-----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, LFDDnbJEcgSFTZpurrHRuNpBaIHpFKYpL5oUBJemtT1jBitfF1srtxOdQDBbTxMj 8dbPx8QRipX9Ce8uIylY1A== 0000912057-02-014941.txt : 20020416 0000912057-02-014941.hdr.sgml : 20020416 ACCESSION NUMBER: 0000912057-02-014941 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 20011231 FILED AS OF DATE: 20020415 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRST FINANCIAL CORP /RI/ CENTRAL INDEX KEY: 0000354948 STANDARD INDUSTRIAL CLASSIFICATION: STATE COMMERCIAL BANKS [6022] IRS NUMBER: 050391383 STATE OF INCORPORATION: RI FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-K SEC ACT: 1934 Act SEC FILE NUMBER: 000-27878 FILM NUMBER: 02609885 BUSINESS ADDRESS: STREET 1: 180 WASHINGTON ST CITY: PROVIDENCE STATE: RI ZIP: 02903 BUSINESS PHONE: 4014213600 10-K 1 a2076492z10-k.txt 10-K SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ----------------------- FORM 10-K ANNUAL REPORT PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2001 Commission File No. 0-27878 First Financial Corp. (Exact name of registrant as specified in its charter) --------------------- Rhode Island 05-0391383 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 180 Washington Street, Providence, Rhode Island 02903 (Address of principal executive offices) (Zip Code) --------------------- (401) 421-3600 (Registrant's telephone number, including area code) Securities Registered Pursuant to Section 12(b) of the Act: Name of Each Exchange Title of Each Class On Which Registered ------------------- --------------------- None None Securities registered pursuant to Section 12(g) of the Act: Common stock, par value $1.00 per share 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 the 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 the Registrant's knowledge, in the definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. The aggregate market value of Common Stock held by nonaffiliates of the Registrant as of April 10, 2002 was $33,379,647 based on the closing sale price of common stock as reported on the Nasdaq National Market on such date. At April 10, 2002, there were 1,328,041 shares of the Company's $1.00 par value Common Stock issued and 1,213,741 outstanding. 2 FORM 10-K TABLE OF CONTENTS
PAGE REFERENCE PART I Item 1. Business................................................................................ 3 Item 2. Properties..............................................................................14 Item 3. Legal Proceedings.......................................................................14 Item 4. Submission of Matters to a Vote of Security Holders.....................................14 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters...................15 Item 6. Selected Consolidated Financial Data....................................................16 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations...18 Item 7A. Quantitative and Qualitative Disclosure About Market Risk. .............................35 Item 8. Financial Statements and Supplementary Data.............................................36 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure....60 PART III Item 10. Directors and Executive Officers of the Registrant......................................60 Item 11. Executive Compensation..................................................................61 Item 12. Security Ownership of Certain Beneficial Owners an Management...........................66 Item 13. Certain Relationships and Related Transactions..........................................67 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K........................68 Signatures.........................................................................................70
3 PART I ITEM 1. BUSINESS GENERAL First Financial Corp. (Company), which elected to become a financial holding company as of February 7, 2001, was organized under Rhode Island law in 1980 for the purposes of owning all of the outstanding capital stock of First Bank and Trust Company (Bank) and providing greater flexibility in helping the Bank achieve its business objectives. The Bank is a Rhode Island chartered commercial bank that was originally chartered and opened for business on February 14, 1972. The Bank provides a broad range of lending and deposit products primarily to individuals and small businesses ($10 million or less in total revenues). Although the Bank has full commercial banking and trust powers, it has not exercised its trust powers and does not, at the current time, provide asset management or trust administration services. The Bank's deposits are insured by the Federal Deposit Insurance Corporation (FDIC) up to applicable limits. The Bank offers a variety of commercial and consumer financial products and services designed to satisfy the deposit and loan needs of its customers. The Bank's deposit products include interest-bearing and noninterest-bearing checking accounts, money market accounts, passbook and statement savings accounts, club accounts, and short-term and long-term certificates of deposit. The Bank also offers customary check collection services, wire transfers, safe deposit box rentals, automated teller machine (ATM) cards and debit cards and services. Loan products include commercial, commercial mortgage, residential mortgage, construction, home equity and a variety of consumer loans. The Bank's strategy of managed growth through varied and often challenging economic cycles has been strategically supplemented by both de novo branch expansion and acquisition. The Bank's first expansion beyond its main office occurred in 1981 with the opening of its Cranston, Rhode Island branch. The Bank was presented with a further growth opportunity in 1991 as a result of the Rhode Island "credit union crisis," when 45 privately-insured banks and credit unions were closed by the then Rhode Island Governor. In 1992, the Bank acquired certain assets and assumed certain liabilities of the Chariho-Exeter Credit Union located in the Wyoming section of Richmond, Rhode Island and opened the facility as its Richmond branch. In June 1997, the Bank opened its fourth retail facility with an in-store branch in the Wal-Mart super store located at Wickford Junction in North Kingstown, Rhode Island. The North Kingstown facility is a full service branch offering the same retail products as the Bank's other branch offices. The core of the Bank's business remains its ability to meet the lending and deposit needs of customers in its market area. Most recently, the Bank has experienced growth in business loans to borrowers with favorable cash flow attributes seeking working capital financing. The Bank is designated a "preferred lender" by the Small Business Administration (SBA). As a participant in the SBA's preferred lenders program, the Bank has the sole authority to approve certain SBA guaranteed loans. The preferred lenders program also authorizes the Bank to act as an SBAExpress lender. This program allows the Bank to underwrite lines of credit up to $150,000 with a 50% SBA guarantee using the Bank's documentation. The Bank's ability to attract these new lending relationships and the related deposits is dependent on its willingness and ability to provide service to customers with identified needs. The Company believes that the Bank is particularly well-situated to serve the banking needs of the metropolitan Providence area. The Company believes that the local character of the business environment coupled with the Company's knowledge of its customers and their needs, together with its comprehensive retail and small business products create opportunities that will enable the Bank to effectively compete. Further, the Company believes that the accessibility and responsiveness of the Bank's personnel allow the Bank to compete effectively for certain segments within its market, in particular local professionals and businesses, who demand and receive customized and personalized banking products and services. 4 RECENT DEVELOPMENTS MERGER WITH WASHINGTON TRUST BANCORP, INC. On November 12, 2001, the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") with Washington Trust Bancorp, Inc. ("Washington Trust"), pursuant to which the Company will merge with and into Washington Trust (the "Merger"). Pursuant to the terms of the Merger Agreement, the issued and outstanding shares of the Company will be converted into the right to $16.00 in cash and that number of shares of Washington Trust common stock, par value $0.625 per share determined based on an exchange ratio set forth in the Merger Agreement. Consummation of the Merger is subject to a number of conditions, including, but not limited to, the approval of the Merger Agreement and the Merger by the shareholders of the Company and the receipt of requisite regulatory approvals. In connection with the Agreement, The Washington Trust Company of Westerly, a subsidiary of Washington Trust (the "Bank") entered into an Agreement and Plan of Merger (the "Subsidiary Agreement") with First Bank and Trust Company, a subsidiary of the Company ("First Bank"), pursuant to which First Bank will merge with and into the Bank (the "Bank Merger"). Pursuant to the Subsidiary Agreement, the issued and outstanding shares of First Bank will be cancelled immediately prior to the Bank Merger. On March 6, 2002, the shareholders of First Financial Corp. approved the Merger Agreement and the Merger. On March 21, 2002, the Federal Deposit Insurance Corporation issued its approval Bank Merger and on April 9, 2002, the Rhode Island Division of Banking issued its approval of the Merger and the Bank Merger. Washington Trust and the Company anticipate that the completion of the Merger will occur in April 2002. DIVIDENDS On January 15, 2002, the Company's Board of Directors declared a regular quarterly dividend of $.15 per share to shareholders of record on February 1, 2002. This dividend was paid on February 14, 2002. On March 25, 2002, the Company's Board of Directors declared a regular quarterly dividend of $.15 per share to shareholders of record on April 1, 2002 and payable on April 15, 2002. MARKET AREA Although its main office is located in downtown Providence, the Bank's Cranston branch is its largest office with deposits of $71.0 million at December 31, 2001. The Providence, Richmond and North Kingstown branches had approximately $34.9 million, $23.3 million and $8.4 million, respectively, in deposits at December 31, 2001. Through its branch locations, the Bank provides for the lending and deposit needs of its commercial and consumer customers in its market area and by targeting customers who desire the convenience and personal service not otherwise available as a result of recent major banking consolidations. LENDING ACTIVITIES GENERAL. The Bank lends primarily to individuals and small businesses, including partnerships, professional corporations and associations, and limited liability companies. Loans made by the Bank to individuals include owner-occupied residential mortgage loans, unsecured and secured personal lines of credit, home equity loans, mortgage loans on investment (generally non-owner occupied 1-4 family) and vacation properties, installment loans, student loans, and overdraft line of credit protection. Loans made by the Bank to businesses include typical secured loans, commercial real estate loans (loans to individuals secured by residential property of 5 units or more are considered commercial real estate loans) and lines of credit. Within the commercial real estate portfolio, a loan may be secured by real estate although the purpose of the loan is not to finance the purchase or development of real estate nor is the principal source of repayment the sale or operation of the real estate collateral. The Bank will often secure commercial loans for working capital or equipment financing with real estate together with equipment and other assets. The Bank characterizes such loans as "commercial real estate," consistent with bank regulatory requirements. Generally, the Bank lends only to borrowers located in Rhode Island or nearby Southeastern 5 Massachusetts or Connecticut. Occasionally, the Bank will lend to a borrower in its market area where collateral securing obligations is vacation property located outside the market area. During the past few years, the commercial and commercial real estate loan portfolios have increased and remain the largest components of the Bank's loan portfolio. This increase is partially attributable to the Bank's positive response to an increase in those businesses seeking working capital and expansion funds who are frustrated by the consolidation of the banking industry. The Bank has in the past, and continues today, to specifically target such businesses through the hiring of experienced commercial loan officers and by focusing on commercial lending to borrowers, the purpose of which is to help finance small business plant purchases, expansion, working capital and other corporate purposes. The Bank continues to believe that opportunities exist to satisfy the banking and borrowing needs of the small business community. During the past few years, and especially during 2001 and 2000, the Bank was more active than ever in working with its commercial borrowers and the SBA in obtaining guarantees under a variety of SBA loan programs. Generally, the Bank will sell the guaranteed portion of such loans with servicing retained. According to the SBA, for its fiscal year ended September 30, 2000, the Bank ranked fourth (4th) in Rhode Island out of 31 lenders in volume by number of loans approved and fifth (5th) in dollar volume of loans guaranteed by the SBA. Overall, the Bank was ranked second (2nd) among community banks and was selected as the recipient of the Bronze Lending Award for 2000. In 1999, the Bank was the recipient of the New Markets Lender of the Year Silver Award for lending to women and minorities. The Bank's policy on real estate lending standards establishes certain maximum loan to value ("LTV") ratios for real estate-related loans depending on the type of collateral securing such loans. These maximum LTV ratios range from 50% for those loans secured by undeveloped real estate up to 90% for loans secured by residential real estate. Notwithstanding these maximum LTV ratios, as a general practice, the Bank imposes higher collateralization requirements than the maximum ratios established in its policy on real estate lending standards. LOAN UNDERWRITING, REVIEW AND RISK ASSESSMENT. When considering loan applications, the primary factors taken into consideration by the Bank are: (i) the cash flow and financial condition of the borrower; (ii) the value of any underlying collateral; (iii) the long-term prospects of the borrower, market share and depth of management; and (iv) the character and integrity of the borrower. These factors are evaluated in a number of ways including an analysis of financial statements, credit reviews, trade reviews, and visits to the borrower's place of business. The total indebtedness of the borrower to the Bank determines the maximum limit which a lending officer has the authority to approve with respect to a particular credit. Total indebtedness means the total of all borrowings, including the loan being requested, whether funded or unfunded, to a particular borrower and all related loan accounts. The authority of individual loan officers is limited to the approval of secured loans equal to or less than either $200,000 or $25,000, depending on the individual loan officer, and unsecured loans equal to or less than either $25,000 or $5,000, depending on the individual loan officer. The authority of the chief executive officer is limited to the approval of secured loans equal to or less than $400,000 and unsecured loans equal to or less than $300,000. All loan requests in excess of an individual loan officer's limit must be approved by the Bank's Credit Committee for secured loans equal to or less than $800,000 and for unsecured loans equal to or less than $300,000. Loan requests in excess of the Credit Committee's limit must be presented to the Bank's Board of Directors. Generally, the Bank requires personal guarantees and supporting financial statements from one or more of the principals of any entity borrowing money from the Bank. Loan business is generated primarily through referrals and direct-calling efforts. Referrals of loan business come from the Bank's directors, stockholders of the Company, existing customers of the Bank and professionals such as lawyers, accountants, financial intermediaries and brokers. At December 31, 2001, the Bank's statutory lending limit to any single borrower approximated $2.4 million, subject to certain exceptions provided under applicable law. The Bank also has a policy of extending loans, on terms and conditions no less favorable than the terms and conditions applicable to any other borrower, to directors and executive officers of the Company and the Bank, limiting the aggregate principal amount of such loans to 100% of 6 capital and otherwise complying with applicable regulatory requirements. At December 31, 2001, the aggregate principal amount of all loans to directors and executive officers and related entities was $1.2 million. The following table sets forth the repricing frequency of fixed and variable rate loans included in the Bank's total loan portfolio at December 31, 2001. Loans having no stated schedule of repayments or no stated maturity (due on demand) are reported as due in one year.
COMMERCIAL AND HOME RESIDENTIAL COMMERCIAL EQUITY REAL REAL LINES OF ESTATE ESTATE CREDIT CONSUMER TOTAL ----------- ----------- --------- -------- ----- (IN THOUSANDS) Fixed Rate Amounts Due: One year or Less $ 2,687 $ 7,722 $ 2 $ 389 $ 10,800 After one year through five years 3,183 59,193 - 468 62,844 Beyond five years 11,083 77,460 - - 15,758 ----------- ---------- -------- -------- ---------- 16,528 72,013 2 857 89,402 ----------- ---------- -------- -------- ---------- Variable Rate Repricing Frequency: Annually or more frequently - 20,567 3,142 73 23,782 Less frequently than annually - - - - - ----------- ---------- -------- -------- ---------- - 20,567 3,142 73 23,782 ----------- ---------- -------- -------- ---------- Total $ 11,083 $ 98,027 $ 3,144 $ 930 $ 113,184 =========== ========== ======== ======== ==========
Scheduled contractual principal repayments do not, in many cases, reflect the actual maturities of loans. The average maturity of loans is substantially less than their average contractual terms because of prepayments and, in the case of conventional mortgage loans, due-on-sale clauses, which generally give the Bank the right to declare a loan immediately due and payable in the event, among other things, that the borrower sells the real property subject to the mortgage. In addition, because many of the Bank's residential and commercial real estate loans are fixed rate loans subject to rate review and/or call option within three to five years, such loans are considered by the Bank to have a stated maturity equal to the rate review period. Prevailing interest rates at the time of scheduled rate reviews may cause the Bank to reset rates on these loans. However, such loans may not actually mature at that time. The average life of mortgage loans tends to increase when current mortgage loan rates are substantially higher than rates on existing mortgage loans and, conversely, decrease when rates on existing mortgages are substantially lower than current mortgage loan rates (due to refinancing at lower rates). Under the latter circumstances, the weighted average yield on loans decreases as higher yielding loans are repaid or refinanced at lower rates. As of December 31, 2001, there were no non-accruing loans in the Bank's portfolio. RESIDENTIAL REAL ESTATE LOANS. At December 31, 2001, the Bank's outstanding residential first and second mortgage loans and home equity lines of credit of approximately $14.3 million, represented 12.6% of the Bank's total loan portfolio. Most fixed rate conforming loans originated by the Bank are referred to correspondents, the majority of which are funded by the correspondents. The Bank does not originate Adjustable Rate Mortgages ("ARMS") for its own portfolio. The Bank does, however, originate fixed rate residential first mortgage loans for its own portfolio with a 15 to 30 year amortization period and a rate review and/or call option at three or five year intervals. Consequently, as 7 the Bank attempts to satisfy the needs of its customers, it maintains an element of interest rate sensitivity embedded in the terms of the loan. COMMERCIAL LOANS AND COMMERCIAL REAL ESTATE LOANS. Subject to federal and state restrictions, the Bank is authorized to make secured or unsecured commercial business loans for general corporate purposes. Commercial loans include working capital loans, equipment financing, standby letters of credit, and secured and unsecured demand, term and time loans. The Bank has committed substantial resources to the promotion and development of commercial lending (i.e. small business plant purchases, expansion and working capital) secured by real estate, which loans are characterized as "commercial real estate loans." At December 31, 2001, outstanding commercial and commercial real estate loans approximated $98.0 million or 86.6% of total loans outstanding, including total construction and land development loans of approximately $3.0 million. Commercial and commercial real estate loans are generally priced at a fixed rate and are generally structured with a three-year or five- year rate review and/or call option. If a loan is priced at a floating rate, it is indexed to the Bank's base lending rate or to the Wall Street Prime Rate. At December 31, 2001, 67% of all residential, commercial and commercial real estate loans are subject to repricing within five years. At December 31, 2001, the Bank's base lending rate was 8.00% while the Prime Rate was 4.75%. CONSUMER LOANS. At December 31, 2001, the Bank's consumer loan portfolio approximated $.9 million or .8% of total loans outstanding. The Bank offers a full range of consumer lending products including new and used automobile loans, passbook and certificate of deposit loans, and other personal secured and unsecured loans. Although the Bank makes an effort to price these loans competitively, it faces substantial competition including, most significantly, from consumer finance companies and, therefore, the Bank does not view this market as possessing significant growth potential. INVESTMENT ACTIVITIES The investment policy of the Bank is an integral part of the overall asset/liability management of the Bank. The Bank's investment policy is to establish a portfolio of investments permissible for banks, providing the liquidity necessary to facilitate funding of loans and to cover deposit fluctuations while at the same time achieving a satisfactory return on the funds invested. The Bank intends to maximize earnings from its investment portfolio consistent with the safety and liquidity of those investment assets. The following table sets forth the amortized cost and fair value of the Bank's investment portfolio at the dates indicated:
DECEMBER 31, --------------------------------------------------- 2001 2000 ------------------------- ----------------------- AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE --------------- -------- --------- ---------- (In thousands) Held-to-Maturity: U.S. Government and agency obligations $ 14,500 $ 14,577 $ 21,836 $ 21,802 Collateralized mortgage obligations 115 116 653 650 -------- -------- --------- --------- $ 14,615 $ 14,693 $ 22,489 $ 22,452 ======== ======== ========= =========
8
DECEMBER 31, ----------------------------------------------------------------- 2001 2000 1999 -------------------- -------------------- ----------------- AMORTIZED FAIR AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE COST VALUE --------- ------- --------- ------- --------- ------ (In thousands) Available-for-Sale: U.S. Government and agency obligations $ 18,495 $ 18,617 $ 17,480 $ 17,536 $ 14,801 $ 14,722 Mortgage-backed securities 2,950 3,021 4,202 4,216 5,198 5,054 Trust preferred stock 14,454 14,958 9,433 8,910 - - Marketable equity securities and other 1,833 1,728 1,485 1,262 1,169 1,081 -------- -------- --------- --------- --------- --------- $ 37,732 $ 38,324 $ 32,600 $ 31,924 $ 21,168 $ 20,857 ======== ======== ========= ========= ========= =========
The following table sets forth certain information regarding maturity distribution and weighted average yields of the Bank's investment portfolio at December 31, 2001:
WITHIN ONE YEAR ONE TO FIVE YEARS OVER FIVE YEARS TOTAL SECURITIES ------------------- ------------------ ----------------- ------------------ WEIGHTED WEIGHTED WEIGHTED WEIGHTED CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE CARRYING AVERAGE VALUE YIELD VALUE YIELD VALUE YIELD VALUE YIELD ------------------- ------------------ ----------------- ------------------ (Dollars in Thousands) Held-to-Maturity: U.S. Government and agency obligations $ 500 6.67% $14,000 5.83% $ - -% $14,500 5.55% Collateralized mortgage obligations(1) 115 6.59 - - - - 115 6.59 Available-for-Sale: U.S. Government and agency obligations 17,587 7.02 1,030 2.47 - - 18,617 6.77 Mortgage-backed securities(1) - - - - 3,021 7.76 3,021 7.76 Trust preferred stock - - - - 14,958 7.86 14,958 7.86 Marketable equity securities 1,728 - - - - - 1,728 - and other ------ ------- ------- ------- ------ ------- ------- ------ 19,315 7.02 1,030 2.47 17,979 7.84 38,324 7.30 ------- ------- ------- ------- ------ ------- ------- ------ Total $19,930 7.01% $15,030 5.60% $17,979 7.84% $52,939 6.93% ======= ======= ======= ======= ======= ======= ======= ======
(1) Fixed rate collateralized mortgage obligations are presented on a scheduled cash flow basis. The mortgage-backed securities are presented using an assumed constant prepayment rate. SOURCES OF FUNDS Deposits obtained through the Bank's offices and automated teller machines ("ATM") have traditionally been the principal source of the Bank's funds for use in lending, investing and for other general business purposes. At December 31, 2001, the Bank had a total of approximately 3,306 demand deposit, NOW and money market accounts with an average balance of approximately $9,377 each; 3,400 passbook and statement savings accounts with an average balance of approximately $5,963 each; and 3,916 certificates of deposit with an average balance of approximately $22,058 (including certificates of deposit of $100,000 or more totaling $19.3 million). The Bank's MasterMoney(TM) Debit Card program as well as the Company's ATM card service supplement office and service hours. The Bank's ATM card can be used in the "PLUS", "CIRRUS" and "NYCE" ATM networks as well as the "MAESTRO" point of sale (POS) network. These networks provide the Bank's cardholder with access to ATM's and POS terminals throughout the United States and in 68 foreign countries. By adding the MasterCard(R) logo to the ATM card, the Bank has enhanced it's card program by offering availability for customers at over 15 million acceptance locations in over 220 countries. Over 3 million of the locations are in the United States. 9 The following table sets forth the average balances and average rates paid on the Bank's deposits for the periods indicated:
