial and small industrial developments. The Bank has curtailed the origination of land loans, except in connection with loans to facilitate the sale of land held and under other limited circumstances. The Bank's lending policy allows for loans secured by multi-family properties and commercial real estate with a maximum loan-to-value ratio of 80% (or up to 85% to finance the sale of OREO). Historically, the Bank's multi-family and commercial real estate loans have maturities of 15 to 30 years. As to current loans, the Bank typically offers maturities of 3 to 25 years and terms which provide that interest rates thereon adjust at regular intervals of one, three, five, seven, or ten years, based upon an index tied to a treasury securities index or the FHLB advance rate for a period matching the repricing period of the loan. The Bank also originates fixed rate commercial mortgages having maturities from 15 to 25 years. The Bank generally obtains personal guarantees on loans from the principals of the borrowing entity. Appraisals of the property securing such loans are generally made by both independent appraisers and by the Bank's licensed, in-house appraisal staff. Multi-family, commercial real estate and commercial construction lending to builders is generally considered to involve a higher degree of risk than one-to-four family residential lending. Such lending typically involves larger loan balances concentrated in a single property or with a single borrower or groups of related borrowers. In addition, the payment experience on loans secured by existing income-producing properties is typically dependent on the successful operation of the related real estate project and thus may be more susceptible to adverse conditions in the real estate markets or in the economy generally. Moreover, such financing is generally considered to involve a higher degree of risk of loss than long-term financing on improved, owner-occupied real estate because of the uncertainties of construction, including the possibility of cost exceeding the initial estimates and risk associated with the failure of the ultimate purchaser to purchase such property, or the failure of the lender holding take-out financing to provide such financing. The Bank has resumed such lending, but on a limited basis consistent with prudent underwriting standards. Home Equity Lines of Credit, Home Improvement and Second Mortgages. At December 31, 1997, $7.6 million, or 1.8% of the Bank's total loan portfolio, consisted of home equity lines of credit. At that date, the Bank had outstanding commitments for an additional $8.7 million of unused home equity lines of credit. Also at December 31, 1997, the Bank had outstanding a variety of home improvement loans and second mortgages secured by one-to-four family residential properties. Although home equity lines of credit and home improvement loans typically are secured by second mortgage liens on residential properties, some of the Bank's home equity lines and home improvement loans are secured by first mortgage liens on property which is not otherwise mortgaged or subject to similar encumbrances. The Bank currently offers home equity lines of credit consistent with prudent underwriting standards and favorable economic conditions. The Bank also currently offers amortizing second mortgage loans to enable home owners to access equity in their home. The Bank offers repayment schedules up to 15 years. The Bank also offers installment second mortgage loans fully amortized over five years. These loans are underwritten based on the borrower's consumer credit and may be up to 100% of the equity in the borrower's home. These loans do not exceed $40,000. The Bank's current Loan Policy permits home equity and second mortgage loans to be made for up to 80% of the appraised value of the property securing the loan, less any existing encumbrances. Appraisals on the property securing the Bank's home equity and second mortgage loan products and lines are made by both independent appraisers and by the Bank's licensed, in-house appraisal staff. Commercial Business Lending. The Bank's Commercial Business Lending Department offers a wide array of commercial lending and deposit services. The Bank is offering traditional commercial and industrial loan products and commercial real estate loans to local businesses consistent with prudent underwriting standards. The Bank believes these loan products will provide higher interest rates and will allow the Bank to serve the local small business community, a market sector which is not currently being served by large regional commercial banks or money center banks. Management believes development of the Bank's commercial department affords the Bank the best opportunity to increase market penetration in the Bank's local market area. Consumer Lending. The Bank currently offers a variety of consumer loan products, including loans secured by passbook accounts at the Bank, unsecured lines of credit, education and automobile loans and personal loans. Interest rates are set from time to time and are intended to be generally competitive in the Bank's market. The Bank is now more actively pursuing direct consumer lending. Management believes that higher interest rates and shorter maturities associated with this type of lending will complement both earnings and asset/liability management objectives. The Bank intends to actively market consumer loan products and to build the consumer loan portfolio. Credit Cards. The Bank currently offers consumer and business credit cards. In addition, the Bank provides merchants services as an additional source of fee income. Mortgage Loan Servicing. The following table sets forth information regarding the Bank's loan servicing portfolio at the dates indicated.
December 31, 1997 (a) 1996 1995 (Dollars in thousands) Percent Percent Percent Amount of Total Amount of Total Amount of Total Loans owned and serviced by the Bank (before net items) $432,269 85.51% $418,818 85.74% $360,475 81.42% Loans serviced for others 73,279 14.49 69,680 14.26 82,281 18.58 Total loans serviced by the Bank (before net items) $505,548 100.00% $488,498 100.00% $442,756 100.00%
(a) Includes $5.3 million of one-to-four family mortgage loans held-for-sale. The Bank has historically serviced loans for other institutions as a means of maintaining customer relationships and generating fee income. These loans are comprised of loans originated by the Bank and securitized into participation certificates or whole loans sold to private banking institutions or FNMA or FHLMC. Fee income derived from these loans serviced for others totalled $296,000, $316,000 and $370,000 in 1997, 1996 and 1995, respectively. Non-Performing, Delinquent and Classified Assets General. At December 31, 1997, non-performing assets were comprised of $4.8 million of non-performing loans and $574,000 of OREO. Most of the Bank's non-performing assets consist of OREO and non-performing loans secured by property located in the Bank's Southern Fairfield County, Connecticut market area. The Bank believes that the reduction in non-performing assets (see following table) is the result of concentrated efforts by the Bank's management and Board of Directors to improve credit quality and dispose of problem assets. The Bank believes the improvement of the Fairfield County residential real estate market and lower market interest rates facilitated the reduction in non-performing assets. The Bank's Watch List, comprised of loans which have been identified by the Bank's credit analysis system as exhibiting more than usual risk of non-performance or loss aggregated $8.5 million at December 31, 1996 and $11.7 million at December 31, 1997. Two loans which were non-accrual at December 31, 1996 were placed on the Watch List during 1997; these loans have been current for the remainder of 1997. Another loan experienced delinquency during the first half of 1997 and was placed on the Watch List; this loan has been current for the last six months of 1997. The Bank implemented the Accelerated Non-Performing Asset Disposition Program in 1994 to allow the Bank to more rapidly dispose of certain non-performing assets at discounts below their net realizable value. The program established a $5.7 million special allowance to dispose of $14.0 million of non-performing assets, $3.1 million allocated to the provision for credit losses and $2.6 million allocated to the provision for estimated losses on OREO. The Bank concluded the ADP program on December 31, 1995. In total, gross assets of $16.1 million were disposed of, and a total of $4.6 million was charged to the ADP allowances. The Bank continued to reduce non-performing assets in 1997 and 1996 through the normal course of business. Total non-performing assets were $5.4 million at December 31, 1997 or 0.83% of total assets compared to $11.3 million or 1.9% of total assets at December 31, 1996. Non-Performing Assets. The following table sets forth the amounts of the Bank's non-performing assets, by category at the dates indicated.
At December 31, 1997 1996 1995 1994 1993 (Dollars in thousands) Non-performing loans: Real estate loans: One-to-four family $2,122 $ 2,784 $ 1,422 $ 2,402 $6,219 Multi-family 1,317 1,739 2,330 2,119 2,120 Commercial real estate 1,043 3,819 7,645 4,538 15,756 Land - - 105 509 1,180 Construction - - 450 191 590 Other loans: Commercial 106 1,197 65 12 - Home equity lines of credit 175 175 395 57 141 Home improvement and second mortgage 44 653 658 148 169 Other consumer 40 74 - - 5 Total non-performing loans (a) (b) 4,847 10,441 13,070 9,976 26,180 OREO: One-to-four family 250 90 148 2,257 2,246 Multi-family - - - - 548 Commercial real estate 324 586 3,386 6,480 10,555 Land - 182 733 2,885 4,475 Allowance for estimated losses on OREO - - - (802) (194) Total OREO, net 574 858 4,267 10,820 17,630 Total non-performing assets, net $5,421 $11,299 $17,337 $20,796 $43,810 Total non-performing assets, net, as a percentage of total assets 0.83% 1.92% 3.36% 4.47% 10.24%
(a) For presentation purposes, no amount of the allowance for credit losses has been allocated to non-performing loans. (b) Includes amounts previously reflected as in-substance foreclosures under prior accounting methods in effect as of the years ended December 31, 1993 and 1994. Troubled debt restructurings ("TDRs") are loans as to which the Bank has granted certain concessions in light of the borrower's financial difficulty. The objective of the Bank in granting these concessions, through a modification of terms, is to maximize the recovery of its investment. This modification of terms may include a reduction in stated rate, an extension of maturity at a more favorable rate and a reduction of accrued interest. In the past, any TDRs entered into by the Bank were classified as non-performing loans. The Bank may, from time to time, engage in TDRs when appropriate. At December 31, 1997, the Bank had no TDR's classified as non-performing. An additional form of troubled debt restructuring that is available to the Bank is loan splitting. In instances where cash flows are insufficient to service total debt, the debt may be split into two separate notes, one note at current market terms and a second at below market terms. This practice enables a certain portion of the loan to return to performing status. At December 31, 1997, the Bank had $1.9 million in former TDR's which have been integrated into the Bank's performing loan portfolio based on satisfactory performance. Delinquent Loans. Total loans delinquent 30 to 89 days decreased to $2.4 million as of December 31, 1997 from $4.1 million at December 31, 1996. The delinquency consisted primarily of one-to-four family residential loans (19 loans with an approximate balance of $2.0 million). The Bank continues to address collection of delinquent loans. Each loan officer is assigned a portfolio of delinquent loans. Delinquent borrowers receive written correspondence once a loan becomes 30 days past due. A loan officer will make contact before the loan becomes 20 days past due. A call letter will be sent out by the time a loan becomes 60 days past due unless a work-out schedule has been agreed to with the borrower. Foreclosure will commence after the loan becomes 90 days past due unless a repayment schedule has been mutually accepted or the Bank determines that foreclosure would not be in its best interests. Because of certain provisions of Connecticut foreclosure law, the Bank may encounter delays in its attempt to foreclose on property for which it is mortgagee. Connecticut foreclosure law requires a lawsuit by the foreclosing party against the mortgagor (owner) of real estate (and the suit must name as defendants all junior lien holders). In addition, Connecticut law protects consumers who are unemployed or under-employed, as defined by statute, by permitting them to obtain a six-month stay of a mortgage foreclosure action and to restructure their mortgage debt. In general, although foreclosure actions are subject to far fewer defenses than ordinary lawsuits, mortgagors can and sometimes do raise defenses which, even if not meritorious, can delay the foreclosure process for months or even years. Foreclosure in Connecticut is typically accomplished by strict foreclosure in contrast to foreclosure by sale. Strict foreclosure involves the rendering of a judgment by a court in favor of the foreclosing party (e.g., a bank) and sets a date by which the property owner (the mortgagor) and any other mortgagees must either redeem the property by paying the foreclosing party the full amount of its debt or lose their interest in the property. Foreclosure by sale requires a court to appoint a committee to sell property at public auction, and involves advertising and appraisal of the property. Foreclosure by sale frequently imposes significant delays when compared to the strict foreclosure process. Management of the Bank regularly reviews delinquent loans, which are placed on non-accrual status when, in its judgment, the probability of collection is too uncertain to warrant further accrual. All loans 90 days or more past due as to interest or principal are placed on non-accrual status unless, in exceptional circumstances, the loan is both well secured and in the process of collection. The Bank was accruing interest on four loans which were 90 days or more past due with an aggregate principal balance of $1.6 million at December 31, 1997. Allowances for Credit Losses. The Bank's allowance for credit losses was $5.8 million at December 31, 1997. The Bank's Watch List loans, unused lines of credit, and letters of credit are taken into account in establishing the allowance for credit losses. The following table sets forth an analysis of the activity in the allowance for credit losses at and during the periods indicated.
At or for the Year Ended December 31, 1997 1996 1995 1994 1993 (Dollars in thousands) Balance at beginning of period $7,334 $4,170 $4,827 $2,532 $4,567 Add: Provision charged to operations - 4,415 2,105 690 1,000 Allowance on Acquired Loans - 1,000 - - - ADP plan - - (1,100) 3,100 - Recoveries 653 237 137 94 38 Less: Charged-off: Real estate loans: One-to-four family 516 394 648 956 392 Multi-family 122 220 355 1 83 Commercial real estate 967 1,788 671 551 1,442 Land - 18 118 - - Construction - - - 61 1,075 Consumer and commercial business 550 68 7 20 81 2,155 2,488 1,799 1,589 3,073 Balance at end of period $5,832 $7,334 $4,170 $4,827 $2,532 Net charged-off $1,502 $2,251 $1,662 $1,495 $3,035 Loans outstanding (before net items) $432,269 $418,818 $360,475 $290,416 $269,300 Ratio of net charged-off to loans outstanding (before net items) at end of period 0.35% 0.54% 0.46% 0.51% 1.13%
The following table sets forth, at the dates indicated, the Bank's allocation of the allowance for credit losses to the total amount of loans in each of the categories listed.
At December 31, 1997 Percent of Percent of Loans Total Allowance in each Category Amount For Credit Losses to Total Loans (Dollars in thousands) Mortgage Loans Residential (a) $1,161 19.9% 78.4% Commercial (b) 3,854 66.1 15.0 Other Loans (c) 817 14.0 6.6 Total allowance for credit losses $5,832 100.0% 100.0% Ratio of allowance for credit losses to loans outstanding (before net items) at end of period 1.35% At December 31, 1996 Percent of Percent of Loans Total Allowance in each Category Amount For Credit Losses to Total Loans (Dollars in thousands) Mortgage Loans Residential (a) $1,045 14.2% 79.9% Commercial (b) 4,710 64.3 13.3 Other Loans (c) 1,579 21.5 6.8 Total allowance for credit losses $7,334 100.0% 100.0% Ratio of allowance for credit losses to loans outstanding (before net items) at end of period 1.75% At December 31, 1995 Percent of Percent of Loans Total Allowance in each Category Amount For Credit Losses to Total Loans (Dollars in thousands) Mortgage Loans Residential (a) $ 750 18.0% 79.8% Commercial (b) 3,153 75.6 15.7 Other Loans (c) 267 6.4 4.5 Total allowance for credit losses $4,170 100.0% 100.0% Ratio of allowance for credit losses to loans outstanding (before net items) at end of period 1.16%
(a) Includes one-to-four family loans. (b) Includes all commercial real estate loans, multi-family, land and construction loans. (c) Includes commercial business, home equity lines of credit, home improvement, second mortgages, passbook and other consumer loans. Allowance for Estimated Losses on OREO. The following table sets forth an analysis of the activity in the allowance for estimated losses on OREO at and during the periods indicated.
At or For the Year Ended December 31, Allowance for Estimated Losses on OREO 1997 1996 1995 1994 1993 (In thousands) Balance at beginning of period $ - $ - $ 802 $ 194 $1,025 Add: Provision charged to operations - 459 460 2,894(b) 3,975 Less: Charged-off: One-to-four family - - 284 449 298 Multi-family - - 58 153 224 Commercial real estate - 459 582 1,097 2,008 Land - - 338 193 840 Construction - - - 394 1,436 - 459 1,262 2,286 4,806 Balance at end of period (a) $ - $ - $ - $ 802 $ 194
(a) The Bank carries OREO at net realizable value. Beginning in 1991, the Bank established general and specific reserves against OREO to arrive at net realizable value. Beginning in 1993, the Bank netted the specific reserves against OREO carrying values, and continues to maintain a general reserve when deemed necessary by management to arrive at net realizable value. (b) Of the $2.9 million provision charged to operations, $2.6 million was a result of the ADP Program. Investment Activities General. In accordance with Statement of Financial Accounting Standard No. 115, "Accounting for Certain Investments in Debt and Equity Securities" ("SFAS 115"), which the Bank adopted as of January 1, 1994, the Bank was required to classify each security in the portfolio as either "Held-to-Maturity", "Available-for-Sale", or "Trading Account Security". It was the decision of management to classify substantially all of the portfolio as Held-to-Maturity at the adoption date based upon the Bank's ability and intent to hold, taking into account currently available liquidity and the potential for additional liquidity afforded by the Bank's stock conversion. During 1996 the Bank assessed whether the Held-to-Maturity classification was supported by management's intent due to the repositioning of the Bank's long term objectives and financial condition; as a result, the Bank reclassified substantially all of these investments to Available-for-Sale. This decision required the Bank to mark each security to market through Shareholders' equity as of December 31, 1996 and reflect each investment at fair value. Under Connecticut law, the Bank has authority to purchase a wide range of investment securities. However, as a result of changes in federal banking laws in 1991, financial institutions such as the Bank may not engage as principals in any activities that are not permissible for a national bank, unless the FDIC has determined that the activity would pose no significant risk to the Bank Insurance Fund and the Bank is in compliance with applicable capital standards. In March 1993, the Regional Director of the FDIC approved a request by the Bank to invest in certain listed stock and/or registered stock subject to certain conditions. The Bank utilizes the trading account classification to account for the portion of the equity portfolio with common stock investments in the covered call option program. This program is designed for yield enhancement and to lessen the Bank's exposure to a potentially volatile stock market. In this program, the Bank purchases shares of qualified common stock and sells a call option against the investment. The holding period of each investment averages one to three months and there are ten to fifteen investment positions in the program. As required by SFAS 115 the Bank marks the common stock and related covered call option to market through current period earnings. During 1997, the Bank effected various purchase and sale transactions designed to increase yields on the existing portfolio investment levels and, during the first six months of the year, invested a net total of approximately $34 million in callable preferred stocks as part of its income tax strategy. These securities accounted for a significant part of the net growth of the portfolio providing an advantageous investment vehicle as the stock converts in approximately 4-1/2 years to adjustable rates which management anticipates will result in the securities being called. An additional benefit to the tax effective yield is an equalization provision, in the event the dividend income becomes subject to full taxation, up to the call date. The following table sets forth the composition of the Bank's securities at fair value at the dates indicated.
At December 31, 1997 1996 1995 1994 1993 (In thousands) Debt Securities: U.S. Treasury securities $ - $ - $ 8,316 $24,137 $38,488 Obligations of other U.S. Government agencies 55,257 42,120 20,366 25,240 19,633 Total $55,257 $42,120 $28,682 $49,377 $58,121 Equity Securities $39,292(a) $5,528(a) $4,844 $22 $23
(a) Includes $1,830 and $3,292 classified as trading at December 31, 1997 and 1996, respectively. The following table sets forth the maturities of the Bank's investment securities (excluding equity securities) by amortized cost at December 31, 1997 and the weighted average yields of such securities.
After One But After Five But Within One Year Within Five Years Within 10 Years After 10 Years Totals (Dollars in Thousands) Weighted Weighted Weighted Weighted Weighted Average Average Average Average Average Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield Other Bonds and notes(a) $ - -% $3,000 6.60% $43,002 6.97% $9,120 7.15% $55,122 6.98% Mortgage- backed securities(b) - - 2,318 7.70 9,686 7.92 73,539 7.86 85,543 7.80 Total $ - -% $5,318 7.08% $52,688 7.14% $82,659 7.78% $140,665 7.48%
(a) Solely U.S. Government agencies. (b) Solely FHLMC and FNMA participation certificates. Mortgage-Backed Securities. Mortgage-backed securities increase the quality of the Bank's assets because of the insurance or guarantees of federal agencies on non-guaranteed mortgage loans. In addition, mortgage- backed securities are more liquid than individual mortgage loans and may be more readily available to collateralize borrowings or other obligations of the Bank. All of the FNMA or FHLMC securities owned by the Bank at December 31, 1997 had initial maturities of seven to thirty years, although the Bank expects the average lives will be considerably shorter due to principal amortization and prepayments. The following table sets forth the activity in the Bank's mortgage-backed securities portfolio at and during the periods indicated.
At or For the Year Ended December 31, 1997 1996 1995 (In thousands) Mortgage-backed securities at beginning of period $92,443 $90,281 $97,719 Purchases 47,205 38,650 44,318 Acquired in exchange for loans - - 4,361 Sales (34,630) (11,886) (38,615) Repayments, accretion and amortization (19,475) (24,602) (17,502) Mortgage-backed securities at end of period $85,543 $92,443 $90,281
Sources of Funds The primary sources of funds for the Bank's use in its lending activities and for other general business purposes are amortization and prepayment of loans, deposit accounts and funds provided from operations. See "Management's Discussion and Analysis - Liquidity and Interest Rate Risk Management". The Bank offers a variety of deposit accounts having a wide range of interest rates and terms. The Bank attempts to control the flow of funds in its deposit accounts according to its need for funds and the cost of alternative sources of funds primarily through the pricing of deposits and, to a lesser extent, by promotional activities. Among the deposit accounts offered by the Bank at December 31, 1997 were regular passbook and statement savings accounts, which earn interest at an annual rate of 1.99% with an effective annual yield at 2.00%. Interest on passbook and statement savings accounts is compounded and credited monthly. The Bank requires a minimum deposit of $5.00 to open a passbook or statement savings account. The Super Savings Account earns interest at annual rates of 2.23% to 3.35% with an effective annual yield of 2.25% to 3.40%. The minimum deposit to open Super Savings Accounts is $1,000 and the interest is compounded and credited monthly. The Bank also offers money market accounts which are competitive with similar money market mutual funds. The Bank requires a $2,500 minimum deposit to open the Advantage Money Market Account. Average monthly balances of less than $2,500 are subject to service charges. The minimum deposit to open the Gold Money Market Account is $5,000. Average monthly balances of less than $5,000 are subject to service charges. Interest is compounded and credited monthly. The interest rate is reviewed weekly and adjusted as money market conditions warrant. Minimum balance requirements for the Bank's certificates of deposit for one year or more are $500. Certificates which have a maturity of under one year have a minimum balance requirement of $1,000. Interest rates on all certificates are determined by the Bank's Funds Management Committee based on market conditions, competitive factors, cash flow requirements of the Bank, and funding objectives. Interest is compounded and credited monthly on all certificates. The Bank offers checking accounts which require a $25 minimum initial deposit and bear no interest, and NOW accounts which pay interest on balances of $1,000 or more and require a $25 minimum initial deposit. The Bank also offers a Municipal Sweep Now Account which requires a minimum initial deposit of $50,000. As an additional source of funds, the Bank offers a commercial repurchase agreement. This account pays interest and the minimum balance to open is $50,000. Balances in the repurchase agreement are collateralized by government securities. The following table sets forth, at the dates indicated, the distribution of the Bank's deposit accounts at the dates indicated and the weighted average cost on each category of deposits for the periods then ended.
At December 31, 1997 (Dollars in Thousands) Percent of Weighted Total Average Total Deposits Cost Demand deposits $ 27,471 6.18% 0.00% Savings: Regular savings 29,455 6.63 1.99 Super savings 47,863 10.78 3.00 NOW 37,287 8.39 1.16 Money Market fund 55,541 12.50 3.17 Escrow deposits 4,727 1.07 2.80 Certificates: Certificate accounts 204,129 45.95 5.66 Money Market certificates 37,738 8.50 4.48 Total Deposits $444,211 100.00% 3.96% At December 31, 1996 (Dollars in Thousands) Percent of Weighted Total Average Total Deposits Cost Demand deposits $22,479 5.31% 0.00% Savings: Regular savings 28,096 6.64 2.06 Super savings 45,404 10.73 2.60 NOW 30,262 7.15 1.88 Money Market fund 47,957 11.33 2.95 Escrow deposits 4,965 1.17 2.83 Certificates: Certificate accounts 197,108 46.56 6.03 Money Market certificates 47,019 11.11 5.01 Total Deposits $423,290 100.00% 3.91% At December 31, 1995 (Dollars in Thousands) Percent of Weighted Total Average Total Deposits Cost Demand deposits $ 13,697 3.40% 0.00% Savings: Regular savings 28,660 7.12 1.82 Super savings 55,042 13.66 2.79 NOW 35,097 8.71 .95 Money Market fund 59,724 14.83 3.89 Escrow deposits 4,142 1.03 2.73 Certificates: Certificate accounts 154,340 38.32 5.31 Money Market certificates 52,095 12.93 4.47 Total Deposits $402,797 100.00% 3.81%
The following table sets forth the net deposit flows of the Bank during the periods indicated.
Year Ended December 31, 1997 1996 1995 (In thousands) Net deposit inflow (outflow) $ 3,781 $ 3,649 (a) $25,557 Interest 17,140 16,844 14,169 Net increase in deposits $20,921 $20,493 $39,726
(a) Includes deposits assumed in the FFB&T transaction of $47.6 million, and $48.0 million in deposits sold in the Brookfield and Bethel branch sales (see Management Discussion and Analysis - Financial Condition). The following table presents the amounts of the Bank's certificate accounts at December 31, 1997 maturing during the periods reflected below and the weighted average interest rate of such accounts at such date:
Weighted Average Amount Interest Rate (Dollars in thousands) Certificate accounts maturing during the 12 months ending: December 31, 1998 $146,109 5.12% December 31, 1999 70,623 5.85 December 31, 2000 20,757 6.51 Thereafter 4,378 5.90 Total $241,867 5.47%
The following table presents the maturities of the Bank's certificate accounts in amounts of $100,000 or more at December 31, 1997 by time remaining to maturity.
Maturing (In thousands) Six months or less $ 9,329 Over six through twelve months 5,164 Over twelve months 9,823 Total $24,316
Borrowings. Although deposits are the Bank's primary source of funds, the Bank also utilizes borrowings from the FHLB and securities sold under agreements to repurchase ("reverse repurchase agreements") as alternative funding sources. The Federal Home Loan Bank System functions in a reserve credit capacity for savings institutions and certain other home financing institutions. The Bank is required to own capital stock in the FHLB in order to access the System and is authorized to apply for advances on the security of such stock and certain of its home mortgages and other assets (principally securities which are obligations of, or guaranteed by, the United States) provided certain credit worthiness standards have been met. In addition, the Bank increased the use of the reverse repurchase agreement as a means to borrow funds. These agreements are essentially collateralized borrowings, similar to FHLB borrowings, and to the extent that the rates and terms are more favorable, the Bank utilizes the reverse repurchase agreement in lieu of an FHLB borrowing. At December 31, 1997, the Bank had outstanding $110.9 million in borrowings from the FHLB, maturing as follows:
Adjustable Rate Next Interest Due Date Adjustment Amount Rate May 1999 November 1997 $ 4,400 5.94% February 2002 February 1999 10,000 5.90 Total Adjustable Rate 14,400 5.91 Fixed Rate January 1998 - 5,000 5.78 February 1998 - 5,000 5.30 March 1998 - 10,000 5.63 April 1998 - 5,000 5.98 May 1998 - 10,000 6.13 May 1998 - 5,000 6.28 May 1998 - 5,000 5.96 June 1998 - 5,000 6.28 June 1998 - 15,000 5.87 June 1998 - 15,000 5.76 July 1998 - 5,000 5.82 July 1998 - 5,000 5.26 November 1998 - 5,000 5.90 December 2013 - 1,537(a) 6.55 Total Fixed Rate 96,537 5.85% Total Borrowings $110,937
(a) This borrowing has an amortization feature attached to it and pays down over a term consistent with the loan it is matched against. FHLB advances to the Bank at December 31, 1995, 1996, 1997 were $61.8 million, $82.2 million and $110.9 million, respectively. The following table sets forth, at the dates indicated, information concerning the Bank's reverse repurchase agreements:
Year Ended December 31, 1997 1996 1995 (Dollar amounts in thousands) Average Balance During the Year $33,847 $29,203 $6,857 Maximum Month-End Balance During the Year $40,441 $36,350 $9,310 Average Interest Rate During the Year 5.90% 5.61% 5.88%
At December 31, 1997, repurchase agreements aggregating approximately $21.0 million, $9.4 million and $10.0 million mature during the years ending December 31, 1998, 2000 and 2002, respectively. The following table sets forth, at the dates indicated, information regarding the weighted average interest rate and the highest and average month-end balances of the Bank's total borrowings.
Year Ended December 31, 1997 1996 1995 (Dollars in thousands) Weighted average interest rate of total borrowings 5.88% 5.89% 6.44% Highest outstanding balance of total borrowings $181,951 $159,903 $77,229 Average month-end balance of total borrowings $158,944 $115,465 $65,644
Credit Card Services The Bank acquired a credit card operation in conjunction with the acquisition of certain assets of Fairfield First Bank and Trust Company in July 1996. The credit card function involves two primary lines of business: merchant deposit and cardholder. As of December 31, 1997 there was $1.4 million in credit card loans outstanding compared to $1.0 million as of December 31, 1996. Interest income is derived from the credit card loans and the merchant deposit function generates fee income for the Bank. Subsidiaries The Bank has one wholly owned subsidiary, NSS Realty, which was formed in 1990 for the sole purpose of developing and disposing of certain real estate the Bank acquired through foreclosure or deed in lieu of foreclosure. NSS Realty recorded sales of Bank owned real estate during the year ended December 31, 1997 of $139,100, which resulted in a gain of $68,700. At December 31, 1997, NSS Realty has one property with a book value of $111,700. NSS Realty has one wholly owned subsidiary, NSS Westport Development Corp., which was formed in 1992 solely for the purpose of developing an OREO property, Sherwood Farms in Westport, CT. This subdivision was completely sold out in 1996 and the subsidiary is currently inactive. Employees 160 employees were employed by the Bank as of February 28, 1998; 156 were full time equivalents. Miscellaneous The Bank has not obtained a material portion of its deposits from a single customer. A material portion of the Bank's loan portfolio is not concentrated in one industry or related group (other than residential mortgage lending in Fairfield County, Connecticut). The Bank holds no material patents, trademarks, licenses or concessions except as required by regulatory authorities. The Bank has undertaken no material research activities related to new services or the improvement of existing services, other than routine activities in the ordinary course of the Bank's business. The Bank conducts substantially all of its marketing research using existing personnel, none of which is engaged full-time in such activities. ITEM 2. Properties At December 31, 1997 the Bank had eight full service banking offices and one satellite (ATM) branch. The following table lists information at December 31, 1997 for the properties of the Bank.
Year Office Area Amount of Owned or Lease Location Opened by Square Feet Deposits Leased Expiration (Dollars in thousands) Executive Offices: 48 Wall Street 1849 24,000 $ - Owned Norwalk, Connecticut Full Service Banking Offices: 48 Wall Street 1849 2,950 158,128 Owned Norwalk, Connecticut 117 Old Ridgefield Road 1960 3,450 42,769 Owned Wilton, Connecticut Rt. 7 & 107 1972 2,560 29,013 Leased June 30,2002 Georgetown, Connecticut Main Avenue & West Rocks Road 1974 3,560 70,841 Leased April 30,2006 Norwalk, Connecticut 578 Westport Avenue 1983 3,500 57,321 Owned Norwalk, Connecticut 1815 Post Road East 1988 3,392 37,944 Owned Westport, Connecticut 2000 Post Road 1996 3,300 35,564 Leased Oct. 31,2006 Fairfield, Connecticut 1089 Post Road Darien, Connecticut 1997 3,000 12,631 Leased Sept. 30,2006 Satellite Branch So. Norwalk Railroad Station 1996 Free standing ATM - Leased June 14,2001
$444,211 ITEM 3. Legal Proceedings The Company and its subsidiary are not involved in any legal proceeding that it believes is material to its financial condition. ITEM 4. Submission of Matters to a Vote of Security Holders There were no matters submitted to a vote of security holders during the fourth quarter of 1997. PART II ITEM 5. Market for the Company's Common Stock and Related Shareholder Matters NSS Bancorp, Inc.'s common stock is traded over the counter on the NASDAQ National Market System under the symbol "NSSY". As of March 27, 1998 the latest practicable date, there were approximately 688 shareholders of record. Information on market prices and dividends paid for the latest two fiscal years is included on page 29 of the Company's Annual Report to Shareholders for the year ended December 31, 1997, which is incorporated herein by reference, under the caption, "Market Price of Common Stock". The Bank began paying dividends to its shareholders in 1996. The first dividend since becoming a public company in June 1994 was $0.05 per share payable to the shareholders of record as of the close of business on May 6, 1996. Subsequent dividends have been declared and paid by the Bank on a quarterly basis during 1996 and the first three quarters of 1997, and, commencing with the fourth quarter of 1997, by Bancorp. The Board of Directors recognizes that it is under no obligation to continue paying dividends and will consider such a payment on a quarterly basis assuming such action would be consistent with its primary goal of maintaining the capital adequacy of both Bancorp and Bank. The ability of Bancorp to pay dividends to its shareholders is primarily dependent upon the Bank's ability and inclination to pay dividends to Bancorp. Connecticut law prohibits the Bank from paying dividends other than to the extent of retained net profits from the current fiscal year and two preceding full fiscal years. ITEM 6. Selected Financial Data The following tables set forth certain selected consolidated financial and other data of the Company at or for the dates indicated. This information should be read in conjunction with the Consolidated Financial Statements and notes thereto included elsewhere herein. The consolidated financial data as of and for the years ended December 31, 1993 through 1997 have been derived from the audited Consolidated Financial Statements of the Company. At or For the Year Ended December 31, ($ thousands, except per share data) 1997 1996 1995 1994 1993 Selected Balance Sheet Data: Total assets $654,222 $589,589 $515,267 $464,901 $427,950 Treasury & other gov't. agency securities 55,257 42,120 28,682 51,139 58,129 Mortgage-backed securities 85,948 92,453 90,339 97,270 58,219 Equity Securities 39,292 5,528 4,844 22 9 Loans Receivable, net of deferred loan fees 431,644 418,100 359,966 289,712 268,713 Allowance for credit losses 5,832 7,334 4,170 4,827 2,532 Loans, net 425,812 410,766 355,796 284,885 266,181 OREO 574 858 4,267 11,622 17,824 Allowance for estimated losses - - - 802 194 OREO, net 574 858 4,267 10,820 17,630 Deposits 444,211 423,290 402,797 363,071 359,063 Borrowings 151,671 114,043 67,123 63,510 48,765 Shareholders' Equity/ Retained Earnings 56,138 49,353 43,595 37,513 19,712 Non-Performing Assets: Non-performing loans 4,847 10,441 13,070 9,976 26,180 OREO, net 574 858 4,267 10,820 17,630 Total non-performing assets $5,421 $11,299 $17,337 $20,796 $43,810 Summary of Operations: Interest and dividend income 45,869 $41,255 $33,015 $25,045 $24,520 Interest expense 26,496 23,640 18,398 13,112 13,719 Net interest and dividend income19,373 17,615 14,617 11,933 10,801 Provision for credit losses - 4,415 1,005 3,790 1,000 Net interest income after provision for credit losses 19,373 13,200 13,612 8,143 9,801 Non-interest income: Service charges and other income3,787 2,687 1,897 1,890 2,173 Gains (losses) on loans and investment securities 1,459 517 798 (64) 2,410 Gain on sale of branches - 3,639 - - - Non-interest expenses: Provision for estimated losses on OREO - 459 460 **2,894 3,975 Holding costs and expenses of OREO, net (103) 903 955 532 850 Operating expenses 15,827 14,104 11,304 9,980 8,705 Income (loss) before income taxes 8,895 4,577 3,588 (3,437) 854 Current income tax provision 1,973 175 10 50 73 Deferred income tax provision (benefit) 1,357 (1,300) (1,200) - - Net income (loss) $5,565 $5,702 $4,778 ($3,487) $781 Net income excluding the effects of the ADP Program (*, **) $2,213 Income (loss) per share $2.31 $2.39 $2.04 $(1.51) N/A Income per share excluding the effects of the ADP Program (*,**) N/A N/A N/A $0.96 N/A
* Includes $3.1 million allocated to loans of the total $5.7 million one-time special charge for the Accelerated Non-Performing Asset Disposition Program (ADP). ** Includes $2.6 million allocated to OREO of the total $5.7 million one-time special charge for the ADP Program. ITEM 6. (continued) Selected Financial Data (continued)
At or For the Year Ended December 31, 1997 1996 1995 1994 1993 (Dollars in thousands) Performance Ratios:(***) Return on average total assets 0.87% 0.97% 0.76% 0.51% 0.18% Return on average equity/retained earnings 10.54 12.52 8.97 7.36 3.95 Net yield on interest- earning assets 3.11 3.12 3.17 2.96 2.84 Asset Quality Data: Non-performing loans as a % of loans receivable 1.12 2.50 3.63 3.44 9.72 Non-performing assets as a % of total assets 0.83 1.92 3.36 4.47 10.24 Allowance for credit losses as a % of loans receivable 1.35 1.75 1.16 1.66 0.95 Allowance for credit losses as a % of non-performing loans 120.32 70.24 31.91 48.39 9.67 Net charge-offs to average loans 0.34 0.56 0.53 0.56 1.13 Capital Ratios: Tier 1 leverage capital 8.2 7.9 8.4 8.2 4.6 Tier 1 risk-based capital 15.4 15.7 16.7 14.5 8.9 Total risk-based capital 16.6 17.0 17.9 15.8 10.0 Other Selected Financial and Statistical Data: Loans originated during period $119,689 $161,984 $115,301 $75,718 $55,133 Dividend payout 15.15% 6.28% N/A N/A N/A
*** Ratios for 1995 and 1994 exclude the effects of the ADP Program. All such ratios for 1994 would be negative if the ADP charge of $5.7 million was included. ITEM 7. Management's Discussion and Analysis of Financial Condition and Results of Operations The data required by this item is included on pages 9 through 30 of the Company's 1997 Annual Report to Shareholders, which is incorporated by reference herein. ITEM 7A. Quantitative and Qualitative Disclosures About Market Risk The data required by this item is included on pages 27 and 28 of the Company's 1997 Annual Report to Shareholders, which is incorporated by reference herein. ITEM 8. Financial Statements and Supplementary Data The data required by this item is included on pages 31 through 59 of the Company's 1997 Annual Report to Shareholders, which is incorporated by reference herein. ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None PART III ITEM 10. Directors and Executive Officers of the Registrant Information regarding the directors of the Company is omitted from this report as the Company intends to file a definitive proxy statement not later than 120 days after the end of the fiscal year and the information to be included therein is incorporated herein by reference. The executive officers of the Company (other than Messrs. Judson and Howell, who are also Directors), all of whom are subject to election annually by the Board of Directors, are: Jeremiah T. Dorney has been Senior Vice President of the Bank since April 1985, and was elected Corporate Secretary in June 1988. His responsibilities are that of Senior Operations Officer and Director of Human Resources. Mr. Dorney's career spans 35 years of diversified banking education and experience. Marcus I. Braverman, C.P.A. has been Senior Vice President and Chief Financial Officer of the Bank since January 1994. He was appointed Treasurer in 1995. From 1988 through June 1993, he was Vice President in the Finance Division of People's Westchester Savings Bank and Senior Vice President in June 1993. ITEM 11. Executive Compensation Information regarding remuneration of executive officers and directors of the Company is omitted from this report as the Company intends to file a definitive proxy statement not later than 120 days after the end of the fiscal year and the information to be included therein is incorporated herein by reference. ITEM 12. Security Ownership of Certain Beneficial Owners and Management Information regarding security ownership of certain beneficial owners and management is omitted from this report as the Company intends to file a definitive proxy statement not later than 120 days after the end of the fiscal year and the information to be included therein is incorporated herein by reference. ITEM 13. Related Parties and Transactions Information regarding certain relationships and related transactions is omitted from this report as the Company intends to file a definitive proxy statement not later than 120 days after the end of the fiscal year and the information to be included therein is incorporated herein by reference. PART IV ITEM 14. Exhibits, Financial Statement Schedules and Reports on Form 8-K (a) (1). The following financial statements of the Company included in the Annual Report to Shareholders for the year ended December 31, 1997 are incorporated herein by reference in Item 8. The remaining information in said Annual Report is not deemed to be filed as part of this report, except as expressly provided herein. (i) Consolidated Statements of Financial Condition as of December 31, 1997 and 1996. (ii) Consolidated Statements of Earnings for years ended December 31, 1997, 1996 and 1995. (iii) Consolidated Statements of Shareholders' Equity for years ended December 31, 1997, 1996 and 1995. (iv) Consolidated Statements of Cash Flows for the years ended December 31, 1997, 1996 and 1995. (v) Notes to Consolidated Financial Statements. (vi) Independent Auditor's Report. (a) (2). All financial statement schedules for which provision is made in applicable accounting regulations are inapplicable and have therefore been omitted. (b) Exhibits and reports on Form 8-K. Form 8-K dated November 21, 1997 reporting the registrant's response to a significant shareholder communication. Form 8-K dated December 1, 1997 reporting the adoption of a stock repurchase program. (c) The following documents are filed as Exhibits to this Form 10-K, as required by Item 601 of Regulation S-K. Exhibit No. Description 3.1 Certificate of Incorporation of the Company (incorporated by reference to Exhibit 3i to the Company's Registration Statement on Form 8-A filed on July 24, 1997). 3.2 Bylaws of the Company (incorporated by reference to Exhibit 3ii to the Company's Registration Statement on Form 8-A filed on July 24, 1997). 4.1 Instruments Defining Rights of Security Holders: Shareholders Rights Agreement; Amendment to Rights Agreement; and Assignment of Rights Agreement (incorporated by reference to the Company's Registration Statement on Form 8-A as Exhibits 4, 4.1, and 4.2 thereto, filed on July 24, 1997. 10.1 Employment Agreement-Robert T. Judson (incorporated by reference to Exhibits 10.1; 10.1.2; 10.1.3 and 10.1.4 to the Company's Registration Statement on Form 8-A filed on July 24, 1997). 10.2 Employment Agreement-Charles F. Howell (incorporated by reference to Exhibits 10.2.1; 10.2.2; 10.2.3 and 10.2.4 to the Company's Registration Statement on Form 8-A filed on July 24, 1997). 10.3. Employment Agreement-Jeremiah T. Dorney (incorporated by reference to Exhibits 10.3.1; 10.3.2; 10.3.3 and 10.3.4 to the Company's Registration Statement on Form 8-A filed on July 24, 1997). 10.4.1 Employment Agreement-Marcus I. Braverman (incorporated by reference to Exhibits 10.4.1; 10.4.2; 10.4.3; and 10.4.4 to the Company's Registration Statement on Form 8-A filed on July 24, 1997). 10.5 Divestiture Agreement between Westport Asset Management and Norwalk Savings Society (incorporated by reference to Exhibit 10.5 to the Company's Registration Statement on Form 8-A filed on July 24, 1997. 10.6 Norwalk Savings Society 1994 Employee Stock Option Plan (incorporated by reference to Exhibits 4.1(a), 4.1(b) and 4.1(c) to the Company's Registration Statement on Form S-8 filed on December 11, 1997. 10.7 Norwalk Savings Society 1994 Director Stock Option Plan (incorporated by reference to Exhibits 4.2(a), 4.2(b) and 4.3(c) to the Company's Registration Statement on Form S-8 filed on December 11, 1997. 10.8 Norwalk Savings Society Executive Incentive Plan (incorporated by reference to Exhibits 4.3(a) and 4.3(b) to the Company's Registration Statement on Form S-8 filed on December 11, 1997). 11 Computation of Earnings Per Share 13 1997 Annual Report to Shareholders. 18 Consent of Friedberg, Smith & Co., P.C. 21 Subsidiaries of NSS Bancorp, Inc. 27 Financial Data Schedule SIGNATURES Pursuant to the requirements of Section 13 of the Securities Exchange Act of 1934, the Company has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. NSS BANCORP, INC. Date: March 25, 1998 By: /s/ Robert T. Judson Robert T. Judson President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated. Chief Executive Officer: /s/ Robert T. Judson Date: March 25, 1998 Robert T. Judson Director, President and Chief Executive Officer (Principal executive officer) Chief Financial Officer: /s/ Marcus I. Braverman, CPA Date: March 25, 1998 Marcus I. Braverman, CPA Senior Vice President, Treasurer and Chief Financial Officer (Principal financial and accounting officer) Directors: /s/ Donald St. John Date: March 25, 1998 Donald St. John Chairman of the Board /s/ Robert T. Judson Date: March 25, 1998 Robert T. Judson Director, President and Chief Executive Officer /s/ Brian A. Fitzgerald Date: March 25, 1998 Brian A. Fitzgerald Director and Corporate Secretary /s/ Charles F. Howell Date: March 25, 1998 Charles F. Howell Director /s/ Herbert L. Jay Date: March 25, 1998 Herbert L. Jay Director /s/ Dr. Edward J. Kelley Date: March 25, 1998 Dr. Edward J. Kelley Director /s/ John L. Segall Date: March 25, 1998 John L. Segall Director /s/ Alan R. Staack Date: March 25, 1998 Alan R. Staack Director
EXHIBIT 11 NSS BANCORP, INC. COMPUTATION OF EARNINGS PER SHARE (in thousands, except per share amounts) Year Ended December 31, 1997 1996 1995 Net Income $5,565 $5,702 $4,778 Outstanding weighted average common shares, including shares issued for exercised stock options 2,405 2,368 2,333 Average shares committed to be released under the ESOP 9 13 13 Weighted average shares - basic 2,414 2,381 2,346 Weighted average effect of: - - Shares contingently issuable for executive compensation plans 9 - - - - Shares issuable for assumed exercise of outstanding stock options 253 225 134 - - Shares repurchasable using the proceeds of assumed exercise of stock options (treasury stock) (143) (166) (129) Weighted average shares - assuming dilution 2,533 2,440 2,351 Income Per Share: Basic $2.31 $2.39 $2.04 Assuming Dilution $2.20 $2.34 $2.03
Exhibit 13 NSS Bancorp, Inc. 1997 Annual Report
FINANCIAL CONDITION DATA December 31, ($ thousands) 1997 1996 1995 1994 1993 Total assets $654,222 $589,589 $515,267 $464,901 $427,950 Investment securities 180,497 140,101 123,865 148,431 116,357 Loans receivable 432,269 418,818 360,475 290,416 269,300 Allowance for credit losses (5,832) (7,334) (4,170) (4,827) (2,532) Deposits 444,211 423,290 402,797 363,071 359,063 Borrowed funds 151,671 114,043 67,123 63,510 48,765 Shareholders' equity/ retained earnings 56,138 49,353 43,595 37,513 19,712 OREO, net 574 858 4,267 10,820 17,630 Non-accrual/ non-performing loans 4,847 10,441 13,070 9,976 26,180 Total non-performing assets 5,421 11,299 17,337 20,796 43,810 EARNINGS DATA ($ thousands, Years ended December 31, except per share data) 1997 1996 1995 1994 1993 Net interest and dividend income $ 19,373 $ 17,615 $ 14,617 $ 11,933 $ 10,801 Provision for credit losses 0 4,415 2,105 690 1,000 Net gains on sales of assets and liabilities 1,459 4,156 798 (64) 2,410 All other non-interest income 3,787 2,687 1,897 1,890 2,173 OREO related costs (gain), net (103) 1,362 1,415 826 4,825 All other non-interest expense 15,827 14,104 11,304 9,980 8,705 Income before income tax provisions 8,895 4,577 2,488 2,263 854 Current tax provision 1,973 175 10 50 73 Deferred tax provision (benefit) 1,357 (1,300) (1,200) - - Income before ADP program 5,565 5,702 3,678 2,213 781 Effect of ADP program - - 1,100 (5,700) - Net income (loss) $ 5,565 $ 5,702 $ 4,778 ($ 3,487) $ 781 Income (loss) per share: Basic $2.31 $2.39 $2.04 ($1.51) n\a Assuming dilution $2.20 $2.34 $2.03 ($1.51) n\a PERFORMANCE, CAPITAL and ASSET QUALITY RATIOS At and for the years ended December 31, 1997 1996 1995 1994 1993 Performance: Tangible book value per share $22.44 $19.90 $18.44 $16.10 n/a Return on average assets Before ADP program 0.87% 0.97% 0.76% 0.51% 0.18% After ADP program n\a n\a 0.99% -0.80% n/a Return on average equity Before ADP program 10.54% 12.52% 8.97% 7.36% 3.95% After ADP program n\a n\a 11.65% -11.60% n/a Net interest margin 3.11% 3.12% 3.17% 2.96% 2.84% Capital: Tier 1 leverage 8.18% 7.90% 8.43% 8.20% 4.61% Total risk-based 16.61% 17.00% 17.90% 15.79% 10.04% Asset quality: Non-performing assets to total assets 0.83% 1.92% 3.36% 4.47% 10.24% Non-performing loans to loans receivable 1.12% 2.50% 3.63% 3.44% 9.72% Allowance for credit losses to non-performing loans 120.32% 70.24% 31.91% 48.39% 9.67% Allowance for credit losses to loans receivable 1.35% 1.75% 1.16% 1.66% 0.95%