YEARS ENDED DECEMBER 31, ------------------------------------------------------------------------------- 2001 2000 1999 -------------------------- ---------------------- ------------------------ AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE AVERAGE BALANCE RATE BALANCE RATE BALANCE RATE ------------- ---------- ---------- --------- ---------- ---------- (In Thousands) Noninterest-bearing deposits $ 19,934 $ 19,177 $ 17,209 Interest bearing deposits: NOW and savings accounts 21,862 2.07% 20,704 2.08% 21,616 2.04% Money market accounts 3,995 1.83% 2,015 2.09 1,835 2.07 Certificates of deposit under $100,000 63,226 4.28% 67,391 5.72 53,039 4.92 Certificates of deposit over $100,000 19,265 6.22% 15,647 6.63 12,079 5.34 ---------- ---------- ---------- Total $ 128,282 $ 124,934 $ 105,778 ========== ========== ==========
Time certificates of deposit in denominations of $100,000 or more, at December 31, 2001, had the following schedule of maturities:
TIME REMAINING TO MATURITY AMOUNT -------------------------- -------------- (In Thousands) Less than 3 months $ 4,262 3 to 6 months 7,214 6 to 12 months 4,741 More than 12 months 3,318 ----------- Total $ 19,535 ===========
For the past several years, the Bank has been active in the Securities Sold Under Agreements to Repurchase (REPO) market as a means of using wholesale funds for capital leverage and interest arbitrage purposes. The Bank also uses advances from the Federal Home Loan Bank of Boston to match the funding for selected loans as well as refinance maturing REPO's at more favorable terms. For information regarding these borrowing arrangements refer to "Notes to Consolidated Financial Statements." COMMUNITY REINVESTMENT ACT The Bank is committed to serving the banking needs of the communities in which its branches are located and surrounding areas, including low and moderate income areas consistent with its obligations under the federal Community Reinvestment Act (CRA). There are several ways in which the Bank attempts to fulfill this commitment, including working with economic development agencies, undertaking special projects, and becoming involved with neighborhood outreach programs. The Bank has undertaken as part of its mission to contribute to the economic and social development of the communities in which it operates. The Bank believes that its obligation is to deliver competitive services that are responsive to the needs of its employees, customers, shareholders, and local communities. At its last CRA-compliance examination, the Bank was given a "satisfactory" ranking which is the second highest rating of the four assigned by the FDIC. In addition to memberships and directorships in a number of civic, charitable and not-for-profit organizations, the Bank meets with specific community-based groups which has provided insight into the credit and housing needs of the local community. The Bank's community outreach efforts rely on the calling activities of the Bank's loan officers and branch managers. These individuals contact the area's under- served small businesses to promote the Bank's 10 services and to gain a better understanding of their business needs. To a lesser extent, loan officers have contacted local realtors to ascertain community credit needs and to inform the realtors of the Bank's residential mortgage and referral program. Loan officers and branch managers are also members of, and routinely contact the Providence and surrounding area's respective Chambers of Commerce. The Bank has identified two primary needs within its communities: small business loans with reduced documentation requirements and unconventional mortgage products with flexible underwriting guidelines. To address the small business lending demand, the Bank participates, as a "preferred lender", in the SBA loan programs; specifically, the 7A and 504 programs, as well as the SBA's Low Doc and SBAExpress programs. As previously mentioned, the Bank was selected as the SBA's 2000 Bronze Lending Award recipient and the 1999 recipient of the New Markets Lender of the Year Silver Award for lending to women and minorities. COMPETITION In attracting deposits and making loans, the Bank encounters competition from other institutions, including larger downtown Providence and suburban- based commercial banking organizations, savings banks, credit unions, other financial institutions and non-bank financial service companies serving Rhode Island. The principal methods of competition include the level of loan interest rates, interest rates paid on deposits, marketing, range of services provided and the quality of these services. These competitors include several major financial companies whose greater resources may afford them a marketplace advantage by enabling them to maintain numerous banking locations and mount extensive promotional and advertising campaigns. Certain of these competitors are not subject to the same regulatory environment as the Bank. EMPLOYEES As of December 31, 2001, the Company had 46 full-time and 6 part-time employees. The Company's employees are not represented by any collective bargaining unit. The Company maintains a benefit program which includes health insurance, life insurance, a defined benefit pension plan and a matching savings incentive plan. The Company believes that its relations with its employees are good. REGULATION AND SUPERVISION Banks and bank holding companies are subject to extensive government regulation through federal and state statutes and regulations which are subject to changes that may have significant impact on the way in which such entities may conduct business. The likelihood and potential effects of any such changes cannot be predicted. Legislation enacted in recent years has substantially increased the level of competition among commercial banks, thrift institutions and nonbanking institutions, including insurance companies, brokerage firms, mutual funds, investment banks and major retailers. The supervision, regulation and examination to which the Company and the Bank are subject are intended primarily for the protection of depositors and the deposit insurance funds that insure the deposits of banks, rather than for the protection of shareholders. Several of the more significant regulatory provisions applicable to banks and financial holding companies to which the Company and the Bank are subject are discussed below. To the extent that the following information describes statutory or regulatory provisions, it is qualified in its entirety by reference to the particular statutory provisions. THE COMPANY FINANCIAL HOLDING COMPANY. The Company elected to become a financial holding company effective on February 7, 2001, and continues to be subject to regulation under the Bank Holding Company Act of 1956, as amended (The "BHCA") and to inspection, examination and supervision by the Board of Governors of the Federal Reserve System (the "Federal Reserve Board"). FINANCIAL AND BANK HOLDING COMPANY ACTIVITIES. As a holding company that has also elected to become a financial holding company, the Company may affiliate with securities firms and insurance companies and engage in other activities that are "financial in nature." Activities that are "financial in nature" include securities underwriting, dealing 11 and market-making, sponsoring mutual funds and investment companies, insurance underwriting and agency, merchant banking, and activities that the Federal Reserve Board has determined to be closely related to banking. No Federal Reserve Board approval is required for the Company to acquire a company, other than a bank holding company, bank or savings association, engaged in activities that are financial in nature or incidental to activities that are financial in nature, as determined by the Federal Reserve Board. Prior Federal Reserve Board approval is required before the Company may acquire the beneficial ownership or control of more than 5% of the voting shares, or substantially all of the assets, of a bank holding company, bank or savings association. If the Bank ceases to be "well capitalized" or "well managed" under applicable regulatory standards, the Federal Reserve Board may, among other actions, require that the Company conform its activities to those permissible for a bank holding company that is not also a financial holding company. If the Bank receives a rating under the Community Reinvestment Act of 1977 of less than satisfactory, the Company will be prohibited from engaging in new activities or acquiring companies other than bank holding companies, banks or savings associations. The Gramm-Leach-Bliley Act which established "financial holding companies", also establishes a system of functional regulation, under which the federal banking agencies will regulate the banking activities of financial holding companies and banks' financial subsidiaries, the U.S. Securities and Exchange Commission will regulate their securities activities and state insurance regulators will regulate their insurance activities. Gramm-Leach also provides new protections against the transfer and use by financial institutions of consumers' nonpublic, personal information. BHCA--ACTIVITIES AND OTHER LIMITATIONS. The BHCA prohibits a bank holding company from acquiring direct or indirect ownership or control of more than 5% of the voting shares of any bank, or, except where a majority of shares are already owned, increasing such ownership or control of any bank, without prior approval of the Federal Reserve Board. No approval under the BHCA is required, however, for a bank holding company already owning or controlling 50% of the voting shares of a bank to acquire additional shares of such bank. RHODE ISLAND LAW. Rhode Island law requires the prior approval of the Banking Division in order for a Rhode Island bank or bank holding company to acquire 5% or more of the voting stock, or merge or consolidate with an out-of-state bank or bank holding company. In examining the transaction, the Banking Division must determine whether the transaction is permitted under the law of the state of the out-of-state bank or bank holding company under conditions not substantially more restrictive than those imposed by Rhode Island law. In determining whether to approve the transaction, the Banking Division must determine whether the transaction is in the public interest, will promote the safety and soundness of the Rhode Island institution and needs of the communities served thereby, and will serve the needs of the state generally. In addition, a merger requires the prior approval of two-thirds of the shareholders of the Rhode Island bank and such percentage of the shareholders of the out-of-state bank as required by the laws of such state. Under Rhode Island law, subject to the approval of the Banking Division, an out-of-state bank or bank holding company may acquire direct or indirect control of more than 5% of the voting stock or merge or consolidate with or acquire substantially all of the assets and liabilities of a Rhode Island bank or bank holding company provided that the laws of the state in which the out- of-state bank is located, or in which operations of the bank subsidiaries of an out-of-state bank holding company are principally conducted, expressly authorize, as determined by the Banking Division, under conditions no more restrictive than those imposed by the laws of Rhode Island, the acquisition by a Rhode Island bank or bank holding company of 5% of the voting stock or the merger or consolidation with or acquisition of all of the assets of banks or bank holding companies located in that state. Additionally, under Rhode Island law, no "person" may acquire 25% of the voting stock, or such lesser number of shares as constitutes control, of a Rhode Island depository institution without the prior approval of the Banking Division. DIVIDENDS. The Company is a legal entity separate and distinct from the Bank. The revenues of the Company (on a parent company only basis) are derived primarily from interest on investments and dividends paid to the Company by the Bank. The right of the Company, and consequently the right of creditors and stockholders of the Company, to participate in any distribution of the assets or earnings of any subsidiary through the payment of such dividends or otherwise is necessarily subject to the prior claims of creditors of the subsidiary (including depositors, in the case of banking subsidiaries), except to the extent that certain claims of the Company in a creditor capacity may be recognized. 12 It is the policy of the FDIC and the Federal Reserve Board that banks and bank holding companies, respectively, should pay dividends only out of current earnings and only if after paying such dividends, the bank or bank holding company would remain adequately capitalized. Federal banking regulators also have authority to prohibit banks and bank holding companies from paying dividends if they deem such payment to be an unsafe or unsound practice. In addition, it is the position of the Federal Reserve Board that a bank holding company is expected to act as a source of financial strength to its subsidiary banks. THE SUBSIDIARY BANK GENERAL. The Bank is subject to extensive regulation and examination by the Banking Division and by the FDIC, which insures its deposits to the maximum extent permitted by law, and to certain requirements established by the Federal Reserve Board. The federal and state laws and regulations which are applicable to banks regulate, among other things, the scope of their business, their investments, their reserves against deposits, the timing of the availability of deposited funds and the nature and amount of, and collateral for, certain loans. The prior approval of the FDIC and the Banking Division is required for the Bank to establish or relocate an additional branch office, assume deposits, or engage in any merger, consolidation or purchase or sale of all or substantially all of the assets of any bank or savings association. The laws and regulations governing the Bank generally have been promulgated to protect depositors and not for the purpose of protecting stockholders. EXAMINATIONS AND SUPERVISION. The FDIC and the Banking Division regularly examine the operations of the Bank, including (but not limited to) their capital adequacy, reserves, loans, investments, earnings, liquidity, compliance with laws and regulations, record of performance under the Community Reinvestment Act and management practices. In addition, the Bank is required to furnish quarterly and annual reports of income and condition to the FDIC and periodic reports to the Banking Division. The enforcement authority of the FDIC includes the power to impose civil money penalties, terminate insurance coverage, remove officers and directors and issue cease- and-desist orders to prevent unsafe or unsound practices or violations of law or regulations. In addition, under recent federal banking legislation, the FDIC has authority to impose additional restrictions and requirements with respect to banks that do not satisfy applicable regulatory capital requirements. DIVIDENDS AND AFFILIATE TRANSACTIONS. The Bank is subject to certain restrictions on loans to the Company, on investments in the stock or securities thereof, on the taking of stock or securities as collateral for loans to any borrower, and on the issuance of a guarantee or letter of credit on behalf of the Company. The Bank also is subject to certain restrictions on most types of transactions with the Company, requiring that the terms of such transaction be substantially equivalent to terms of similar transactions with non-affiliates. In addition, there are various limitations on the distribution of dividends to the Company by the Bank. CAPITAL REQUIREMENTS The FDIC has established guidelines with respect to the maintenance of appropriate levels of capital by FDIC-insured banks. At such time, if ever, that the Company exceeds $150 million in consolidated assets or either: (i) engages in any non-bank activity involving significant leverage; or (ii) has a significant amount of outstanding debt that is held by the general public, it will become subject to various capital adequacy requirements of the Federal Reserve Board applicable to all such bank holding companies. Until such time, the Federal Reserve Board applies the following guidelines on a bank only basis. The Federal Reserve Board has adopted substantially identical capital adequacy guidelines pursuant to which it assesses the adequacy of capital in examining and supervising a bank holding company and in analyzing applications to it under the BHCA. If a banking organization's capital levels fall below the minimum requirements established by such guidelines, a bank or bank holding company will be expected to develop and implement a plan acceptable to the FDIC or the Federal Reserve Board, respectively, to achieve adequate levels of capital within a reasonable period, and may be denied approval to acquire or establish additional banks or non-bank businesses, merge with other institutions or open branch facilities until such capital levels are achieved. The guidelines generally require banks and bank holding companies to maintain at least half of its total capital comprised of common equity, retained earnings and a limited amount of perpetual preferred stock, less goodwill 13 ("Tier I Capital"). Additionally, these guidelines require banks and bank holding companies to maintain a ratio of Tier I Capital to risk-weighted assets of at least four (4%) percent and a ratio of total capital to risk- weighted assets of at least eight (8%) percent ("Total Risk-Based Capital Ratio"). Hybrid capital instruments, perpetual preferred stock which is not eligible to be included as Tier I Capital, term subordinated debt and intermediate-term preferred stock and, subject to limitations, general allowances for loan losses, is known as "Tier 2 Capital." The sum of Tier 1 and Tier 2 Capital is "Total Risk-Based Capital." Assets are adjusted under the risk-based guidelines to take into account different risk characteristics. PROMPT CORRECTIVE ACTION Under Section 38 of the Federal Deposit Insurance Act (FDIA), as added by the Federal Deposit Insurance Corporation Improvement Act (FDICIA), each federal banking agency has implemented a system of prompt corrective action for institutions which it regulates. Under the regulations, a bank shall be deemed to be (i) "well capitalized" if it has Total Risk-Based Capital Ratio of 10.0% or more, has a Tier Risk-Based Capital Ratio of 6.0% or more, has a Tier I Leverage Capital Ratio of 5.0% or more and is not subject to any written capital order or directive; (ii) "adequately capitalized" if it has a Total Risk-Based Capital Ratio of 8.0% or more, a Tier I Risk-Based Capital Ratio of 4.0% or more and a Tier I Leverage Capital Ratio of 4.0% or more (3.0% under certain circumstances) and does not meet the definition of "well capitalized," (iii) "undercapitalized" if it has a Total Risk-Based Capital Ratio that is less than 8.0%, a Tier I Risk- Based Capital Ratio that is less than 4.0% or a Tier I Leverage Capital Ratio that is less than 4.0% (3.0% under certain circumstances), (iv) "significantly undercapitalized" if it has a Total Risk-Based Capital Ratio that is less than 6.0%, a Tier I Risk- Based Capital Ratio that is less than 3.0% or a Tier I Leverage Capital Ratio that is less than 3.0%, and (v) "critically undercapitalized" if it has a ratio of tangible equity to total assets that is equal to or less than 2.0%. Section 38 of the FDIA and the regulations also specify circumstances under which a federal banking agency may reclassify a well capitalized institution as adequately capitalized and may require an adequately capitalized institution or an undercapitalized institution to comply with supervisory actions as if it were in the next lower category (except that the FDIC may not reclassify a significantly undercapitalized institution as critically undercapitalized). As of December 31, 2001, the Bank was classified as "well capitalized" under these provisions. INTERSTATE BANKING LEGISLATION The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994, as amended (the "Interstate Banking Act") generally permits bank holding companies to acquire banks in any state, and preempts all state laws restricting the ownership by a bank holding company of banks in more than one state. The Interstate Banking Act also permits a bank to merge with an out-of-state bank and convert any offices into branches of the resulting bank if both states have not opted out of interstate branching; permits a bank to acquire branches from an out-of-state bank if the law of the state where the branches are located permits the interstate branch acquisition; and permits banks to establish and operate de novo interstate branches whenever the host state opts-in to de novo branching. Bank holding companies and banks seeking to engage in transactions authorized by the Interstate Banking Act must be adequately capitalized and managed. In 1996, Rhode Island adopted legislation pursuant to which Rhode Island "opted in" to interstate banking. The Rhode Island act allows Rhode Island banks to establish and maintain branches through a merger or consolidation with or by the purchase of the whole or any part of the assets or stock of any out-of-state bank or through de novo branch establishment in any state other than Rhode Island. 14 ITEM 2. PROPERTIES The Bank delivers its products and services through its four branch network system. The Bank owns its main office building which is located at 180 Washington Street, Providence, Rhode Island. This location consists of a two- story masonry and steel frame building containing (with basement storage) approximately 6,800 square feet of space. The ground floor of this building is used for retail banking as the Bank's Providence branch. Attached to this building is a two lane drive-up facility, the only drive-up facility located in downtown Providence. The building also houses a built-in ATM. The second floor of this location is used predominately for executive, administrative, and support staff office space. This building is located on two lots which are owned by the Bank and which have a total area of approximately 10,000 square feet. This land space is also used for customer parking and access and egress through the drive-up facility. The Bank also owns an adjacent lot of approximately 3,300 square feet which is used solely as employee parking. In 1981, the Bank opened a branch office building at the corner of Park and Reservoir Avenues, Cranston, Rhode Island. This one-story masonry and steel frame building (including the lower level) has approximately 7,400 square feet space. The ground floor of this location contains the Cranston branch, the Bank's largest branch as measured by deposits. The building also has a three lane drive-up facility and a drive- up ATM. The basement of this building is used predominately by the Operations Department along with several administrative offices. The building is situated on approximately 21,000 square feet of leased land. The lease has an original noncancellable term of 15 years with four successive renewal options, each for an additional five years ending in the year 2009. The Bank is presently in the third of the four renewal options which expires in the year 2004. Upon the expiration of the lease in the year 2009, the Bank will have the right to renew the lease upon the same terms and conditions, except for the term and annual rent to be paid thereunder which are to be determined by mutual agreement or, if not so determined, by arbitration. In late 1994, the Bank acquired an adjacent parcel of land, which approximates 4,700 square feet, for use as expanded customer parking and access to the facility from Reservoir Avenue. The Bank also owns land across the street from this building. This land, with total area of approximately 3,300 square feet, is used solely for employee parking. In 1992, the Bank purchased a former credit union's land and building and reopened the facility as the Bank's Richmond branch at 1168 Main Street, Richmond, Rhode Island. The facility is located in the Wyoming section in the Town of Richmond. The two story wood frame building has nearly 6,500 square feet space (exclusive of unfinished basement area) on a land area of approximately 40,400 square feet. The branch location has a built-in ATM and a two lane drive-up facility. In June 1997, the Bank opened an in-store branch located in the Wal-Mart super store at Wickford Junction in North Kingstown, Rhode Island. The Bank leases nearly 1,700 square feet under an original lease term of five years with two successive renewal options, each for an additional five years ending in the year 2012. The branch is a full service facility, exclusive of safe deposit boxes, with an ATM. The Company believes that its facilities are adequate for its operations at this time. ITEM 3. LEGAL PROCEEDINGS The Company is involved in routine legal proceedings occurring in the ordinary course of business. In the opinion of management, final disposition of these lawsuits, based upon the advice of legal counsel as to potential outcome, will not have a material adverse effect on the financial condition or results of operations of the Company. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS During the fourth quarter of fiscal 2001, the Company did not submit any matter to a vote of its security holders, through a solicitation of proxies or otherwise. 15 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS STOCK LISTING On May 14, 1996, the Company's common stock began trading on the NASDAQ National Market tier of the NASDAQ Stock Market under the symbol: FTFN. High and low sales prices and dividends declared during 2001 and 2000 are as follows:
QUARTERLY DIVIDENDS SALES PRICES HIGH LOW DECLAREDS -------------- -------- -------- ----------- 2001 1st Quarter $ 14.50 $ 11.75 $ .15 2nd Quarter 18.00 13.50 .15 3rd Quarter 19.86 16.00 .15 4th Quarter 31.99 17.50 .15 2000 1st Quarter $ 13.00 $ 9.75 $ .12 2nd Quarter 11.25 9.75 .12 3rd Quarter 11.88 10.44 .12 4th Quarter 11.75 11.00 .12
As of April 8, 2002, there were approximately 140 holders of record of the Company's common stock. 16 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
YEARS ENDED DECEMBER 31, -------------------------------------------------------- 2001 2000 1999 1998 1997 ------ -------- -------- -------- ------ (Dollars in Thousands, Except Per Share Data) FINANCIAL CONDITION DATA: Total assets $ 185,188 $ 168,372 $ 144,782 $ 141,919 $ 127,310 Investments, securities purchased under agreements to resell, federal funds sold and interest bearing deposits 64,289 56,161 40,351 49,544 42,944 Total loans, net of unearned discount 113,182 103,880 94,939 86,296 77,680 Allowance for loan losses 1,832 1,752 1,556 1,287 1,597 Total deposits 137,658 129,046 104,589 104,372 99,290 Securities sold under agreements to repurchase 6,843 9,575 9,411 12,256 10,105 Federal Home Loan Bank advances 21,614 10,869 13,610 6,204 - Senior debenture - - - 2,971 2,947 Total stockholders' equity 16,551 16,491 15,482 14,813 13,713