To Our Shareholders We are pleased to report that 1997 marked another profitable year for NSS Bancorp, Inc. Your Company continues to realize solid growth in assets, deposits, loans and core earnings. The Company's stock price increased over 60% in 1997, and the quarterly cash dividend was doubled in the second quarter. The combination of stock appreciation plus cash dividends paid during the year resulted in each share of NSS stock returning 63% to the shareholder on a total return basis. Pre tax earnings for 1997 increased to $8.9 million from $4.6 million in 1996. Earnings per share were $2.31 in 1997 compared to $2.39 in 1996. The Company's earnings in 1997 were fully taxable while 1996 earnings included deferred tax benefits of $1.3 million or $0.55 per share. Non-performing assets were reduced to 0.83% of total assets at December 31, 1997 as compared to 1.92% of total assets at December 31, 1996. In October we completed the formation of your holding company, NSS Bancorp, Inc. This move will improve our competitive position by giving your Company's management the flexibility needed to implement new strategies to create value for shareholders over the long-term. In May we opened a branch in Darien to enable us to expand our market share in Southern Fairfield County. The Darien branch gained over $12 million in deposits during its first six months of operation. In December we renovated our Fairfield branch to provide a more attractive banking environment for our customers. NSS has been aggressively expanding its commercial banking operation. The rapid pace of consolidation in the Connecticut banking industry has resulted in the acquisition of local community banks by large out-of-state-banks. This trend has created a void in the market and has left many small business owners displaced. As a locally managed bank, NSS has the ability to deliver a level of responsive service not available at multi-billion dollar banks. Management has taken advantage of this opportunity and will continue to rapidly grow its profitable commercial banking business. Today we have positioned the Company as a full-service community bank serving the consumer, mortgage, and business banking needs of our market. Customer surveys have rated NSS's service as "excellent." The Bank's increased volume for both commercial and retail banking services reinforces our Company's belief that great growth potential exists for NSS. Rapid advancement in technology offers new alternatives for more efficient and convenient delivery of banking services. Customer usage of the NSS BankLine, our 24-hour telephone banking service, has grown beyond our expectations. The establishment of our internet website (www.nssbank.com) has served to set the stage for PC banking. Because our personal and business lives are so deeply involved in Southern Fairfield County, officers, directors, and employees of NSS devote time and money to a wide variety of local charities and civic organizations. Their involvement and your Company's commitment have been instrumental in NSS's receiving an outstanding Community Reinvestment Act rating. We are committed to seek ways to continue to enhance shareholder value by increasing earnings through market share growth, using alternative delivery systems, and maintaining high quality service while controlling expenses. We are very aware that consolidation in the banking industry is in vogue. In many cases, shareholder value can be enhanced by sale. We believe that a better strategy for NSS at this time is to take advantage of market opportunities created by the loss of many of our traditional competitors in lower Fairfield County. By remaining independent, and being truly the local community bank alternative, we believe we can build our franchise and improve the shareholder's investment over both the short and long-term. We pledge to enhance shareholder value while balancing our responsibilities to our shareholders, customers, employees and the communities we serve, and we will continue to work diligently to ensure that your investment and confidence in NSS are rewarded. Commercial Banking Serving the banking needs of small and mid-sized businesses continues to be an area of emphasis for NSS. Our local presence allows our Commercial Banking team to be accessible to business owners, providing them with quick responses. This accessibility has helped the Bank to earn credibility as a competing commercial lender in the marketplace. In 1997, the Bank originated $27.8 million in loans to local businesses. In addition to the interest income generated, we benefited from the checking account relationships we have developed with many of these customers. As a result, commercial checking account balances increased over 64% this past year. Our goal is to remain responsive to the needs of small and medium sized businesses in our market. Our experienced commercial lending staff understands the credit needs of business owners. They are knowledgeable in our lending programs and they take genuine interest in their customers to help them find the best possible solution. In addition to a full line of lending programs, we offer checking accounts and cash management services for small business customers. This year we have expanded our commercial banking products to include sweep investment accounts and merchant credit card deposit services. The NSS BankLine, a 24-hour telephone banking service, provides an efficient way for our business customers to obtain account information and transfer funds between accounts. The system was recently enhanced to include a statement fax feature that provides business customers with daily account balances and transactions. This year we will add BusiNSS-Link, a PC cash management service. Business customers will be able to initiate transactions, retrieve account information and analyze their cash flow from their personal computer. Retail Banking NSS has been serving the banking needs of consumers in Southern Fairfield County for almost 150 years. Our commitment to providing personalized quality service is an NSS tradition and we will continue to operate the bank with this philosophy. Throughout 1997 our retail banking focus was on strengthening relationships with our customers, by rewarding them for doing more of their banking at NSS. As customers expand their banking relationships with us, the Bank will gain stronger market presence, thereby increasing value to shareholders. We restructured the Schedule of Fees on our checking and savings accounts to reward customers. When the required deposit balance is met, our customers are rewarded with no account fees or fees for using another bank's Automated Teller Machines. Customers who pay fees are charged a flat dollar amount. As a result, personal checking and NOW account balances increased by 24% over the 1996 level. In September we introduced the Gold Money Market Account. Depositors benefit from competitive rates, easy access to their funds with an ATM Card and a complete package of services including no fee checking, reduced rate consumer loans and no fee credit cards. This account serves as a competitive alternative to a broker's money market account. The Investment Management and Trust Services Department provides an excellent complement to our range of deposit accounts, allowing us to strengthen our clients' banking relationship by providing many options to meet their investment needs. The Department's assets increased by 14.6% during 1997. Mortgage & Consumer Lending NSS continues to maintain its position as a major residential mortgage lender in Fairfield County, originating both portfolio and correspondent loans. For the third consecutive year, originations of residential mortgage loans exceeded $100 million. Our increased emphasis on correspondent lending this past year allowed us to offer a broader array of mortgage products, which produced a substantial increase in income. In fact, income from correspondent loans increased 280% over the 1996 level. In celebration of our upcoming 150th anniversary, the Credit Card Department issued the "1849 Gold Rush" MasterCard and Visa cards. The cards were designed to honor the longevity of the Bank, having been a part of the local community since 1849. Many of our customers have taken advantage of the low introductory fixed rate offer by transferring balances from higher rate credit cards. They also appreciate the local personalized service that we offer. The Bank views the credit card program as an excellent means of solidifying customers' banking relationships as well as being a source of additional income. Community Involvement Improving the quality of life of residents in the communities we serve is a long standing tradition at NSS. Throughout 1997, many of our officers, directors and employees gave of their time regularly to a variety of local community causes. The school mentor program and the AmeriCares HomeFront Project continue to have a high level of team participation. NSS also donated funds for educational, health, cultural and low to moderate-income housing programs. As we look toward the year 2000, we vow to position the Bank as a leader in providing community banking services for the long-term benefit of our shareholders, customers and employees. MANAGEMENT'S DISCUSSION AND ANALYSIS OVERVIEW NSS Bancorp, Inc. (the "Company" or "NSS Bancorp") is the holding company for Norwalk Savings Society ("NSS" or the "Bank"). The Company's principal asset consists of all of the outstanding shares of NSS. NSS Bancorp was formed effective October 1, 1997 and is subject to regulation by the Board of Governors of the Federal Reserve System. Norwalk Savings Society was founded in 1849 and is a Connecticut chartered capital stock savings bank, with deposits insured by the Federal Deposit Insurance Corporation ("FDIC"), headquartered in Norwalk, Connecticut. Its initial public offering of common stock was effective June 15, 1994. As a result of the successful completion of its public offering, the Bank had sufficient capital to meet regulatory requirements, deal with its non-performing assets, and restructure its balance sheet to improve its operating results. The years 1994 and 1995 were devoted to converting non-performing assets to performing assets and repositioning its balance sheet. In 1996, the Bank positioned itself for long-term growth and profitability by redefining its market area as well as determining the products and services to be offered to its customers. In 1996 the Bank defined its market area as southern Fairfield County and embarked on a program of expanding its business products and services as well as continuing to provide a full range of personal banking products and services. As part of this program, in July 1996 the Bank acquired certain assets and assumed essentially all of the liabilities of Fairfield First Bank & Trust Company ("FFB&T") in an FDIC-assisted transaction. This acquisition provided the Bank with a significant physical presence in the eastern part of the county and FFB&T's back office operation allowed the Bank to provide merchant bankcard processing and other business-related services. In 1997 it was determined that the Bank's goal would best be served by continued geographic expansion and broadening its products and services. The Bank opened a full service branch office in Darien in May 1997. To expand its business relationships, the Bank initiated several new products such as the commercial deposit sweep account and the commercial checking line of credit. Both the Darien branch and the Fairfield branch are staffed to allow for a dual focus to ensure that each segment of the Bank's customer base is properly served. In October 1997 the Bank formed NSS Bancorp, a holding company, that will allow the Company to expand or enter into other financial service activities, capitalizing on its newly acquired business customer base and affording it the opportunity to expand its services to its existing consumer relationships. This reemphasis has not changed our organization's strong commitment to the communities where its business and consumer customers live and work. During 1997 the Bank experienced a significant increase in commercial non-interest bearing deposits and consumer and merchant credit card relationships; it also expanded its support to local area small businesses through loans for working capital, machinery and equipment and other business-related needs. At the same time, consumer lending and consumer deposit levels continued to increase in response to this expansion. This new level of activity generated a significant increase in net interest and fee-based income. In order to respond to the community's significant demand for credit and at the same time manage balance sheet growth, in 1997 the Bank expanded its correspondent loan program, whereby it acts as an agent for third party lenders and receives a fee for its origination efforts. Throughout this period of expansion, the Bank has been able to continue its program of improving asset quality. As a result of the FFB&T acquisition, the Bank was required to purchase a portfolio of mixed quality loans against which the Bank established an allowance for credit losses of $1.0 million. Through marketing and collection efforts, the Bank's non-performing assets, both originated and acquired, declined significantly. As a result of the asset quality improvement and a substantial level of recoveries, management determined that there was no need to add to the allowance for possible credit losses in 1997. Early in 1997, the Bank adopted an investment strategy to grow the investment securities portfolio with callable preferred securities which provide dividend income, a substantial portion of which is exempt from State and Federal taxation. The results of this strategy is a lower effective tax rate for the Company. The Company reported net earnings of $5.6 million, or $2.31 per share, for the year ended December 31, 1997. During the year ended December 31, 1997, the Company paid to its shareholders $0.35 per share in dividends as compared to $0.15 per share for the year ended December 31, 1996. The Company's stock price rose from $23.38 per share on January 1, 1997 to $37.75 per share on December 31, 1997. On a total return basis, stock appreciation plus cash dividends paid in 1997 resulted in a 63% rate of return to shareholders. The Company's tier one leverage capital ratio was 8.2% as of December 31, 1997, qualifying it as "well capitalized" according to standards established by bank regulatory authorities. RESULTS OF OPERATIONS Comparison of Operating Results for the Years Ended December 31, 1997 and 1996 General Net earnings for the year ended December 31, 1997 were $5.6 million, or $2.31 per share, compared to $5.7 million or $2.39 per share for 1996. Net earnings for 1996 included $1.3 million of deferred tax benefits from the recognition of the benefits of operating loss carryforwards. The continued improvement in asset quality, coupled with substantial recoveries in 1997 of loans previously charged-off, resulted in no need for a provision for credit losses in 1997. There was a significant increase in credit card, deposit and loan-based fees for the year ended December 31, 1997 compared to 1996. There was a significant decrease in losses and expenses associated with OREO for the year ended December 31, 1997 compared to 1996. There was a significant increase in income before taxes from $4.6 million for the year ended December 31, 1996 to $8.9 million for the year ended December 31, 1997, an increase of 93%. NSS Bancorp's 1997 earnings were fully taxable as compared to the prior year when the earnings were, for the most part, sheltered by the recognition of tax benefits associated with operating loss carryforwards. Net Interest Income Net interest income, which is the primary source of income for the Bank, is the difference between the interest, fees and dividends earned on loans and investments, and the interest paid on deposits and borrowings. Net interest income was $19.3 million for the year ended December 31, 1997, an increase of 9.7% over the $17.6 million for the year ended December 31, 1996. The $1.7 million increase resulted from an increase in interest income of $4.6 million partially offset by a $2.9 million increase in interest expense. The $4.6 million increase in interest income was attributable to a $3.7 million increase due to volume and a $0.9 million increase due to rate, while the $2.9 million increase in interest expense resulted from a $2.7 million increase due to volume and a $0.2 million increase related to rate. The 11.1% increase in interest income, from $41.3 million for 1996 to $45.9 million for 1997, was primarily attributable to the growth in the loan portfolio, augmented by a net increase in interest income from the various segments of the Bank's securities portfolio. The 12% increase in interest expense, from $23.6 million in 1996 to $26.5 million in 1997, resulted primarily from the $2.6 million increase in interest expense attributable to the increased level of borrowings. On an overall basis, the Bank was able to shift its earning assets into higher yielding products while controlling the rate component of the cost of funds. The following table summarizes the Bank's net interest income and net yield on average interest-earning assets. Non-accruing loans are included in average loans outstanding during the periods, and daily average amounts were used to compute average balances.
TABLE 1 - AVERAGE BALANCE SHEETS AND NET INTEREST INCOME Years Ended December 31, ($ thousands) 1997 1996 Average Average Average Average Balance Interest Rate Balance Interest Rate Interest-Earning Assets Total Loans $435,610 $33,369 7.66 % $403,207 $30,589 7.59% Investment Securities 52,065 3,747 7.20 36,012 2,571 7.14 Mortgage-Backed Securities 86,714 6,199 7.15 104,000 7,076 6.80 Short-Term Investments 14,815 899 6.07 14,970 739 4.94 Marketable Equity Investments 32,826 1,655 5.04 7,253 280 3.86 Total Securities 186,420 12,500 6.70 162,235 10,666 6.57 Total Interest- Earning Assets 622,030 45,869 7.37% 565,442 41,255 7.30% Non-Interest-Earning Assets Cash and Cash Equivalents 9,359 9,310 Accrued Income Receivable 6,291 6,645 Premises and Equipment 3,446 3,150 Other 7,045 9,957 Less: Allowance for Credit Losses (6,921) (4,882) Total Non-Interest- Earning Assets 19,220 24,180 Total Assets $641,250 $589,622 Interest-Bearing Liabilities Deposits Regular Savings and NOW $61,578 1,002 1.63% $ 58,599 745 1.27% Super and Money Market Savings 96,029 2,968 3.09 116,232 3,411 2.93 Time 240,197 13,068 5.44 227,255 12,580 5.54 Total Deposits 397,804 17,038 4.28 402,086 16,736 4.16 Borrowings 158,944 9,356 5.89 115,465 6,796 5.89 Mortgage Escrow Deposits 3,710 102 2.75 3,556 108 3.04 Total Interest-Bearing Liabilities 560,458 26,496 4.73% 521,107 23,640 4.54% Non-Interest-Bearing Liabilities Non-Interest-Bearing Deposits 26,035 18,922 Other Liabilities 1,950 4,036 Total Non-Interest-Bearing Liabilities 27,985 22,958 Shareholders' Equity 52,807 45,557 Total Liabilities and Shareholders' Equity $641,250 $589,622 Net Interest-Earning Assets and Interest Rate Spread $ 61,572 2.64% $ 44,335 2.76% Net Interest Income and Net Yield on Average Interest-Earning Assets $19,373 3.11% $17,615 3.12%
Rate/Volume Analysis The following table presents the changes in interest and dividend income and the changes in interest expense attributable to changes in interest rates or changes in volume of interest-earning assets and interest-bearing liabilities during the years of 1997 and 1996. Changes which are attributable to both rate and volume have been allocated proportionately.
TABLE 2 - RATE/VOLUME ANALYSIS Year Ended December 31, 1997 Compared to Year Ended December 31, 1996 ($ thousands) Rate Volume Net Change Interest Income: Loans Receivable $295 $2,485 $2,780 Mortgage-Backed Securities 345 (1,222) (877) Short-Term Investments 168 (8) 160 Investment Securities 131 2,420 2,551 Total 939 3,675 4,614 Interest Expense: Deposits: Savings and Other (217) (40) (257) Super and Money Market (173) 616 443 Time 219 (707) (488) Total Deposits (171) (131) (302) Borrowings (3) (2,557) (2,560) Mortgage Escrow Deposits 11 (5) 6 Total (163) (2,693) (2,856) Change in Net Interest Income $776 $ 982 $1,758
Provision for Credit Losses The improvement in asset quality coupled with substantial recoveries in 1997 of loans previously charged-off resulted in no need for a provision for credit losses for the year ended December 31, 1997. The provision for credit losses for the year ended December 31, 1996 was $4.4 million. (see Financial Condition - Non-Performing Assets/ Asset Quality). Non-Interest Income Non-interest income consists of deposit service charges and fees, fees derived from servicing of loans, net realized and unrealized gains on securities, net gain on sale of loans, fees derived from the Bank's Trust Department and, beginning in 1996, the credit card program. Non-interest income for the year ended December 31, 1997 was $5.2 million compared to $6.8 million for the comparable period of 1996. The table below identifies the primary components of Non-interest income which are Fees and Gains on Sales of Assets and Liabilities. The fee-based elements of Non-interest income, in total, showed sustainable improvement over the prior period.
TABLE 3 - NON-INTEREST INCOME Years Ended December 31, ($ thousands) 1997 1996 Non-interest Income Loan Servicing Fees $ 324 $ 334 Other Loan Fees 160 146 Deposit Service Charges 813 763 Credit Card Fees 1,396 514 Trust Department Fees 576 552 Correspondent Loan Program Fees 302 74 Other 216 304 Total Fees 3,787 2,687 Net Gains on Securities 1,115 661 Net Gain (Loss) on Sale of Loans 344 (144) Gain on Sale of Branches - 3,639 Total Gains on Sales of Assets and Liabilities 1,459 4,156 Total Non-Interest Income $5,246 $6,843
Non-interest income for 1997 decreased $1.6 million, or 23.5% from 1996. Total fees for the year ended December 31, 1997 were $3.8 million, compared to $2.7 million for the year ended December 31, 1996. Of the increase of $1.1 million or 40.7% , $0.9 million was attributable to an increase in credit card fees. Credit card fees amounted to $1.4 million for a full year of credit card operations during 1997, compared to $0.5 million attributable to six months of operations during 1996. The other component of Non-interest income is Gains on Sales of Assets and Liabilities. The Bank's investment strategy in its Trading portfolio is to sell covered call options against high quality equities, primarily for yield enhancement. A significant component of net gains on securities resulted from the premium received on expired call options. Net gains on securities were $1.1 million compared to $661,000 for the years ended December 31, 1997 and 1996, respectively. The increase of $454,000 amounted to a 68.7% increase. Included in the net gain on sale of securities for the year ended December 31, 1996 was a gain of $627,000 from the sale of the Bank's investment in Hometown Bancorporation. Also included in Gains on Sales of Assets and Liabilities for the year ended December 31, 1996 was a gain of $3.6 million resulting from the sale of deposits in conjunction with the sale of the Bank's Brookfield and Bethel branches. Non-Interest Expense Non-interest expense is comprised of general and administrative expenses incurred in managing the business of the Bank and costs associated with managing and selling OREO properties. Non-interest expense was $15.7 million for the year ended December 31, 1997, compared to $15.5 million for the same period in 1996. The table that follows indicates the elements of Non-interest expense, including OREO related expense, which is directly related to the level of non-performing assets.