YEARS ENDED DECEMBER 31, -------------------------------------------------------- 2001 2000 1999 1998 1997 ------ -------- -------- -------- ------ (Dollars in Thousands, Except Per Share Data) STATEMENT OF INCOME DATA: Interest income 13,470 13,394 11,180 10,564 9,969 Interest expense 6,349 6,585 4,934 5,218 4,803 ---------- ---------- ---------- --------- ---------- Net interest income 7,121 6,809 6,246 5,346 5,166 Provision for loan losses 75 175 275 250 250 ---------- ---------- ---------- --------- ---------- Net interest income after provision for loan losses 7,046 6,634 5,971 5,096 4,916 Noninterest income 922 1,003 826 616 465 Noninterest expense 6,786 4,578 3,917 3,468 3,341 Income taxes 1,155 1,088 1,061 794 728 ---------- ---------- ---------- --------- ---------- Net income $ 27 $ 1,971 $ 1,819 $ 1,450 $ 1,312 ========== ========== ========== ========= ========== PER SHARE DATA: Net income: Basic $ 0.02 $ 1.62 $ 1.47 $ 1.15 $ 1.04 Diluted 0.02 1.62 1.47 1.15 1.04 Book value 13.64 13.59 12.63 11.75 10.87 Cash dividends declared 0.60 0.48 0.36 0.24 0.20 Dividend payout ratio 29.56% 24.45% 20.88% 19.23% Weighted average common shares outstanding 1,213,741 1,214,125 1,233,104 1,261,241 1,261,241 Weighted average common and common stock equivalent shares outstanding 1,213,741 1,214,125 1,233,104 1,261,241 1,261,241
17 OPERATING RATIO DATA: Return on average total assets 0.02% 1.20% 1.26% 1.07% 1.07% Return on average stockholders' equity 0.15 12.54 12.04 10.20 10.00 Net interest margin 4.15 4.30 4.49 4.12 4.38 Loans to deposits ratio 82.20 80.50 90.77 82.68 78.24 Leverage capital ratio 8.65 10.10 10.71 10.56 10.77 ASSET QUALITY RATIOS: Nonperforming assets to total assets NM NM 0.12% 0.36% 0.63% Nonperforming loans to total loans NM NM 0.19 NM 0.02 Net loan (recoveries) charge-offs to average loans(1) NM (0.02) 0.01 0.22 0.34 Allowance for loan losses to total loans(1) 1.62 1.69 1.64 1.53 1.64 Allowance for loan losses to nonperforming loans(1) NM NM 861.94 NM 7,333.39
(1) Ratios are exclusive of acquired loans, acquired allowance for loan losses, and activity in the acquired allowance for loan losses associated with the 1992 acquisition of certain assets and the assumption of certain liabilities of the former Chariho-Exeter Credit Union. NM- Not Meaningful 18 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The following discussion and analysis of financial condition and results of operations of the Company and its subsidiaries should be read in conjunction with the consolidated financial statements and accompanying notes. CRITICAL ACCOUNTING POLICIES The Company's significant accounting policies are described in Note 1 to the consolidated financial statements included in Item 7 of this Form 10-K. The Company considers the following accounting policies to be most critical in their potential effect on its financial position or results of operations: ALLOWANCE FOR LOAN LOSSES The allowance for loan losses is established through a charge to the provision for loan losses. Provisions are made to reserve for estimated losses in outstanding loan balances. The allowance for loan losses is a significant estimate and is regularly reviewed by the Company for adequacy by assessing such factors as changes in the mix and volume of the loan portfolio; trends in portfolio credit quality, including delinquency and charge-off rates; and current economic conditions that may affect a borrower's ability to repay. The Company's methodology with respect to the assessment to the adequacy of the allowance for loan losses is more fully discussed on pages 26 - 27 of Management's Discussion and Analysis. INCOME TAXES The Company must estimate income tax expense in each of the jurisdictions in which it operates for each period for which a statement of operations is presented. This involves estimating the Company's actual current tax exposure as well as assessing temporary differences resulting from differing treatment of items, such as timing of the deduction of expenses, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the Company's consolidated balance sheets. The Company must also assess the likelihood that any deferred tax assets will be recovered from future taxable income and to the extent that recovery is not likely, a valuation allowance must be established. Significant management judgment is required in determining income tax expense, and deferred tax assets and liabilities. As of December 31, 2001, there were no valuation allowances set aside against any deferred tax assets. INTEREST INCOME RECOGNITION Interest on loans is included in income as earned based upon interest rates applied to unpaid principal. Interest is not accrued on loans 90 days or more past due unless they are adequately secured and in the process of collection, or on other loans when management believes collection is doubtful. All loans considered impaired (except troubled debt restructurings), as defined below, are nonaccruing. Interest on nonaccruing loans is recognized as payments are received when the ultimate collectibility of interest is no longer considered doubtful. When a loan is placed on nonaccrual status, all interest previously accrued is reversed against current-period interest income. MORTGAGE SERVICING RIGHTS Servicing assets are recognized as separate assets when rights are acquired through purchase or through sale of financial assets. Capitalized servicing rights are reported in other assets and are amortized into noninterest income in proportion to, and over the period of, the estimated future net servicing income of the underlying financial assets. Servicing assets are evaluated for impairment based upon the fair value of the rights as compared to amortized cost. Impairment is determined by stratifying right by predominant characteristics, such as interest rates and terms. The Company utilizes a single stratum for measuring the fair value of its loan servicing rights because of the homogeneity of its serviced loan portfolio. Fair value is determined using prices for similar assets with similar characteristics, when available, or based upon discounted cash flows using market-based assumptions. 19 OVERVIEW The results of operations of First Financial Corp. and its wholly-owned subsidiary, First Bank and Trust Company (collectively, the "Company"), depend primarily on its net interest income, which is the difference between interest and dividend income on interest-earning assets and interest expense on its interest-bearing liabilities. Its interest-earning assets consist primarily of loans and investment securities, while its interest-bearing liabilities consist primarily of deposits, securities sold under agreements to repurchase and Federal Home Loan Bank advances. The Company's net income is also affected by its level of noninterest income, including fees and service charges, as well as by its noninterest expenses, such as salary and employee benefits, provisions to the allowance for loan losses, occupancy costs and, when necessary, expenses related to other real estate owned (OREO) and to the administration of nonperforming and other classified assets. On November 12, 2001, the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") with Washington Trust Bancorp, Inc. ("Washington Trust"), pursuant to which the Company will merge with and into Washington Trust (the "Merger"). Pursuant to the terms of the Merger Agreement, the issued and outstanding shares of the Company will be converted into the right to $16.00 in cash and that number of shares of Washington Trust common stock, par value $0.625 per share determined based on an exchange ratio set forth in the Merger Agreement. Consummation of the Merger is subject to a number of conditions, including, but not limited to, the approval of the Merger Agreement and the Merger by the shareholders of the Company and the receipt of requisite regulatory approvals. The Company reported net income for 2001 of $26,846 as compared to $1,970,719 for 2000. Diluted earnings per share amounted to $0.02 per share for 2001, based on 1,213,741 weighted average shares outstanding as compared to $1.62 per share for 2000 based on 1,214,125 weighted average shares outstanding. In 2001, the Company's return on average equity (ROE) decreased to 0.15% from 12.54% in 2000. The Company's return on average assets (ROA) was 0.02% in 2001 and 1.20% in 2000. The decrease in net income was primarily the result of Merger related costs partially offset by an increase in net interest income and a decrease in the provision for loan losses. RESULTS OF OPERATIONS NET INTEREST INCOME In 2001, total interest income amounted to $13.5 million compared to $13.4 million in 2000. Average earning assets increased $13.1 million to $171.5 million from $158.4 million and was offset by lower yields. Of the increase, $9.3 million went to the loan portfolio which grew on average to $108.1 million in 2001 from $99.9 million in 2000. The remaining $4.4 million was placed in repurchase agreements with the Federal Home Loan Bank. During 2001 and 2000, average loans represented 63% of total average earning assets. The growth in earning assets offset by the decreasing rate environment accounted for the overall increase in interest income. In terms of volume/rate, earning asset growth (volume) contributed $940,000 to the increase in interest income, while the decreasing rate environment reduced it by $864,000. The funding for the $13.1 million increase in average earning assets came primarily from a $8.6 million increase in retail time deposits. Total interest expense decreased $0.3 million, or 4.5% to $6.3 million in 2001 from $6.6 million in 2000. Total average interest-bearing liabilities increased $9.7 million or 7.6% to $137.5 million in 2001 from $127.8 million in 2000. Overall, net interest income increased $312,000 to $7.1 million from $6.8 million. Of this increase, $512,000 was attributable to balance sheet growth (volume), while there was a $200,000 reduction attributable to changes in interest rates. The ability to maintain relatively neutral balance sheet exposure to changes in interest rates resulted in a modest impact to the Company's net interest income. For 2001, the Company's net interest spread declined 6 basis points to 3.24% from 3.30% in 2000. During 2001, the Company increased the excess of average interest-earning assets over interest-bearing liabilities by $3.13 million to $34.0 from $30.7 million during 2000. Lower asset yields and lower deposit and borrowing rates were primarily caused by a lower overall interest rate environment in 2001 as compared to 2000. The average yield on interest earning assets decreased 60 basis points from 8.45% in 20 2000 to 7.85% in 2001 and the average yield on interest bearing liabilities decreased 53 basis points from 5.15% in 2000 to 4.62% in 2001. The following table sets forth certain information relating to the Company's average balance sheets and reflects the average yield on assets and average cost of liabilities for the periods indicated. Such yields and costs are derived by dividing income or expense by the average balance of assets or liabilities. Average balances are derived from daily balances. Loans are net of unearned discount. Non-accrual loans are included in the average balances used in calculating this table. 21 AVERAGE BALANCES AND INTEREST RATES (Dollars in Thousands)
YEARS ENDED DECEMBER 31, ---------------------------------------------------------------------------------------- 2001 2000 1999 -------------------------- ---------------------------- ----------------------------- INTEREST AVERAGE INTEREST AVERAGE INTEREST AVERAGE AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/ AVERAGE INCOME/ YIELD/ BALANCE EXPENSE RATE BALANCE EXPENSE RATE BALANCE EXPENSE RATE -------- -------- ------- ------- -------- ------- ------- -------- ------- INTEREST-EARNING ASSETS: Loans $108,131 $10,027 9.27% $ 99,862 $9,694 9.71% $91,965 $ 8,688 9.45% Investment securities taxable - AFS 35,839 2,177 6.08 30,405 2,050 6.74 28,000 1,509 5.39 Investment securities taxable - HTM 15,941 896 5.62 21,421 1,289 6.02 14,462 789 5.46 Securities purchased under agreements to resell 10,355 301 2.90 5,960 306 5.13 4,048 162 4.00 Federal Home Loan Bank stock and other 1,266 69 5.55 819 55 6.72 556 32 5.76 ------- ------- ------ ------- ------ ------ ------ ------- ------- TOTAL INTEREST EARNING ASSETS 171,532 13,470 7.85% 158,467 13,394 8.45% 139,031 11,180 8.04% ------- ------- ------- ------ ------- ------- NONINTEREST-EARNING ASSETS: Cash and due from banks 2,606 2,765 2,702 Premises and equipment 1,918 2,075 2,276 Other real estate owned - 103 231 Allowance for loan losses (1,792) (1,696) (1,367) Other assets 3,080 2,280 1,390 -------- -------- ------- TOTAL NONINTEREST- EARNING ASSETS 5,812 5,527 5,232 -------- -------- ------- TOTAL ASSETS $177,344 $163,994 $144,263 ======== ======== ======== INTEREST-BEARING LIABILITIES: Deposits: Interest-bearing demand and NOW deposits $ 3,147 $ 41 1.31% $ 3,204 $ 47 1.47% $ 3,347 $ 49 1.46% Savings deposits 18,715 412 2.20 17,500 383 2.19 18,269 392 2.15 Money market deposits 3,995 73 1.83 2,015 42 2.09 1,835 38 2.07 Time deposits 82,572 4,362 5.28 83,038 4,891 5.89 65,118 3,253 5.00 Securities sold under agreements to repurchase 8,172 344 4.21 9,205 459 4.99 11,311 553 4.89 Federal Home Loan Bank advances 20,907 1,117 5.34 12,790 763 5.97 9,605 564 5.87 Senior debenture - - - - - - 1,204 85 7.06 -------- ------- ------ -------- ------ ------ ------- ------- ------- TOTAL INTEREST- BEARING LIABILITIES 137,508 6,349 4.62% 127,752 6,585 5.15% 110,689 4,934 4.46% ------- ------ ------ ------ ------- ------- NONINTEREST- BEARING LIABILITIES: Noninterest-bearing deposits 19,934 19,177 17,209 Other liabilities 2,370 1,355 1,262 -------- -------- ------- TOTAL NONINTEREST- BEARING LIABILITIES 22,304 20,532 18,471 STOCKHOLDERS' EQUITY 17,532 15,710 15,103 -------- -------- ------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $177,344 $163,994 $144,263 ======== ======== ======== NET INTEREST INCOME $ 7,121 $6,809 $ 6,246 ======= ====== ======= NET INTEREST SPREAD 3.24% 3.30% 3.58% ===== ====== ======= NET INTEREST MARGIN 4.15% 4.30% 4.49% ===== ====== =======
22 The following table describes the extent to which changes in interest rates and changes in volume of interest-earning assets and interest- bearing liabilities have affected the Company's interest income and interest expense during the periods indicated. Information is provided in each category with respect to changes attributable to: (i) changes in volume (changes in volume multiplied by prior rate); and (ii) changes in rate (changes in rate multiplied by prior volume). Changes in rate/volume have been allocated to volume variances throughout this table. Loans are net of unearned discount. Non-accrual loans are included in the average balances used in calculating this table.
RATE/VOLUME ANALYSIS OF NET INTEREST INCOME YEAR ENDED YEAR ENDED YEAR ENDED DECEMBER 31, 2001 DECEMBER 31, 2000 DECEMBER 31, 1999 COMPARED WITH COMPARED WITH COMPARED WITH DECEMBER 31, 2000 DECEMBER 31, 1999 DECEMBER 31, 1998 INCREASE (DECREASE) INCREASE (DECREASE) INCREASE (DECREASE) DUE TO DUE TO DUE TO ------------------------ ----------------------- ------------------------ VOLUME RATE TOTAL VOLUME RATE TOTAL VOLUME RATE TOTAL ------ ------ ------ ------ ----- ------ ------- ----- ----- (Dollars in Thousands) INTEREST-EARNING ASSETS: Loans $ 767 $ (434) $ 333 $ 766 $ 240 $ 1,006 $ 1,084 $ (193) $ 891 Investment securities taxable - AFS 330 (202) 128 162 379 541 (236) (78) (314) Investment securities taxable - HTM (308) (85) (393) 419 81 500 147 (41) 106 Securities purchased under agreements to resell, and other 151 (143) 8 116 51 167 (28) (39) (67) -------- ------ ------- ------- ------- -------- ------- ------ ------ TOTAL INTEREST- EARNING ASSETS $ 940 $ (864) $ 76 $ 1,463 $ 751 $ 2,214 $ 967 $ (351) $ 616 ======== ======= ======= ======= ======= ======== ======= ====== ====== INTEREST-BEARING LIABILITIES: Interest-bearing demand and NOW deposits $ (1) $ (5) $ (6) $ (2) $ - $ (2) $ (2) $ (16) $ (18) Savings deposits 27 2 29 (17) 8 (9) 26 (80) (54) Money market deposits 36 (5) 31 3 1 4 11 (4) 7 Time deposits (24) (504) (528) 1,056 582 1,638 (8) (287) (295) Securities sold under agreements to repurchase (44) (71) (115) (105) 11 (94) (86) (73) (159) Federal Home Loan Bank advances 434 (81) 353 190 9 199 408 (5) 403 Senior debenture - - - (85) - (85) (127) (41) (168) -------- ------ ------- ------- ------- -------- ------- ------ ------ TOTAL INTEREST- BEARING LIABILITIES $ 428 $ (664) $ (236) $ 1,040 $ 611 $ 1,651 $ 222 $ (506) $ (284) ======== ======= ======== ======= ======= ======== ======= ====== ====== NET CHANGE IN NET INTEREST INCOME $ 512 $ (200) $ 312 $ 423 $ 140 $ 563 $ 745 $ 155 $ 900 ======== ======= ======= ======= ======= ======== ======= ====== ======
23 PROVISION FOR LOAN LOSSES The provision for loan losses was $75,000 in 2001 and $175,000 in 2000. The following table identifies the significant elements of asset quality embedded within the Company's loan portfolio as of and for the years ended December 31, 2001 and 2000. Refer to "Financial Condition" within this section for a discussion of the methodology used in addressing asset quality and the adequacy of the allowance for loan losses.
2001 2000 ---------- ----------- (In Thousands) Recorded investment in impaired loans $ 1,025 $ 1,410 Impaired loans requiring a valuation allowance 403 441 Valuation allowance 145 124 Net recoveries 6 21 Nonperforming loans - - Loans 30-89 days delinquent 588 460 Allowance for loan losses to total loans 1.61% 1.69%
NONINTEREST INCOME The following table identifies the major sources of noninterest income.
YEARS ENDED DECEMBER 31, --------------------------------------- 2001 2000 1999 ---------- ----------- ----------- (Dollars in Thousands) Service charges and fees on deposit accounts $ 301 $ 284 $ 268 Safe deposit box rental 27 27 25 Other service fees 25 30 26 Gain on sale of loans 224 383 340 Loan servicing fees 84 95 73 Residential mortgage program fees 134 77 10 ATM surcharge fees 87 69 55 Other 40 38 29 --------- -------- --------- $ 922 $ 1,003 $ 826 ========= ======== =========
Noninterest income decreased $80,884 or 8.1% to $922,050 from $1,002,934 in 2000. The single largest contributor to the decrease in noninterest income was a $159,000 decrease in gains on SBA loan sales to $224,000 in 2001 from $383,399 in 2000. During 2001, the Company sold $4.4 million of the guaranteed portion of SBA loans compared to $7.1 million during 2000. As a result of this SBA activity, at December 31, 2001 the Company was servicing nearly $16.5 million in sold loans compared to $15.5 million at December 31, 2000. This was offset by an $56,348 increase in residential mortgage program fees related to an increase in the residential loans sold. 24 NONINTEREST EXPENSE The following table identifies the major components of noninterest expense for the respective periods presented:
YEARS ENDED DECEMBER 31, ----------------------------------- 2001 2000 1999 -------- --------- ------ (Dollars in Thousands) Salaries and employee benefits $ 4,627 $ 2,644 $ 2,133 Occupancy expense 482 460 551 Equipment expense 245 251 290 OREO losses (gains), write-downs, and carrying costs, net 32 (14) (209) Computer service fees 268 252 252 Other operating expenses: FDIC insurance premium 28 23 12 Legal and professional fees 467 154 214 Directors' fees 126 128 116 Postage 54 65 47 Advertising 108 182 146 Office supplies, forms, stationery, printing, etc. 90 115 87 Miscellaneous 259 318 278 --------- -------- --------- $ 6,786 $ 4,578 $ 3,917 ========= ======== =========
Total overhead spending for the Company increased 48.2% to $6,786,517 in 2001 from $4,578,052 in 2000. During 2001, the Company's efficiency ratio was 84.37%, compared to 58.60% in 2000. Essentially, it cost the Company $0.84 to generate $1.00 of revenue in 2001. The primary reason for the increase in total overhead spending was due to costs associated with the Merger. Salaries and wages increased $1,982,872 to $4,627,229 in 2001 from $2,644,357. The primary reason for the increase was due to payments made related to the Merger. Other operating expenses increased $174,301 or 18.1% to $1,135,237 in 2001 from $960,936 in 2000. There were many expense categories which added or subtracted from this net increase. However, most of the net increase was due to two accounts. First, legal and professional fees increased $311,267 to $465,058 in 2001 from $153,791 in 2000 due to the Merger. Second, advertising costs decreased $73,612 to $108,185 from $181,797 in 2000 due to the promotion of the residential mortgage program and new deposit products in 2000. INCOME TAXES Income tax expense amounted to $1,155,191 in 2001, primarily due to non-deductible Merger related costs, which resulted in the Company's effective tax rate being 2001 higher than the statutory rate. The effective rate in 2000 was 35.6%. The Company's combined federal and state (net of federal benefit) statutory income tax rate was 39.94% in 2000. The Company's effective combined federal and state tax rate in 2000 was lower than the statutory rate primarily due to the exclusion of, from state taxable income, interest income on U.S. Treasury obligations and certain government agency debt securities in 2000. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, assets and liabilities are adjusted through the provision for income taxes. 25 FINANCIAL CONDITION TOTAL ASSETS The Company's total assets increased $16.8 million, or 10.0%, to $185.2 million at December 31, 2001, from $168.4 million at December 31, 2000. The increase in total assets primarily occurred within the Company's loan portfolio which increased $9.0 million, and a $9.6 million increase in the Company's securities purchased under agreement to resell, offset by a $11.5 million decrease in the Company's investment securities portfolio. Wholesale funding sources increased $10.7 million and retail deposits increased $8.6 million and stockholders' equity increased $1.0 million. INVESTMENT SECURITIES The Company's total investment securities portfolio decreased $1.5 million to $52.9 million at December 31, 2001, from $54.4 million at December 31, 2000. At December 31, 2001, securities which were classified as held-to-maturity were carried at an amortized cost of $14,415,394, with a fair value of $14,692,477. Securities classified as available-for-sale were carried at a fair value of $38,324,199, with an amortized cost of $37,732,024. At December 31, 2001, government agency debt securities and collateralized mortgage obligations were classified as held-to-maturity which is consistent with the Company's intent and ability. The available-for-sale segment of investment securities was comprised of U.S. Treasury securities, government agency debt securities, mortgage-backed securities, trust preferred stock, and marketable equity securities. The securities in which the Company may invest are subject to regulation and, for the most part, are limited to securities which are considered investment grade securities. In addition, the Company has an internal investment policy which restricts investments to: (i) United States treasury securities; (ii) obligations of United States government agencies and corporations; (iii) collateralized mortgage obligations, including securities issued by the Federal National Mortgage Association (FNMA), the Government National Mortgage Association (GNMA), and the Federal Home Loan Mortgage Corporation (FHLMC); (iv) securities of states and political subdivisions; (v) corporate debt, all of which must be considered investment grade by a recognized rating service; and (vi) corporate stock. In addition to achieving a rate of return which is consistent with the overall risk profile 23 of the investment portfolio, the Company views the principal purpose of its investment securities portfolio as a ready source of liquidity and as a management tool against interest rate risk embedded within the Company's balance sheet. Generally, the Company invests in fixed rate government and agency obligations with a maturity not to exceed three years. Single index floating rate or step-up securities generally have final maturities which do not exceed five years at time of purchase. During 2000 the Company did, however, purchase $10 million par value in investment grade trust preferred stock from five issuers. These fixed rate securities have maturities extending to 2027 with call provisions commencing in 2007. At December 31, 2001, the Company's investment securities had net unrealized gains of $669,258 as compared to net unrealized losses of $713,464 at December 31, 2000. LOANS Total loans, net of unearned discount, amounted to $113.1 million at December 31, 2001, up $9.2 million, or 9.0%, from $103.9 million at the end of 2000. The increase in total loans was predominately in the commercial real estate portfolio, which grew $10.6 million. At December 31, 2001, total loans represented 61.1% of total assets and 82.2% of total deposits compared to 61.7% and 80.5%, respectively, at the end of 2000. 26
AS OF DECEMBER 31, -------------------------------------------------------------------------- 2001 2000 1999 --------------------- --------------------- -------------------- AMOUNT PERCENT AMOUNT PERCENT AMOUNT PERCENT -------- ------- ------ ------- ------ ------- (Dollars in Thousands) Commercial $ 13,895 12.3% $ 13,099 12.6% $ 12,249 12.9% Commercial real estate 84,133 74.3 73,523 70.8 65,812 69.3 Residential real estate 11,083 9.8 13,378 12.9 13,084 13.8 Home equity lines of credit 3,142 2.8 2,949 2.8 3,051 3.2 Consumer 931 0.8 939 0.9 766 0.8 --------- --------- ---------- -------- ---------- -------- 113,184 103,888 94,962 Unearned discount 2 8 23 --------- ---------- ---------- 113,182 100.0% 103,880 100.0% 94,939 100.0% ========= ======== ======== Allowance for loan losses 1,832 1,752 1,556 --------- ---------- ---------- Net loans $ 111,350 $ 102,128 $ 93,383 ========= ========== ==========
For the past several years, including 2001, the Company encountered solid loan demand from small businesses. The Company believes a primary reason for this demand was the desire of small business borrowers to obtain banking relationships with banks which are responsive to their needs, and the success of the Company in meeting those needs. The increase in commercial and commercial real estate loans reflected the Company's emphasis on: (i) small business lending; (ii) obtaining loan guarantees from the SBA; and (iii) cash- flow analysis and an overall assessment of the borrower's financial strength and ability to repay with a secondary view towards collateral values. The Bank offers a full range of consumer lending products including residential mortgages and home equity lines of credit, new and used automobile loans, passbook and certificate of deposit loans, and other personal secured and unsecured loans. Although the Bank makes an effort to price these loans competitively, it faces substantial competition from mortgage and consumer finance companies. NONPERFORMING ASSETS Nonperforming assets include nonperforming loans and other real estate owned (OREO). The nonperforming loans category includes loans on which the accrual of interest is discontinued when the collectibility of principal or interest is in doubt, or when payments of principal or interest have become 90 days past due and have arrearages that have not been eliminated. In certain instances, nonperforming loans may also include loans that have become 90 days past due but remain on accrual status because the value of the collateral securing the loan is sufficient to cover principal and interest and the loan is in the process of collection. OREO consists of real estate acquired through foreclosure proceedings. In addition to the preceding two categories, the Company may, under appropriate circumstances, restructure loans as a concession to a borrower. At December 31, 2001, 2000 and 1999, no troubled debt restructurings were included in the Company's loan portfolio. 27 The following table sets forth information regarding nonperforming assets and delinquent loans 30-89 days past due as to interest or principal, and held by the Company at the dates indicated.