TABLE 4 - NON-INTEREST EXPENSE Years Ended December 31, ($ thousands) 1997 1996 General and Administrative Expense Compensation $ 5,769 $ 5,726 Employee Benefits 1,976 1,923 Occupancy and Equipment 1,742 1,646 Credit Card Processing 1,148 382 Data Processing 977 921 Regulatory Assessments 55 9 Marketing 779 687 Legal and Professional 872 779 Printing, Postage & Office Supplies 782 746 Insurance 217 228 Amortization of Goodwill 326 76 Other 1,184 981 Total 15,827 14,104 OREO Related Expense Net Holding Costs and Expenses 206 352 Net (Gain) Loss on Sales of OREO (309) 551 Provision for Estimated Losses - 459 Total (103) 1,362 Total Non-Interest Expense $15,724 $15,466
Overall, Non-interest expense did not increase significantly; however, the general and administrative expense component increased $1.7 million, and the OREO related expenses decreased $1.5 million. General and Administrative Expense Of the total increase of $1.7 million in general and administrative expense, an insignificant part of the increase was attributable to compensation and benefits. The 1996 compensation and employee benefits expense included the expanded labor force in the commercial loan and credit card departments, additional branch personnel to enhance service capability and incentive compensation programs for achieving the Bank's profitability and service performance goals. The expense also included one-time payments made for severance and other termination costs as well as a duplication of personnel costs for a period of several months in connection with FFB&T acquisition and the sale of the Bank's two branches. As of December 31, 1997, the Bank employed 159 people based on a full time equivalent measure, compared to 157 people as of December 31, 1996. The savings achievable in payroll related costs by not having the severance termination and duplication of personnel costs reoccur in 1997, were offset by regular salary increases and higher levels of both short and long-term performance bonuses paid in 1997 as compared to 1996. Occupancy and equipment costs increased $96,000 in 1997 from 1996, attributable primarily to operating costs of the new branch in Darien. Credit card processing costs increased from $382,000 in 1996 to $1.1 million in 1997. The increase of $766,000 was due to a full year of operation, as well as increased volume levels. Data processing costs increased from $921,000 in 1996 to $977,000 in 1997, representing an increase of $56,000 or 6.1%. The actual increase, primarily due to increased volume during 1997, was significantly higher but was not evident due to the non-recurring costs incurred in 1996 from the FFB&T transaction, the branch sales, and upgrades and integration enhancements to the Bank's EDP capabilities during that year. Marketing expense increased to $779,000 in 1997 from $687,000 in 1996. The $92,000 increase was due primarily to increased advertising to publicize the new expanded services and the new Darien branch location. Expenses associated with legal and professional fees increased from $779,000 in 1996 to $872,000 in 1997, representing an increase of $93,000 or 11.9%. This increase resulted from legal costs related to the Bank's lending activities as well as legal and professional costs associated with researching the legal, financial and investment opportunities of forming a holding company, as well as related expanded financial reporting requirements. Amortization of goodwill increased from $76,000 in 1996 to $326,000 in 1997, an increase of $250,000 which was attributable to a full year of amortization of the goodwill incurred from the acquisition of FFB&T in 1996. The Other component of general and administrative expense increased from $981,000 in 1996 to $1.2 million in 1997. The increase of $203,000 or 20.7% was primarily attributable to increased volume and inflation, with no one category reflecting a significant increase. OREO Related Expenses OREO related expenses continued to decline and decreased by $1.5 million to a net gain of $103,000 in 1997 from net expense of $1.4 million in 1996. As of December 31, 1996 there were six properties comprising the OREO portfolio, four of which were under contract of sale. During 1997, the sale of these as well as additional OREO properties acquired and sold during the year resulted in a gain of $309,000 as compared to a net loss on properties sold of $551,000 in 1996. Additionally, there was no need for a provision for estimated losses on OREO properties in 1997 as compared to a provision for estimated losses of $459,000 in 1996. As of December 31, 1997, there were four properties comprising the OREO portfolio, one of which was under contract of sale. The reduced level of OREO properties in 1997 resulted in holding costs declining from $352,000 in 1996 to $206,000 in 1997. Provision for Income Taxes The Company's income is subject to Federal and State taxation at a combined rate approximating 40%. The Company's effective tax rate for the year ended December 31, 1997 was 37.4%, substantially due to the tax savings from the dividend earnings on the Bank's equity securities portfolio, substantial portions of which are exempt from both State and Federal taxation. In 1996 the Bank recovered the remainder of the valuation allowance against its net deferred tax assets by reflecting a deferred tax benefit in earnings of $1.3 million. As of December 31, 1996 the Bank had recognized all of its available net deferred tax assets. RESULTS OF OPERATIONS Comparison of Operating Results for the Years Ended December 31, 1996 and 1995 Overview Net earnings for the year ended December 31, 1996 were $5.7 million, or $2.39 per share, compared to $4.8 million or $2.04 per share for 1995. Net earnings for 1996 and 1995 included $1.3 million and $1.2 million, respectively, of deferred tax benefits from the recognition of the benefits of operating loss carryforwards. Several significant non-recurring items were included in 1996 net earnings. The first of these items was the gain on the sale of the branch operations in Brookfield and Bethel, the result of the deposit premium of $3.6 million or 7 1/2% of total deposits of $48.0 million in the two branches. In addition, the Bank recognized a gain on the sale of its investment in Hometown Bancorporation of $627,000. The allowance for credit losses was increased to $7.3 million at December 31, 1996, resulting from a provision for credit losses aggregating $4.4 million for the year ended December 31, 1996 and a $1.0 million credit risk allocation for the loans acquired in the FFB&T transaction. Net Interest Income Net interest income, which is the primary source of income for the Bank, is the difference between the interest earned on loans and investments and the interest paid on deposits and borrowings. Net interest income was $17.6 million for the year ended December 31, 1996, an increase of 20.5% over the $14.6 million for the year ended December 31, 1995. The $3.0 million increase resulted from an increase in interest income of $8.2 million partially offset by a $5.2 million increase in interest expense. The 25% growth in interest income, from $33.0 million for 1995 to $41.3 million for 1996, was primarily attributable to the growth in the mortgage and commercial loan portfolios, while the 28% growth in interest expense, from $18.4 million in 1995 to $23.6 million in 1996, resulted primarily from the increased levels of deposits and short-term borrowings. The Bank's "wholesale" borrowings, which increased 71% from 1995, are comprised of borrowings from the Federal Home Loan Bank and reverse repurchase agreements. These funding tools were utilized to sustain the Bank's substantial growth in total assets over the last two years. The Bank's plan, through the branch transactions accomplished in 1996 and the upcoming opening of a new branch in Darien in 1997, is to move away from higher cost borrowings from the wholesale market into less costly core deposits, primarily from small business commercial and consumer relationships. The overall favorable interest rate environment played a significant role in the Bank's net interest income improvement for 1996. The effect of lower, more attractively priced rates (from the borrower's viewpoint) in the residential mortgage loan market spurred activity, and the Bank's share of that activity contributed $6.8 million of the $7.6 million volume increase in the Bank's gross interest income, while $0.6 million of the increase was due to rate increases, primarily in the securities portfolio. The Bank's average cost on interest-bearing liabilities rose to 4.54% for the year 1996 from 4.29% for the year 1995. The Bank's interest expense increased primarily as a result of the increase in the volume of borrowed funds and secondarily from the increased volume of time deposits, reflecting the continued shift by the consumer into time deposits from regular savings and money market accounts. However, the Bank was able to mitigate the effect of higher interest rates on time deposits through lower rates on borrowed funds. On an overall basis, approximately $2.4 million of the $3.0 million increase in net interest income was due to increased volume, while $0.6 million of the increase in net interest income was due to favorable rate adjustments. As a result of all of these significant movements in interest income and interest expense, the Bank experienced a slight decrease in its net interest margin during the year ended December 31, 1996, from 3.17% for 1995 down to 3.12% for 1996. The following table summarizes the Bank's net interest income and net yield on average interest-earning assets. Non-accruing loans are included in average loans outstanding during the periods, and daily average amounts were used to compute average balances.
TABLE 1 - AVERAGE BALANCE SHEETS AND NET INTEREST INCOME ($ thousands) Years Ended December 31, 1996 1995 Average Average Average Average Balance Interest Rate Balance Interest Rate Interest-Earning Assets Loans Receivable $403,207 $30,589 7.59% $313,072 $23,666 7.56% Investment Securities 36,012 2,571 7.14 39,490 1,961 4.97 Mortgage-Backed Securities 104,000 7,076 6.80 98,334 6,753 6.87 Short-Term Investments 14,970 739 4.94 6,915 514 7.43 Marketable Equity Investments 7,253 280 3.86 3,076 121 3.93 Total Interest-Earning Assets 565,442 41,255 7.30% 460,887 33,015 7.16% Non-Interest-Earning Assets Cash and Cash Equivalents 9,310 8,138 Accrued Income Receivable 6,645 3,532 Premises and Equipment 3,150 3,117 Other 9,957 10,341 Less: Allowance for Credit Losses (4,882) (4,468) Total Non-Interest- Earning Assets 24,180 20,660 Total Assets $589,622 $481,547 Interest-Bearing Liabilities Deposits Regular Savings and NOW $58,599 745 1.27% $ 53,788 749 1.39% Super and Money Market Savings 116,232 3,411 2.93 123,582 3,902 3.16 Time 227,255 12,580 5.54 182,430 9,434 5.17 Total Deposits 402,086 16,736 4.16 359,800 14,085 3.91 Borrowings 115,465 6,796 5.89 65,644 4,229 6.44 Mortgage Escrow Deposits 3,556 108 3.04 3,089 84 2.72 Total Interest-Bearing Liabilities 521,107 23,640 4.54% 428,533 18,398 4.29% Non-Interest-Bearing Liabilities Non-Interest-Bearing Deposits 18,922 10,221 Other Liabilities 4,036 1,787 Total Non-Interest- Bearing Liabilities 22,958 12,008 Shareholders' Equity 45,557 41,006 Total Liabilities and Shareholders' Equity $589,622 $481,547 Net Interest-Earning Assets and Interest Rate Spread $ 44,335 2.76% $ 32,354 2.87% Net Interest Income and Net Yield on Average Interest-Earning Assets $17,615 3.12% $14,617 3.17%
Rate/Volume Analysis The following table presents the changes in interest and dividend income and the changes in interest expense attributable to changes in interest rates or changes in volume of interest-earning assets and interest-bearing liabilities during the years of 1996 and 1995. Changes which are attributable to both rate and volume have been allocated proportionately.
TABLE 2 - RATE/VOLUME ANALYSIS Year Ended December 31, 1996 ($ thousands) Compared to Year Ended December 31, 1995 Rate Volume Net Change Interest Income: Loans Receivable $ 94 $6,829 $6,923 Mortgage-Backed Securities (69) 392 323 Short-Term Investments (217) 442 225 Investment Securities 793 (24) 769 Total 601 7,639 8,240 Interest Expense: Deposits: Savings and Other 68 (64) 4 Super and Money Market 270 221 491 Time (709) (2,438) (3,147) Total Deposits (371) (2,281) (2,652) Borrowings 396 (2,962) (2,566) Mortgage Escrow Deposits (10) (14) (24) Total 15 (5,257) (5,242) Change in Net Interest Income $616 $2,382 $2,998 Provision for Credit Losses
The provision for credit losses for the year ended December 31, 1996 was $4.4 million, compared to $2.1 million for the year ended December 31, 1995. The allowance for credit losses as of December 31, 1996 was $7.3 million, compared to $4.2 million as of December 31, 1995. Coverage of non-performing loans provided by the allowance for credit losses was 70.2% and 31.9% as of December 31, 1996 and 1995, respectively. Coverage of the net loan portfolio provided by the allowance for credit losses was 1.8% and 1.2% as of December 31, 1996 and 1995, respectively. The increase in the allowance was the result of several factors, including the overall loan portfolio growth, the increased level of higher risk consumer and commercial lending, the increasing average size of the residential mortgages being originated, and the increase in the Bank's Watch List from $5.6 million at December 31, 1995 to $6.0 million at September 30, 1996 and $8.5 million at December 31, 1996. The Bank's Watch List is comprised of loans which have been identified by the Bank's credit analysis system as exhibiting more than usual risk of nonperformance or loss. Non-Interest Income Non-interest income consists of deposit service charges and fees, fees derived from servicing of loans, net realized and unrealized gains on securities, net gain on sale of loans, fees derived from the Bank's Trust Department and, in 1996, the credit card program. Non-interest income for the year ended December 31, 1996 was $6.8 million compared to $2.7 million for the comparable period of 1995. The table below identifies the primary components of Non-interest income. The core elements of Non-interest income, in total, showed sustainable improvement over the prior period.
TABLE 3 - NON-INTEREST INCOME Years Ended December 31, ($ thousands) 1996 1995 Loan Servicing Fees $ 334 $ 379 Other Loan Fees 146 136 Deposit Service Charges 763 599 Credit Card Fees 514 - Trust Department Fees 552 515 Other 378 268 Total Fees 2,687 1,897 Net Gains on Securities 661 798 Net Loss on Sale of Loans (144) - Gain on Sale of Branches 3,639 - Total Gains on Sales of Assets and Liabilities 4,156 798 Total Non-Interest Income $6,843 $2,695
Non-interest income for 1996 increased by $4.1 million, or 153.9% over 1995. Service fees from deposits increased to $763,000 for the year ended December 31, 1996 compared to $599,000 for the same period a year ago. The 27.4% increase of $164,000 is indicative of the Bank's strategy of establishing small business commercial account relationships, which provide a higher level of fee income. Excluding the gain transactions, the overall increase in fee income was primarily attributable to the credit card fees from both the consumer and merchant programs aggregating $514,000, which resulted from the Bank acquiring a credit card portfolio in the FFB&T transaction in July 1996. Included in Non-interest income for the year ended December 31, 1996 is $3.6 million of gain on deposits as a result of selling the Bank's branch operations in Brookfield and Bethel. Included in the net gain on sales of securities and loans was the $627,000 gain from the sale of the Bank's investment in Hometown Bancorporation, other securities gains and losses (both realized and unrealized as a result of the Trading portfolio of equities), and the loss of $144,000 from the sale of $44.8 million in five-year adjustable residential mortgages. Non-Interest Expense Non-interest expense is comprised of general and administrative expenses incurred in managing the business of the Bank and costs associated with managing and selling OREO properties. Non-interest expense was $15.5 million for the year ended December 31, 1996, compared to $12.7 million for the same period in 1995. The table that follows indicates the elements of Non-interest expense, including OREO related expense, which is directly related to the level of non-performing assets.
TABLE 4 - NON-INTEREST EXPENSE Years Ended December 31, ($ thousands) 1996 1995 General and Administrative Expense Compensation $ 5,726 $ 4,665 Employee Benefits 1,923 1,567 Occupancy and Equipment 1,646 1,336 Data Processing 1,303 702 Regulatory Assessments 9 438 Marketing 687 700 Legal and Professional 779 354 Office Supplies 578 481 Insurance 228 237 Other 1,225 824 Total 14,104 11,304 OREO Related Expense Net Holding Costs and Expenses 352 728 Net Loss on Sales of OREO 551 227 Provision for Estimated Losses 459 460 Total 1,362 1,415 Total Non-Interest Expense $15,466 $12,719
Overall, Non-interest expense increased by $2.7 million or 21.6%. The overall result was the difference between a net increase of $2.8 million in general and administrative expense and a $0.1 million decrease in OREO related expenses. On an overall basis, there were approximately $500,000 of nonrecurring expenses in 1996 included in the classifications of compensation, occupancy, data processing, and other, primarily related to the Bank's significant, one-time transactions. General and Administrative Expense Of the total increase of $2.8 million in general and administrative expense, approximately $1.4 million was attributable to increased compensation and benefits expenses. Part of the increase was the result of the expanded labor force in the commercial loan and credit card departments, and additional branch personnel to enhance service capability; incentive compensation programs were also offered to all personnel for loan origination, service performance, and Bank profitability goals. As of December 31, 1996, the Bank employed 157 people based on a full time equivalent measure. The comparable number as of December 31, 1995 was 146, representing a 7.5% increase, most of which was attributable to the commercial lending function. The balance of the increase was attributable to an average salary increase of 4%. Employee benefits rose $356,000 as a result of higher staff levels, a severance package for former FFB&T employees, and an increase in Employee Stock Ownership Program (ESOP) costs. The ESOP cost is based on the average market price per share for NSS stock, which calculated out to be $21.56 per share for 1996, compared to $16.33 for 1995. The price per share increase of more than $5.00, combined with the shares allocated in 1996, resulted in an additional $128,000 of employee benefits expense. Although the ESOP purchased the shares at the time of the stock conversion for $10.00 per share, the accounting rules for ESOP compensation require the expense to be based upon the average market value of the Bank's stock during the period employees perform service to earn their allocated shares. Occupancy and equipment costs rose $310,000 from 1995's level as a result of increased square footage of space under lease for a period of time in 1996. The total square footage increase was due to an overlap of time between the FFB&T transaction and the sale of the Brookfield and Bethel branches. Additionally, the Bank incurred significantly higher depreciation costs on capital improvements, primarily attributable to the updating and replacement of the automated teller machine network during the year. Higher data processing costs resulted for the most part from the FFB&T transaction, the branch sales, and upgrades and integration enhancements to the Bank's EDP capabilities during the year. In addition, other elements of 1996 Non-interest expense not present in 1995, but likely to continue, are the fees the Bank paid to an outside service bureau relating to the credit card program, which amounted to $382,000 for the year ended December 31, 1996. Expenses associated with legal and professional fees increased as a result of the large and unusual transactions in 1996; legal fees also increased as a result of several new litigations related to the Bank's lending activities. Office supplies showed slightly more than a 20% increase, attributable to outfitting the Bank's newly acquired office in Fairfield and the Bank's generally expanded level of operations. These increases were partially offset by the decline in regulatory assessments from $438,000 for 1995 to $9,000 for 1996, reflecting the full year's effect of the roll-back of FDIC insurance assessments. The Bank qualifies as well-capitalized in accordance with FDIC guidelines and pays the lowest rate available to member institutions. OREO Related Expenses In addition to the general and administrative component of Non-interest expense, OREO related expenses declined by $53,000 to $1,362,000 for the year ended December 31, 1996. Net holding costs and expenses declined to $352,000 from $728,000 for the years ended December 31, 1996 and 1995, respectively. This reduction is a result of the overall decline in the OREO portfolio. The net balance of OREO was $0.9 million as of December 31, 1996 compared to $4.3 million at December 31, 1995. As of December 31, 1996 there were six properties comprising the OREO portfolio, four of which were under contract of sale. Management's long-standing approach has been to reduce OREO as quickly, efficiently and effectively as possible, balancing the effect of accepting a reduced offer for an OREO property against the holding costs associated with continued ownership. Aggregating the allowance provisions and net losses on sales, the Bank incurred losses on OREO properties of $1.0 million in 1996 and $687,000 in 1995. Provision for Income Taxes The current provision for income taxes for the year ended December 31, 1996 as well as the year ended December 31, 1995 represented estimated minimum state and federal tax requirements for the periods inasmuch as both federal and state income-based tax liabilities were offset by loss carryforwards. In 1995 the Bank recognized a portion of its net deferred tax assets in the amount of $1.2 million by reflecting a deferred tax benefit. In 1996 the Bank recovered the remainder of the valuation allowance against its net deferred tax assets by reflecting a deferred tax benefit in the current year's earnings of $1.3 million. As of December 31, 1996 the Bank has recognized all of its available net deferred tax assets, and future taxable earnings will be subject to taxation at a combined state and federal rate of approximately 40%. FINANCIAL CONDITION General Total assets were $654.2 million as of December 31, 1997, representing a $64.6 million increase from the $589.6 million at December 31, 1996. Total loans, net of allowance for credit losses, were $425.8 million, an increase of $15.0 million from the $410.8 million as of December 31, 1996. Total investment securities were $180.5 million as of December 31, 1997, an increase of $40.4 million from $140.1 million as of December 31, 1996. Total deposits were $444.2 million, an increase of $20.9 million from the December 31, 1996 level of $423.3 million. Total other borrowed money was $151.4 million as of December 31, 1997, an increase of $37.8 million from the December 31, 1996 level of $113.6 million. Shareholders' equity was $56.1 million as of December 31, 1997, an increase of $6.7 million or 13.6% as compared to $49.4 million as of December 31, 1996. The Company's Tier 1 leverage capital ratio was 8.2% as of December 31, 1997, compared to 7.9% as of December 31, 1996. Investment Securities Total securities amounted to $180.5 million as of December 31, 1997 compared to $140.1 million at December 31, 1996, representing a $40.4 million increase or 28.8%. The $40.4 million increase represented the net effect of purchases of $140.7 million of various investments, partially offset by sales of lower yielding securities, maturities and the monthly amortization (pay-downs) of the mortgage backed securities portfolio. During 1997, the Bank effected various purchase and sale transactions designed to increase yields on the existing portfolio investment levels and, during the first six months of the year, invested a net total of approximately $34 million in callable preferred stocks as part of its tax advantaged investment strategy. These securities accounted for a significant part of the net growth of the portfolio providing an advantageous investment vehicle as the stock converts in approximately 4 1/2 years to adjustable rates which management anticipates will result in the securities being called. An additional benefit to the tax effective yield is an equalization provision in the event the dividend income becomes subject to full taxation up to the call date. In accordance with Statement of Financial Accounting Standard No. 115, "Accounting for Certain Investments in Debt and Equity Securities" (SFAS 115), the Bank classifies each security in the portfolio as either "Held-to-Maturity," "Available-for-Sale," or "Trading Account Security." During 1996 management re-assessed the objectives of its Held-to-Maturity portfolio in light of its plans to transform the Bank's financial condition, and effective December 31, 1996 reclassified all of its Held-to-Maturity investments to the Available-for-Sale classification. During 1996 the Bank decided to liquidate its portfolio of utility stocks as a result of the decision to reposition the investment security portfolios, resulting in a net loss of $165,000. The Bank had established two portfolios of equity securities, an Available-for-Sale portfolio of a variety of equities and mutual funds aggregating $2.2 million at December 31, 1996, and a Trading Account group of equities for certain other common stock equity securities against which the Bank sells covered call options from time to time as market conditions allow. The Bank's covered call option program which began in 1996 and continues, is designed for yield enhancement and to lessen the Bank's exposure to a potentially volatile stock market. In this program, the Bank purchases shares of qualified common stock and sells a call option against the investment. As required by SFAS 115, the Bank marks the common stock and related covered call option to market through current period earnings. Inasmuch as the Bank's equity investment privileges have been grandfathered by the FDIC, it intends to continue to maintain an equity stock portfolio. To provide direction, the Bank's Board of Directors has established upward limits and an investment policy which includes guidelines that the Bank's equity investments have a minimum quality rating of "A" by a widely recognized rating service; the policy also requires adequate diversification to avoid concentrations in lines of business and geographic regions. The following table presents a summary of the investments and other securities portfolios as of December 31, 1997 and December 31, 1996, fair values and unrealized gains and losses as of those dates.
TABLE 1 - INVESTMENT & OTHER SECURITIES ($ thousands) December 31, 1997 Amortized Unrealized Holding Fair Cost Gains Losses Value Available for Sale U.S. Government and Federal Agency Obligations $ 55,122 $ 190 $ 55 $ 55,257 Mortgage-Backed Securities 85,543 461 56 85,948 Equity Securities 36,091 1,429 58 37,462 Total Available for Sale $176,756 $2,080 $169 $178,667 Trading Equity Securities $ 1,976 $ 4 $150 $ 1,830 December 31, 1996 Amortized Unrealized Holding Fair Cost Gains Losses Value Available for Sale U.S. Government and Federal Agency Obligations $ 42,436 $ 145 $461 $ 42,120 Mortgage Backed Securities 92,443 382 372 92,453 Equity Securities 2,110 138 12 2,236 Total Available for Sale $136,989 $ 665 $845 $136,809 Trading Equity Securities $ 3,353 $ 46 $107 $ 3,292
Loans Total loans, before reductions for deferred credits, fees and the allowance for credit losses, amounted to $437.6 million as of December 31, 1997, representing an $18.8 million or 4.5% increase over the December 31, 1996 level of $418.8 million. The overall increase in the loan portfolio was not significant. What was significant was the change in mix which was part of a strategy to increase yield while managing growth.
TABLE 2 - LOAN PORTFOLIO ($ thousands) December 31, 1997 December 31, 1996 Real Estate Loans 1 To 4 Family Adjustable Rate $278,231 63.7% $257,459 61.5% 1 To 4 Family Fixed Rate 64,510 14.7% 77,160 18.4% 1 To 4 Family Held-for-Sale 5,311 1.2% - - Multi-Family 5,398 1.2% 7,450 1.8% Commercial 55,124 12.6% 46,272 11.0% Home Equity Lines Of Credit 7,632 1.7% 7,127 1.7% Home Improvement and Second Mortgages 2,852 0.7% 2,568 0.6% Land 640 0.1% 828 0.2% Construction 2,942 0.7% 1,227 0.3% Total Real Estate Loans 422,640 96.6% 400,091 95.5% Commercial Loans 7,587 1.7% 8,425 2.0% Consumer Loans Passbook 1,508 0.3% 1,510 0.4% Automobile Loans 2,332 0.6% 2,619 0.6% Automobile Leases - - 3,149 0.8% Credit Cards 1,409 0.3% 991 0.2% All Other 2,104 0.5% 2,033 0.5% Total Consumer Loans 7,353 1.7% 10,302 2.5% Total Loans, Gross 437,580 100% 418,818 100% Deferred Fees and Credits (625) (718) 436,955 418,100 Allowance for Credit Losses (5,832) (7,334) Total Loans, Net 431,123 410,766 1 To 4 Family Held for Sale (5,311) - Loans Receivable, Net $425,812 $410,766
The strong demand for new residential mortgage loans that existed in 1996 continued into 1997 and, in response to a favorable interest rate environment, the trend for the latter part of 1997 was to increased levels of refinancing. In order to maintain yield, the Bank's response to the increased level of new residential and refinancing activity was to step-up the utilization of the correspondent loan program. In conjunction with the management of the portfolio, the Bank also sold $13.1 million of new originations of fixed rate residential mortgages during 1997 and as of December 31, 1997 had identified an additional $5.3 million of residential loans to be sold. Management's Discussion and Analysis The Bank continued to emphasize small business commercial lending during 1997. A significant increase in the portfolio was in the growth of owner-occupied commercial real estate loans which grew from $46.3 million as of December 31, 1996 to $55.1 million as of December 31, 1997 for an increase of $8.8 million or 19%. The other portion of loans to small business is comprised mainly of working capital lines of credit and other similar short-term financing. As of December 31, 1996, a significant portion of these loans resulted from the FFB&T acquisition. During 1997 these loans were for the most part collected and the portfolio at December 31, 1997 is comprised of loans originated by the Bank's newly structured commercial lending operation which emphasizes risk minimization and industrial diversification. Total Consumer loans decreased by $2.9 million from $10.3 million at December 31, 1996 to $7.4 million at December 31, 1997. This decline was primarily due to the fact that the portfolio of automobile leases, which had been generated on an indirect basis, was liquidated during the second quarter of 1997. Non-Performing Assets/Asset Quality The Bank's level of non-performing assets continued to steadily decline during the years 1997 and 1996. Total non-performing assets as of December 31, 1997 were $5.4 million, representing 0.83% of total assets. As of December 31, 1996, total non-performing assets were $11.3 million or 1.92% of total assets. The Bank's Watch List, comprised of loans which have been identified by the Bank's credit analysis system as exhibiting more than usual risk of non-performance or loss, aggregated $8.5 million at December 31, 1996 and $11.7 million at December 31, 1997. Two loans which were non-accrual at December 31, 1996 were placed on the Watch List during 1997 and, subsequently, these loans have been current for a majority of 1997. Another loan experienced delinquency during the first half of 1997 and was placed on the Watch List; this loan has been current for the last six months of 1997. Of the total non-performing assets, non-performing loans were $4.8 million as of December 31, 1997, compared to $10.4 million as of December 31, 1996. There were no troubled debt restructurings included in non-performing loans as of December 31, 1997 and 1996. The allowance for credit losses amounted to $5.8 million as of December 31, 1997, representing coverage of 120.3% of non-performing loans, compared to $7.3 million and 70.24% coverage of non-performing loans at December 31, 1996. The allowance for credit losses at December 31, 1996 includes $1.0 million of credit risk allowance allocated to the loans acquired through the FFB&T transaction. The credit risk allowance for the FFB&T acquired loans was $575,000 as of December 31, 1997. Net charge-offs in 1997 were $1.5 million or 34 basis points of the average loan portfolio, compared to $2.3 million or 56 basis points, respectively, for the year ended December 31, 1996. The continued improvement in asset quality, coupled with substantial recoveries in 1997, resulted in no need for a provision for credit losses. At December 31, 1996, the Bank had six properties comprising foreclosed assets (OREO) for a total of $0.9 million. During 1997 the Bank foreclosed on twelve loans and subsequently sold fourteen OREO properties. At December 31, 1997, the Bank had four properties in OREO for a total of $0.6 million. No allowance for estimated OREO losses was deemed necessary as of December 31, 1997 and December 31, 1996 as a result of the minimal amount of OREO remaining at those dates, the stabilization of the residential real estate market during the periods, and management's assessment that the carrying value of OREO fairly represents net realizable values at those dates. Details of the Bank's asset quality are shown in the analysis provided by Table 3.
TABLE 3 - ASSET QUALITY ($ thousands) At December 31, 1997 1996 1995 1994 1993 Non-Performing Assets Non-Accrual Loans $ 4,847 $ 10,441 $ 12,598 $ 9,489 $ 26,180 Restructured Loans - - 472 487 - Total Non-Performing Loans 4,847 10,441 13,070 9,976 26,180 Foreclosed Assets 574 858 4,267 11,622 17,824 Allowance for Estimated OREO Losses - - - (802) (194) Total OREO 574 858 4,267 10,820 17,630 Total Non-Performing Assets $ 5,421 $ 11,299 $ 17,337 $20,796 $ 43,810 Allowance for Credit Losses Balance at Beginning of Period $7,334 $ 4,170 $ 4,827 $ 2,532 $ 4,567 Provision for Credit Losses - 4,415 1,005(A) 3,790 1,000 Allocated to FFB&T Acquired Loans - 1,000 - - - Charge-Offs (2,155) (2,488) (1,799) (1,589) (3,073) Recoveries 653 237 137 94 38 Net Charge-Offs (1,502) (2,251) (1,662) (1,495) (3,035) Balance at End of Period $ 5,832 $ 7,334 $ 4,170 $ 4,827 $ 2,532 (A) Gross Provision of $2,105 Less ADP Credit of $1,100 Allowance for Estimated OREO Losses Balance at Beginning of Period $ - $ - $ 802 $ 194 $ 1,025 Provision for Estimated OREO Losses - 459 460 2,894 3,975 Charge-Offs - (459) (1,262) (2,286) (4,806) Balance at End of Period $ - $ - $ - $ 802 $ 194 Loans Receivable End of Period $432,269 $418,818 $360,475 $290,416 $269,300 Average $435,610 $403,207 $313,072 $265,581 $267,729 Total Assets, End Of Period $654,222 $589,589 $515,267 $464,901 $427,950 Ratios Allowance for Credit Losses to Loans Receivable 1.35% 1.75% 1.16% 1.66% 0.95% Net Charge-Offs to Average Loans 0.34% 0.56% 0.53% 0.56% 1.13% Non-Performing Loans to Loans Receivable 1.12% 2.50% 3.63% 3.44% 9.72% Non-Performing Assets to Total Assets 0.83% 1.92% 3.36% 4.47% 10.24% Allowance for Credit Losses to Non-Performing Loans 120.32% 70.24% 31.91% 48.39% 9.67%
Deposits Total deposits at December 31, 1997 were $444.2 million, compared to $423.3 million at December 31, 1996, an increase of $20.9 million or 4.9%, resulting from the Bank's strategy of obtaining core deposit relationships from both the commercial and consumer segments of its market. The Bank continues to seek deposits with marketing and sales efforts concentrated on its new and diversified products. The Bank does not solicit, nor does it accept, brokered deposits. The following table presents a summary of deposits as of December 31, 1997 and 1996.
TABLE 4 - DEPOSITS ($ thousands) December 31, 1997 December 31, 1996 Demand $ 27,471 6.2% $ 22,479 5.3% Savings Regular Savings 29,455 6.6% 28,096 6.6% NOW 37,287 8.4% 30,262 7.2% Super and Money Market Accounts Super Savings 47,863 10.8% 45,404 10.7% Money Market 55,541 12.5% 47,957 11.3% Time Certificate Accounts 204,129 45.9% 197,204 46.6% Money Market Certificates 37,738 8.5% 46,923 11.1% Escrow Deposits 4,727 1.1% 4,965 1.2% Total Deposits $444,211 100.0% $423,290 100.0%
Federal Home Loan Bank of Boston Advances and Other Borrowings The Bank continues to utilize the FHLB as a source of funds alternative to the traditional deposit account relationship. As of December 31, 1997, borrowings from the FHLB totaled $110.9 million, compared to $82.2 million as of December 31, 1996. In addition, the Bank increased the use of the reverse repurchase agreement as a means to borrow funds. These agreements are essentially collateralized borrowings, similar to FHLB borrowings, and to the extent that the rates and terms are more favorable, the Bank utilizes the reverse repurchase agreement in lieu of an FHLB borrowing. As of December 31, 1997 there were $40.4 million of borrowings outstanding under reverse repurchase agreements compared to $31.4 million as of December 31, 1996. In total, borrowings as of December 31, 1997 were $151.3 million at a weighted average rate of 5.8% and a weighted average maturity of 1.4 years, compared to $113.6 million at a weighted average rate of 5.74% and a weighted average maturity of 1.1 years as of December 31, 1996. As a percentage of total assets, borrowings amounted to 23.1% as of December 31, 1997, compared to 19.3% as of December 31, 1996. The Company has reflected the guaranty of the ESOP loan as an obligation in accordance with applicable accounting requirements. This loan was a five-year adjustable rate loan (convertible to a fixed rate at the Bank's option) with interest and principal payable monthly. The outstanding balance was $485,000, and the rate in effect as of December 31, 1996 was 6.86%. In July 1997 the Bank refinanced the ESOP obligation with a different third party lender into a 24 month fixed-rate loan at 7.75%. The outstanding balance was $293,000 at December 31, 1997. Shareholders' Equity Shareholders' equity at December 31, 1997 increased to $56.1 million from $49.4 million at December 31, 1996, reflecting Tier 1 regulatory leverage capital ratios of 8.2% and 7.9%, respectively. The following table indicates required and actual levels of capital for the Bank and the Company as of December 31, 1997 and 1996.
TABLE 5 - REGULATORY CAPITAL Required Actual December 31, 1997 1996 Company Tier 1 Risk-Based Capital 4.0% 15.4% N/A Total Risk-Based Capital 8.0% 16.6% N/A Tier 1 Leverage Capital 4.0%-5.0% 8.2% N/A Bank Tier 1 Risk-Based Capital 4.0% 14.3% 15.7% Total Risk-Based Capital 8.0% 15.5% 17.0% Tier 1 Leverage Capital 4.0%-5.0% 7.6% 7.9%
Liquidity and Interest Rate Risk Management The Company seeks to achieve consistent growth in net interest income and net income while managing volatility from changes in interest rates. Interest rate risk management is the responsibility of the Asset Liability Committee of management (ALCO) and is a dynamic process which seeks to achieve the Company's overall balance sheet objectives within changing market and business environments through appropriately diversified investments and funding sources, and management of the Company's needs for liquidity to support its operations, meet the credit needs of its market area, and respond to the investment, financial service, and liquidity needs of its depositors. The Company's equity price risk is essentially limited to its portfolio of trading securities, and its bond market price risk focuses on its portfolio of available-for-sale (AFS) securities. Market price risk for mortgages or other loans is not a significant risk for the Company, inasmuch as the Company's loan portfolios are primarily held for investment to maturity or sooner prepayment by the debtor. Market risk of the AFS securities is centered primarily on a sudden shift of interest rates at a time when sale of the securities might be required to meet unexpected liquidity needs, or when sale would be advantageous to the improvement of the yield in the AFS portfolio itself. The Company's interest rate risk encompasses all of its rate-sensitive financial instruments. The Company has no derivative financial instruments or derivative commodity instruments. Management of the trading portfolio of common and preferred stocks is governed by a trading portfolio investment policy which provides guidance on such issues as investment quality, diversification by industry and geographic regions, and overall marketability. To enhance yield and reduce the overall investment at risk, the Bank may also sell call options on individual issues held in the trading portfolio. To reduce market risk for the AFS portfolio, as well as the risk to the Company's net income from interest rate risk, the Company has chosen at this time to employ more traditional methods of reducing interest rate risk rather than engage in derivative financial instruments such as swaps, options or hedges. While this choice does not preclude management from employing derivatives in the future to manage risk, management has no immediate plans to do so. Traditional means of managing interest rate risk include: establishing a solid base of core deposit relationships; maximizing investment in variable rate loans and investments; limited fixed rate loans and investments to the highest quality and shortest possible term to maturity; ensuring the availability of several alternative sources of funding in order to be able to respond to liquidity needs and investment opportunities with the greatest amount of flexibility and the least amount of cost. Thus the Bank has established a cash management line of credit with Federal Home Loan Bank of Boston, established wholesale borrowing relationships with several brokerage firms to avail itself of access to the repurchase agreement market (essentially a collateralized borrowing) for intermediate term liquidity needs, has become a member of the Federal Home Loan Bank of Boston in order to be able to avail itself of advantageous, stable longer-term borrowings to lock-in interest rate spread on fixed rate loans held for portfolio, and has established several correspondent lending arrangements whereby the Bank acts as an originator for certain investors for fixed rate mortgage products which the Bank chooses not to originate for its own portfolio. The financial risk management activities of the ALCO are governed by a broad policy which provides specific limits for the financial risks, including interest rate, liquidity, and market, inherent in the Company's operations. Strategies and tactics are reviewed and monitored regularly to ensure that the Company's financial condition is maintained within approved risk tolerances for growth rate, investment mix, rate sensitivity, and liquidity, while providing appropriate levels of interest rate spread to support profitable operations and adequate regulatory capital ratios. Table 6 presents a static measure of the Company's interest rate risk position at December 31, 1997. The table presents the various categories of the Company's interest-rate-sensitive financial instruments by their contractual time to maturity, their weighted average contractual interest rates, and their estimated fair values at December 31, 1997. Instruments with no stated maturity are included in the one year category, and no adjustments have been made for expected prepayments on mortgage loans or mortgage-backed securities. Off-balance sheet financial instruments at December 31, 1997, consisting primarily of commitments to extend credit and existing unused lines of credit, were not significant and have not been included in the Table.
TABLE 6- RATE SENITIVE FINANCIAL INSTRUMENTS AT ESTIMATED FAIR VALUE AND WEIGHTED AVERAGE CONTRACTUAL RATE BY YEAR OF MATURITY Financial Instruments Scheduled to Mature in the Year 1998(a) 1999 2000 2001 2002 2003 Weighted Weighted Weighted Weighted Weighted Weighted Average Average Average Average Average Average Contract Contract Contract Contract Contract Contract Total Rate Rate Rate Rate Rate Rate Cash Equivalents $10,555 $10,555 - - - - - 5.70% - - - - - Securities Trading: 1,830 1,830 - - - - - 13.00% - - - - - Available for Sale: U.S. Gov and Agency Obligations 55,257 - - - - $2,996 $52,261 - - - - 6.60% 7.45% Mortgage Backed 85,950 - - - $500 1,841 83,609 - - - 8.83% 8.02% 8.18% Equities 268 268 - - - - - 1.80% - - - - - Mutual Funds 2,135 2,135 - - - - - 0.00% - - - - - Preferred Stock 35,058 - - - 25,156 5,200 4,702 - - 6.16% 5.84% 6.07% Loans: Held-for-Sale 5,311 5,311 - - - - - 7.25% - - - - - Held-for- Portfolio 443,083 20,967 3,442 7,418 5,072 5,961 400,223 9.19% 8.82% 8.19% 9.43% 9.13% 7.59% FHLBB Stock 7,347 7,347 - - - - - 6.50% - - - - - Deposits: NOW Accounts (37,287)(37,287) - - - - - 1.50% - - - - - Regular Savings(29,455)(29,455) - - - - - 1.99% - - - - - Super/Money Market Savings(103,404)(103,404) - - - - - 2.85% - - - - - Escrow Accounts (4,727) (4,727) - - - - - 2.80% - - - - - Time Accounts (241,867)(146,109)(70,623)(20,757) (3,466) (912) - 5.12% 5.85% 6.51% 5.95% 5.73% - FHLBB Borrowings(110,940) (95,037) (4,400) - - (10,072) (1,431) 5.88% 5.94% - - 5.90% 5.86% Repurchase Agreements (40,582) (9,457) - (21,101) - (10,024) - 5.75% - 5.76% - 5.65% - Other Borrowed Money(293) (293) - - - - - 7.75% - - - - - Net $78,239 ($377,356) ($71,581) ($34,440) $27,262 ($5,010) $539,364
(a) Includes all financial instruments with no scheduled maturity date. Liquidity is the ability of the Bank to meet its cash flow requirements arising from fluctuations in loans, securities, deposits, and other borrowings. At December 31, 1997, the Bank's primary liquidity, consisting of cash, cash equivalents and marketable securities with maturities of one year or less was $54.0 million or 8.3% of total assets, compared to $30.6 million or 5.2% of total assets at December 31, 1996. In addition, liquidity is the ability of the Company to meet its cash flow requirements to pay operating expenses, dividends, and to make other payments as may be necessary. The Company's liquidity is provided by dividends from its wholly owned subsidiary, the Bank. The Bank's ability to pay dividends is restricted by Connecticut law to the Bank's net profits in the current year, plus retained net profits from the two most recent fiscal years. The Company is in the process of negotiating a line of credit. The Company may also effect borrowings from time to time to meet specific liquidity needs. The Bank's primary sources of funds are deposits and other borrowings, primarily from the FHLB. The Bank monitors its liquidity in accordance with policy guidelines established by the Asset and Liability Management Policy and regulatory standards administered by the Asset and Liability Management Committee of the Bank. As of December 31, 1997, the Bank had approved loan commitments outstanding for one-to four-family loans of $9.5 million. In addition, there was $8.7 million of unused credit under the home equity line of credit facility, $1.0 million under the overdraft protection credit line facility, and $2.2 million in unused credit card lines. The unadvanced portion of residential construction loans amounted to $1.2 million. There were $3.1 million in approved loan commitments in the Commercial Lending Department, $6.2 million in unused commercial lines of credit and $0.6 million in commercial letters of credit outstanding. Management believes that the Bank's liquidity is currently in a position to meet normal operating needs. To meet unexpected demands, the Bank maintains a line of credit with the FHLB. At December 31, 1997, this line of credit was $11.8 million of which no amount was outstanding. Management also believes that the capital position of the Company and the Bank are currently adequate to meet present needs and anticipated growth, and does not currently plan to raise capital from external sources in the near future (see Shareholders' Equity). The Company announced in December 1997 a stock repurchase plan subject to which the Company may elect to repurchase up to 15% of its issued and outstanding common stock. Such repurchases, if effected, will not adversely affect the Company's "well capitalized" status. Market Price of Common Stock NSS Bancorp, Inc. (Norwalk Savings Society prior to October 1, 1997) trades on the NASDAQ National Market under the symbol "NSSY". The following table sets forth the high/low price range, as reported by NASDAQ, and dividends paid for the periods indicated:
1997 1996 High Low Div High Low Div (1) First Quarter $26.25 $22.94 $0.05 $22.00 $18.75 $ - Second Quarter $31.00 $23.00 $0.10 $22.25 $17.94 $0.05 Third Quarter $37.50 $28.25 $0.10 $23.13 $20.88 $0.05 Fourth Quarter $40.25 $31.75 $0.10 $24.88 $22.75 $0.05
(1) The Bank began paying quarterly dividends during the second quarter of 1996. At December 31, 1997 NSS Bancorp had approximately 700 shareholders of record. Year 2000 Compliance The Bank, like all institutions that utilize computer technology, is facing significant challenges associated with the inability of many existing computer systems to process time sensitive data accurately beyond the year 1999 (Year 2000 compliance). Substantially all of the Bank's software systems are licensed from an outside vendor. Primary exposure emanates from the ability of its technology vendor to implement the necessary changes for Year 2000 compliance. The Bank has received a commitment from its major vendor to provide the required systems modifications to ensure compliance, and management believes those commitments will be met. If not modified or replaced, these programs could cause system failures or miscalculations, which could adversely affect the Bank's ability to process customer transactions or provide customer service. The Bank is also reviewing certain commercially available in-house software applications to ensure Year 2000 compliance. The Bank is monitoring the activities of its third party vendor in developing and implementing plans to address the Year 2000 compliance. While the Bank expects its Year 2000 compliance to be completed on a timely basis, there can be no assurance that the systems of other companies on which the Bank relies will be Year 2000 compliant. In addition, the Bank exchanges data with a number of entities, such as credit bureaus and governmental entities. The failure of these entities to adequately address the Year 2000 compliance could adversely affect the Bank's ability to conduct its business. Costs associated with modifying existing system applications have been and will continue to be expensed as incurred. The Bank does not expect incremental costs associated with application modifications for Year 2000 compliance to be material. However, as the Bank progresses in implementing its plan for addressing the Year 2000 compliance, current estimates of costs could change, including costs as a result of the failure of the third party vendor or other entities to adequately address the Year 2000 compliance in a timely fashion. There can be no assurance that the Bank will not experience cost overruns or delays in connection with its plan for modifying systems. Management of the Bank believes it will be successful in the achievement of its plan and does not believe that the execution of the plan will have a material adverse affect on future operating results. Independent Auditor's Report The Board of Directors and Shareholders NSS Bancorp, Inc. and Subsidiary Norwalk, Connecticut We have audited the accompanying consolidated statements of financial condition of NSS Bancorp, Inc. and Subsidiary (Note 1) as of December 31, 1997 and 1996, and the related consolidated statements of earnings, shareholders' equity, and cash flows for each of the three years in the period ended December 31, 1997. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall consolidated financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of NSS Bancorp, Inc. and Subsidiary at December 31, 1997 and 1996, and the consolidated results of their operations, changes in their shareholders' equity and their cash flows for each of the three years in the period ended December 31, 1997 in conformity with generally accepted accounting principles. FRIEDBERG, SMITH & CO., P.C. Bridgeport, Connecticut February 11, 1998
Consolidated Statements of Financial Condition December 31, 1997 and 1996 (Note 1) ($ thousands) 1997 1996 Assets Cash and Due from Banks (Note 1) $ 11,486 $ 14,978 Interest-Bearing Deposits in Other Banks (Notes 2 and 8) 5,555 2,373 Federal Funds Sold (Note 1) 5,000 1,500 Securities (Notes 1 and 2): Trading, At Estimated Fair Value 1,830 3,292 Available-for-Sale, At Estimated Fair Value 178,667 136,809 180,497 140,101 Loans Held-for-Sale (Note 1) 5,311 - Loans Receivable, Net of Allowance for Credit Losses of $5,832 in 1997 and $7,334 in 1996 (Notes 1, 3, 7, 14, 17 and 18) 425,812 410,766 Accrued Income Receivable (Notes 1 and 3) 3,859 4,034 Investment in FHLBB Stock, At Cost (Note 7) 7,347 6,184 OREO, Net (Notes 1, 4 and 14) 574 858 Bank Premises and Equipment, Net (Notes 1, 5 and 17) 3,738 3,151 Deferred Income Tax Asset, Net (Notes 1 and 9) 361 2,574 Other Assets (Notes 1, 3 and 18) 4,682 3,070 Total Assets $654,222 $589,589 Liabilities and Shareholders' Equity Liabilities Deposits (Notes 6, 17 and 18): Non-Interest Bearing $ 27,471 $ 22,479 Interest Bearing 416,740 400,811 444,211 423,290 Advances from FHLBB (Note 7) 110,937 82,208 Securities Sold Under Agreements to Repurchase (Notes 2 and 7) 40,441 31,350 Other Borrowings (Notes 8 and 12) 293 485 Accrued Expenses and Other Liabilities (Note 8) 2,202 2,903 Total Liabilities 598,084 540,236 Commitments and Contingent Liabilities (Notes 5 and 11) Shareholders' Equity (Notes 1, 2, 5, 8, 11, 12, 13, 16, 19 and 22) Preferred Stock - $.01 Par Value - 500,000 Shares Authorized, None Issued - - Common Stock - $.01 Par Value - Authorized 7,000,000 Shares; Issued 2,460,370 Shares in 1997 and 2,442,129 Shares in 1996; Outstanding 2,434,096 Shares in 1997 and 2,397,312 Shares in 1996 25 24 Additional Paid-In Capital 24,199 23,545 Retained Earnings 31,048 26,339 Net Unrealized Gain (Loss) on Securities Available-for-Sale, Net of Tax Effect 1,129 (106) Total 56,401 49,802 Less: Unearned ESOP Shares (263) (449) Total Shareholders' Equity 56,138 49,353 Total Liabilities and Shareholders' Equity $654,222 $589,589 See notes to consolidated financial statements.