DECEMBER 31, ----------------------------------------- 2001 2000 1999 ----------- ---------- ---------- (Dollars in Thousands) Loans past due 90 days or more but not included in nonaccrual loans $ - $ - $ - Nonaccrual loans - - 181 ---------- --------- ---------- Total nonperforming loans - - 181 Other real estate owned - - - ---------- --------- ---------- Total nonperforming assets $ - $ - $ 181 ========== ========= ========== Delinquent loans 30-89 days past due $ 588 $ 460 $ 154 ========== ========= ========== Nonperforming loans as a percent of gross loans NM NM 0.19% Nonperforming assets as a percent of total assets NM NM 0.12% Delinquent loans 30-89 days past due as a percent of gross loans 0.52% 0.44% 0.16%
ALLOWANCE FOR LOAN LOSSES The allowance for loan losses is established through provisions charged against income. Assessing the adequacy of the allowance for loan losses involves substantial uncertainties and is based upon management's evaluation of the amounts required to meet estimated charge-offs in the loan portfolio after weighing various factors. Among the factors are: (i) the risk characteristics of the loan portfolio generally; (ii) the quality of specific loans; (iii) the level of non-accruing loans; (iv) current economic conditions; (v) trends in delinquencies and prior charge-offs; and (vi) the value of the underlying collateral. Ultimate loan losses may vary significantly from current estimates. The Company reviews nonperforming and performing loans to ascertain whether any impairment exists within the loan portfolio. The Company evaluates these problem loans and estimates the potential loss exposure when assessing the adequacy of the allowance for loan losses. Because the allowance for loan losses is based on various estimates and includes a high degree of judgment, subsequent changes in general economic conditions and the economic prospects of the borrowers may require changes in those estimates. The Bank has a loan peer review function and a loan loss review committee. The loan peer review committee, which meets monthly, is comprised of the Bank's chief executive officer and all loan officers. Every loan of $250,000 or more or a total relationship of $500,000 or more is scheduled to be reviewed not less than once every two years by the loan peer review committee. All loans that undergo loan peer review receive a numerical grade ranging from 1 to 6 based on a number of criteria, including the financial strength of the borrower as determined, in part, by such borrower's liquidity, debt service coverage and historical performance. Any loan rated 4 or worse will automatically be placed on a "watchlist." Certain 3 rated loans for which the committee has identified potential problems may also be placed on the watchlist. The loans on the watchlist are reviewed monthly by the Bank's Credit Committee in order to determine what actions should be taken with respect to such loans, whether any loans should be added or deleted from the watchlist, and to make estimates regarding loan loss exposure to the loan loss review committee. The loan loss review committee, comprised of the Bank's chief executive officer, chief financial officer and all other loan officers, reviews loans on the watchlist on a quarterly basis in order to establish specific loan loss reserve levels. In addition to assessing loss exposure for all loans included on the watchlist (specific allowance), the loan loss review committee also applies a three year moving weighted average, by category, of net charge-offs to 25 each loan type (general allowance) (exclusive of watchlist loans which are specifically reviewed). Finally, the loan loss review committee will take into consideration the above mentioned conditions, the effects of which are not directly measured 28 in determining the general and specific allowances. The evaluation of the inherent loss regarding these conditions involves a higher degree of uncertainty because they are not identified with specific problem loans or loan portfolio types. Thus, an unallocated allowance for loan losses is used to recognize the estimated risk associated with the general and specific allowance calculations and to reflect management's evaluation of various conditions, the effect of which are not directly measurable in determining the general and specific allowance. The following table, exclusive of the acquired allowance for loan losses, represents the distribution of the Bank's allowance for loan losses for the periods ending as indicated:
DECEMBER 31, ---------------------------------------------------------------------------- 2001 2000 1999 ----------------------- ---------------------- ------------------------- (Dollars in Thousands) Loan Category: Commercial $ 313 17.1% $ 212 12.1% $ 192 12.3% Commercial Real Estate 1,287 70.2 1,182 67.5 1,044 67.1 Residential Real Estate 175 9.6 281 16.0 248 15.9 Home Equity Lines of Credit 44 2.4 63 3.6 60 3.9 Consumer 13 0.7 14 0.8 12 0.8 --------- --------- --------- --------- --------- -------- Total $ 1,832 100% $ 1,752 100.0% $ 1,556 100.0% ========= ======= ========= ========= ========= ========
The unallocated portion of the allowance for loan losses is distributed among the various loan categories in the same proportion as the combined specific and general allowance to each loan type. This distribution of the allowance for loan losses reflects management's judgment of the relative risks of the various categories of the Bank's loan portfolio. This distribution should not be considered as an indication of the future amounts or types of loan charge-offs. At December 31, 2001, the Bank classified $1.4 million of loans as impaired based on the rating system adopted by the Bank. Of these amounts, a majority of which are included in the commercial and commercial real estate loan portfolio, the Bank estimates a potential loss exposure of $124,000. The following table is an analysis of the Allowance for Loan Losses over the last three years.
YEARS ENDED DECEMBER 31, ------------------------------------------ 2001 2000 1999 ----------- ----------- ----------- (Dollars in Thousands) AVERAGE LOANS OUTSTANDING $ 108,131 $ 99,862 $ 91,965 =========== =========== =========== ALLOWANCE FOR LOAN LOSSES AT BEGINNING OF YEAR $ 1,752 $ 1,556 $ 1,287 CHARGED-OFF LOANS: Commercial 19 44 52 Commercial Real Estate: Non-owner occupied 1-4 family - - - Non-owner occupied multi-family - - - Commercial - 41 - Residential Real Estate: Owner occupied 1-4 family - 4 - Non-owner occupied 1-4 family - - - Home Equity Lines of Credit - - - Consumer 5 1 2 ----------- ----------- ----------- Total charged-off loans 24 90 54 ----------- ----------- -----------
29
YEARS ENDED DECEMBER 31, ----------------------------------- 2001 2000 1999 -------- --------- ------- (Dollars in Thousands) RECOVERIES ON LOANS PREVIOUSLY CHARGED-OFF: Commercial - 21 3 Commercial Real Estate: Non-owner occupied 1-4 family - - - Non-owner occupied multi-family - - 19 Commercial - - 23 Residential Real Estate: Owner occupied 1-4 family 6 57 3 Non-owner occupied 1-4 family 23 33 - Home Equity Lines of Credit - - - Consumer - - - -------- -------- -------- Total recoveries 29 111 48 -------- -------- -------- NET LOANS (RECOVERED) CHARGED-OFF (5) (21) 6 PROVISION FOR LOAN LOSSES 75 175 275 -------- -------- -------- ALLOWANCE FOR LOAN LOSSES AT END OF YEAR $ 1,832 $ 1,752 $ 1,556 ======== ======== ======== Net loans (recovered) charged-off to average loans NM (0.02)% 0.01% Allowance for loan losses to gross loans at end of year 1.62% 1.69 1.64 Allowance for loan losses to nonperforming loans 164.60% NM 861.94 Net loans (recovered) charged-off to allowance for loan losses at beginning of year (0.34) (1.35) 0.47 Recoveries to charge-offs 123.71% 123.33 88.89
The following table summarizes the gross activity in OREO during the periods indicated:
YEARS ENDED DECEMBER 31, ----------------------------------- 2001 2000 1999 -------- --------- ------- (Dollars in Thousands) Balance at beginning of year $ - $ - $ 513 Property acquired - 430 - Sales and other adjustments, net of gains and losses - (430) (493) Write-downs (charged to operations) - - (20) ----------- ----------- --------- Balance at end of year $ - $ - $ - =========== =========== =========
DEPOSITS AND BORROWINGS The Company devotes considerable time and resources to gathering deposits through its retail branch network system. Total deposits increased $8.6 million, to $137.6 million at December 31, 2001, from $129.0 million at the end of 2000. During 2001, the Company reported increases in its core transactional type deposit products. Total demand deposits increased $3.1 million, and savings and money market accounts increased $3.7 million. Time deposits, which are more interest rate sensitive, increased only by $1.7 million. Along with its deposit gathering efforts, the Company continues to rely on borrowings from securities sold under agreements to repurchase (REPO) to leverage its capital. At December 31, 2001, securities sold under agreements to repurchase amounted to $6.8 million, compared to $9.6 million at December 31, 2000. 30 During 2001, the Company used wholesale funding sources from the Federal Home Loan Bank of Boston (FHLB). The purpose of these borrowings was to match the funding for selected loans as well as refinance maturing REPO's at more favorable terms. At December 31, 2001, advances from the FHLB amounted to $21.6 million, compared to $10.9 million at December 31, 2000. COMPARISON OF 2000 WITH 1999 The Company reported net income for 2000 of $1,970,719, as compared to $1,818,648 for 1999, or an increase of 8.4%. Diluted earnings per share amounted to $1.62 per share for 2000, based on 1,214,125 weighted average shares outstanding, as compared to $1.47 per share for 1999, based on 1,233,104 weighted average shares outstanding. During 1999, the Company recorded two one-time transactions. The first nonrecurring transaction was the sale of OREO at a gain of $222,452. The second nonrecurring transaction was a $129,362 write-off of a long-lived asset in recognition of its impaired value. The after-tax impact of these two transactions was to increase net income by $61,439, or $.05 per diluted share. Excluding these two nonrecurring transactions, net income would have increased 12.2% in 2000. In 2000 the Company's return on average equity (ROE) was 1.20% in 2000 and 1.26% in 1999. The improvement in net income was primarily the result of an increase in net interest income, noninterest income and a decrease in the provision for loan losses, offset somewhat by an increase in noninterest expense and provision for income taxes. In general, the Company's record performance in 2000 was attributable to (i) balance sheet growth, especially within the loan portfolio, (ii) an increase in the recognition of gains on SBA loan sales, and (iii) continued strength in asset quality. NET INTEREST INCOME In 2000, total interest income amounted to $13.4 million compared to $11.2 million in 1999, or an increase of $2.2 million or 19.8%. This increase was attributable to a $19.4 million, or 14.0% increase in average interest-earning assets to $158.5 million in 2000 from 139.0 million in 1999. The increase in interest income was also aided by a rising interest rate environment which contributed to the rise in earning asset yield to 8.45% in 2000 from 8.04% in 1999. Of the $19.4 million increase in average interest-earning assets, $7.9 million went to the loan portfolio which grew on average to $99.9 million in 2000 from $92.0 million in 1999. The remaining $11.5 million was placed in the Company's investment portfolio. During 2000, average loans represented 63.0% of total average earning assets compared to 66.1% during 1999. The growth in earning assets and the rising rate environment accounted for the overall increase in interest income. In terms of volume/rate, earning asset growth (volume) contributed $1,463,000 to the increase in interest income, while the rising rate environment added another $751,000. The funding for the $19.4 million increase in average earning assets came primarily from a $17.9 million increase in retail time deposits. In February 2000, the Company began its promotion of a 14-month certificate of deposit. This promotion resulted in the opening of over 1,000 certificates, raised $23 million in new deposits and resulted in the shifting of $3 million from other deposit products. The promoted rate of 7.00% APY along with a rising rate environment drove up the rate on time deposits to 5.89% from 5.00% in 1999. Total interest expense increased $1.7 million, or 25.8% to $6.6 million in 2000 from $4.9 million in 1999. Total average interest-bearing liabilities increased $17.1 million or 15.4% to $127.8 million in 2000 from $110.7 million in 1999 the 17 increase in average interest-bearing liabilities contributed $1,040,000 to the increase in total interest expense. The 14-month certificate of deposit promotion coupled with a rising rate environment increased the Company's cost of funds to 5.15% in 2000 from 4.46% in 1999, and contributed $611,000 to the increase in interest expense. Overall, net interest income increased $563,000 to $6.8 million from $6.2 million. Of this increase, $423,000 was attributable to balance sheet growth (volume), while $140,000 was attributable to changes in interest rates. the ability to maintain relatively neutral balance sheet exposure to changes in interest rates resulted in a modest impact to the Company's net interest income. For 2000, the Company's net interest spread declined 28 basis points to 3.30% from 3.58% in 1999. However, net interest margin only declined 19 basis points or 4.2% to 4.30% from 4.49% in 1999. During 2000, the Company increased the excess of average interest-earning assets over interest-bearing liabilities by $2.4 million to $30.7 million from $28.3 million during 1999. This improvement helped lower the net interest margin erosion of 19 basis points versus the net interest spread erosion of 28 basis points. 31 PROVISION FOR LOAN LOSSES The provision for loan losses was $75,000 in 2000 and 275,000 in 1999. At December 31, 2000 and 1999, the Company's recorded investment in impaired loans was $1,410,398 and $1,630,204, respectively, of which $440,574 and $613,074, respectively, was determined to require a valuation allowance of $123,639 and $147,586. At December 31, 2000 and 1999, there were no nonperforming loans. Loans 30-89 days delinquent increased to $460,000 from $153,714 at the end of 2000 and 1999, respectively. At December 31, 2000 and 1999, the allowance for loan losses to total loans was 1.69% and 1.64%, respectively. NONINTEREST INCOME Noninterest income increased $176,859 or 21.4% to $1,002,934 in 2000 from $826,075 in 1999. The single largest contributor to this increase was fees from the residential mortgage program which increased $67,553 to $77,292 in 2000 from $9,739 in 1999. This fee based program, which the Company became involved in during 1999, provides for the Company to act as an originator of conforming residential mortgages on behalf of other institutions. The other major contributor to the increase in noninterest income was a $43,338 increase in gains on SBA loan sales to $383,399 in 2000 compared to $340,061 in 1999. During 2000, the Company sold $7.1 million of the guaranteed portion of SBA loans compared to $5.5 million during 1999. As a result of this SBA activity, at December 31, 2000 the Company was servicing nearly $15.5 million in sold loans compared to $10.9 million at December 31, 1999. This increase in loan servicing accounted for the increase in servicing fee income of $22,035 to $95,453 in 2000. NONINTEREST EXPENSE Total overhead spending for the Company increased 16.9% to $4,578,052 in 2000 from $3,916,893 in 1999. During 2000 the Company's efficiency ratio was 58.60%, compared to 55.39% in 1999. Essentially, it cost the Company $.5860 to generate $1.00 of revenue in 2000. Salaries and wages increased $182,235 or 10.8% to $1,865,192. The primary reason for the increase was due to salary increases, additional staff and increased incentive accruals based on earnings. Benefit costs increased $328,930 or 73.1% during 2000 to $779,165 from $450,235 in 1999. Higher salaries and wages led to an $18,365 increase in related payroll taxes. Also, a 15% increase in premiums led to a $17,304 increase in health insurance costs. However, the single major reason for the increase in benefit costs was the $293,150 increase in pension costs to $423,145 in 2000 compared to $129,995 in 1999. During 1999, the Company's pension plan was fully funded and, consequently, no contribution was required. During 2000, the pension fund's investment performance declined and the Company was required to contribute and expense $131,900. Also, during 2000 the Company amended its Supplemental Executive Retirement Plan to provide for a minimum benefit of 80% of the participant's three highest years' base salary. This amendment increased the net periodic benefit cost by $146,000. Occupancy expense decreased $91,637 or 16.6% to $459,797 in 2000 compared to $551,434 in 1999. This decrease was primarily related to the 1999 write-off of a long-lived asset of 129,362 in recognition of its impaired value. Equipment expense decreased $38,941 or 13.4% to $251,147 in 2000 from $290,088 in 1999. A number of capital assets reached a fully depreciated status during 2000, thereby resulting in a reduction in depreciation expense of $30,646. OREO costs increased $195,471 to a net gain of $13,506 in 2000 compared to a net gain of $208,977 in 1999. During 1999, the Company sold vacant lots at a gain of $222,452. This single nonrecurring transaction was the major reason for the increase in net costs. Overall, foreclosure activity during 2000 was relatively insignificant. The OREO portfolio averaged $103,000 in 2000 compared to $231,000 during 1999. The Company only had four foreclosures during 2000 at a total carrying value of approximately $430,000. At December 31, 2000 and 1999, the Company had no foreclosed property on its books. Other operating expenses increased $73,757 or 8.3% to $960,936 in 2000 from $887,179. There were many expense categories which added or subtracted from this net increase. However, most of the net increase was confined to a handful of accounts. First, legal and professional fees decreased $59,829 to $153,791 in 2000 from $213,620 in 32 1999. This decrease was solely the result of providing $59,000 in 1999 for uninsured costs related to an ongoing legal matter. Second, postage, office supplies, forms, stationery, printing, etc. increased approximately $40,000. This increase related to the costs associated with the delivery of new products and updating of marketing materials and direct mail events to promote these new products. Finally, advertising costs increased $36,010 to $181,797 in 2000 from $145,787 in 1999. The promotion of the residential mortgage program and the new deposit products contributed to this increase. INCOME TAXES Income tax expense amounted to $1,088,613 in 2000, or an effective tax rate of 35.6%. The effective rate in 1999 was 36.8%. The Company's combined federal and state (net of federal benefit) statutory income tax rate was 39.94% in 2000 and 1999. The Company's effective combined federal and state tax rate was lower than the statutory rate primarily due to the exclusion of, from state taxable income, interest income on U.S. Treasury obligations and certain government agency debt securities in 2000 and 1999. Deferred tax assets and liabilities are reflected at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, assets and liabilities are adjusted through the provision for income taxes. FORWARD-LOOKING INFORMATION This report on Form 10-K may contain certain forward-looking statements, including without limitation, statements regarding (i) the level of reserve for loan loss, (ii) the rate of delinquencies and amounts of charge-offs and (iii) the rates of loan growth. Moreover, the Company may form time to time, in both written reports and oral statements by Company management, express its expectations regarding future performance of the Company. These forward-looking statements are inherently uncertain and actual results may differ from Company expectations. The following factors which, among others, could impact current and future performance include but are not limited to: (i) adverse changes in asset quality and resulting credit risk-related losses and expenses; (ii) adverse changes in the economy of the New England region, (iii) adverse changes in the local real estate market, as most of the Company's loans are concentrated in Southeastern Massachusetts and a substantial portion of these loans have real estate as collateral; (iv) fluctuations in market rates and prices which can negatively affect net interest margin, asset valuations and expense expectations; and (v) changes in regulatory requirements of federal and state agencies applicable to banks and bank holding companies, such as the Company, which could have materially adverse effect on the Company's future operating results. When relying on forward-looking statements to make decisions with respect to the Company, investors and others are cautioned to consider these and other risks and uncertainties. RECENT ACCOUNTING PRONOUNCEMENTS During 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement was amended by SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities--Deferral of the Effective Date of FASB Statement No. 133." This statement establishes accounting and reporting standards requiring that every derivative instrument, including certain derivative instruments embedded in other contracts, be recorded in the consolidated statement of condition as either an asset or liability measured at fair value. This statement requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative's gains and losses to offset related results on the hedged item in the consolidated statement of operations, and requires that an entity must formally document, designate and assess the effectiveness of transactions that receive hedge accounting. The Company adopted this statement effective January 1, 2001. The impact of adopting SFAS No. 133 did not have a material effect on the Company's consolidated financial position or results of operations. In June 2001, the FASB issued SFAS No. 141, "Business Combinations," which requires all business combinations initiated after June 30, 2001, to be accounted for using the purchase method. Accordingly, any future business combinations will be accounted for using the purchase method of accounting. 33 In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangibles." With the adoption of SFAS No. 142, goodwill will no longer be subject to amortization over its estimated useful life, but will be subject to annual assessment for impairment by applying a fair-value-based test. Recognized intangible assets, including core deposit intangibles, will continue to be amortized over their useful lives. The Company anticipates no material impact on the Bank's consolidated financial position or results of operations upon the adoption of SFAS No. 142. In July 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS No. 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. SFAS No. 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002 with early adoption permitted. Management is currently assessing the impact of SFAS No. 143. The Company does not believe the adoption of this statement will have a material impact on the Company's consolidated financial statements. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", which supersedes SFAS No. 121 and portions of APB Opinion No. 30. This statement addresses the recognition of an impairment loss for long-lived assets to be held and used, or disposed of by sale or otherwise. This statement is effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years. Management does not believe that the adoption of this statement will have a material effect on the Company's financial condition. ASSET/LIABILITY MANAGEMENT The principal objective of the Company's asset and liability management is to minimize interest rate risk on net interest income and stockholders' equity. This objective is accomplished by managing the ratio of interest rate sensitive assets to interest rate sensitive liabilities within specified maturities or repricing dates. The Company's actions in this regard are taken under the guidance of the Asset/ Liability Management Committee which includes members of the Company's senior management and two members of the Company's Board of Directors. The Asset/Liability Management Committee is actively involved in formulating the economic assumptions that the Company uses in its financial planning and budgeting process and establishes policies which control and monitor the Company's sources, uses and pricing of funds. The effect of interest rate changes on assets and liabilities is analyzed by examining the extent to which such assets and liabilities are "interest rate sensitive" and by monitoring the interest rate sensitivity "gap." An asset or liability is interest rate sensitive within a specific time period if it will mature or reprice within that time period. The interest rate sensitivity "gap" is defined as the difference between interest-earning assets and interest- bearing liabilities maturing or repricing within a given time period. A gap is considered positive when the amount of interest rate sensitive assets exceeds the amount of interest rate sensitive liabilities. A gap is considered negative when the amount of interest rate sensitive liabilities exceeds interest rate sensitive assets. During a period of falling interest rates, a positive gap would tend to adversely affect net interest income, while a negative gap would tend to result in an increase in net interest income. During a period of rising interest rates, a positive gap would tend to result in an increase in net interest income while a negative gap would tend to affect net interest income adversely. The Company has historically sought to maintain a relatively narrow gap position and has, in some instances, foregone investment in higher yielding assets where such investment, in management's opinion, exposed the Company to undue interest rate risk. However, the Company does not attempt to perfectly match interest rate sensitive assets and liabilities and will selectively mismatch its assets and liabilities to a controlled degree where it considers it both appropriate and prudent to do so. In managing its interest rate risk exposure, the Company does not engage in derivative financial instruments for hedging or speculative purposes. Other than fixed rate loan commitments, the Company is prohibited, by internal policy, from engaging in the use of off- balance sheet financial instruments. 34 There are a number of relevant time periods in which to measure the Company's gap position, such as at the three, six, and twelve month points and beyond in the maturity schedule. Management tends to focus most closely on the gap up to the one-year point in making its principal funding and investing decisions. The following table presents the repricing schedule for the Company's interest-earning assets and interest-bearing liabilities at December 31, 2001:
WITHIN OVER THREE OVER ONE OVER FIVE THREE TO TWELVE YEAR TO YEARS TO OVER FIFTEEN MONTHS MONTHS FIVE YEARS FIFTEEN YEARS YEARS TOTAL ------- ----------- ---------- ------------- ------------ ----- (Dollars in Thousands) INTEREST-EARNING ASSETS: Securities purchased under agreements to resell, and other $ 11,350 $ - $ - $ - $ - $ 11,350 Investment securities 15,426 5,801 20,616 10,964 - 52,807 Loans 28,087 14,328 55,593 14,100 - 112,108 ---------- --------- -------- --------- -------- -------- Total interest-earning assets 54,863 20,129 76,209 25,064 - 176,265 INTEREST-BEARING LIABILITIES: Money Market accounts 802 2,335 1,522 - - 4,659 Savings deposits and NOW accounts 1,988 6,143 16,017 - - 24,148 Time deposits 25,903 52,125 8,460 - - 86,488 Securities sold under agreements to repurchase 2,843 - 4,000 - - 6,843 Federal Home Loan Bank advances 325 974 7,692 12,623 - 21,614 ---------- --------- -------- --------- -------- -------- Total interest-bearing liabilities 31,861 61,577 37,691 12,623 - 143,752 ---------- --------- -------- --------- -------- -------- NET INTEREST SENSITIVITY GAP $ 23,002 $ (41,448) $ 38,518 $ 12,441 $ - $ 32,513 ========== ========= ======== ========= ======== ======== CUMULATIVE GAP $ 23,002 $ (18,446) $ 20,072 $ 32,513 $ 32,513 $ 32,513 ========== ========= ======== ========= ======== ======== NET INTEREST SENSITIVITY GAP AS A PERCENT OF TOTAL ASSETS 0.01% (0.02)% 0.02% 0.01% -% 0.02% ======== ======== ======= ======== ======= ======= CUMULATIVE GAP AS A PERCENT OF TOTAL ASSETS 0.01% (0.01)% 0.01% 0.02% 0.02% 0.02% ======== ======== ======= ======== ======= =======
Certain shortcomings are inherent in the method of analysis presented in the foregoing table. For example, although certain assets and liabilities may have similar maturities or periods to repricing, they may react in different degrees to changes in market interest rates. Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market rates. Additionally, certain assets, such as adjustable-rate loans, have features which restrict changes in interest 35 rates both on a short- term basis and over the life of the asset. Further, in the event of a change in interest rates, prepayment and early withdrawal levels could deviate significantly from those assumed in calculating the table. By using simulation modeling techniques, the Company is able to measure its interest rate risk exposure as determined by the impact of sudden movements in interest rates on net interest income and equity. This exposure is termed "earnings-at-risk" and "equity-at-risk". At December 31, 2001, the Company's earnings-at-risk under a +/-200 basis point interest rate shock test measured a negative 2.88% in a worst case scenario. Under a similar test, the Company's equity-at-risk measured a negative 26.08% of market value of equity at December 31, 2001. At December 31, 2001, the Company's earnings-at-risk and equity-at-risk fell well within tolerance levels established by internal policy. LIQUIDITY Liquidity is defined as the ability to meet current and future financial obligations of a short-term nature. The Company further defines liquidity as the ability to respond to the needs of depositors and borrowers and to earning enhancement opportunities in a changing marketplace. Primary sources of liquidity consist of deposit inflows, loan repayments, securities sold under agreement to repurchase, FHLB advances, maturity of investment securities and sales of securities from the available-for-sale portfolio. These sources fund the Bank's lending and investment activities. At December 31, 2001, cash and due from banks, securities purchased under agreements to resell, and short-term investments (unpledged and maturing within one year) amounted to $32,318 million, or 17.4% of total assets. Management is responsible for establishing and monitoring liquidity targets as well as strategies and tactics to meet these targets. Through membership in the Federal Home Loan Bank of Boston (FHLB), the Company has access to both short and long-term unused borrowings of nearly $30.5 million, which could assist the Company in meeting its liquidity needs and funding its asset mix. At December 31, 2001, the Company held state and municipal demand deposits of $4.3 million which it considered highly volatile. Nonetheless, the Company believes that there are no adverse trends in the Company's liquidity or capital reserves, and the Company believes that it maintains adequate liquidity to meet its commitments. CAPITAL RESOURCES The Bank is subject to the leverage and risk-based capital ratio requirements of the FDIC. The Bank is deemed to be "well capitalized" by the FDIC and is classified as such for FDIC insurance-assessment purposes. At December 31, 2001, the Bank's Leverage Capital Ratio was 8.65%, as compared to 9.79% at December 31, 2000. The FDIC's minimum Leverage Capital Ratio for "adequately capitalized" financial institutions is 3%, although this minimum leverage ratio applies only to certain of the most highly-rated banks. Other institutions are subject to higher requirements. The risk-based capital guidelines include both a definition of capital and a framework for calculating risk-weighted assets by assigning assets and off- balance sheet items to broad risk categories. According to these standards, the Bank had a Tier I Risk-Based Capital Ratio of 12.05% and a Total Risk - Based Capital Ratio of 13.3% at December 31, 2001, as compared to a Tier I Risk-Based Capital Ratio of 14.18% and a Total Risk-Based Capital Ratio of 15.44% at December 31, 2000. The minimum risk-based Tier I and Total Capital Ratios at each of these dates were 4.0% and 8.0%, respectively. The capital structure of the Company is subject to the capital ratio requirements of the Federal Reserve Board, which are similar to the requirements which FDIC imposes on the Bank. The Company is deemed to be "well-capitalized" by the Federal Reserve Board. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK Refer to "Asset/Liability Management" within Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations". 36 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS To the Shareholders and the Board of Directors of First Financial Corp.: We have audited the accompanying consolidated balance sheets of First Financial Corp. (a Rhode Island corporation) and subsidiary as of December 31, 2001 and 2000, and the related consolidated statements of income, stockholders' equity and comprehensive income, and cash flows for each of the three years in the period ended December 31, 2001. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of First Financial Corp. and subsidiary as of December 31, 2001 and 2000, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. Boston, Massachusetts January 9, 2002 37 FIRST FINANCIAL CORP. AND SUBSIDIARY Consolidated Balance Sheets As of December 31, 2001 and 2000
2001 2000 -------------- -------------- ASSETS CASH AND DUE FROM BANKS $ 2,881,803 $ 3,055,863 --------------- -------------- SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL 11,349,518 1,748,068 --------------- -------------- LOANS HELD FOR SALE 758,150 505,000 --------------- -------------- INVESTMENT SECURITIES: Held-to-maturity (fair value of $14,692,477 in 2001 and $22,451,901 in 2000) 14,615,394 22,488,801 Available-for-sale 38,324,199 31,923,655 --------------- -------------- Total investment securities 52,939,593 54,412,456 --------------- -------------- FEDERAL HOME LOAN BANK STOCK 1,091,500 716,000 --------------- -------------- LOANS: Commercial 13,895,322 13,099,260 Commercial real estate 84,132,491 73,522,872 Residential real estate 11,082,326 13,377,532 Home equity lines of credit 3,142,307 2,948,764 Consumer 931,420 939,063 --------------- -------------- 113,183,866 103,887,491 Less - unearned discount (2,014) (7,674) - allowance for loan losses (1,832,276) (1,751,621) ---------------- --------------- Net loans 111,349,576 102,128,196 --------------- -------------- PREMISES AND EQUIPMENT, net 1,783,191 2,003,583 --------------- -------------- OTHER ASSETS 3,034,720 3,802,341 --------------- -------------- TOTAL ASSETS $ 185,188,051 $ 168,371,507 =============== ============== LIABILITIES AND STOCKHOLDERS' EQUITY DEPOSITS: Demand $ 22,364,001 $ 19,187,122 Savings and money market accounts 28,807,904 25,084,287 Time deposits 86,486,199 84,774,840 --------------- -------------- Total deposits 137,658,104 129,046,249 SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE 6,843,162 9,574,571 FEDERAL HOME LOAN BANK ADVANCES 21,613,637 10,869,241 ACCRUED EXPENSES AND OTHER LIABILITIES 2,522,589 2,390,731 --------------- -------------- Total liabilities 168,637,492 151,880,792 --------------- -------------- COMMITMENTS AND CONTINGENCIES STOCKHOLDERS' EQUITY: Common stock, $1 par value; authorized - 5,000,000 shares; issued - 1,328,041 shares 1,328,041 1,328,041 Surplus 4,431,380 4,431,380 Retained earnings 11,190,918 11,892,318 Accumulated other comprehensive income (loss) 355,305 (405,939) --------------- -------------- 17,305,644 17,245,800 Less - Treasury stock, at cost, 114,300 shares 755,085 755,085 --------------- -------------- Total stockholders' equity 16,550,559 16,490,715 --------------- -------------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 185,188,051 $ 168,371,507 =============== ==============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS. 38 FIRST FINANCIAL CORP. AND SUBSIDIARY Consolidated Statements of Income For the Years Ended December 31, 2001, 2000 and 1999
2001 2000 1999 --------------- --------------- --------------- INTEREST INCOME: Interest and fees on loans $ 10,027,070 $ 9,693,958 $ 8,687,625 Interest and dividends on investment securities-- U.S. Government and agency obligations 1,693,269 2,213,320 1,735,195 Collateralized mortgage obligations 24,604 65,477 129,786 Mortgage-backed securities 236,140 305,300 393,975 Trust preferred stock 1,050,705 706,498 - Marketable equity securities and other 137,220 103,989 71,483 Interest on cash equivalents 301,456 305,788 161,506 --------------- -------------- --------------- Total interest income 13,470,464 13,394,330 11,179,570 --------------- -------------- --------------- INTEREST EXPENSE: Interest on deposits 4,888,066 5,362,533 3,732,477 Interest on repurchase agreements 344,167 459,222 553,342 Interest on borrowings 1,116,728 763,125 563,746 Interest on debenture - - 84,503 --------------- -------------- --------------- Total interest expense 6,348,961 6,584,880 4,934,068 --------------- -------------- --------------- Net interest income 7,121,503 6,809,450 6,245,502 PROVISION FOR LOAN LOSSES 75,000 175,000 275,000 --------------- -------------- --------------- Net interest income after provision for loan losses 7,046,503 6,634,450 5,970,502 --------------- -------------- --------------- NONINTEREST INCOME: Service charges on deposits 301,238 284,077 267,626 Gain on loan sales 223,674 383,399 340,061 Other 397,138 335,458 218,388 --------------- -------------- --------------- Total noninterest income 922,050 1,002,934 826,075 --------------- -------------- --------------- NONINTEREST EXPENSE: Salaries and employee benefits 4,627,229 2,644,357 2,133,193 Occupancy expense 481,539 459,797 551,434 Equipment expense 244,901 251,147 290,088 Other real estate owned net losses (gains), and expenses 32 (13,506) (208,977) Computer services 268,644 251,883 251,964 Deposit insurance assessments 28,935 23,438 12,012 Other operating expenses 1,135,236 960,936 887,179 --------------- -------------- --------------- Total noninterest expense 6,786,516 4,578,052 3,916,893 --------------- -------------- --------------- Income before provision for income taxes 1,182,037 3,059,332 2,879,684 PROVISION FOR INCOME TAXES 1,155,191 1,088,613 1,061,036 --------------- -------------- --------------- NET INCOME $ 26,846 $ 1,970,719 $ 1,818,648 =============== ============== =============== Earnings per share: Basic $ 0.02 $ 1.62 $ 1.47 =============== ============== ============== Diluted $ 0.02 $ 1.62 $ 1.47 =============== ============== ============== Weighted average common and common stock equivalent shares outstanding 1,213,741 1,214,125 1,233,104 =============== ============== ===============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS. 39 FIRST FINANCIAL CORP. AND SUBSIDIARY Consolidated Statements of Stockholders' Equity And Comprehensive Income For the Years Ended December 31, 2001, 2000 and 1999
COMMON RETAINED STOCK SURPLUS EARNINGS ------------- ------------- -------------- BALANCE, December 31, 1998 $ 1,328,041 $ 4,431,380 $ 9,130,143 Net income - - 1,818,648 Other comprehensive income, net of tax: Unrealized holding losses, net of reclassification adjustment - - - ------------- ------------- ------------- Comprehensive income ------------- ------------- ------------- Dividends declared ($.36 per share) - - (444,597) Repurchase of 35,000 shares of common stock - - ------------- ------------- ------------- BALANCE, December 31, 1999 1,328,041 4,431,380 10,504,194 Net income - - 1,970,719 Other comprehensive income, net of tax: Unrealized holding losses, net of reclassification adjustment - - - ------------- ------------- ------------- Comprehensive income ------------- ------------- ------------- Dividends declared ($.48 per share) - - (582,595) Repurchase of 12,500 shares of common stock - - - ------------- ------------- ------------- BALANCE, December 31, 2000 1,328,041 4,431,380 11,892,318 Net income - - 26,846 Other comprehensive income, net of tax: Unrealized holding gains, net of reclassification adjustment - - - ------------- ------------- ------------- Comprehensive income ------------- ------------- ------------- Dividends declared ($.60 per share) - - (728,246) ------------- ------------- ------------- BALANCE, December 31, 2001 $ 1,328,041 $ 4,431,380 $ 11,190,918 ============= ============= ============= ACCUMULATED OTHER TOTAL COMPREHENSIVE TREASURY STOCKHOLDERS' COMPREHENSIVE (LOSS) INCOME STOCK EQUITY INCOME ---------------- -------------- -------------- -------------- BALANCE, December 31, 1998 $ 70,638 $ (146,960) $ 14,813,242 Net income - - 1,818,648 $ 1,818,648 Other comprehensive income, net of tax: Unrealized holding losses, net of reclassification adjustment (256,903) - (256,903) (256,903) ------------- ------------- ------------- -------------- Comprehensive income $ 1,561,745 ------------- ------------- ------------- ============== Dividends declared ($.36 per share) - - (444,597) Repurchase of 35,000 shares of common stock - (448,750) (448,750) ------------- ------------- ------------- BALANCE, December 31, 1999 (186,265) (595,710) 15,481,640 Net income - - 1,970,719 $ 1,970,719 Other comprehensive income, net of tax: Unrealized holding losses, net of reclassification adjustment (219,674) - (219,674) (219,674) ------------- ------------- ------------- -------------- Comprehensive income $ 1,751,045 ------------- ------------- ------------- ============== Dividends declared ($.48 per share) - - (582,595) Repurchase of 12,500 shares of common stock - (159,375) (159,375) ------------- ------------- ------------- BALANCE, December 31, 2000 (405,939) (755,085) 16,490,715 Net income - - 26,846 $ 26,846 Other comprehensive income, net of tax: Unrealized holding gains, net of reclassification adjustment 761,244 - 761,244 761,244 ------------- ------------- ------------- -------------- Comprehensive income $ 788,090 ------------- ------------- ------------- ============== Dividends declared ($.60 per share) - - (728,246) ------------- ------------- ------------- BALANCE, December 31, 2001 $ 355,305 $ (755,085) $ 16,550,559 ============= ============= =============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS. 40 FIRST FINANCIAL CORP. AND SUBSIDIARY Consolidated Statements of Cash Flows For the Years Ended December 31, 2001, 2000 and 1999
2001 2000 1999 --------------- -------------- ---------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 26,846 $ 1,970,719 $ 1,818,648 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses 75,000 175,000 275,000 Depreciation and amortization 398,978 278,865 305,694 Write-off of impaired long-lived assets - - 129,362 Gains on sale of other real estate owned - (21,544) (215,008) Gain on sales of loans (223,674) (383,399) (340,061) Proceeds from sales of loans 4,414,133 7,082,463 5,547,975 Loans originated for sale (3,446,219) (6,261,726) (5,792,759) Net (decrease) increase in deferred loan fees 17,628 (8,454) 4,535 Net accretion on investment securities held-to-maturity (15,102) (12,339) (6,916) Net accretion on investment securities available-for-sale (263,605) (330,756) (370,177) Net decrease in unearned discount (5,668) (15,547) (43,043) Net decrease (increase) in other assets 661,947 (1,660,072) (290,742) Deferred income taxes (117,000) (180,000) (237,000) Amortization of discount on debenture - - 15,860 Net increase in accrued expenses and other liabilities 131,858 700,732 280,385 ---------------- --------------- --------------- Net cash provided by operating activities 1,655,122 1,333,942 1,081,753 ---------------- --------------- --------------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from maturities of investment securities held-to-maturity 26,560,115 2,547,151 3,532,387 Proceeds from maturities of investment securities available-for-sale 268,735,464 259,462,848 310,600,674 Purchase of investment securities held-to-maturity (19,000,000) (9,332,609) (5,483,082) Purchase of investment securities available-for-sale (274,749,355) (270,564,744) (298,428,506) Purchase of Federal Home Loan Bank stock (375,500) (34,500) (233,800) Net increase in loans (9,222,138) (9,326,567) (8,610,414) Purchase of premises and equipment (72,914) (115,345) (185,369) Sales of other real estate owned - 451,625 728,135 ---------------- --------------- --------------- Net cash (used in) provided by investing activities (8,124,328) (26,912,141) 1,920,025 ---------------- --------------- --------------- CASH FLOWS FROM FINANCING ACTIVITIES: Net increase in demand accounts 3,176,879 1,664,813 1,779,124 Net increase in savings and money market accounts 3,723,617 1,245,585 1,898,372 Net increase (decrease) in time deposits 1,711,359 21,547,346 (3,460,919) Net (decrease) increase in repurchase agreements (2,731,409) 163,460 (2,844,769) Net increase (decrease) in Federal Home Loan Bank advances 10,744,396 (2,741,159) 7,406,323 Repayment of Senior Debenture - - (2,708,777) Purchase of common stock for treasury - (159,375) (448,750) Dividends paid (728,246) (582,595) (444,597) ---------------- --------------- --------------- Net cash provided by financing activities 15,896,596 21,138,075 1,176,007 ---------------- --------------- --------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 9,427,390 (4,440,124) 4,177,785 CASH AND CASH EQUIVALENTS, beginning of year 4,803,931 9,244,055 5,066,270 ---------------- --------------- --------------- CASH AND CASH EQUIVALENTS, end of year $ 14,231,321 $ 4,803,931 $ 9,244,055 ================ =============== =============== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Interest paid $ 6,428,238 $ 6,479,173 $ 4,907,286 ================ =============== =============== Income taxes paid $ 1,115,000 $ 1,535,000 $ 1,236,000 ================ =============== =============== SUPPLEMENTAL DISCLOSURE OF NONCASH TRANSACTIONS: Transfer of loans to OREO $ - $ 430,081 $ - ================ =============== ===============
THE ACCOMPANYING NOTES ARE AN INTEGRAL PART OF THESE CONSOLIDATED FINANCIAL STATEMENTS. 41 FIRST FINANCIAL CORP. AND SUBSIDIARY Notes to Consolidated Financial Statements For the Year Ended December 31, 2001 (1) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES PRINCIPLES OF CONSOLIDATION The accompanying consolidated financial statements include the accounts of First Financial Corp. and its wholly-owned subsidiary First Bank and Trust Company (the "Bank") (collectively, "Company"), after elimination of all intercompany transactions and balances. On November 12, 2001, the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") with Washington Trust Bancorp, Inc. ("Washington Trust"), pursuant to which the Company will merge with and into Washington Trust (the "Merger"). Pursuant to the terms of the Merger Agreement, the issued and outstanding shares of the Company will be converted into the right to $16.00 in cash and that number of shares of Washington Trust common stock, par value $0.625 per share determined based on an exchange ratio set forth in the Merger Agreement. Consummation of the Merger is subject to a number of conditions, including, but not limited to, the approval of the Merger Agreement and the Merger by the shareholders of the Company and the receipt of requisite regulatory approvals. In connection with the Merger Agreement, The Washington Trust Company of Westerly, a subsidiary of Washington Trust entered into an Agreement and Plan of Merger (the "Subsidiary Agreement") with First Bank and Trust Company, a subsidiary of the Company ("First Bank"), pursuant to which First Bank will merge with and into Washington Trust (the "Bank Merger"). Pursuant to the Subsidiary Agreement, the issued and outstanding shares of First Bank will be cancelled immediately prior to the Bank Merger. USE OF ESTIMATES The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant changes in the near term relate to the determination of the allowance for loan losses, deferred tax assets and servicing rights assets. CASH AND CASH EQUIVALENTS For the purpose of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks and securities purchased under agreements to resell, which represent short-term investments in government treasury and agency securities purchased from another institution. INVESTMENT SECURITIES Debt securities that management has the positive intent and ability to hold to maturity are classified as held-to-maturity and are carried at cost, adjusted for the amortization of premium or the accretion of discount. Debt and equity securities with readily determinable fair values which are bought and held principally for the purpose of selling them in the near term are classified as trading securities and are carried at fair value, with unrealized gains and losses included in current earnings. At December 31, 2001 and 2000, the Company had no securities classified as trading. Debt and equity securities not classified as either held-to-maturity or trading 42 are classified as available-for-sale and are carried at fair value, with unrealized after-tax gains and losses reported as a separate component of stockholders' equity. LOANS Loans are stated at the principal amount outstanding, net of unamortized deferred loan origination fees and costs. Deferred loan origination fees and costs are amortized as an adjustment to yield over the life of the related loans. Interest on commercial, real estate and consumer loans is accrued based on the principal amounts outstanding. The Company's policy is to discontinue the accrual of interest on loans when scheduled payments become past due in excess of 90 days, and when, in the judgment of management, the ultimate collectibility of principal or interest becomes doubtful. When a loan is placed on nonaccrual status, all interest previously accrued but not collected is generally reversed against interest income in the current period. Interest income is recognized on an accrual basis for impaired loans, until such loans are placed on nonaccrual status. The Company recognizes interest income on these nonaccrual loans on a cash basis when the ultimate collectibility of principal is no longer considered doubtful. Otherwise, cash payments on nonaccrual loans are applied to principal. Loans held for sale are carried at the lower of cost or net realizable value. A loan is impaired when, based on current information and events, it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement. Impaired loans are measured based on the present value of expected future cash flows discounted at the loan's effective interest rate or, as a practical expedient, at the loan's observable market price or the face value of the collateral if the loan is collateral-dependent. Currently, all impaired loans have been measured through the latter method. All loans on nonaccrual status are considered to be impaired. All adversely classified loans at December 31, 2001 and 2000 are also considered to be impaired. When the measure of the impaired loan is less than the recorded investment in the loan, the impairment is recorded through a valuation allowance. Loans are evaluated for impairment according to the Company's normal loan review process, including overall credit evaluation and rating, nonaccrual status and payment experience. Loans identified as impaired are further evaluated to determine the estimated extent of impairment. For collateral-based loans, the extent of impairment is the shortfall, if any, between the collateral value less costs to dispose of such collateral and the carrying value of the loan. In accordance with Statement of Financial Accounting Standards (SFAS) No. 125 and SFAS No. 140 "Accounting for Transfers and Servicing of Financial Assets and Extinguishments on Liabilities," the Company capitalizes the rights to service loans for others. The total cost of originated loans that are sold with servicing rights retained is allocated between the servicing rights and the loans without the servicing rights based on their relative fair values. Capitalized servicing rights are included in other assets and are amortized as an offset to other income over the period of estimated net servicing income. They are periodically evaluated for impairment based on their fair value. Impairment is measured on an aggregated basis according to interest rate band and period of origination. The fair value is estimated based on the present value of expected cash flows, incorporating assumptions for discount rate, prepayment speed and servicing cost. Any impairment is recognized as a charge to earnings through a valuation allowance. Certain disclosure provisions required by SFAS No. 140 were effective immediately and are included in these consolidated financial statements. Additional requirements related to SFAS No. 140 were effective March 31, 2001, and did not have a material effect on the Company's consolidated financial position or results or operations. PROVISION AND ALLOWANCE FOR LOAN LOSSES The balance of the allowance and the amount of the annual provision charged to expense are estimated amounts based on management's systematic review of past loan loss experience, changes in the character and size of the loan portfolio, current economic conditions, adverse situations that may affect the borrower's ability to repay, and other pertinent factors. Ultimate losses may vary from the current estimates. These estimates are reviewed periodically, and as adjustments become necessary, they are reported as an expense in the periods in which they become known. The allowance is maintained at a level considered by 43 management to be adequate to cover inherent loan losses. Losses are charged against the allowance for loan losses when management believes that the collectibility of principal is unlikely. This evaluation is subjective as it requires estimates that are susceptible to significant revision as more information becomes available. OTHER REAL ESTATE OWNED Real estate properties acquired through, or in lieu of, loan foreclosure are to be sold and are initially recorded at fair value at the date of foreclosure establishing a new cost basis. After foreclosure, valuations are periodically performed by management and the real estate is carried at the lower of carrying amount or fair value less cost to sell. Expenses from operations and changes in valuations are included in other real estate owned net (gains) losses and expenses. At December 31, 2001 and 2000, the Company did not own any real estate acquired through, or in lieu of, foreclosure. PREMISES AND EQUIPMENT Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets. The following is a summary of the lives over which the Company computes depreciation and amortization: Building and Improvements 10-40 years Leasehold Improvements 10 years Furniture and Fixtures 10-20 years Equipment 5-10 years