Consolidated Statements of Earnings Years Ended December 31, 1997, 1996 and 1995 (Note 1) ($ thousands) 1997 1996 1995 Interest and Dividend Income (Note 1) Interest and Fees on Loans $33,369 $30,589 $23,666 Securities: U.S. Government and Agencies 3,747 2,571 1,961 Mortgage-Backed Securities 6,199 7,076 6,753 Marketable and Other Equities 2,040 528 358 11,986 10,175 9,072 Cash Equivalent Investments and Other 514 491 277 Total Interest and Dividend Income 45,869 41,255 33,015 Interest Expense Deposits (Note 6) 17,140 16,844 14,169 Borrowed Funds (Note 7) 9,356 6,796 4,229 Total Interest Expense 26,496 23,640 18,398 Net Interest and Dividend Income 19,373 17,615 14,617 Provision for Credit Losses (Notes 1 and 3) - 4,415 1,005 Net Interest and Dividend Income after Provision for Credit Losses 19,373 13,200 13,612 Non-Interest Income Net Security Gains (Note 2) 1,115 661 798 Net Gains (Losses) on Sales of Loans (Note 3) 344 (144) - Net Gain on Branch Sale (Note 17) - 3,639 - Loan Servicing and Other Loan Fees 484 480 515 Service Charges on Deposit Accounts 813 763 599 Trust Department Fees 576 552 515 Other (Note 10) 1,914 892 268 Total Non-Interest Income 5,246 6,843 2,695 Non-Interest Expense Salaries and Employee Benefits (Notes 8 and 13) 7,745 7,649 6,232 Occupancy and Equipment (Note 5) 1,742 1,646 1,336 (Gains) Losses and Expenses of OREO, Net (Note 4) (103) 1,362 1,415 Other (Notes 10, 12 and 18) 6,340 4,809 3,736 Total Non-Interest Expense 15,724 15,466 12,719 Income before Income Tax Provision 8,895 4,577 3,588 Income Tax Provision (Benefit), Net (Notes 1 and 9) 3,330 (1,125) (1,190) Net Income $ 5,565 $ 5,702 $ 4,778 Per Share Data (Notes 1 and 13) Weighted Average Number of Common Shares Outstanding (thousands): Basic 2,414 2,381 2,346 Assuming Dilution 2,533 2,440 2,351 Income Per Common Share: Basic $2.31 $2.39 $2.04 Assuming Dilution $2.20 $2.34 $2.03 See notes to consolidated financial statements.
Consolidated Statements of Shareholders' Equity Years Ended December 31, 1997, 1996 and 1995 (Note 1) Un- Un- Total Additional realized earned Share- Common Paid-In Retained Gains ESOP holders' ($ thousands) Shares Stock Capital Earnings (Losses) Shares Equity Balance - January 1, 1995 2,329,670 $24 $22,838 $16,225 $ (603) $(971) $37,513 Net Income for 1995 - - - 4,778 - - 4,778 Shares Committed to be Released (Note 8) 26,556 - 168 - - 266 434 Stock Options Exercised (Note 13) 8,494 - 127 - - - 127 Change in Unrealized Gains (Losses), Net (Note 2) - - - - 743 - 743 Balance - December 31, 1995 2,364,720 24 23,133 21,003 140 (705) 43,595 Net Income for 1996 - - - 5,702 - - 5,702 Cash Dividends Paid on Common Stock, $0.15 per share (Note 12) - - - (366) - - (366) Shares Committed to be Released (Note 8) 25,697 - 304 - - 256 560 Stock Options Exercised (Note 13) 6,665 - 103 - - - 103 Shares Distributed to Advisory Board (Note 12) 230 - 5 - - - 5 Change in Unrealized Gains (Losses), Net (Note 2) - - - - (246) - (246) Balance - December 31, 1996 2,397,312 24 23,545 26,339 (106) (449) 49,353 Net Income for 1997 - - - 5,565 - - 5,565 Cash Dividends Paid on Common Stock, $0.35 per share (Note 12) - - - (856) - - (856) Shares Committed to be Released (Note 8) 18,543 - 381 - - 186 567 Stock Options Exercised (Note 13) 18,201 1 272 - - - 273 Shares Distributed to Advisory Board (Note 12) 40 - 1 - - - 1 Change in Unrealized Gains (Losses), Net (Note 2) - - - - 1,235 - 1,235 Balance - December 31, 1997 2,434,096 $25 $24,199 $31,048 $1,129 $(263) $56,138 See notes to consolidated financial statements.
Consolidated Statements of Cash Flows Years Ended December 31, 1997, 1996 and 1995 - Increase (Decrease) in Cash and Cash Equivalents (Note 1) ($ thousands) 1997 1996 1995 Cash Flows from Operating Activities Net Income $ 5,565 $ 5,702 $ 4,778 Adjustments to Reconcile Net Income to Net Cash Provided by Operating Activities: Provision for Credit Losses - 4,415 1,005 Provision for Estimated Losses on OREO - 459 460 Provision for ESOP Benefit Cost 567 560 434 Stock Issued to Advisory Board As Compensation 1 5 - Depreciation and Amortization 587 521 391 Goodwill Amortization 326 76 - Net Amortization (Accretion) of Discounts and Premiums on Securities 752 504 (954) Deferred Income Tax Provision (Benefit) 1,357 (1,300) (1,200) Net Gain on Branch Sale - (3,639) - Net Realized Gains on Sales of Securities Available-for-Sale (688) (693) (803) Net (Gains) Losses on Sales of Loans (344) 144 - Net (Gains) Losses on Sales of OREO (309) 551 227 Net Decrease (Increase) in Trading Securities 1,462 (847) (263) Decrease (Increase) in Accrued Income Receivable 175 (1,022) (477) (Increase) Decrease in Other Assets (1,842) 243 (341) (Decrease) Increase in Accrued Expenses and Other Liabilities (701) 1,157 945 Total Adjustments 1,343 1,134 (576) Net Cash Provided by Operating Activities 6,908 6,836 4,202 Cash Flows from Investing Activities Proceeds From: Sales of Securities Available-for-Sale 81,926 37,261 62,062 Maturities & Principal Amortization of Securities Available-for-Sale 18,907 29,612 37,199 Sales of Loans 13,130 45,319 - Sale of Bank Premises and Equipment - 340 - Sales of OREO 1,218 2,917 3,288 Purchases of Loans - (13,724) - Purchases of Securities Available-for-Sale (140,664) (81,601)(67,571) Purchases of Securities Held-to-Maturity - (792) - Purchases of FHLBB Stock (1,163) (2,563) (290) Net Increase in Loans Receivable (33,768) (91,532)(72,529) Additions to OREO - (110) (1,170) Additions to Bank Premises and Equipment (1,174) (660) (750) Acquisition of Goodwill (96) (1,830) - Net Cash Used by Investing Activities (61,684) (77,363) (39,761) Cash Flows from Financing Activities Net Increase in Deposits from Customers 20,921 20,934 39,726 Assumption of Deposits - 47,556 - Sale of Deposits - (44,397) - Advances from FHLBB 65,000 68,750 32,900 Repayments of Advances from FHLBB and Other Borrowings (36,463) (48,580) (33,887) Net Increase in Securities Sold Under Agreements to Repurchase 9,091 26,750 4,600 Proceeds from Exercised Stock Options 273 103 127 Dividends Paid to Shareholders (856) (366) - Net Cash Provided by Financing Activities 57,966 70,750 43,466 Increase in Cash and Cash Equivalents (Note 1) 3,190 223 7,907 Cash and Cash Equivalents - Beginning 18,851 18,628 10,721 Cash and Cash Equivalents - Ending $22,041 $18,851 $18,628 Supplemental Disclosures of Cash Flow Information Cash Paid During the Year For: Interest $26,524 $23,546 $18,458 Income Taxes $ 2,055 $ 22 $ - Non-Cash Investing and Financing Activities: Loans Receivable Transferred to OREO $ 1,143 $ 1,758 $ 324 Loans Originated in Connection with Sales of OREO $ 518 $ 1,350 $4,072 Exchange of Loans for Mortgage-Backed Securities $ - $ - $4,361 Transfer of Securities Available-for-Sale to Trading $ - $ 2,182 $ - Transfer of Securities Held-to- Maturity to Available-for-Sale $ - $ 30,514 $36,628 Transfer of Loans Receivable to Loans Held-for-Sale $ 5,311 $ - $ - See notes to consolidated financial statements.
Notes to Consolidated Financial Statements December 31, 1997, 1996 and 1995 1. Nature of Operations & Summary of Significant Accounting Policies The following is a summary of significant accounting policies followed by NSS Bancorp, Inc.(Company) and its wholly owned subsidiary Norwalk Savings Society (Bank) and NSS Realty Corporation (NSSR), the Bank's wholly owned subsidiary, and reflected in the accompanying Consolidated financial statements. The financial statements of NSSR are not significant to either the Bank's or the Consolidated financial statements. Formation of Holding Company At the Bank's annual meeting on May 20, 1997, Shareholders approved the formation of a bank holding company. On July 24, 1997, the Federal Reserve Bank of New York approved the Bank's application to form a bank holding company and on October 1, 1997 the Company was formed as a bank holding company and parent company of the Bank. Nature of Operations The Bank is primarily engaged in the business of providing credit secured by residential real estate and retail banking services to the consumer segment of its service area, which is in and around the Norwalk, Connecticut area. Its operations are regulated by the Banking Commissioner of the State of Connecticut and its deposit accounts are insured by the Federal Deposit Insurance Corporation, and as such its activities are subject to periodic examination by both agencies. NSSR is a special-purpose subsidiary whose operations consist of the development and sale of certain of the real property acquired by the Bank in satisfaction of loans. Principles of Consolidation The accompanying Consolidated financial statements include the accounts of the Company and the Bank. Inasmuch as the results of the operations of NSSR and the financial condition of NSSR are wholly dependent on the financial and administrative support of the Bank, separate financial information on NSSR has not been provided. All significant intercompany accounts and transactions have been eliminated in consolidation. Basis of Consolidated Financial Statement Presentation The accompanying Consolidated financial statements have been prepared in accordance with generally accepted accounting principles and general practice within the banking industry. In preparing the Consolidated financial statements, management is required to make estimates and assumptions that effect the reported amounts of assets, liabilities, income and expenses, and disclosure of contingent assets and liabilities. Actual results could differ significantly from those estimates. Material Estimates Material estimates that are particularly susceptible to significant change in the near-term relate to the determination of the Allowance for credit losses and the valuation of real estate acquired in satisfaction of loans (other real estate owned or OREO). Such estimates reflect the realization that the Bank's OREO and a substantial portion of the Bank's mortgage loans receivable are related to real estate located in markets in and around Norwalk, Connecticut, which have experienced value fluctuations in recent years. While management uses available information to recognize possible losses on loans and OREO, including the services of professional appraisers for significant properties, future adjustments to the Allowance for credit losses and valuation of OREO may be necessary based on changes in economic and real estate market conditions in and around the Bank's service area. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Bank's Allowance for credit losses and valuation of OREO and may require the Bank to recognize adjustments based on their judgment of information available to them at the time of their examination. Cash Equivalents For the purposes of reporting cash flows in the Consolidated statements of cash flows, cash equivalents include federal funds sold and interest-bearing deposits in other financial institutions. Securities Securities are accounted for in accordance with the Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities" (SFAS No. 115). This statement establishes standards of financial accounting and reporting for investments in equity securities that have readily determinable fair values and for all investments in debt securities. SFAS No. 115 requires the classification of investment securities into categories of Held-to-maturity, Available-for-sale or Trading. Investments in debt securities are classified as Held-to-maturity only if there is a positive intent and ability to hold those securities to maturity. Carrying basis is reflected at amortized cost and adjusted for any premiums or discounts. Premiums are amortized and discounts are accreted to interest income using the level yield method. Securities classified as Trading comprise securities purchased in connection with the Bank's trading activities and, as such, are expected to be sold in the near-term. Trading securities are carried at estimated fair value with unrealized holding gains and losses recognized in Non-interest income. Equity securities and debt securities not classified as Held-to-maturity or Trading are classified as Available-for-sale. Securities classified as Available-for- sale are carried at estimated fair value, with net unrealized holding gains and losses reported as a separate component of Shareholders' equity, net of applicable income taxes. A decline in the estimated fair value of any security below its carrying value that is deemed by management to be other than temporary results in a write-down of the individual security to its estimated fair value. Such write-downs are recognized as a realized loss in earnings in the accompanying Consolidated financial statements. Mortgage-backed securities are accounted for in the same manner as debt securities and consist of certificates that are participation interests in pools of long-term first mortgage loans. Gain or loss on dispositions of securities is based on the net proceeds and adjusted carrying amount of the securities sold using the specific identification method. Loans Held for Sale Loans held for sale generally consist of certain first mortgage loans that management has identified will most likely be sold for reasons of managing rate risk, liquidity, and/or asset growth and are reflected at the lower of aggregate cost or estimated fair value. Net unrealized losses, if any, resulting from estimated fair value less than cost are recognized through a valuation allowance by a charge to earnings in the accompanying Consolidated Financial Statements. Loans Receivable Loans receivable that the Bank has the intent and ability to hold for the foreseeable future or until maturity or payoff are reflected at amortized cost (unpaid principal balances reduced by any partial charge-offs or specific valuation accounts) net of any net deferred fees or costs on originated loans or any unamortized premiums or discounts on purchased loans, and less an Allowance for credit losses. Effective January 1, 1995, the Bank implemented the provisions of SFAS Nos. 114/118, "Accounting by Creditors for Impairment of a Loan" (SFAS Nos. 114/118). These statements address the accounting for loans considered impaired and the recognition of impairment. A loan is considered impaired when, in management's judgment, current information and events indicate it is probable that collection of all amounts due according to the contractual terms of the loan agreement will not be met. An impairment loss is recognized through a valuation allowance by charges to income. The provisions of these statements are prospective, with any adjustments resulting from initial application reflected as an adjustment to the provision for credit losses. The effect on the accompanying Consolidated financial statements of adopting these statements was not significant. Interest on loans is included in income as earned based on rates applied to principal amounts outstanding. The accrual of interest income is generally discontinued and all previously unpaid accrued interest is reversed when a loan becomes past due 90 days or more as to contractual payments of principal or interest, or is determined to be impaired. Management may elect to continue the accrual of interest when the estimated net realizable value of collateral is sufficient to cover the principal balance and accrued interest. Interest on purchased loans is adjusted for the accretion of discounts and the amortization of premiums using the interest method over the contractual lives of the loans, adjusted for estimated prepayments. Loan origination fees and certain direct related costs are deferred, and the net fee or cost is amortized as an adjustment of the loan yield over the life of the related loan. The Allowance for credit losses has been established by provisions charged to income, decreased by loans charged off (net of recoveries). This Allowance represents an amount which, in management's judgment, is adequate to absorb possible losses on loans that may become uncollectible based on such factors as the Bank's past loan loss experience, changes in the nature and volume of the loan portfolio, current and prospective economic conditions that may affect the borrower's ability to pay, overall portfolio quality, and review of specific problem loans. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated future cash flows. Effective January 1, 1997, the Bank implemented the accounting for mortgage servicing rights provided for in SFAS 125. This statement requires recognition of the value of the rights to service mortgage loans (MSR's) for others as a separate asset, however those servicing rights are acquired, and assessment for impairment based on fair value. Capitalized MSR's are amortized to Non-interest income in proportion to estimated mortgage service fee revenues. Any impairment adjustments are reflected through a valuation allowance recognized by a charge or credit to Non-interest income. The effect on the accompanying Consolidated financial statements of adopting this statement was not significant. Bank Premises and Equipment Bank premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation is computed by accelerated and straight-line methods, generally at rates based on estimated useful lives of the related assets. Bank premises are generally depreciated over periods ranging from 10 to 50 years; furniture and equipment are generally depreciated over periods ranging from 3 to 20 years. For income tax purposes, the Bank uses the appropriate depreciation provisions of the Internal Revenue Code. Other Real Estate Owned (OREO) OREO includes real estate properties that are held for sale which have been acquired through foreclosure proceedings or deeds accepted in lieu of foreclosure. These properties are initially recorded at the lower of the carrying value of the related loans or the estimated fair value of the real estate acquired, with any excess of the loan balance over the estimated fair value of the property charged to the Allowance for credit losses. Subsequent changes in net realizable values are reflected by charges or credits to the Allowance for estimated losses on OREO. Costs relating to the subsequent development or improvement of a property are capitalized when value is increased. All other holding costs and expenses, net of rental income, if any, are expensed as incurred. Goodwill The goodwill acquired in connection with the Fairfield First Bank and Trust Company transaction (Note 18) is being amortized on a straight-line basis over six years. Income Taxes Deferred income tax assets and liabilities are recognized for the future tax consequences attributable to temporary differences, which are differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases. Deferred income tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred income tax assets and liabilities of a change in tax rates is recognized in earnings in the period that includes the enactment date. Provisions for income taxes are computed based on all taxable revenue and deductible expense items included in the accompanying Consolidated statements of earnings regardless of the period in which such items are recognized for income tax filing purposes. The Company and the Bank file consolidated Federal and combined Connecticut income tax returns. Employee Retirement Benefits Employee retirement benefits and related deferred assets and/or liabilities are accounted for in accordance with SFAS No. 106, "Employers'Accounting for Postretirement Benefits Other than Pensions" (SFAS No. 106). Post-retirement health care expenses are based on actuarial computations of current and future benefits. Earnings Per Share (EPS) Per share data is based on the weighted average number of outstanding common shares in accordance with the requirements of SFAS 128. EPS data for prior years and quarterly periods have been restated accordingly. Financial Instruments Financial instruments include substantially all the Bank's financial assets and liabilities, and certain off-balance-sheet rights and/or obligations. Such items generally reflect cash and cash equivalents and contractual rights or obligations to receive cash or other financial instruments, respectively. Derivative financial instruments are financial instruments used to construct a transaction that is derived from and reflects the underlying value of assets, other instruments or various indices. The primary purpose of derivative financial instruments is to transfer price risk associated with the fluctuations in asset values rather than borrow or lend funds. Such items include forward contracts, interest rate swap contracts, options and futures, and other financial instruments with similar characteristics, which include the Bank's off-balance-sheet financial instruments (Note 15). All derivative financial instruments held or issued by the Bank are held or issued for purposes other than trading. In accordance with SFAS No. 105, "Disclosure of Information About Financial Instruments with Off-Balance-Sheet Risk and Concentrations of Credit Risk," SFAS No. 107, "Disclosures About Fair Value of Financial Instruments," and SFAS No. 119, "Disclosure About Derivative Financial Instruments and Fair Value of Financial Instruments," the Bank is required to disclose information about financial instruments with off-balance-sheet market or credit risk and concentrations of credit risk associated with its financial instruments (Notes 14 and 15), fair values of its financial instruments (Note 15), and information about its derivative financial instruments (Note 15), respectively. Reclassification Certain reclassifications have been made to the accompanying 1996 and 1995 Consolidated financial statements to conform to the 1997 presentation. 2. Securities Securities have been classified in the accompanying Consolidated statements of financial condition according to management's intent. Carrying amounts and approximate fair values of Securities consisted of the following:
December 31, 1997 Amortized Gross Unrealized Holding Fair ($ thousands) Cost Gains Losses Value Trading Equity Securities $ 1,976 $ 4 $(150) $ 1,830 Available-for-Sale U.S. Government and Agency Obligations $ 55,122 $ 190 $ (55) $ 55,257 Mortgage-Backed Securities 85,543 461 (56) 85,948 Mutual Funds 2,183 10 (58) 2,135 Preferred Stock 33,792 1,267 - 35,059 Equity Securities 116 152 - 268 Total $176,756 $2,080 $(169) $178,667 December 31, 1996 Amortized Gross Unrealized Holding Fair ($ thousands) Cost Gains Losses Value Trading Equity Securities $ 3,353 $ 46 $(107) $ 3,292 Available-for-Sale U.S. Government and Agency Obligations $ 42,436 $ 145 $(461) $ 42,120 Mortgage-Backed Securities 92,443 382 (372) 92,453 Mutual Funds 2,011 88 (12) 2,087 Equity Securities 99 50 - 149 Total $136,989 $ 665 $(845) $136,809
The scheduled contractual maturities of debt securities at December 31, 1997 were as follows: Amortized Fair ($ thousands) Cost Value Due After One Year Through Five Years $ 3,000 $ 2,996 Due After Five Years Through Ten Years 43,002 43,187 Due Over Ten Years 9,120 9,074 55,122 55,257 Mortgage-Backed Securities 85,543 85,948 Total $140,665 $141,205
Proceeds and gross realized gains and losses from sales of securities classified as Available-for-sale and Trading securities gains and losses consisted of the following:
Years Ended December 31, ($ thousands) 1997 1996 1995 Available-For-Sale Proceeds from Sales $81,926 $37,261 $62,062 Gross Realized Gains $ 776 $ 1,157 $ 985 Gross Realized Losses (88) (464) (182) Net Realized Gains (Losses) 688 693 803 Trading Realized Gains 683 24 - Gross Change in Unrealized Losses (256) (56) (5) Trading Gains (Losses), Net 427 (32) (5) Net Security Gains $ 1,115 $ 661 $ 798
During the year ended December 31, 1996, the Bank transferred securities Available-for-sale with a carrying basis of approximately $2.2 million to the classification of Trading and securities Held-to-maturity with an amortized cost of approximately $30.5 million to the classification of Available-for- sale at their estimated fair value of approximately $30.6 million. The transfer of securities Held-to-maturity to the classification of Available- for-sale was the result of management's assessment that there was no longer a positive intent to hold these securities to maturity based on management's revised asset/liability management strategies. Gross unrealized gains and losses reflected in the accompanying Consolidated statements of earnings for the year ended December 31, 1996 as a result of the transfer to Trading were approximately $95,000 and $41,000, respectively. Net unrealized gains, net of tax effect, which were reflected in the accompanying Consolidated statements of shareholders' equity as a result of the transfer to Available- for-sale were approximately $46,000. At December 31, 1997, the aggregate amortized cost of securities pledged as collateral against public funds and securities sold under agreements to repurchase (Note 7) were approximately $6.0 million and $51.3 million, respectively, which approximated fair values. At December 31, 1997, the Bank was committed to purchase approximately $10.4 million of Mortgage-backed securities. 3. Loan Receivable The components of Loans Receivable, net in the accompanying Consolidated statements of financial condition consisted of the following:
December 31, ($ thousands) 1997 1996 Loans Secured by Real Estate: One-to-Four Family Residential $353,225 $344,314 Commercial and Multi-Family 61,162 54,550 Construction and Land Development 2,942 1,227 417,329 400,091 Consumer 7,353 10,302 Commercial 7,587 8,425 Total Loans Receivable 432,269 418,818 Less: Net Deferred Fees, Premiums and Discounts (625) (718) 431,644 418,100 Allowance for Credit Losses (5,832) (7,334) Loans Receivable, Net $425,812 $410,766 Loans receivable carry interest rate terms as follows: December 31, ($ thousands) 1997 1996 Fixed Rate $ 97,763 $110,245 Variable Rate 334,506 308,573 Total Loans Receivable $432,269 $418,818