When property is retired or otherwise disposed of, the asset and accumulated depreciation and amortization are removed from the accounts, and any resulting gain or loss is reflected in the consolidated statements of income. Costs of major additions and improvements are capitalized, and expenditures for maintenance and repairs are charged to operations as incurred. IMPAIRMENT OF LONG-LIVED ASSETS Long-lived assets and certain identifiable intangibles are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If an asset being tested for recoverability was acquired in a business combination, the related goodwill is included as part of the asset grouping in determining recoverability. In instances where goodwill is identified with assets that are subject to an impairment loss, the carrying amount of the identified goodwill is eliminated before making any reduction of the carrying amounts of impaired long-lived assets and identifiable intangibles. The Company evaluates the recoverability of its carrying amounts of long-lived assets based on estimated cash flows to be generated by each of such assets as compared to the original estimates used in measuring such assets. To the extent impairment is identified, this Company would reduce the carrying value of such assets. INCOME TAXES The Company accounts for income taxes using the asset and liability method of accounting under which deferred taxes are recognized for the future tax consequences of the temporary differences between the financial statement and tax basis of assets and liabilities, using the enacted tax rates expected to be in effect when the amounts related to such temporary differences are realized or settled. As changes in tax laws or rates are enacted, deferred assets and liabilities will be adjusted accordingly through the provision for income taxes. 44 EARNINGS PER SHARE Basic earnings per share is determined by dividing net income by the weighted average number of common shares outstanding. Diluted earnings per share is determined by dividing net income by the weighted average number of common shares and common stock equivalent shares outstanding. There were no dilutive shares outstanding during 2001, 2000 and 1999. COMPREHENSIVE INCOME Comprehensive income, which consists of net income and changes in unrealized gains and losses on securities available-for-sale net of income taxes, is disclosed in the consolidated statements of stockholders' equity and comprehensive income. There were no reclassification adjustments to comprehensive income during 2001, 2000 and 1999. RECENT ACCOUNTING PRONOUNCEMENTS During 1998, the Financial Accounting Standards Board (FASB) issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement was amended by SFAS No. 137, "Accounting for Derivative Instruments and Hedging Activities--Deferral of the Effective Date of FASB Statement No. 133." This statement establishes accounting and reporting standards requiring that every derivative instrument, including certain derivative instruments embedded in other contracts, be recorded in the consolidated statement of condition as either an asset or liability measured at fair value. This statement requires that changes in the derivative's fair value be recognized currently in earnings unless specific hedge accounting criteria are met. Special accounting for qualifying hedges allows a derivative's gains and losses to offset related results on the hedged item in the consolidated statement of operations, and requires that an entity must formally document, designate and assess the effectiveness of transactions that receive hedge accounting. The Company adopted this statement effective January 1, 2001. The impact of adopting SFAS No. 133 did not have a material effect on the Company's consolidated financial position or results of operations. In June 2001, the FASB issued SFAS No. 141, "Business Combinations," which requires all business combinations initiated after June 30, 2001, to be accounted for using the purchase method. Accordingly, any future business combinations will be accounted for using the purchase method of accounting. In June 2001, the FASB issued SFAS No. 142, "Goodwill and Other Intangibles." With the adoption of SFAS No. 142, goodwill will no longer be subject to amortization over its estimated useful life, but will be subject to annual assessment for impairment by applying a fair-value-based test. Recognized intangible assets, including core deposit intangibles, will continue to be amortized over their useful lives. The Company anticipates no material impact on the Bank's consolidated financial position or results of operations upon the adoption of SFAS No. 142. In July 2001, the FASB issued SFAS No. 143, "Accounting for Asset Retirement Obligations." SFAS No. 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS No. 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. SFAS No. 143 is effective for financial statements issued for fiscal years beginning after June 15, 2002 with early adoption permitted. Management is currently assessing the impact of SFAS No. 143. The Company does not believe the adoption of this statement will have a material impact on the Company's consolidated financial statements. In August 2001, the FASB issued SFAS No. 144, "Accounting for the Impairment or Disposal of Long-Lived Assets", which supersedes SFAS No. 121 and portions of APB Opinion No. 30. This statement addresses the recognition of an impairment loss for long-lived assets to be held and used, or disposed of by sale or otherwise. This statement is effective for financial statements issued for fiscal years beginning after December 15, 2001, and interim periods within those fiscal years. Management does not believe that the adoption of this statement will have a material effect on the Company's financial condition. 45 (2) INVESTMENT SECURITIES The estimated fair value and amortized cost of investment securities at December 31, 2001 and 2000 are as follows:
DECEMBER 31, 2001 -------------------------------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ---------- ----------- ------------ -------- Held-to-maturity: U.S. Government & agency obligations $ 14,500,000 $ 113,913 $ (37,011) $ 14,576,902 Collateralized mortgage obligations 115,394 181 - 115,575 ------------- ------------ ------------ ------------- $ 14,615,394 $ 114,094 $ (37,011) $ 14,692,477 ============= =========== =========== ============= Available-for-sale: U.S. Government & agency obligations $ 18,494,795 $ 122,274 $ - $ 18,617,069 Mortgage-backed securities 2,950,518 71,575 (1,000) 3,021,093 Trust preferred stock 14,454,186 503,425 - 14,957,611 Marketable equity securities and other 1,832,525 3,775 (107,874) 1,728,426 ------------- ------------ ------------ ------------- $ 37,732,024 $ 701,049 $ (108,874) $ 38,324,199 ============= =========== =========== =============
DECEMBER 31, 2001 -------------------------------------------------------- GROSS GROSS AMORTIZED UNREALIZED UNREALIZED FAIR COST GAINS LOSSES VALUE ---------- ----------- ------------ -------- Held-to-maturity: U.S. Government & agency obligations $ 21,836,272 $ 32,173 $ (66,614) $ 21,801,831 Collateralized mortgage obligations 652,529 - (2,459) 650,070 ------------- ------------ ------------ ------------- $ 22,488,801 $ 32,173 $ (69,073) $ 22,451,901 ============= =========== ============ ============= Available-for-sale: U.S. Government & agency obligations $ 17,480,446 $ 64,362 $ (9,411) $ 17,535,397 Mortgage-backed securities 4,202,320 24,494 (10,856) 4,215,958 Trust preferred stock 9,432,439 - (522,239) 8,910,200 Marketable equity securities and other 1,485,014 22,697 (245,611) 1,262,100 ------------- ------------ ------------ ------------- $ 32,600,219 $ 111,553 $ (788,117) $ 31,923,655 ============= =========== ============ =============
A schedule of the maturity distribution of U.S. Government and agency obligations as of December 31, 2001 is as follows:
HELD-TO-MATURITY AVAILABLE-FOR-SALE ------------------------------- ------------------------------ AMORTIZED FAIR AMORTIZED FAIR COST VALUE COST VALUE --------------- -------------- -------------- ------------- Within one year $ 500,000 $ 501,830 $ 17,494,795 $ 17,586,629 Over one year to five years 14,000,000 14,075,072 1,000,000 1,030,440 ------------- -------------- -------------- ------------- $ 14,500,000 $ 14,576,902 $ 18,494,795 $ 18,617,069 ============= ============= ============= =============
46 At December 31, 2001, $14,000,000 par value of debt securities maturing in the one-to-five-year period are subject to call provisions within one year. There were no sales of investment securities in 2001, 2000 and 1999. At December 31, 2001, issues of trust preferred stock have maturities extending to 2027 with call provisions commencing in 2007. The call provisions are at a declining premium for 10 years and then at par thereafter. Investment securities with a carrying value of $5,376,166 and $11,869,188 at December 31, 2001 and 2000, respectively, were pledged as collateral for repurchase agreements, public deposits and other purposes, as required by law. (3) LOANS AND ALLOWANCE FOR LOAN LOSSES The Bank devotes significant attention to maintaining high loan quality through its underwriting standards, active servicing of loans and aggressive management of nonperforming assets. The allowance for loan losses is maintained at a level estimated by management to provide adequately for loan losses which are inherent in the loan portfolio. Loan losses are estimated based on a quarterly review of the loan portfolio, loss experience, specific problem loans, economic conditions and other pertinent factors. In assessing risks inherent in the portfolio, management considers the risk of loss on non performing and classified loans including an analysis of collateral in each situation. The Bank's methodology for assessing the appropriateness of the allowance includes several key elements. Problem loans are identified and analyzed individually to detect specific losses. The loan portfolio is also segmented into pools of loans that are similar in type and risk characteristics (i.e. commercial, consumer and mortgage loans). Loss factors are applied using the Bank's historic experience and may be adjusted for significant factors that in management's judgement affect the collectability of the portfolio as of the evaluation data. Additionally, the portfolio is segmented into pools based on internal risk ratings with loss factors applied to each rating category. Other factors considered in determining loan losses are: - the impact of larger concentrations in the portfolio, - trends in loan growth, - the relationship and trends in recent years of recoveries as a percentage of prior chargeoffs, and - peer bank loss experience. While management believes that, based on information currently available, the allowance for loan losses is sufficient to cover probable losses inherent in it loan portfolio at this time, no assurances can be given that the Bank's level of allowance for loan losses will be sufficient to cover loan losses incurred by the Bank or that future adjustments to the allowance for loan losses will not be necessary if economic and other conditions differ substantially from the economic and other conditions used by management to determine the current level of the allowance for loan losses. In 1992, the Company acquired certain assets and assumed certain deposit liabilities of the former Chariho-Exeter Credit Union ("Chariho"). The Company and the State of Rhode Island Depositors Economic Protection Corporation ("DEPCO") established an allowance for loan losses of $3,850,000 for loans acquired. This allowance was available only for loans of Chariho existing as of the acquisition date. As set forth in the Chariho Acquisition Agreement, the remaining balance, if any, in the acquired allowance at May 1, 1999, less an amount equal to 1% of the remaining acquired loans, must be refunded to DEPCO. Conversely, in the event the allowance is inadequate, additional loan charge-offs were to reduce the amount owed on the debenture (Note 12) issued to DEPCO in connection with the acquisition. On May 31, 1999, the Company repaid the Senior Debenture in the amount of $2,708,777, which represented the original face value of $3,000,000, less $291,223 in net acquired loan losses in excess of the acquired loan loss allowance. The following analysis summarizes activity for both the acquired allowance and the Company's allowance for loan losses. 47
DECEMBER 31 ----------------------------------------------------- 2001 2000 1999 ---------------- ---------------- --------------- Allowance for loan losses: Balance at beginning of year $ 1,751,621 $ 1,556,405 $ 1,287,058 Provision 75,000 175,000 275,000 Loan charge-offs (23,854) (89,994) (53,634) Recoveries 29,509 110,210 47,981 ---------------- ---------------- ---------------- Balance at end of year 1,832,276 1,751,621 1,556,405 ---------------- ---------------- ---------------- Acquired allowance: Balance at beginning of year - - - Loan charge-offs - - (266,482) Recoveries - - 1,638 Reclassification to Senior Debenture (Note 12) - - 264,844 ---------------- ---------------- ---------------- Balance at end of year - - - ---------------- ---------------- ---------------- Total allowance $ 1,832,276 $ 1,751,621 $ 1,556,405 =============== =============== ===============
At December 31, 2001 and 2000, the Company's recorded investment in impaired loans was $925,977 and $1,410,398, respectively, of which $402,936 and $440,574, respectively, was determined to require a valuation allowance of $144,752 and $123,639, respectively. The average recorded investment in impaired loans during 2001 and 2000 was $1,168,875 and $1,119,027, respectively. For the years ended December 31, 2001 and 2000, interest income on impaired loans totaled $203,327 and $169,190, respectively. At December 31, 2001 and 2000, the Company had no nonaccruing loans. Loans serviced for others are not included in the accompanying consolidated balance sheets. The unpaid principal balances of mortgage and other loans serviced for others were $16,521,015 and $15,522,774 at December 31, 2001 and 2000, respectively. The balance of capitalized servicing rights, net of valuation allowances, included in other assets at December 31, 2001 and 2000, was $530,341 and $464,926, respectively. Amortization of these servicing rights totaled $105,673, $29,873 and $0 for the years ended December 31, 2001, 2000 and 1999, respectively. (4) PREMISES AND EQUIPMENT Premises and equipment are summarized as follows at December 31,:
2001 2000 ------------------ ------------------- Land and improvements $ 676,294 $ 676,294 Buildings and improvements 1,466,082 1,435,752 Leasehold improvements 277,824 277,824 Furniture, fixtures and equipment 1,564,034 1,521,450 ------------------ ------------------- 3,984,234 3,911,320 Less - accumulated depreciation and amortization 2,201,043 1,907,737 ------------------ ------------------- $ 1,783,191 $ 2,003,583 ============== =============
48 In June 1999, the Company recognized impairment in value of one of its long-lived assets and recorded a write-off in value of $129,362. Depreciation and amortization expense related to bank premises and equipment was $293,306, $278,865 and $305,694 in 2001, 2000 and 1999, respectively. (5) TIME DEPOSITS At December 31, 2001, scheduled maturities of time deposits are as follows:
$100,000 MATURITY OR MORE OTHER TOTAL --------- ------------ ------------- ----------- (IN THOUSANDS) 2002 $ 17,327 $ 60,607 $ 77,934 2003 1,403 3,059 4,462 2004 202 2,364 2,566 2005 - 410 410 2006 and thereafter 333 781 1,114 ------------- ----------- ----------- $ 19,265 $ 67,221 $ 86,486 ============= =========== ===========
Included in total time deposits are $14,606,000 of certificates of deposit subject to repricing on a quarterly basis (indexed to the three month yield on U.S. Treasury bills). Of these time deposits, $3,389,000 have remaining maturities of one year or less. (6) FEDERAL HOME LOAN BANK ADVANCES AND OTHER BORROWINGS At December 31, 2001, advances from the Federal Home Loan Bank of Boston ("FHLB") have scheduled repayments as follows:
YEAR ENDING DECEMBER 31, AMOUNT ------------- -------------- 2002 $ 1,413,547 2003 2,500,000 2004 - 2005 - 2006 and thereafter 17,700,090 -------------- $ 21,613,637 ==============
Of the total FHLB advances, $9,200,090 represents amortizing notes with final maturities of 2-14 years and amortization periods of 3-15 years. The remaining $11,000,000 matures in 2011, of which $6,000,000 has a one time call option on January 22, 2002 and $5,000,000 which has a one time call option on February 5, 2003 exercisable by the FHLB. Information relative to the Company's advances from the FHLB during 2001 is as follows: Balance, December 31, 2001 $ 21,613,637 Average amount outstanding during the year 16,241,440 Weighted average interest rate at December 31, 2001 5.236% Weighted average interest rate during the year 5.309%
All borrowings from the FHLB are secured by the Company's stock in the FHLB and a blanket lien on "qualified collateral" defined principally as 90% of the market value of unpledged U.S. government and federal agency obligations and 75% of the carrying value of certain unpledged residential mortgage loans. At December 31, 2001 and 2000, the Company had an unused borrowing capacity of $10,077,000 and $28,164,000, respectively, which excludes an unused overnight line of credit of $2,352,000. 49 The Company also had $6,843,162 and $9,574,571 of other borrowings at December 31, 2001 and 2000, respectively. These borrowings consist of repurchase agreements with customers and securities dealers and are collateralized by mortgage-backed securities and obligations of the U.S. Government and agency obligations. The following table represents scheduled maturities and interest rates of these agreements at December 31, 2001:
WEIGHTED AVERAGE MATURITY RATE AMOUNT ----------------- ----------- ------------- Commercial Repo February 12, 2004 5.38% $ 4,000,000 City of Providence January 9, 2002 1.25% 2,843,162 --------------- $ 6,843,162 ===============
At December 31, 2001, the Company's risk with counterparties to securities sold under repurchase agreements was approximately $10,385,000. The amount at risk with counterparties represents the excess of the greater of the carrying value or estimated market value of underlying collateral plus related accrued interest receivable over the total repurchase borrowing and related accrued interest payable. Securities sold under repurchase agreements averaged $8,171,637 and $9,204,791 during 2001 and 2000, respectively. The weighted average interest rate was 4.21% during 2001 and 4.99% during 2000. (7) COMMITMENTS AND CONTINGENCIES LEASES The Company leases the land on which its Cranston branch office is located, and building space in which its North Kingstown in-store branch is located. The annual rental expense under these leases is as follows:
YEAR ENDING DECEMBER 31, AMOUNT ----------- --------- 2002 $ 31,915 2003 21,500 2004 8,958 ---------- $ 62,373 ==========
The leases contain renewal options commencing in May 2002 and extending to May 2009. The Bank has chosen not to exercise any of the renewal options. Under the terms of the renewal options, the annual rental expense for both leases will not exceed $63,562. LITIGATION As of December 31, 2001, the Company was involved in certain lawsuits that arose in the ordinary course of business. Management has reviewed these actions with legal counsel and has taken into consideration the views of legal counsel as to the outcome of the litigation. In management's opinion, final disposition of such lawsuits will not have a materially adverse effect on the Company's financial position or results of operations. 50 RESERVE REQUIREMENT The Company is required to maintain reserve balances with the Federal Reserve Bank under the Federal Reserve Act and Regulation D. Required balances, including vault cash, were $467,000 and $460,000 as of December 31, 2001 and 2000, respectively. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK AND CONCENTRATION OF CREDIT RISK In the normal course of business, the Company enters into various commitments, such as commitments to extend credit and guarantees (including standby letters of credit), which are not reflected in the accompanying consolidated financial statements. These instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amounts recognized in the accompanying consolidated balance sheets. The contract amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments. The Company's exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Off-balance sheet instruments, whose contract amounts present credit risk, include the following:
DECEMBER 31, ------------------------- 2001 2000 ---- ---- Unused portion of existing lines of credit $ 6,291,000 $ 8,150,000 Unadvanced construction loans 4,106,000 2,283,000 Firm commitments to extend credit 3,121,000 1,077,000
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since some of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer's creditworthiness on a case-by-case basis. The amount of collateral obtained upon extension of the credit is based on management's credit evaluation of the customer. Collateral held varies but may include accounts receivable, inventory, property, plant and equipment, and income-producing commercial real estate. The Company originates primarily residential and commercial real estate loans and, to a lesser extent, commercial and installment loans to customers primarily located in the State of Rhode Island and, to a lesser extent, southeastern Massachusetts. The Company operates two branches in the metropolitan Providence area, and two branches in Washington County, Rhode Island. Its primary source of revenue is providing loans to customers who are predominantly small and middle-market businesses and middle-income individuals. (8) INCOME TAXES The provision for income taxes consists of the following components:
YEAR ENDED DECEMBER 31, ---------------------------------------------------- 2001 2000 1999 -------------- --------------- ---------------- Federal: Current $ 1,162,191 $ 1,212,863 $ 1,140,786 Deferred (117,000) (180,000) (237,000) State 110,000 55,750 157,250 ------------- ------------ ------------ $ 1,155,191 $ 1,088,613 $ 1,061,036 ============= ============ ============
51 The provision for income taxes differs from the amount computed by applying the statutory rate of 34%, as summarized below:
YEAR ENDED DECEMBER 31, ---------------------------------------------------- 2001 2000 1999 -------------- --------------- ---------------- Provision for income taxes at statutory rate $ 401,893 $ 1,040,173 $ 979,093 State taxes, net of federal benefit 72,600 36,795 103,785 Other, including non-deductible acquisition costs 680,698 11,645 (21,842) ------------- ------------ ------------ $ 1,155,191 $ 1,088,613 $ 1,061,036 ============= ============ ============
The approximate tax effects of temporary differences that give rise to gross deferred tax assets and gross deferred tax liabilities at December 31, 2001 and 2000 are as follows:
2001 2000 --------------- --------------- Gross deferred tax assets: Unrealized loss on securities available for sale $ - $ 270,679 Allowance for loan losses 539,004 509,004 Deferred loan origination fees 88,137 57,430 Supplemental executive pension plan 400,031 279,336 Accrued expenses 17,918 118,647 --------------- --------------- Gross deferred tax assets 1,045,090 1,235,042 --------------- --------------- Gross deferred tax liabilities: Unrealized gain on securities available for sale 236,870 - Depreciation 127,111 156,161 Installment 5,979 13,256 --------------- --------------- Gross deferred tax liabilities 369,960 169,417 --------------- --------------- Net deferred tax asset $ 675,130 $ 1,065,625 =============== ===============
A valuation reserve is provided when it is more likely than not that some portion of the gross deferred tax asset will not be realized. No valuation reserve was required as of December 31, 2001 or 2000. (9) RELATED PARTY TRANSACTIONS Certain directors and executive officers of the Company, their immediate families, companies in which they are principal owners, and trusts in which they are involved are borrowers of the Company. These related party loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with unrelated persons, and do not involve more than normal risk of collectibility. Related party loan activity was as follows:
2001 2000 ----------------- ------------------ Balance at beginning of year $ 1,232,682 $ 1,604,451 Originations 190,000 68,620 Payments (199,660) (440,389) --------------- --------------- Balance at end of year $ 1,223,022 $ 1,232,682 =============== ===============
52 As of December 31, 2001 and 2000, all of these loans were performing in accordance with the contractual terms of the loans. (10) EMPLOYEE BENEFIT PLANS The Company is a member of the Financial Institutions Retirement Fund ("FIRF"), a multiple employer pension plan. As a participant in FIRF, the Company expenses its contributions to this plan, which is accounted for as a defined contribution plan. The Company's pension expense was $87,643 and $131,900 for the years ended December 31, 2001 and 2000, respectively. For the year ended December 31, 1999, the plan reached a fully funded status and the Company was not required to make a contribution. Consequently, no pension expense was recorded during 1999. Effective January 1, 1995, the Company established a nonqualified retirement plan (Plan) to provide supplemental retirement benefits to designated employees whose pension benefits are otherwise limited by the Internal Revenue Code regulations. During 2000, the Company amended the Plan to provide for a minimum benefit of 80% of the participant's three highest years' base salary. This amendment was accounted for in accordance with SFAS No. 87, "Employer's Accounting for Pensions." A liability and transition asset of $423,633 were recorded. The impact of this amendment was to increase the benefit obligation for prior service cost by $720,000 and to increase net periodic benefit cost by $146,000. The following table sets forth a reconciliation of the Plan's projected benefit obligation, a reconciliation of fair value of plan assets, the funded status of the plan, and the components of net periodic benefit cost for the years ended December 31, 2001, 2000 and 1999:
2001 2000 1999 --------------- --------------- --------------- Change in benefit obligations: Benefit obligation at beginning of year $ 1,664,318 $ 752,754 $ 488,093 Service cost - 32,164 28,316 Interest cost 136,203 113,871 50,542 Actuarial loss 151,719 765,529 185,803 ------------- ------------ ------------ Benefit obligation at end of year 1,952,240 1,664,318 752,754 ------------- ------------ ------------ Change in plan assets: Fair value of plan asset at beginning of year 872,783 574,611 412,318 Actual return on plan assets 20,462 6,927 32,298 Employer contributions 301,737 291,245 129,995 ------------- ------------ ------------ Fair value of plan assets at end of year 1,194,982 872,783 574,611 ------------- ------------ ------------ Funded status (757,258) (791,535) (178,143) Unrecognized net actuarial loss 352,140 234,528 202,879 Unrecognized prior service cost 600,022 731,449 142,779 Unrecognized net asset being recognized over 10 years (489,229) (514,329) (90,696) ------------- ------------ ------------ (Accrued) prepaid benefit cost $ (294,325) $ (339,887) $ 76,819 ============= ============ ============ Components of net periodic benefit cost: Service cost $ - $ 32,164 $ 28,316 Interest cost 136,203 113,871 50,542 Amortization of prior service cost 131,427 131,427 28,556 Amortization of unrecognized loss (gain) 34,107 13,783 22,581 ------------- ------------ ------------ Net periodic benefit cost $ 301,737 $ 291,245 $ 129,995 ============= ============ ============
53 For calculating 2001, 2000 and 1999 pension costs for this nonqualified plan the following assumptions were used: Assumed discount rate 7.5% Rate of increase in compensation level 5.0% Amortization period for unrecognized prior service cost 10 years
The Company is a member of the Financial Institutions Thrift Plan for the benefit of its employees. This plan, which was effective January 1, 1997, is a qualified savings incentive plan under Internal Revenue Code section 401(k). Under the terms of the Plan, the Company matches 50% of the first 6% of each eligible employee's contribution. The Company's expense under this plan amounted to $41,079, $41,175, and $46,995 for the years ended December 31, 2001, 2000 and 1999, respectively. (11) STOCKHOLDERS' EQUITY On November 16, 1998, the Company's Board of Directors authorized the repurchase of up to 5%, or 63,062 shares, of the Company's common stock. During 2000 and 1999, the Company repurchased a total of 47,500 shares under the repurchase program at prices ranging from $12.625 to $12.9375 per share. Total capital used for these repurchases amounted to $608,125. (12) CHARIHO-EXETER CREDIT UNION ACQUISITION In May 1992, the Company entered into the Acquisition Agreement with the receiver for Chariho and DEPCO. In connection with the Acquisition Agreement, the Company entered into a Securities Purchase Agreement with DEPCO. Under this agreement, the Company issued the Senior Debenture, a $3 million variable rate debenture to DEPCO. The Company invested the proceeds on the issuance of the debenture as a contribution of capital to the Bank. Under the terms of the debenture, interest began to accrue on the third anniversary of the Senior Debenture and was payable semiannually thereafter. The Senior Debenture bore interest at the average five-year Treasury rate (indexed rate) plus 1% until maturity and at the indexed rate plus 4% during the extension period. A discount of $717,005 was recorded to reduce the carrying value of the Senior Debenture at the date of issuance in recognition of its favorable interest terms. This discount was amortized over the initial term of the Senior Debenture on the level yield method. The discount amortization for the year ended December 31, 1999 amounted to $15,860, and is classified as interest expense in the accompanying consolidated statements of income. As discussed in Note 3, the Senior Debenture matured on May 1, 1999 and the Company repaid the obligation. (13) FAIR VALUE OF FINANCIAL INSTRUMENTS The Company is required to disclose fair values for certain of its financial instruments. Financial instruments include such items as loans, securities, deposits, swaps and other instruments, as defined. Quoted market prices are used to estimate fair values where available. Many of the Company's financial instruments, however, lack an available trading market as characterized by a willing buyer and willing seller engaging in an exchange transaction. It is the Company's general practice and intent to hold the majority of its financial instruments, such as loans and deposits, to maturity and not engage in trading or sales activities. Therefore, permitted valuation techniques such as present value calculations, were used for the purposes of this disclosure. Management notes that reasonable comparability between financial institutions may not necessarily be made due to the wide range of permitted valuation techniques and numerous estimates which must be made given 54 the absence of active secondary markets for many of the financial instruments. This lack of uniform valuation methodologies also introduces a greater degree of subjectivity to these estimated fair values. The methods and assumptions used to estimate the fair values of each class of financial instruments are as follows: CASH AND DUE FROM BANKS, AND SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL - These items are generally short-term in nature and, accordingly, the carrying amounts reported in the consolidated balance sheets are reasonable approximations of their fair values. INVESTMENT SECURITIES HELD-TO-MATURITY AND AVAILABLE-FOR-SALE - Fair values are based principally on quoted market prices. FHLB STOCK - The FHLB stock does not have a readily determinable market value. Consequently, the carrying amount is considered to approximate its fair value. LOANS - The fair value of accruing loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities or for classified loans using a discount rate that reflects the risk inherent in the loan. The fair value of nonaccrual loans is based on the estimated market value of the underlying collateral held. LOAN SERVICING ASSET - The fair value is estimated based on the present value of expected cash flows, incorporating assumptions for discount rate, prepayment speed and servicing cost. DEPOSITS - The fair value of demand, NOW, savings and money market deposits is the amount payable on demand at the reporting date. The fair value of time deposits is estimated using discounted value of contractual cash flows. The discount rates are the rates currently offered for deposits of similar remaining maturities. SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE - The face value is considered to approximate its fair value. FHLB ADVANCES - The fair value of Federal Home Loan Bank advances are estimated using a discounted cash flow technique that applies interest rates currently being offered on advances to a schedule of aggregated expected monthly maturities on FHLB advances. COMMITMENTS TO EXTEND CREDIT AND STANDBY LETTERS OF CREDIT - The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value amounts are not material. At December 31, 2001 and 2000, the estimated fair value of the Company's financial instruments are as follows (in thousands):
DECEMBER 31, --------------------------------------------------------------- 2001 2000 ----------------------------- --------------------------- CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE ----------- --------- ----------- --------- ASSETS: Cash and due from banks and securities purchased under agreement to resell $ 14,231 $ 14,231 $ 4,804 $ 4,804 Loans held for sale 758 761 505 508 Investment securities: Held-to-maturity 14,615 14,693 22,489 22,452 Available-for-sale 38,324 38,324 31,924 31,924 Federal Home Loan Bank stock 1,091 1,091 716 716 Loans, net 111,349 111,129 102,128 104,462 Loan servicing asset 530 530 465 465
55
DECEMBER 31, ------------------------------------------------------------- 2001 2000 --------------------------- --------------------------- CARRYING FAIR CARRYING FAIR AMOUNT VALUE AMOUNT VALUE ----------- --------- ------------ --------- LIABILITIES Deposits $ 137,658 $ 139,915 $ 129,046 $ 129,617 Securities sold under agreements to repurchase 6,843 6,950 9,574 9,572 Federal Home Loan Bank advances 21,614 20,947 10,869 11,028
(14) THE COMPANY (PARENT COMPANY ONLY) The condensed separate financial statements of the Parent Company are presented below. CONDENSED BALANCE SHEETS
DECEMBER 31, ------------------------------- 2001 2000 ----------- -------- ASSETS Cash and due from banks $ 107,909 $ 57,762 Investment securities: Available-for-sale (amortized cost: $631,779 in 2001 and 2000) 529,168 386,167 Investment in subsidiary bank 16,012,029 15,949,905 Other assets 47,103 119,882 --------------- -------------- Total assets $ 16,696,209 $ 16,513,716 =============== ============== LIABILITIES AND STOCKHOLDERS' EQUITY Other liabilities $ 145,649 $ 23,001 --------------- -------------- Stockholders' equity: Common stock 1,328,041 1,328,041 Surplus 4,431,380 4,431,380 Retained earnings 11,190,919 11,892,318 Accumulated other comprehensive income (loss) 355,305 (405,939) --------------- -------------- 17,305,645 17,245,800 Less - Treasury stock 755,085 755,085 --------------- -------------- Total stockholders' equity 16,550,560 16,490,715 --------------- -------------- Total liabilities and stockholders' equity $ 16,696,209 $ 16,513,716 =============== ==============
CONDENSED STATEMENTS OF INCOME
YEARS ENDED DECEMBER 31, ----------------------------------------------------- 2001 2000 1999 ------------- ------------- -------------- Interest and dividend income $ 1,101,938 $ 766,313 $ 1,028,666 Interest and other expense 466,581 88,000 162,503 ------------- ------------- -------------- Income before income taxes and equity in undistributed earnings on subsidiary 635,357 678,313 866,163 Applicable income tax benefit (4,809) (20,387) (28,963) ------------- ------------- -------------- Income before equity in (distribution in excess) undistributed earnings of subsidiary 640,166 698,700 895,126 Equity in (distribution in excess) undistributed earnings of subsidiary (613,320) 1,272,019 923,522 ------------- ------------- -------------- Net income $ 26,846 $ 1,970,719 $ 1,818,648 ============= ============= ==============
56 CONDENSED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, ----------------------------------------------------- 2001 2000 1999 ------------- ------------- -------------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 26,846 $ 1,970,719 $ 1,818,648 Adjustments to reconcile net income to net cash provided by operating activities - Equity in (distribution in excess) undistributed earnings of subsidiary 613,320 (1,272,019) (923,522) Amortization of discount on debenture - - 15,860 Net accretion on investment securities - - (34,904) Net increase in accrued expenses and other liabilities 122,648 13,230 12,702 Net decrease in other assets 15,579 8,575 32,692 ------------- ------------- -------------- Net cash provided by operating activities 778,393 720,505 921,476 ------------- ------------- -------------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from maturities of investment securities available-for-sale - - 8,825,000 Purchase of investment securities available-for-sale - - (5,876,675) ------------- ------------- -------------- Net cash provided by investing activities - - 2,948,325 ------------- ------------- -------------- CASH FLOWS FROM FINANCING ACTIVITIES: Repayment of Senior Debenture - - (3,000,000) Purchase of common stock for treasury - (159,375) (448,750) Dividends paid (728,246) (582,595) (444,597) ------------- ------------- -------------- Net cash used in financing activities (728,246) (741,970) (3,893,347) ------------- ------------- -------------- NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 50,147 (21,465) (23,546) CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR 57,762 79,227 102,773 ------------- ------------- -------------- CASH AND CASH EQUIVALENTS, END OF YEAR $ 107,909 $ 57,762 $ 79,227 ============= ============= ============== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Interest paid $ - $ - $ 82,369 ============= ============= ==============
(15) REGULATORY CAPITAL The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory - and possibly additional discretionary - actions by regulators that, if undertaken, could have a direct material effect on the Company's and the Bank's financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank's assets, liabilities 57 and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank's capital amounts and classification are also subject to quantitative judgements by the regulators about components, risk weightings and other factors. Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts of ratios (set forth in the table below) of total Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average assets (as defined). As of December 31, 2001, the Company and the Bank met all capital adequacy requirements to which they are subject and are considered "well capitalized" by the federal banking agencies. The most recent Federal Deposit Insurance Corporation examination categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events that management believes have changed the Bank's category.
TO BE WELL CAPITALIZED FOR CAPITAL ADEQUACY UNDER PROMPT CORRECTIVE ACTUAL PURPOSES ACTION PROVISIONS ------------------- -------------------- ---------------------- AMOUNT RATIO AMOUNT RATIO AMOUNT RATIO ------ ----- -------- ----- -------- ------ As of December 31, 2001: The Company: $ 19,402,000 14.99% $ 10,354,636 8.00% $ - - Total capital (to risk weighted 17,769,000 13.73 5,176,693 4.00 - - assets) Tier I capital (to risk weighted 17,769,000 9.79 5,445,046 3.00 - - assets) Tier I capital (to average assets) The Bank: Total capital (to risk weighted 17,215,000 13.30 10,354,887 8.00 12,943,609 10.00% assets) Tier I capital (to risk weighted 15,595,000 12.05 5,176,763 4.00 7,765,145 6.00 assets) Tier I capital (to average assets) 15,595,000 8.65 5,408,670 3.00 9,014,451 5.00 As of December 31, 2000: The Company: Total capital (to risk weighted 18,338,000 15.94 9,229,440 8.00 - - assets) Tier I capital (to risk weighted 16,896,000 14.68 4,614,720 4.00 - - assets) Tier I capital (to average assets) 16,896,000 10.10 5,019,330 3.00 - - The Bank: Total capital (to risk weighted 17,641,000 15.44 9,143,200 8.00 11,429,000 10.00 assets) Tier I capital (to risk weighted 16,208,000 14.18 4,571,600 4.00 6,857,400 6.00 assets) Tier I capital (to average assets) 16,208,000 9.79 4,966,080 3.00 8,276,800 5.00 As of December 31, 1999: The Company: Total capital (to risk weighted 16,843,000 17.97 7,497,920 8.00 - - assets) Tier I capital (to risk weighted 15,667,000 16.72 3,748,960 4.00 - - assets) Tier I capital (to average assets) 15,667,000 10.71 4,386,930 3.00 - - The Bank: Total capital (to risk weighted 16,105,000 17.30 7,446,720 8.00 9,308,400 10.00 assets) Tier I capital (to risk weighted 14,937,000 16.05 3,723,360 4.00 5,585,040 6.00 assets) Tier I capital (to average assets) 14,937,000 10.26 4,367,130 3.00 7,278,550 5.00
(16) BUSINESS SEGMENTS The Company's chief operating decision maker is the Chairman, President and Chief Executive Officer of the Company. The Company has identified its reportable operating business segment as Community Banking based on how the business is strategically managed. The Company's community banking business segment consists of commercial and retail banking. The community banking business segment is managed as a single strategic unit which derives its revenues from a wide range of banking services, including investing and lending activities and acceptance of demand, savings and time deposits. There is no major customer and the Company operates within a single geographic area (southeastern New England). 58 Non reportable operating segments of the Company's operations which do not have similar characteristics to the community banking operations and do not meet the quantitative thresholds requiring disclosure, are included in the Other category in the disclosure of business segments below. These non reportable segments include the Parent Company (Note 14). The accounting policies used in the disclosure of business segments are the same as those described in the summary of significant accounting policies. The consolidation adjustments reflect certain eliminations of intersegment revenue, cash and the Parent Company investments in subsidiary. Reportable segment specific information and reconciliation to consolidated financial information is as follows:
OTHER ADJUSTMENTS COMMUNITY AND BANKING OTHER ELIMINATIONS CONSOLIDATED --------------- --------------- --------------- -------------- December 31, 2001 Investment securities $ 52,410,425 $ 16,541,197 $ (16,012,029) $ 52,939,593 Net loans 111,349,576 - - 111,349,576 Total assets 184,581,412 16,690,150 (16,083,511) 185,188,051 Total deposits 137,729,585 - (71,481) 137,658,104 Total liabilities 168,569,383 139,590 (71,481) 168,637,492 Net interest income 7,097,809 1,101,939 (1,078,245) 7,121,503 Provision for loan losses 75,000 - - 75,000 Total noninterest income 922,050 613,320 (613,320) 922,050 Total noninterest expense 6,319,936 466,580 - 6,786,516 Net income 464,925 26,846 (464,925) 26,846 December 31, 2000 Investment securities $ 54,026,289 $ 16,336,072 $ (15,949,905) $ 54,412,456 Net loans 102,128,196 - - 102,128,196 Total assets 167,829,981 16,513,716 (15,972,190) 168,371,507 Total deposits 129,068,534 - (22,285) 129,046,249 Total liabilities 151,880,076 23,001 (22,285) 151,880,792 Net interest income 6,785,108 766,313 (741,971) 6,809,450 Provision for loan losses 175,000 - - 175,000 Total noninterest income 1,002,934 1,272,019 (1,272,019) 1,002,934 Total noninterest expense 4,490,052 88,000 - 4,578,052 Net income 2,013,990 1,970,719 (2,013,990) 1,970,719 December 31, 1999 Investment securities $ 36,045,873 $ 15,330,161 $ (14,827,906) $ 36,548,128 Net loans 93,382,709 - - 93,382,709 Total assets 144,163,948 15,491,411 (14,873,704) 144,781,655 Total deposits 104,634,303 - (45,798) 104,588,505 Total liabilities 129,336,042 9,771 (45,798) 129,300,015 Net interest income 6,255,500 944,163 (954,161) 6,245,502 Provision for loan losses 275,000 - - 275,000 Total noninterest income 826,075 923,522 (923,522) 826,075 Total noninterest expense 3,838,893 78,000 - 3,916,893 Net income 1,877,683 1,818,648 (1,877,683) 1,818,648
59 (17) SELECTED QUARTERLY FINANCIAL DATA (UNAUDITED) A summary of selected quarterly financial data for the years ended December 31, 2001 and 2000 is as follows:
2001 QUARTER ENDED ----------------------------------------------------------------- MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 ------------ ------------- -------------- --------------- (In thousands, except per share data) Interest income $ 3,459 $ 3,377 $ 3,360 $ 3,274 Interest expense 1,764 1,585 1,532 1,467 ------------ ------------- ------------- --------------- Net interest income 1,695 1,792 1,828 1,807 Provision for loan losses 25 25 25 - ------------ ------------- ------------- --------------- Net interest income after provision for loan losses 1,670 1,767 1,803 1,807 Noninterest income 228 164 204 326 Noninterest expense 1,136 1,086 1,097 3,467 ------------ ------------- ------------- --------------- Income (loss) before taxes 762 845 910 (1,334) Income taxes 253 309 340 253 ------------ ------------- ------------- --------------- Net income (loss) $ 509 $ 536 $ 570 $ (1,587) ========== ========== ========== =============== Basic earnings per share $ 0.42 $ 0.44 $ 0.47 $ (1.31) ========== ========= ========== ============== Diluted earnings per share $ 0.42 $ 0.44 $ 0.47 $ (1.31) ========== ========= ========== ==============
2000 QUARTER ENDED ----------------------------------------------------------------- MARCH 31 JUNE 30 SEPTEMBER 30 DECEMBER 31 ------------ ------------- -------------- --------------- (In thousands, except per share data) Interest income $ 3,108 $ 3,357 $ 3,460 $ 3,469 Interest expense 1,491 1,667 1,705 1,722 ------------ ------------- ------------- ------------ Net interest income 1,617 1,690 1,755 1,747 Provision for loan losses 50 75 50 - ------------ ------------- ------------- ------------ Net interest income after provision for loan losses 1,567 1,615 1,705 1,747 Noninterest income 199 231 275 298 Noninterest expense 1,071 1,103 1,155 1,249 ------------ ------------- ------------- ------------ Income before taxes 695 743 825 796 Income taxes 246 264 292 286 ------------ ------------- ------------- ------------ Net income $ 449 $ 479 $ 533 $ 510 ========== ========== ========== ======== Basic earnings per share $ 0.37 $ 0.39 $ 0.44 $ 0.42 =========== ========== ========== ========= Diluted earnings per share $ 0.37 $ 0.39 $ 0.44 $ 0.42 =========== ========== ========== =========
60 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE. None. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF REGISTRANT The By-laws of the Company stipulate that the business and affairs of the Company are to be managed by a Board of Directors (the "Company Board"), which is to consist of not less than three nor more than thirteen individuals divided into three classes as nearly equal in size as possible. The Directors of the Company are elected by the shareholders of the Company for staggered three-year terms or until their successors are elected and qualified. Currently, each of the members of the Company Board are also members of the Board of Directors of the Bank (the "Bank Board"). The Directors of the Bank are elected annually for a one-year term. The following table sets forth certain information about the Directors of the Company.
PRINCIPAL DIRECTOR OF TERM OF OFFICE CLASS NAME AGE OCCUPATION COMPANY SINCE WILL EXPIRE - --------- -------- ------ ---------- ------------- -------------- I John Nazarian, Ph.d. 69 President, Rhode Island 1996 2003 College I William P. Shields 64 Retired 1993 2003 II Patrick J. Shanahan, Jr. 57 Chairman, President and 1980 2004 Chief Executive Officer of the Company and the Bank II Gary R. Alger 44 Director of E.R. Alger and 1998 2004 Company II Joseph V. Mega 68 President, Crugnale Bakery 1994 2004 III Joseph A. Keough, Esq. 60 Judge/Magistrate, Rhode 1980 2002 Island Superior Court III Peter L. Mathieu, Jr., M.D. 77 Pediatrician 1980 2002 III Fred J. Simon, Jr. 53 President, Simon 1998 2002 Chevrolet-Buick, Ltd.