Activity in the Allowance for credit losses consisted of the following: Years Ended December 31, ($ thousands) 1997 1996 1995 Balance - January 1 $7,334 $4,170 $4,827 Allowance on Acquired Loans (1) - 1,000 - Provisions (Credit) for Credit Losses: Regular - 4,415 2,105 ADP (2) - - (1,100) Net Provision for Credit Losses - 4,415 1,005 Loans Charged-Off or Settled at Loss: Regular (2,155) (2,488) (662) ADP (2) - - (1,137) Total Loans Charged-Off or Settled at Loss (2,155) (2,488) (1,799) Recoveries of Loans Previously Charged-Off 653 237 137 Net Loans Charged-Off (1,502) (2,251) (1,662) Balance - December 31 $5,832 $7,334 $4,170
(1) In connection with the Fairfield First Bank and Trust Company transaction (Note 18), the Bank reflected approximately $1.0 million as an allowance against the acquired loans. This valuation allowance reflects the estimated credit risk associated with the respective loans and was based on the Bank's valuation analysis of the loans acquired in the transaction. The Allowance for credit losses at December 31, 1997 includes a remaining balance in the acquired allowance of approximately $575,000. (2) In conjunction with the Bank's stock conversion in June 1994 (Note 12), the Bank made a special provision for credit losses of $3.1 million and a special provision for estimated losses on OREO of $2.6 million in order to more rapidly dispose of certain non-performing assets at discounts below their net realizable value. As of December 31, 1995 the Bank had absorbed approximately $2.0 million of the special allowance for credit losses and $2.6 million of the special allowance for OREO losses through packaged or individual discounted sales of loans and OREO or other discounted settlements of non-performing assets with borrowers. The Bank concluded the "Accelerated Disposition Program" or "ADP" on December 31, 1995 and reflected a credit to the Provision for credit losses in the amount of $1.1 million for the unused portion of the special provisions for estimated losses. Total non-performing assets sold or otherwise settled under the ADP aggregated approximately $3.7 million of loans and $12.4 million of OREO. The Bank has sold the rights to receive payments of interest and principal on certain loans while retaining the related servicing rights (Note 1). Aggregate principal balances of loans serviced for others that are not reflected in the accompanying Consolidated statements of financial condition approximated $73.3 and $69.7 million at December 31, 1997 and 1996, respectively. During the years ended December 31, 1997 and 1996, the Bank sold mortgage loans with carrying amounts aggregating approximately $12.8 and $45.4 million, respectively. All of the sales during the year ended December 31, 1997 were sold with servicing retained, while all of the sales during the year ended December 31, 1996 were sold with servicing released. As a result of such sales, a net gain approximating $344,000 and a net loss approximating $144,000 are reflected in Non-interest income in the accompanying Consolidated statements of earnings for the years ended December 31, 1997 and 1996, respectively. There were no significant loan sales during the year ended December 31, 1995. At December 31, 1997, capitalized mortgage servicing rights reflected in Other assets in the accompanying Consolidated statements of financial position aggregated approximately $184,000, net of a valuation allowance which approximated $50,000 (Note 1). At December 31, 1996, the Bank had no capitalized mortgage servicing rights. During the year ended December 31, 1995, loans securitized into participation certificates (Note 1) issued by the Federal Home Loan Mortgage Corporation (FHLMC), with servicing retained, aggregated approximately $4.4 million. There were no loan securitizations during the years ended December 31, 1997 or 1996. At December 31, 1997, the Bank was committed to sell approximately $5.6 million of fixed rate mortgage loans to FHLMC. SFAS Nos. 114/118 (Note 1) applies to loans that are individually evaluated for impairment in accordance with the Bank's ongoing loan review procedures. The Bank's recorded investment in impaired loans and related Allowance for credit losses measured under SFAS Nos. 114/118 approximated $4.8 million and $0.6 million at December 31, 1997 and $10.4 million and $1.4 million at December 31, 1996, respectively. The average recorded investment in impaired loans during the years ended December 31, 1997 and 1996 was approximately $8.9 million and $11.7 million, respectively. During the years ended December 31, 1997, 1996 and 1995 amounts recognized as interest income on impaired loans were not significant. At December 31, 1997, the Bank had no commitments outstanding to lend additional funds to debtors whose loans were determined to be impaired. Loans to directors and their associates aggregated approximately $289,000 and $341,000 at December 31, 1997 and 1996, respectively. These related party loans are made on substantially the same terms, including interest rates and collateral requirements, as those prevailing at the time for comparable transactions with unrelated persons and do not involve more than normal risk of collectibility. 4. Other Real Estate Owned (OREO) OREO, net consisted of the following:
December 31, ($ thousands) 1997 1996 Real Estate Owned: One-to-Four Family Residential $250 $272 Commercial Real Estate 324 586 Total Real Estate Owned 574 858 Allowance for Estimated Losses - - OREO, Net $574 $858 Activity in the Allowance for estimated losses consisted of the following: Years Ended December 31, ($ thousands) 1997 1996 1995 Balance - January 1 $ - $ - $ 802 Provision Charged to Expense - 459 460 Losses Charged to the Allowance: Regular - (459) (494) ADP (Note 3) - - (768) Total Losses Charged to the Allowance - (459) (1,262) Balance - December 31 $ - $ - $ - (Gains) Losses and expenses, net related to OREO consisted of the following: Years Ended December 31, ($ thousands) 1997 1996 1995 Provision Charged to Expense $ - $ 459 $ 460 Gains on Sales (312) (73) (163) Losses on Sales 3 624 390 (Gains) Losses on Sales, Net (309) 551 227 Holding Costs and Expenses 242 523 839 Rental Income (36) (171) (111) Holding Costs and Expenses, Net 206 352 728 (Gains) Losses and Expenses of OREO, Net $(103) $1,362 $1,415
5. Bank Premises & Equipment Bank premises and equipment, net consisted of the following:
December 31, ($ thousands) 1997 1996 Banking House and Land $4,086 $4,086 Furniture, Equipment and Autos 2,886 2,317 Leasehold Improvements 673 82 Total Bank Premises and Equipment 7,645 6,485 Accumulated Depreciation and Amortization (3,907) (3,334) Bank Premises and Equipment, Net $3,738 $3,151
Depreciation and amortization expense included in Non-interest expense in the accompanying Consolidated statements of earnings for the years ended December 31, 1997, 1996 and 1995 was approximately $587,000, $521,000 and $391,000, respectively. The Bank has operating leases for certain branch and administrative offices and equipment. Rental expense of $365,000, $333,000 and $220,000 is included in Occupancy and equipment expense in the accompanying Consolidated statements of earnings for the years ended December 31, 1997, 1996 and 1995, respectively. The office leases contain provisions which provide for adjustments of the rent to reflect changes in cost of living and real estate taxes. During the year ended December 31, 1995, the Bank entered into an operating lease agreement for office space with one of its directors. Amounts included in Occupancy and equipment expense in the accompanying Consolidated statements of earnings for the years ended December 31, 1997, 1996 and 1995 relating to this lease aggregated approximately $49,000, $49,000 and $32,000, respectively. Future minimum payments under non-cancellable operating leases with initial or remaining terms of one year or more at December 31, 1997 consisted of the following: Years Ending December 31, Amount ($ thousands) 1998 $ 322 1999 320 2000 284 2001 237 2002 181 Thereafter 674 Total Future Minimum Lease Payments $2,018 6. Deposits Deposits consisted of the following:
December 31, 1997 1996 Weighted Average Weighted Average ($ thousands) Rates (a) Amount Rates (a) Amount Demand - $ 27,471 - $ 22,479 NOW 1.00-2.47% 37,287 1.00-2.75% 30,262 Regular Savings 1.99 29,455 1.99 28,096 Money Market and Super Savings 2.23-3.40 103,404 1.99-2.98 93,361 Time Accounts 5.47 241,867 5.54 244,127 Escrow 2.80 4,727 3.10 4,965 Total Deposits $444,211 $423,290
(a) ranges indicate tiers Scheduled maturities of Time accounts at December 31, 1997 were as follows: Weighted Year of Maturity Average Stated Rate Amount ($ thousands) 1998 5.12% $146,109 1999 5.85% 70,623 2000 6.51% 20,757 2001 5.95% 3,466 2002 5.73% 912 Total Time Accounts 5.47% $241,867 Time accounts of $100,000 or more approximated $24.3 million at December 31, 1997. Of that amount approximately $9.3 million mature in six months or less, $5.2 million mature after six months to one year, and $9.8 million mature after one year. Interest expense on deposits consisted of the following:
Years Ended December 31, ($ thousands) 1997 1996 1995 NOW $ 383 $ 309 $ 242 Regular Savings 619 436 507 Money Market and Super Savings 2,967 3,411 3,902 Time Accounts 13,069 12,580 9,434 Escrow 102 108 84 Total Interest Expense on Deposits $17,140 $16,844 $14,169
7. Borrowed Funds Advances from Federal Home Loan Bank of Boston (FHLBB) Terms of the Advances from FHLBB at December 31, consisted of the following:
1997 1996 Weighted Weighted Average Average Maturity/ Interest Interest ($ thousands) Reprice Date Rate Amount Rate Amount Fixed Rate 1997 -% $ - 5.72% $26,250 1998 5.92 95,000 5.91 40,000 2013 6.55 1,537(a) 6.55 1,558(a) Adjustable Rate 1997 - - 5.61 10,000 1999/1998 5.94 4,400 5.73 4,400 2002/1998 5.90 10,000 - - Total Advances from FHLBB $110,937 $82,208
(a) amortizing with monthly payment of $10,358 and balloon payment of $917,000 at maturity The Bank has a cash management line of credit with FHLBB approximating $11.8 million. There were no advances outstanding on the line at December 31, 1997 or 1996. The Bank's investment in the stock of the FHLBB, mortgage loans and mortgage-backed securities with market values as determined in accordance with FHLBB's blanket collateral pledge agreement, at least equal to the outstanding advances and any unused line of credit, are pledged against outstanding advances from the FHLBB. Securities Sold Under Agreements to Repurchase (Repurchase Agreements) (Note 2) Information concerning Repurchase agreements consisted of the following:
Years Ended December 31, ($ thousands) 1997 1996 Average Balance During the Year $33,847 $29,203 Maximum Month-End Balance During the Year $40,441 $36,350 Average Interest Rate During the Year 5.90% 5.61%
Repurchase agreements aggregating approximately $9.4, $21.0, and $10.0 million mature during the years ending December 31, 1998, 2000 and 2002, respectively. Interest Expense Interest expense on borrowed funds consisted of the following:
Years Ended December 31, ($ thousands) 1997 1996 1995 Advances from FHLBB $7,359 $5,158 $4,015 Repurchase Agreements 1,997 1,638 214 Total Interest Expense on Borrowed Funds $9,356 $6,796 $4,229
8. Employee Benefit Plans Incentive Savings Plan The Bank sponsors an incentive savings plan which is available to substantially all of its employees. The Bank may make a discretionary 50% match of employee contributions up to 4% of each employee's salary. The Bank's matching expense contributions, included in Salaries and employee benefits in the accompanying Consolidated statements of earnings for the years ended December 31, 1997, 1996 and 1995, approximated $96,000, $86,000 and $60,000, respectively. Postretirement Benefits Other Than Pensions The Bank provides certain health care, dental care and life insurance benefits to previously retired employees. The net periodic postretirement benefit cost included in Salaries and employee benefits in the accompanying Consolidated statements of earnings approximated $44,000 for each of the years ended December 31, 1997, 1996 and 1995. The unrecognized transition obligation aggregated approximately $202,000 and $224,000 at December 31, 1997 and 1996, respectively, and will be amortized over a remaining ten-year assumed benefit period from December 31, 1997. Employee Stock Ownership Plan (ESOP) The Bank established a leveraged ESOP and a related trust in connection with its stock conversion in 1994 (Note 12) as a long-term non-contributory benefit for substantially all of its employees. In accordance with the terms of its Plan of Conversion, the Bank sold to the ESOP 5% of the shares issued in its conversion, or 121,337 shares at $10 per share, the stated conversion offering price. Effective with the formation of NSS Bancorp, Inc. (Note 1), the ESOP shares were converted to shares of NSS Bancorp, Inc. The shares were purchased by the ESOP with the proceeds of a five-year LIBOR-based interest-bearing loan from a third party lender, which was guaranteed by the Bank and required the pledge of an interest-bearing deposit at the third party lender as security for its guarantee. The loan terms also required monthly payments of principal and interest. At December 31, 1996 and 1995 the interest rate on the loan was 6.86%. The ESOP refinanced the loan during 1997 with the proceeds of a two-year fixed rate loan with another third party lender. Terms of the refinance require monthly payments of principal including interest at 7.75%. Additionally, the Bank guarantees the loan and the ESOP has pledged 44,000 shares of its stock in the Company as collateral for the loan. The loan is reflected in the accompanying Consolidated statements of financial condition as a long-term debt and a reduction of Shareholders' equity. Interest expense on the loan included in Salaries and employee benefits expense in the accompanying Consolidated statements of earnings approximated $28,000, $45,000 and $60,000 for the years ended December 31, 1997, 1996 and 1995, respectively. The shares are held by the ESOP in trust and are committed to be issued to employees' accounts in the ESOP ratably over a five-year period in settlement of the Bank's agreed-upon annual ESOP benefit cost. The Bank's ESOP benefit cost, included in Salaries and employee benefits in the accompanying Consolidated statements of earnings, aggregated approximately $567,000, $560,000 and $434,000 for the years ended December 31, 1997, 1996 and 1995, respectively. The difference between the annual ESOP benefit cost and the cost basis of the shares to be committed is charged or credited to Additional paid-in capital. Activity in the shares subject to the ESOP consisted of the following:
Years Ended December 31, 1997 1996 1995 Shares - Beginning 44,817 70,514 97,070 Shares Committed to be Released (18,543) (25,697) (26,556) Shares - Ending 26,274 44,817 70,514 Shares Allocated to ESOP 25,697 26,556 24,267
9. Income Taxes The components of the federal and state income tax provision (benefit) consisted of the following:
Years Ended December 31, 1997 1996 1995 Current Income Tax Provision: Federal $1,542 $ 150 $ - State 431 25 10 Total Current Income Tax Provision 1,973 175 10 Deferred Income Tax Provision (Benefit): Federal 955 (960) (984) State 402 (340) (216) Total Deferred Income Tax Provision (Benefit) 1,357 (1,300) (1,200) Income Tax Provision (Benefit), Net $3,330 $(1,125) $(1,190)
The significant components of the deferred income tax provision (benefit) consisted of the following:
Years Ended December 31, 1997 1996 1995 Allowances for Losses $ 450 $ (869) $ 820 Basis Difference - Securities (45) (389) (265) Deferred Compensation and Benefits (33) (106) (18) Deferred Loan Fees 107 264 389 Depreciation (16) 75 - Goodwill (80) - - Net Operating Losses 1,037 3,031 1,236 Other, Net (63) (42) 26 1,357 1,964 2,188 Valuation Allowance - (3,264) (3,388) Total Deferred Income Tax Provision (Benefit) $1,357 $(1,300) $(1,200)
The Company's effective income tax rate differed from the federal statutory tax rate of 34% as follows:
Years Ended December 31, 1997 1996 1995 ($ thousands) Amount % Amount % Amount % Tax at Statutory Federal Rate $3,024 34.0 $ 1,556 34.0 $1,220 34.0 State Tax* 616 6.9 167 3.6 276 7.7 Capital Loss Carryover Benefit - - (95) (2.1) (200) (5.6) Effect of ESOP 152 1.7 108 2.4 65 1.8 Dividends Received Deduction (474) (5.3) - - - - Current Loss Carryover Benefit - - (1,930) (42.2)(1,322) (36.9) Future Loss Carryover Benefit - - (1,037) (22.7)(1,200) (33.4) Federal Minimum Tax - - 150 3.3 - - Other 12 0.1 (44) (0.9) (29) (0.8) Total and Effective Rate $3,330 37.4 $(1,125) 24.6$(1,190) (33.2) * Net of Federal tax benefit
The tax effects of significant components of temporary differences and net unrealized gains (losses) on securities Available-for-sale that give rise to deferred income tax assets and deferred income tax liabilities consisted of the following:
December 31, ($ thousands) 1997 1996 Deferred Income Tax Assets: Allowance for Credit Losses $1,349 $1,798 Goodwill 99 19 Employee Benefits 181 149 Unrealized Trading Loss, Net 62 25 Future Loss Carryover Benefit - 1,037 Other, Net 63 - Deferred Income Tax Asset 1,754 3,028 Deferred Income Tax Liabilities: Depreciation 59 75 Basis Difference on Securities 59 68 Deferred Loan Fees 493 385 Deferred Income Tax Liability 611 528 Net Deferred Income Tax Asset - Operations 1,143 2,500 Tax (Provision) Benefit on Unrealized (Gains) Losses on Securities Available-for-Sale (782) 74 Deferred Income Tax Asset, Net $ 361 $2,574
At December 31, 1995, management reviewed its projections of future profitability and determined that $1.2 million of net deferred income tax asset was more likely than not realizable in the future. During the fourth quarter of 1996, management reviewed the Bank's estimated profitability for the year ended December 31, 1996 and, on a projected basis, for the year ending December 31, 1997. Based on this review, management determined that it was more likely than not that the Bank's net deferred tax assets, including available future net operating loss benefits of approximately $1.1 million as of December 31, 1996 were realizable, and therefore, reversed the existing valuation allowance against net deferred tax assets. Realization of the Bank's net deferred tax assets is dependent, however, on various factors and is not assured. During the years ended December 31, 1996 and 1995, the Bank was able to absorb approximately $278,000 and $494,000, respectively, of available capital loss carryforwards, the benefits of which approximated $95,000 and $200,000, respectively, which benefits had not been previously reflected in deferred income tax assets. Deductions from taxable income in prior years have been claimed as loan loss provisions for qualifying (real estate) loans in accordance with the Internal Revenue Code. Retained earnings at December 31, 1997 includes a tax reserve for qualifying loans aggregating approximately $4.6 million. If the reserve is used for any purpose other than to absorb losses on loans, an income tax liability could be incurred. Management does not anticipate that this reserve will be made available for any purposes other than to absorb losses on loans. In accordance with generally accepted accounting principles, no deferred income taxes have been provided for this temporary difference. In August 1996, Congress amended the Internal Revenue Code retroactively to January 1, 1996 relative to existing tax bad debt reserves of savings banks as well as to allowable methods of taking future tax bad debt deductions. The amendment requires savings banks with "excess tax bad debt reserves," as defined, to recapture such excess into taxable income ratably over the next six to eight years beginning in 1996. In addition, future tax bad debt deductions will be based solely on loan charge-offs. Based on the Bank's tax return as filed for the year ended December 31, 1995, the Bank has an excess tax bad debt reserve approximating $1.9 million which is subject to recapture in accordance with the change in the tax law. A deferred income tax liability approximating $800,000 has been provided for this temporary difference and is reflected, net, in the deferred income tax asset related to the Allowance for credit losses. 10. Other Non-Interest Income & Other Non-Interest Expense
Years Ended December 31, ($ thousands) 1997 1996 1995 Other Non-Interest Income Credit card fees $1,396 $ 514 $ - All Other, None Greater than 1% of Income 518 378 268 Total $1,914 $ 892 $ 268 Other Non-Interest Expense Advertising and Marketing $ 779 $ 687 $ 700 Legal and Professional 872 779 354 Regulatory Assessments 55 9 438 Postage, Stationery and Supplies 782 746 626 Data Processing 977 921 702 Credit Card Processing Costs 1,148 382 - Insurance 217 228 237 Goodwill Amortization (Note 18) 326 76 - All Other, None Greater than 1% of Income 1,184 981 679 Total Other Non-Interest Expense $6,340 $4,809 $3,736
Payments to a related party for advertising services for the years ended December 31, 1997, 1996 and 1995 approximated $456,000, $353,000 and $316,000, respectively, significant portions of which were reimbursements for payments by the related party to media companies. 11. Commitments & Contingencies Off-Balance-Sheet Risk The accompanying Consolidated financial statements do not reflect various commitments and contingent liabilities which arise in the normal course of business and which involve elements of credit risk, interest-rate risk and liquidity risk. These commitments and contingent liabilities are described in Note 15. Litigation The Company and the Bank are parties to certain litigation and claims arising from the normal course of business. After consultation with legal counsel, management is of the opinion that the liabilities, if any, arising from such litigation and claims will not be material to the consolidated financial condition. 12. Shareholders' Equity Stock Conversion On February 23, 1994, the Board of Directors unanimously adopted and approved the Bank's plan of Conversion (Conversion) to convert from a Connecticut- chartered mutual to a Connecticut-chartered capital stock savings bank through amendmentof its mutual charter and the sale of common stock to the Bank's depositors and others. Effective with the formation of the Company (Note 1), such stock was converted accordingly. As part of the Conversion, the Board of Directors adopted a tax-qualified employee stock ownership plan (ESOP) (Note 8). In addition, the Board has adopted stock option plans for the benefit of the employees and directors of the Bank, which became effective following approval by the Bank's shareholders at the Annual Meeting in April 1995. The options to be issued under the plans are granted on a post-Conversion basis and became exercisable as of the first annual anniversary date of the Conversion (Note 13). At the time of Conversion, the Bank established a liquidation account in an amount equal to its Retained earnings as of that date, which approximated $19.7 million. The liquidation account will be maintained for a period of ten years from the date of the Conversion for the benefit of eligible account holders who continue to maintain their accounts in the Bank after Conversion. In the event of a complete liquidation, each eligible account holder would be entitled to receive a liquidation distribution equal to the current amount in their subaccount balance. The Company and the Bank (Note 1) may not declare or pay dividends on its stock if such declaration and payment would violate statutory or regulatory requirements. Advisory Board Compensation During the year ended December 31, 1997, the Bank compensated any new advisory board members with shares of the Company's common stock in lieu of cash in accordance with a new policy. During the year ended December 31, 1996, the Bank compensated all advisory board members with shares of its common stock in lieu of cash. The Bank reflected compensation expense in Other non-interest expense in the accompanying Consolidated statements of earnings for the years ended December 31, 1997 and 1996 in the amounts of approximately $1,000 and $5,000, respectively, which represented the fair value of the shares on the dates of issuance. Dividends During the years ended December 31, 1997 and 1996, the Company, and formerly the Bank (Note 1), declared and paid cash dividends on common stock aggregating $0.35 and $0.15 per share, respectively, which totaled approximately $856,000 and $366,000, respectively. In January 1998 the Company declared a cash dividend of $0.10 per share to shareholders of record on February 9, 1998 and payable on February 27, 1998. Pursuant to Connecticut law, cash dividends may be paid by the Bank to the Company out of net profits, defined as the remainder of earnings from current operations plus actual recoveries of loans and investments and other assets, after deducting all current operating expenses, actual losses, accrued dividends on preferred stock and all federal and state taxes. Total dividends declared by the Bank in any calendar year shall not exceed the total of its profits for that year combined with its net profits for the preceding two years. Preferred Stock In May 1996, the Bank declared and paid a dividend distribution of one "Right" for each outstanding share of its common stock. Effective with the formation of NSS Bancorp, Inc. (Note 1), such Rights were converted accordingly. Each Right entitles the holder to purchase from the Company one one-hundredths of a share of preferred stock, at a price of $40.000 per one one-hundredths of a preferred share, subject to adjustment. The Rights are not exercisable except as a result of particular events, including certain acquisitions of 10% or more of the Company's common stock and certain exchange offers. If not sooner exercised, the Rights will expire in May 2006. Preferred shares purchasable upon exercise of the Rights will not be redeemable. Each preferred share will be entitled to a minimum preferential quarterly dividend payment of $1 per share but will be entitled to an aggregate dividend of 100 times the dividend declared per common share. In the event of liquidation, the holders of the preferred shares will be entitled to a minimum preferential liquidation payment of $100 per share but will be entitled to an aggregate payment of 100 times the payment made per common share. All liquidation payments are subject to the prior rights of Bank account holders to the Bank's "Liquidation Account". Each preferred share will have 100 votes, voting together with the common shares. In the event of any merger, consolidation or other transaction in which common shares are exchanged, each preferred share will be entitled to receive 100 times the amount received per common share. In the event that the Company is acquired in a merger or other business combination, proper provision shall be made so that each holder of a Right shall thereafter have the right to receive, upon the exercise thereof at the then current exercise price of the Right, that number of shares of common stock of the surviving company which at the time of such transaction would have a market value of four times the exercise price of the Rights. At any time prior to the close of business on the date that Rights holders become entitled to purchase preferred shares, the Company may redeem the Rights in whole, but not in part, at a price of $.001 per Right as adjusted. 13. Stock Options & Executive Incentive Plans Stock Option Plan During the year ended December 31, 1995, the Bank's Shareholders approved stock option plans (Plans) for the benefit of the Bank's employees and directors. Under the Plans, 169,872 and 72,802 shares of the Bank's common stock were reserved for the Employee and Director Plans, respectively. In April 1996, the Shareholders approved increasing the shares of common stock reserved by 150,000 shares. Effective with the formation of the Company (Note 1), such options to purchase common stock were converted accordingly. At December 31, 1997, 359,314 shares of common stock remained reserved under the Company's plans. Included in this amount are 108,477 shares of common stock reserved for the Director Plans and 250,837 shares of common stock reserved for the Employee Plans. The Company accounts for its stock options under APB 25 (Note 1). Accordingly, at the time options are granted no accounting entry is made; however, when options are exercised, proceeds are credited to Common stock for the par value of the options purchased and the excess of the option price over the par value of shares issued is credited to Additional paid-in capital. The exercise price of options granted equaled the fair market value of the shares on the dates granted. The following table summarizes the shares subject to options under the Plans for the years ended December 31, 1997 and 1996:
Directors Employees Total Outstanding at January 1, 1996 46,108 169,804 215,912 Granted in 1996 12,000 30,000(c) 42,000 Exercised in 1996 (2,831) (3,834) (6,665) Canceled in 1996 - (5,666) (5,666) Outstanding at December 31, 1996 55,277 190,304 245,581 Granted in 1997 12,000 36,000(c) 48,000 Exercised in 1997 (3,000) (15,201) (18,201) Outstanding at December 31, 1997 64,277(a) 211,103(b) 275,380(d) Exercisable at December 31, 1997: Options 64,277 146,770 211,047 Average Exercise Price $17.94 $15.80 $16.45
(a) Exercisable at prices ranging from $15 to $26.88. (b) Exercisable at prices ranging from $15 to $36.00. (c) Exercisable based on three-year vesting schedules from the dates of grant. (d) Expire after 10 years from dates of grant. Executive Incentive Plan During the year ended December 31, 1995, the Bank's Shareholders approved an incentive plan for certain of the Bank's executives. The Plan has a 10-year term during which awards of common stock can be made based on specific performance goals over a three-year period. Under the plan, 100,000 shares of the Company's common stock have been reserved. Effective with the formation of the Company (Note 1), such reserved shares were converted accordingly. The first measurement period covers the period January 1, 1995 to December 31, 1997. The Bank reflected expense provisions of approximately $42,000 and $200,000 in Salaries and employee benefits in the accompanying Consolidated statements of earnings for the years ended December 31, 1997 and 1996, respectively, relative to this plan; no compensation expense was reflected for the year ended December 31, 1995. In accordance with SFAS No. 123 (Note 1), the Company has elected to continue accounting for its stock options under APB 25. Had compensation cost for the Company's stock option plans been determined based on the fair value at the grant dates for awards granted during the years ended December 31, 1997, 1996 and 1995, which is consistent with the method under SFAS No. 123, the Company's net income and per share data would have been reduced to the pro forma amounts as follows:
Years Ended December 31, ($ thousands, except per share data) 1997 1996 1995 Net Income As Reported $5,565 $5,702 $4,778 Pro Forma $5,189 $5,456 $4,650 Income Per Share Basic: As Reported $2.31 $2.39 $2.04 Pro Forma $2.15 $2.29 $1.98 Assuming Dilution: As Reported $2.20 $2.34 $2.03 Pro Forma $2.05 $2.23 $1.97
14. Sigificant Group Concentration of Credit Risk The concentration of the Bank's loan portfolio by type of loan at December 31, 1997 and 1996 is set forth in Note 3. A substantial portion of these loans are collateralized by real estate located in markets in and around Norwalk, Connecticut. The Bank also has loan commitments, including unused lines of credit and amounts not yet advanced on construction loans, secured by real estate substantially located in these same markets. In addition, a substantial portion of the Bank's OREO at December 31, 1997 is located in those same markets. Accordingly, the ultimate collectibility of a substantial portion of the Bank's loan portfolio and the recovery of a substantial portion of the carrying amount of its OREO are particularly susceptible to changes in real estate market conditions in and around Norwalk, Connecticut. In the normal course of business the Bank may have deposits in correspondent accounts substantially in excess of depository insurance limits. To reduce the credit risk associated with such activities, the Bank periodically reviews the financial condition of such correspondent banks. 15. Financial Instruments Financial Instruments with Off-Balance-Sheet Risk The Bank is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers and basically includes commitments to extend credit. These instruments involve, to varying degrees, elements of credit risk in excess of amounts recognized in the accompanying Consolidated statements of financial condition. The contract or notional amounts of these instruments reflect the extent of the Bank's involvement in particular classes of financial instruments. The Bank's exposure to credit loss in the event of non-performance by the counterparty for commitments to extend credit is represented by the contractual notional amount of those instruments. Commitments to Extend Credit Loan commitments are agreements to lend to a customer as long as there is no violation of any condition established in the contract. These financial instruments are recorded in the financial statements when they are funded or when related fees are incurred or received. Loan commitments are subject to the same credit policies as loans and generally have fixed expiration dates or other termination clauses. Since commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained is based on management's credit evaluation of the counterparty. Collateral held is primarily residential and commercial real property. Interest rates are generally variable with the exception of the unadvanced portions of construction loans, which have fixed rates of interest and generally mature within one year. The contractual notional amounts of the Bank's credit commitments consisted of the following:
December 31, ($ thousands) 1997 1996 Loan Commitments Commitments to Extend Credit: One-to-Four Family Residences $9,542 $4,054 Commercial Loans 3,123 2,581 Letters of Credit 646 603 Unadvanced Portion of Construction Loans 1,209 1,823 Unused Lines of Credit: Home Equity 8,659 7,771 Consumer Loans 963 833 Consumer Credit Cards 2,167 1,080 Commercial Loans 6,169 1,689
Fair Value of Financial Instruments Estimating the fair values of financial instruments reflected in the Consolidated statements of financial condition includes the use of information that is highly subjective. The subjective factors include, among other things, the estimated timing and amount of cash flows, risk characteristics, and credit quality and interest rates, all of which are subject to change. As a result, fair values estimated could be significantly different from amounts actually realized or paid at settlement or maturity of the financial instruments. The following methods and assumptions were used to estimate the fair values of each class of financial instruments: Cash and equivalent investments. For those short-term instruments, the carrying amount is a reasonable estimate of fair value. Securities. Fair values are based on quoted market prices. Loans held-for-sale and loans receivable. Fair value for certain homogeneous categories of loans is estimated using quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. Fair value for other types of loans is estimated by discounting future cash flows using current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. Accrued income receivable and Investment in FHLBB stock. The carrying amounts approximate fair value. Deposit liabilities. Carrying amounts for checking, NOW accounts, regular and club savings, money market and mortgagors' escrow accounts are reasonable estimates of fair value, since they generally represent amounts payable on demand. Fair value of time deposits is estimated to be the present value of the deposits using rates currently offered for deposits of similar remaining maturities. Advances from FHLBB. The fair values of advances and borrowings from the FHLBB are estimated using rates which approximate the rates currently being offered by the FHLBB for similar remaining maturities. Securities sold under agreements to repurchase and Other borrowings. The fair value of these borrowings is estimated using rates which approximate rates currently being offered for similar borrowings and remaining maturities. Off-balance-sheet financial instruments. The fair values of commitments to extend credit and unadvanced lines of credit are estimated based on interest rates and fees currently charged to enter into similar transactions, considering the remaining terms of the commitments and the creditworthiness of the potential borrowers. Using the preceding assumptions, the estimated fair values of financial instruments reflected on the Consolidated statements of financial condition consisted of the following:
December 31, 1997 1996 Carrying Fair Carrying Fair ($ thousands) Amount Value Amount Value Financial Assets Cash and Due from Banks $ 11,486 $ 11,486 $ 14,978 $ 14,978 Federal Funds Sold and Interest-Bearing Deposits in Other Banks 10,555 10,555 3,873 3,873 Securities 180,497 180,497 140,101 140,101 Loans Held-for-Sale 5,311 5,311 - - Total Loans Receivable 432,269 443,083 418,818 411,200 Accrued Interest Receivable 3,859 3,859 4,034 4,034 Investment in FHLBB Stock 7,347 7,347 6,184 6,184 Financial Liabilities Deposits 444,211 445,900 423,292 424,740 Advances from FHLBB 110,937 110,940 82,208 81,958 Securities Sold Under Agreements to Repurchase 40,441 40,582 31,350 31,369 Other Borrowings 293 293 485 485 Off-Balance-Sheet Financial Instruments Commitments to Extend Credit * (a) * (a) (a) Amounts were not significant.
16. Regulatory Matters & Capital Adequacy The Company, on a consolidated basis, and the Bank are subject to risk-based capital standards regulations of the Federal Reserve Board and the Federal Deposit Insurance Corporation, respectively. These risked-based standards require a minimum ratio of total capital to risk-weighted assets of 8.0%. Of the required capital, 4.0% must be Tier 1 capital (primarily Shareholders' Equity). The Federal Reserve Board has supplemented these standards with a minimum leverage ratio of 3.0% of Tier 1 capital to total assets. The Federal Reserve Board has indicated that all but the most highly ranked bank holding companies should maintain a leverage ratio of 4.0% to 5.0% of Tier 1 capital to total assets. The Federal Deposit Insurance Corporation has adopted a similar requirement. The following table summarizes the capital ratios of the Company and the Bank at December 31, 1997: Leverage Risk-Based Capital Tier 1 Total NSS Bancorp, Inc. and Subsidiary 8.18% 15.36% 16.61% Norwalk Savings Society 7.55% 14.27% 15.52% 17. Branch Sale In October 1996, the Bank sold two of its branch office operations, comprised of deposits aggregating approximately $48.0 million, loans aggregating approximately $210,000, and premises and equipment amounting to approximately $307,000. As a result of the sale, the accompanying Consolidated statements of earnings for the year ended December 31, 1996 includes a total gain, reflected in Non-interest income, of approximately $3.64 million, which includes a deposit premium gain of approximately $3.6 million and a gain of approximately $33,000 from the sale of assets. 18. Acquisition of Assets & Related Liabilities FAIRFIELD FIRST BANK & TRUST COMPANY (FFB&T) In July 1996, the Bank assumed essentially all liabilities, primarily $47.6 million in deposits, and acquired certain assets of FFB&T, in an FDIC-assisted transaction. Certain of the commercial real estate loans acquired from the FDIC were simultaneously sold to another bank at an amount in excess of the Bank's bid price to the FDIC. The Bank has allocated the net purchase price to the assets acquired and the liabilities assumed based upon their fair values. The net acquired loans were reflected at a fair value of approximately $13.7 million, which was net of a valuation allowance of $1.0 million (Note 3), and the excess of the purchase price over the net assets acquired, which approximated $1.8 million and which management deems to represent a core deposit intangible, has been reflected as Goodwill. Goodwill net of accumulated amortization approximated $1.5 million and $1.8 million at December 31, 1997 and 1996, respectively, and is included in Other Assets in the accompanying Consolidated statements of financial condition. During the year ended December 31, 1997, the Bank and the FDIC completed a final settlement, which increased Goodwill approximately $95,000. Goodwill amortization included in Other non-interest expense in the accompanying Consolidated statements of earnings for the years ended December 31, 1997 and 1996 approximated $325,600 and $76,000, respectively (Note 10). 19. Condensed Financial Information NSS BANCORP, INC. (PARENT COMPANY ONLY) The condensed Statement of financial condition of NSS Bancorp, Inc. (Note 1) is as follows:
($ thousands) December 31, 1997 Assets Cash in Bank Subsidiary $ 4,019 Investment in Bank Subsidiary, at Equity 52,346 Other Assets 66 Total Assets $56,431 Liabilities and Shareholders' Equity Liabilities Notes Payable - Bank $ 293 Shareholders' Equity Preferred Stock - Common Stock 25 Additional Paid-In Capital 24,199 Retained Earnings 32,177(a) Less: Unearned ESOP Shares (263) Total Shareholders' Equity 56,138 Total Liabilities and Shareholders' Equity $56,431 (a) includes net unrealized gain on securities available-for-sale of $1,129, net of tax effect
The condensed Statement of earnings of NSS Bancorp, Inc. is as follows:
For The Initial Fiscal Period ended (Dollar amounts in thousands, except per share data) December 31, 1997 Income Dividends from Subsidiary $4,245 Expenses Interest Expense 6 Other 90 Total Expense 96 Income Before Income Taxes and Change in Equity of Subsidiary 4,149 Income Tax Benefit (59) Income Before Change in Equity of Subsidiary 4,208 Change in Equity of Subsidiary (2,514) Net Income $1,694 Per Share Data (Notes 1 and 13) Weighted Average Common Shares Outstanding (thousands): Basic 2,431 Assuming Dilution 2,577 Net Income Per Common Share: Basic $0.70 Assuming Dilution $0.66
The condensed changes in the components of Shareholders' Equity of NSS Bancorp, Inc. for the initial period from October 1, 1997 to December 31, 1997 were as follows:
Additional Common Paid-In Retained Unearned Stock Capital Earnings ESOP Shares (a) Balance - October 1, 1997 $ - $ - $ - $ - Formation (Note 1) 25 24,107 30,749 (291) Net Income - - 1,694 - Cash Dividends Declared on Common Stock (Note 12) - - (245) - Stock Options Exercised (4,067 shares) - 60 - - Change in Unrealized Gains (Losses) of Investment Securities Held by Bank Subsidiary (Note 2) - - (21) - ESOP Shares Committed to be Released - 31 - 28 Shares Distributed to Advisory Board (Note 12) - 1 - - Balance - December 31, 1997 $25 $24,199 $32,177 $(263)
(a) includes net unrealized gain on available-for-sale securites, net of tax effect. The condensed Statement of cash flows of NSS Bancorp, Inc. for the initial period October 1, 1997 to December 31, 1997 is as follows ($ thousands):
Cash Flows from Operating Activities Dividends Received from Subsidiary $4,245 Interest Paid (6) Cash Paid to Suppliers (39) Net Cash Provided by Operating Activities 4,200 Cash Flows from Investing Activities Cash Paid to Subsidiary Bank to Transfer Unearned ESOP shares (291) Cash Flows from Financing Activities Cash Received from Subsidiary Bank to Transfer Notes Payable - Bank 342 Payments on Notes Payable - Bank (47) Dividends Paid to Shareholders (245) Proceeds from Exercise of Stock Options 60 Net Cash Provided by Financing Activities 110 Net Increase in Cash 4,019 Cash - Beginning - Cash - End of Year $4,019 A reconciliation of net income to cash provided by operating activities is as follows ($ thousands): Net Income $1,694 Items Not Resulting in Cash Flow: Change in Equity of Undistributed Earnings of Subsidiary 2,514 Increase in Income Tax Benefits Receivable (59) Decrease in Other Assets 51 Net Cash Flow Provided by Operating Activities $4,200
20. Recent Accounting Pronouncements In June 1997 the FASB issued SFAS No. 130, "Reporting Comprehensive Income." This statement establishes standards for reporting and display of comprehensive income and its components (revenues, expenses, gains and losses) in a full set of general purpose financial statements, and requires that the accumulated balance of other comprehensive income be reported separately from retained earnings in the Consolidated statements of financial condition. The Company will be required to implement this statement in 1998. Management has not yet determined the effect, if any, which this statement may have on the future presentation of the Company's consolidated financial statements. 21. Quarterly Results of Operations (Unaudited) The quarterly results of consolidated operations consisted of the following ($ thousands, except per share data):
Quarters Ended 12/31/97 9/30/97 6/30/97 3/31/97 Interest and Dividend Income $11,876 $11,969 $11,179 $10,845 Interest Expense 6,782 6,928 6,601 6,185 Net Interest and Dividend Income 5,094 5,041 4,578 4,660 Provision for Credit Losses - - - - Non-Interest Income 1,617 1,507 1,262 860 Non-Interest Expense 4,120 3,906 3,913 3,785 Income Taxes 897 965 777 691 Net Income $ 1,694 $ 1,677 $ 1,150 $ 1,044 Income Per Share - Basic $0.70 $0.69 $0.48 $0.43 Income Per Share - Assuming Dilution $0.66 $0.66 $0.46 $0.42 Weighted Average Shares - Basic 2,431 2,418 2,407 2,400 Weighted Average Shares - Assuming Dilution 2,577 2,551 2,508 2,490 Quarters Ended 12/31/96 9/30/96 6/30/96 3/31/96 Interest and Dividend Income $10,920 $11,298 $9,962 $9,075 Interest Expense 6,376 6,638 5,650 4,976 Net Interest and Dividend Income 4,544 4,660 4,312 4,099 Provision for Credit Losses 3,205 405 405 400 Non-Interest Income 4,574 499 1,149 621 Non-Interest Expense 5,003 3,443 3,624 3,396 Income Taxes (1,147) - 17 5 Net Income $ 2,057 $ 1,311 $1,415 $ 919 Income Per Share - Basic $0.85 $0.55 $0.60 $0.39 Income Per Share - Assuming Dilution $0.83 $0.54 $0.58 $0.38 Weighted Average Shares - Basic 2,394 2,388 2,376 2,368 Weighted Average Shares - Assuming Dilution 2,466 2,446 2,424 2,420
22. Significant Shareholder Communication In November 1997, the Company received notice from a significant shareholder suggesting that the Company seriously explore a sale of the Company as a way of enhancing shareholder value. The Company issued a public response that it has continually articulated and implemented a strategy of enhancing shareholder value by remaining a community-based, independent financial institution and that its strategy will continue to serve shareholders well for the foreseeable future. Directors and Officers NSS Bancorp, Inc. Board Of Directors Donald St. John, Chairman Brian A. Fitzgerald Charles F. Howell Herbert L. Jay Robert T. Judson Dr. Edward J. Kelley John L. Segall Alan R. Staack Officers Robert T. Judson President & CEO Charles F. Howell Executive Vice President & COO Jere T. Dorney Senior Vice President & Secretary Marcus I. Braverman, CPA Senior Vice President, Treasurer & CFO Mary D. Ladewig Assistant Corporate Secretary NSS Bank Board Of Directors Donald St. John, Chairman Brian A. Fitzgerald Charles F. Howell Herbert L. Jay Robert T. Judson Dr. Edward J. Kelley John L. Segall Alan R. Staack Executive Officers Robert T. Judson President & CEO Charles F. Howell Executive Vice President & COO Jere T. Dorney Senior Vice President & Secretary Marcus I. Braverman, CPA Senior Vice President, Treasurer & CFO Vice Presidents Larry L. Bentley New Business Development Barbara Budnick Commercial Loan Officer Lawrence J. Bues Manager Commercial Loans Judy M. DeVito Loan Servicing John J. Duffy, Jr. Trust & Investment Management Kevin G. Gilmartin Area Manager Richard J. Homberger Loan Origination Robert J. Iannotti Finance & Controller Darryl W. Johnson Commercial Loan Officer Robert A. Locke Private Banking John A. Lynn Operations Wendy A. Macedo Area Manager E. Diana Napier Marketing Richard J. Stumpf Consumer Lending Stephen A. Thomas Loan Appraisal John J. Troy Area Manager Assistant Vice Presidents Nancy Austin Credit Card Manager Norma J. Bell Westport Avenue Branch Manager Joan Gilmartin Fairfield Branch Manager Dianne Merkey Commercial Loan Officer Willard M. Miley Caldor Branch Manager James Oligino Trust & Investment Management Lawrence A. Ruttenberg Branch Coordinator D. Valerie Watson Main Office Branch Manager Linda West Commercial Loan Officer Assistant Treasurers H. Joyce Deering Collections Roula Stefanidis Finance Michael C. Ventre Purchasing Assistant Corporate Secretary Mary D. Ladewig Advisory Board Attorney Thomas T. Adams Attorney William D. Allen William R. Amundsen Robert W. Andre Alfred Cioppa, Jr. Nicholas DePalma Frank DiCostanzo William T. Gardella, Sr. William L. Gault Donald E. Gaynor John M. Green Harvey L. Jacobs Attorney William D. Lane Dr. Kevin F. McCaul Bruce Minoff Lea Mintz Richard A. Moccia Daniel F. O'Connor Dr. Jeremiah A. O'Connor John P. O'Connor Dr. Rudolph A. Passero Rita F. Siegel Attorney John J. Ryan Calvin W. Smith Edith M. Smith Lawrence A. Somma, Jr. Shareholder Reference CORPORATE HEADQUARTERS NSS Bancorp, Inc. 48 Wall Street Norwalk, CT 06850 (203) 838-4545 FAX (203) 899-2523 INVESTOR RELATIONS Marcus I. Braverman, CPA Senior Vice President Treasurer & CFO NSS Bancorp, Inc. 48 Wall Street, P.O. Box 28 Norwalk, CT 06852 1-800-315-3115 STOCK TRANSFER AGENT ChaseMellon Shareholder Services, L.L.C. 450 West 33rd Street, 15th Floor New York, NY 10001-2697 1-800-851-9677 CORPORATE COUNSEL Tyler Cooper & Alcorn, L.L.P. City Place, 35th Floor Hartford, CT 06103-3488 INDEPENDENT PUBLIC ACCOUNTANTS Friedberg, Smith & Co., P.C. Certified Public Accountants 855 Main Street Bridgeport, CT 06604-4915 To obtain a copy of the Company's Annual Report on Form 10K, please direct your inquiry to: NSS Bancorp, Inc. Shareholder Information 48 Wall Street, P.O. Box 28 Norwalk, CT 06852 Attn: Marcus I. Braverman, CPA NSS Bancorp, Inc. is traded over the counter and quoted on the NASDAQ National Market System under the symbol "NSSY". Office Locations DARIEN 1089 Post Road Darien, CT 06820 Manager: John Troy, VP FAIRFIELD 2000 Post Road Fairfield, CT 06430 Manager: Joan Gilmartin, AVP GEORGETOWN Route 7 & 57-107 Georgetown, CT 06829 Manager: Geneffa Lucci NORWALK 48 Wall Street Norwalk, CT 06850 Manager: Valerie Watson, AVP NORWALK 578 Westport Avenue Norwalk, CT 06851 Manager: Norma J. Bell, AVP NORWALK Route 7 West Rocks Road Norwalk, CT 06851 Manager: Willard M. Miley, AVP WESTPORT 1815 Post Road East Westport, CT 06880 Manager: Andrea Barron WILTON 117 Old Ridgefield Road Wilton, CT 06897 Manager: Kevin Gilmartin, VP SATELLITE OFFICE South Norwalk Railroad Station Free Standing ATM EXHIBIT 18.3 NSS BANCORP, INC. CONSENT OF FRIEDBERG, SMITH & CO., P.C. CONSENT OF INDEPENDENT ACCOUNTANTS To the Board of Directors of NSS Bancorp, Inc. We consent to the incorporation by reference in the Registration Statement of NSS Bancorp, Inc. (the "Company") on Form S-8 (File No. ____________) of our report dated February 11, 1998, on our audits of the consolidated financial statements of the Company as of December 31, 1997 and 1996, and for the years ended December 31, 1997, 1996 and 1995, which report is included in the Company's Annual Report to Shareholders for the year ended December 31, 1997 and incorporated by reference in the Company's Annual Report on Form 10-K. /s/ Friedberg, Smith & Co., P.C. Bridgeport, Connecticut March 27, 1998 EXHIBIT 21.1 SUBSIDIARIES OF REGISTRANT Norwalk Savings Society (changed to "NSS Bank"), a Connecticut state chartered savings bank. EX-27 2
9 This schedule contains summary financial information extracted from the registrant's December 31, 1997 audited balance sheet, income statement and cash flow statement, and notes thereto, and is qualified in its entirety by reference to such financial statements. 12-MOS DEC-31-1997 DEC-31-1997 11,486,000 5,555,000 5,000,000 1,830,000 178,667,000 0 0 431,644,000 5,832,000 654,222,000 444,211,000 47,271,000 2,202,000 104,400,000 0 0 25,000 56,113,000 654,222,000 33,369,000 11,986,000 514,000 45,869,000 17,140,000 26,496,000 19,373,000 0 1,115,000 15,724,000 8,895,000 8,895,000 0 0 5,565,000 2.31 2.20 3.11 4,847,000 0 0 11,700,000 7,334,000 2,155,000 653,000 5,832,000 5,832,000 0 0
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