Mr. Keough has been Judge/Magistrate, Rhode Island Superior Court since 1998. From 1997 until 1998, Mr. Keough was Master, Rhode Island Superior Court. Prior to that time, Mr. Keough was an attorney with the law firm of Keough and Gearon. Mr. Coloian has served as a Director of the Company since 1996. 61 COMPENSATION OF DIRECTORS Currently, all Directors of the Company receive a Director's fee of five hundred dollars ($500) for each Company Board meeting attended. Each Director receives an annual retainer of five thousand dollars ($5,000) and a Director's fee of five hundred dollars ($500) for each Bank Board meeting attended up to a maximum of one thousand dollars ($1,000) for meetings attended on any given day. In addition, each non-employee Director of the Company and the Bank receives a fee of five hundred dollars ($500) for all committee meetings attended. The Company and the Bank have implemented a deferred compensation plan for their Directors which allows Directors to defer the receipt of Director's fees paid by the Company and the Bank until their services with the Company Board and Bank Board terminate. EXECUTIVE OFFICERS OF THE COMPANY AND THE BANK The names and ages of the Executive Officers of the Company and the Bank and each Executive Officers' position with the Company or the Bank is listed below.
POSITIONS AND OFFICERS WITH THE NAME AGE COMPANY OR THE BANK ------ ------ ------------------------------- Patrick J. Shanahan, Jr. 57 Chairman, President and Chief Executive Officer of the Company and the Bank Robert D. McCormick 57 Vice President of the Bank, Senior Loan Officer Betty C. Ricci 49 Vice President of the Bank - Information and Network Systems and Operations Thomas E. Coughlin 57 Vice President of the Bank - Retail Banking
Mr. Shanahan has served as Chairman of the Company since 1997 and President and Chief Executive Officer of the Company since its formation in 1980. Mr. Shanahan has served as Chairman of the Board of Directors of the Bank since 1987 and President and Chief Executive Officer of the Bank since 1975. In 1999, Mr. McCormick was appointed Senior Loan Officer of the Bank in addition to his duties as Vice President and Manager of Credit and Loan Administration of the Bank. Mr. McCormick joined the Bank as Vice President and Commercial Loan Officer in 1993. Mrs. Ricci has been employed as Vice President of Information and Network Systems and Operations of the Bank since October 1997, and Branch and Network Systems since December 1996. From November 1995 to December 1996, Mrs. Ricci was Vice President of Retail Banking at the Bank and from 1988 until November 1995, Mrs. Ricci was Vice President of Deposit Operations at the Bank. Mr. Coughlin joined the Bank as Vice President of Retail Banking in December 1996. Prior to joining the Bank, Mr. Coughlin held various positions at BayBank, Inc. since 1970, most recently as Vice President and Area Manager. ITEM 11. EXECUTIVE COMPENSATION EXECUTIVE COMPENSATION The following table sets forth in summary form all compensation paid by the Company and the Bank to Patrick J. Shanahan, Jr., Chairman, President and Chief Executive Officer of the Company and the Bank, and John A. Macomber, former Vice President, Treasurer and Chief Financial Officer of the Company and the Bank, for services rendered in all capacities to the Company and the Bank during the past three fiscal years. No other executive officer of the Company received compensation in excess of $100,000 for such years. 62 SUMMARY COMPENSATION TABLE
NAME AND ALL OTHER PRINCIPAL POSITION YEAR SALARY BONUS COMPENSATION -------------------- ---- ------ ------- -------------- PATRICK J. SHANAHAN, JR. 2001 $294,000 $2,150,000(1) $27,700(2) Chairman, President and Chief Executive 2000 $280,000 $100,000 $19,071(3) Officer 1999 $265,000 $60,000 $17,059(4) JOHN A. MACOMBER (5) 2001 $111,300 $11,100 $3,336(6) Former Vice President, Treasurer and 2000 $105,904 $15,000 $3,177(7) Chief Financial Officer 1999 $101,000 $4,000 $3,030(8)
- ------------------------ (1) For further information regarding bonuses paid to Mr. Shanahan during 2001, see "--Employment Agreement." (2) Includes $5,100 in contributions made to the Company's 401(k) Plan on Mr. Shanahan's behalf in 2001. Also, includes $971 in insurance premiums paid by the Company for a term life insurance policy in favor of Mr. Shanahan in 2001 and $14,500 paid to Mr. Shanahan as director fees in 2001. (3) Includes $5,100 in contributions made to the Company's 401(k) Plan on Mr. Shanahan's behalf in 2000. Also, includes $971 in insurance premiums paid by the Company for a term life insurance policy in favor of Mr. Shanahan in 2000 and $13,000 paid to Mr. Shanahan as director fees in 2000. (4) Includes $4,388 in contributions made to the Company's 401(k) Plan on Mr. Shanahan's behalf in 1999. Also, includes $971 in insurance premiums paid by the Company for a term life insurance policy in favor of Mr. Shanahan in 1999 and $11,700 paid to Mr. Shanahan as director fees in 1999. (5) Mr. Macomber resigned as an employee of the Company in January 2002. (6) Includes $3,336 in contributions made to the Company's 401(k) Plan on Mr. Macomber's behalf in 2001. (7) Includes $3,177 in contributions made to the Company's 401(k) Plan on Mr. Macomber's behalf in 2000. (8) Includes $3,030 in contributions made to the Company's 401(k) Plan on Mr. Macomber's behalf in 1999. OPTION GRANTS IN LAST FISCAL YEAR The Company does not maintain any stock option or stock-based compensation plans. No stock options were granted to Messrs. Shanahan and Macomber for the year ended December 31, 2001. AGGREGATED OPTION EXERCISES IN LAST FISCAL YEAR AND FISCAL YEAR-END OPTION VALUES Neither Messrs. Shanahan and Macomber held any stock options during the year ended December 31, 2001. SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN The Company has implemented a non-qualified supplemental executive retirement plan (the "SERP") to provide certain officers and highly compensated employees with additional retirement benefits. Benefits under the SERP are intended to supplement benefits payable under the defined Pension Plan (see below) which are subject to: (i) federal law limitations applicable to qualified pension plans; and (ii) early retirement penalties set forth in the Pension Plan. Benefits payable under the SERP are designed to recover those benefits that would be payable under the Pension Plan if not for these limitations. 63 The SERP is a non-qualified benefit plan. Prior to the establishment of the Company's Compensation Committee, participants in the SERP were determined by the Company Board. Any future participants in the SERP will be determined by the Compensation Committee. During 2000, the Company amended the SERP to provide for a minimum benefit of 80% of the participant's three highest years' total compensation. Benefits are payable only upon death, retirement in accordance with the terms of the SERP, or termination of employment with the Company. As of December 31, 2001, the only participant in the SERP was Mr. Shanahan. The Company has established an irrevocable grantor's trust ("rabbi trust") in connection with the SERP. This trust is funded with contributions from the Company for the purpose of providing the benefits promised under the terms of the SERP. The SERP participants have only the rights of unsecured creditors with respect to the trust's assets, and do not recognize income with respect to benefits provided by the SERP until those benefits are received by the participants. The assets of the rabbi trust are considered part of the general assets of the Company and are subject to the claims of the Company's creditors in the event of the Company's insolvency. Earnings on the trust's assets are taxable to the Company. PENSION PLAN The Bank is a member of the Financial Institutions Retirement Fund ("FIRF") which sponsors a multiple employer pension plan (the "Pension Plan"). Contributions to the Pension Plan are determined on an actuarial basis for the benefit of all qualifying employees. Employees become eligible for participation on attainment of age 21 and completion of one year of service to the Bank. The Pension Plan provides an annual benefit upon retirement calculated by adding the products of (i): (a) 1.5% multiplied by; (b) the employee's years of benefit service multiplied by; (c) the employee's highest average salary for three consecutive years of service ("High-3 Average Compensation"); up to the covered Compensation Level (defined generally as the average of the maximum social security wage base for the 35-year period preceding social security retirement age), and (ii): (x) 2.0% multiplied by; (y) the employee's years of benefit service multiplied by; (z) the employee's High-3 Average Compensation to the extent it exceeds the Covered Compensation Level. Under the terms of the Pension Plan, benefits are calculated as a 10 year certain and continuous annuity. Participants may elect payment in the "regular form" or in another one of the annuity forms or "lump sum" options available under the Pension Plan. Benefit payments generally begin at age 65, but they can begin earlier in a reduced amount, or, if the employee continues working past 65, later in an increased amount. Administrative expenses for the Pension Plan are paid by the Company. Benefits under the Pension Plan become fully vested upon 5 or more years of service to the Company. Benefits are not offset against Social Security. The following table sets forth estimated annual benefits payable upon retirement at age 65 assuming the employee chooses the regular form of benefit under the Pension Plan.
PENSION PLAN TABLE HIGH-3 AVERAGE YEARS OF BENEFIT SERVICE COMPENSATION 5 10 20 30 40 ------------ ----------- ----------- ---------- ---------- ------- $ 25,000........................ $ 1,900 $ 3,800 $ 7,500 $11,300 $ 15,600 50,000........................ 4,100 8,100 16,300 24,400 33,500 75,000........................ 6,600 13,100 26,300 39,400 53,500 100,000........................ 9,100 18,100 36,300 54,400 73,500 125,000........................ 11,600 23,100 46,300 69,400 93,500 150,000 and over (1)........... 14,100 28,100 56,300 84,400 113,500(1)
- ----------------- (1) The Maximum amount payable under the pension plan in 2001 is $133,080. 64 For purposes of the table, Mr. Shanahan had 27 years of service with the Company as of December 31, 2001. 401(k) PLAN Effective as of January 1, 1997, the Company adopted the Financial Institutions Thrift Plan, an employee savings incentive plan established pursuant to Section 401(k) of the Internal Revenue Code of 1986, as amended (the "401(k) Plan"). Under the 401(k) Plan, eligible participants may defer portions of their salaries for future receipt and the Company may match up to 50% of the deferral contribution made by such participant up to a maximum deferral contribution of 6% of a participant's compensation during the fiscal year. EMPLOYMENT AGREEMENT Effective as of February 8, 1999, the Company entered into a Second Amended and Restated Employment Agreement with Patrick J. Shanahan, Jr., Chairman, President and Chief Executive Officer of the Company and the Bank (the "Employment Agreement"). The Employment Agreement provides that Mr. Shanahan's base salary from January 1, 2001 to December 31, 2001 will be $294,000, and that his salary will be reviewed each year and that there will be an annual increase of not less than five (5%) percent. In addition to base salary, the Employment Agreement provides for, among other things, participation in other fringe benefits applicable to Executive Officers including the Company's supplemental executive retirement plan (described above). The Employment Agreement provides that either the Company or Mr. Shanahan may terminate the agreement upon 90 days notice to the other. The Employment Agreement provides for termination by the Company "for cause," as defined in the Employment Agreement, at any time without further compensation. In the event the Company chooses to terminate Mr. Shanahan's employment for reasons other than cause, Mr. Shanahan would be entitled to continue to receive from the Company his existing base salary and all benefits for twenty-four (24) months from the date of termination. Under the Employment Agreement, if Mr. Shanahan voluntarily terminates the Employment Agreement upon a "change of control" of the Company (as defined in the Employment Agreement), or Mr. Shanahan is deemed involuntarily terminated as a result of certain events or circumstances following a change of control, then Mr. Shanahan would be entitled, at his sole discretion, to either: (i) the payments and benefits due under the Employment Agreement upon termination by the Company other than for cause as set forth above; or (ii) 2.99 times the sum of (a) Mr. Shanahan's average base salary for the immediately preceding five (5) years prior to the change of control, PLUS, (b) the amount of the bonus paid to Mr. Shanahan by the Company or the Bank, if any, during the immediately preceding year prior to the change of control, in each case, payable in one lump sum on the date of termination. In the event of a change in control of the Company, were Mr. Shanahan to opt for the lump-sum payment of 2.99 times the sum of his average base salary for the immediately preceding five (5) years plus the amount of any bonus received by Mr. Shanahan in the preceding year, the total amount of payments under the Employment Agreement, based solely on cash compensation paid to Mr. Shanahan over the past five fiscal years and excluding any benefits under any employee benefit plan which may be payable, would be approximately $1,310,000. In connection with entering into the Merger Agreement, the Company, Washington Trust and Mr. Shanahan entered into a letter agreement amending Mr. Shanahan's employment agreement. Under this letter agreement, Mr. Shanahan's employment with the Company will terminate on the later to occur of the closing date of the merger or March 1, 2002. In addition, Mr. Shanahan has agreed to forego the cash severance payment he is entitled to receive under his Employment Agreement in connection with a change of control. In lieu of this cash severance payment, the Company agreed to pay Mr. Shanahan a special one-time bonus of $2.1 million. As required under the Merger Agreement, this bonus was paid to Mr. Shanahan in November 2001. The Company also agreed with Washington Trust that Mr. Shanahan's bonus relating to our 2001 performance would not exceed $150,000 and would be paid in 2001. The Company paid Mr. Shanahan a bonus for 2001 performance in the amount of $150,000 in November 2001. Under this letter agreement, Mr. Shanahan will also receive the payments to which he is entitled under our 65 retirement and pension plans and he will be eligible to participate in Washington Trust's family health plan until age 65. In addition, the Company will transfer ownership of his company automobile to him. In the event that any of these arrangements with Mr. Shanahan were in the future to be subject to an excise tax imposed by Section 4999 of the Internal Revenue Code, Mr. Shanahan may also be entitled to an additional payment, referred to as a gross-up payment, so that the net amount retained by Mr. Shanahan after the payment of any excise tax and any income and employment taxes due as a result of the receipt of the gross-up payment will equal the amount to which Mr. Shanahan was otherwise entitled. The Company does not anticipate that these arrangements will be subject to the excise tax. Washington Trust and Mr. Shanahan have also agreed, at or prior to the effective time of the Merger, to enter into a three-year noncompetition agreement. This agreement contains customary non-competition, non-solicitation of employees and customers, non-interference and non-disclosure of confidential information provisions. Mr. Shanahan will be paid $840,000 in connection with entering into this agreement. COMPENSATION COMMITTEE REPORT The Compensation Committee represents both the Company and the Bank and, in 2001, consisted of two Directors who were not officers or employees of the Company; Joseph V. Mega and Dr. John Nazarian as well as Patrick J. Shanahan, Jr., Chairman, President, Chief Executive Officer and a Director of the Company and Chairman, President, Chief Executive Officer and a Director of the Bank. The Committee's primary responsibilities are to provide independent review and oversight and promote corporate accountability for executive compensation, approve performance and base compensation policies for executive management and employees, approve incentive plans, and to provide oversight of Company benefit programs. Decisions on compensation of the Company's and the Bank's executives generally are made by the Compensation Committee. All decisions by the Compensation Committee relating to the compensation of the Company's and the Bank's Executive Officers are reviewed by each of the full Company and Bank Board. Pursuant to rules of the Securities and Exchange Commission, set forth below is a report prepared by the Company's and the Bank's Board Compensation Committee addressing the Company's and the Bank's compensation policies for 2001 as they affected Mr. Shanahan, the Company's Chief Executive Officer and the other Executive Officers. COMPENSATION POLICIES TOWARD EXECUTIVE OFFICERS. The Company's and the Bank's compensation program for Executive Officers consists of base salary. The Compensation Committee's executive compensation policies are designed to provide competitive levels of compensation that integrate pay with the Company's annual and long-term performance goals, reward above average corporate performance, recognize individual initiative and achievements, and assist the Company in attracting and retaining qualified executives. Levels of executive compensation are set at levels that the Compensation Committee believes to be consistent with others in the Bank's industry. CHIEF EXECUTIVE OFFICER COMPENSATION: Mr. Shanahan serves the Company and the Bank pursuant to an amended employment agreement which provides for his employment as Chairman, President and Chief Executive Officer of the Company and the Bank. The terms of Mr. Shanahan's contract were negotiated at arms-length. Mr. Shanahan's base salary was $294,000 in the calendar year 2001 and is subject to an increase of no less than 5% each calendar year. See "EMPLOYMENT AGREEMENT." Members of the Compensation Committee: JOSEPH V. MEGA, CHAIRMAN JOHN NAZARIAN, PH.D. PATRICK J. SHANAHAN, JR. 66 COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION During 2001, each member of the Compensation Committee other than Mr. Shanahan was an independent, non-employee Director of both the Company and the Bank. Mr. Shanahan is Chairman, President and Chief Executive Officer of the Company and the Bank. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth information regarding the ownership of Common Stock as of March 19, 2002, by each of the Directors and Executive Officers and the Directors and Executive Officers as a group.
AMOUNT AND NATURE OF BENEFICIAL NAME OWNERSHIP PERCENT OF CLASS - ----- ------------------------------- ----------------- Gary R. Alger (a) 2,100 * Thomas E. Coughlin (b) 250 * Joseph A. Keough, Esq.(a) 5,500 * Peter L. Mathieu, Jr., M.D.(a) 61,800(3) 5.1% Robert D. McCormick (b) 100(4) * Joseph V. Mega (a) 6,500(5) * John Nazarian, Ph.D.(a) 3,000 * Betty C. Ricci(b) 100(6) * Patrick J. Shanahan, Jr.(a)(b) 79,956(7) 6.6% William P. Shields (a) 2,200 * Fred J. Simon, Jr.(a) 15,000 1.2% Directors and Executive Officers as a Group (13 persons) 176,506 14.5%
* Shareholdings represent less than 1.0% of class (a) Designates Director of the Company and the Bank (b) Designates Executive Officer of the Company and/or the Bank NOTES: (1) In accordance with Rule 13d-3 under the Securities Exchange Act of 1934, shares are shown as beneficially owned if the person named in the table has or shares the power to vote or direct the voting of, or the power to dispose or to direct the disposition of those shares. Inclusion of shares in the table does not necessarily mean that the persons named have any economic interest in shares set opposite their respective names. (2) Includes 40,000 shares owned in joint tenancy with Dr. Mathieu's wife, Betty Burkhardt Mathieu, M.D. (3) Shares are owned in joint tenancy with Nancy A. McCormick, his wife. (4) Shares are owned in joint tenancy with Antonette M. Mega, his wife. (5) Shares are owned in joint tenancy with Vincent A. Ricci, Jr., her husband. (6) Includes 8,150 shares owned in joint tenancy with Mr. Shanahan's wife. 67 COMPLIANCE WITH SECTION 16(A) OF THE SECURITIES EXCHANGE ACT OF 1934 Section 16(a) of the Securities Exchange Act of 1934 requires the Company's Executive Officers, Directors, and 10% shareholders to file reports of ownership (Form 3) and changes of ownership (Form 4) with respect to the Company's Common Stock with the Securities and Exchange Commission. Executive Officers, Directors and principal shareholders are required to furnish the Company with copies of all Section 16(a) forms they file. Based upon a review of the filings for 2001 furnished to the Company, no required Section 16(a) filing was reported late. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS The Bank has had, and may have in the future, various loan and other banking transactions in the ordinary course of business with the Directors, Executive Officers, and principal shareholders of the Company, the Bank and entities with which these persons may be associated. All of these transactions: (i) have been and will be made in the ordinary course of business; (ii) have been and will be made on substantially the same terms, including interest rates and collateral on loans, as those prevailing at the time for comparable transactions with unrelated persons; and (iii) in the opinion of management do not and will not involve more than the normal risk of collectibility or otherwise present other terms less favorable to the Bank than would otherwise be obtained with unrelated persons. As of December 31, 2001, the total dollar amount of extensions of credit to Directors, Executive Officers and any of their associates was $1,223,022, which represented approximately 7.40% of the Company's total stockholders' equity as of that date. 68 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS ON FORM 8-K (1) EXHIBITS The exhibits listed in the Exhibit Index are filed with this Form 10-K or are incorporated by reference into this Form 10-K. (2) FINANCIAL STATEMENTS The following financial statements and accountant's report have been filed as Item 8 in Part 11 of this report: Report of Independent Public Accountants Consolidated Balance Sheets as of December 31, 2001 and 2000 Consolidated Statements of Income for the years ended December 31, 2001, 2000, and 1999 Consolidated Statements of Stockholders' Equity and Comprehensive Income for the years ended December 31, 2001, 2000, and 1999 Consolidated Statements of Cash Flows for the years ended December 31, 2001, 2000 and 1999 Notes to Consolidated Financial Statements (3) FINANCIAL STATEMENT SCHEDULES Certain financial statement schedules are omitted because they are not applicable or because the information is provided in Part II, Item 8, "Financial Statements and Supplementary Data". (4) REPORTS ON FORM 8-K On November 14, 2001, the Company filed a Current Report on Form 8-K with respect to its execution of the Agreement and Plan of Merger with Washington Trust Bancorp, Inc. 69 EXHIBIT INDEX
EXHIBIT REFERENCE NUMBER DESCRIPTION - --------- ------- ----------- (1) 3.1 --Amended and Restated Articles of Incorporation of the Registrant. (1) 3.2 --By-Laws of Registrant. (1) 4.1 --Specimen Certificate for Shares of the Registrant's Common Stock, $1.00 par value. (1) 10.1 --Lease Agreement between the Bank and Angelo Archetto regarding Cranston, Rhode Island property dated as of May 14, 1974. (1) 10.2 --Acquisition Agreement between the Registrant, Maurice C. Paradis, receiver for Chariho-Exeter Credit Union, and the Rhode Island Depositors Economic Protection Corporation (DEPCO) dated as of May 1, 1992. (1) 10.3 --Senior Debenture issued by Registrant to DEPCO dated as of May 1, 1992. (4) 10.4 --Second Amended and Restated Employment Agreement between Registrant and Patrick J. Shanahan, Jr. dated as of February 8, 1999. (5) 10.6 --Amended Supplemental Executive Retirement Plan dated November 13, 2000. (1) 10.7 --Financial Institutions Retirement Fund Defined Pension Plan-Summary Plan Description. (1) 10.8 --Form of Deferred Compensation Agreement regarding Directors' Fees. (2) 10.9 --Financial Institutions Thrift Plan-Summary Plan Description. (2) 10.10 --Lease Agreement(s) between Bank and Wal-Mart Stores, Inc., dated as of January 27, 1997. (3) 10.11 --Service Agreement dated as of April 1, 1997 by and between First Bank and Trust Company and BISYS, Inc. (Confidential treatment granted for certain portions of the Exhibit). (1) 21.1 --Subsidiaries of Registrant. (6) 99.1 --Letter from Arthur Andersen LLP regarding financial statements.
- --------------- (1) Incorporated by reference to the Registrant's Registration Statement on Form S-1 (Registration No. 333-1654), as amended, which was initially filed with the Securities and Exchange Commission on February 26, 1996. (2) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended March 31, 1997. (3) Incorporated by reference to the Registrant's Quarterly Report on Form 10-Q for the quarter ended June 30, 1997. (4) Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 1998. (5) Incorporated by reference to the Registrant's Annual Report on Form 10-K for the year ended December 31, 2000. (6) Filed herewith. 70 SIGNATURES PURSUANT TO THE REQUIREMENTS OF SECTION 13 OR 15(D) OF THE SECURITIES EXCHANGE ACT OF 1934, AS AMENDED, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ON ITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED. FIRST FINANCIAL CORP. By: /s/ Patrick J. Shanahan, Jr. ------------------------------ Patrick J. Shanahan, Jr. Chairman, President and Chief Executive Officer Date: April 12, 2002 Pursuant to the requirements of the Securities Act of 1934, as amended, this Report has been signed below by the following persons in the capacities and on the dates indicated:
SIGNATURE TITLE DATE - --------- ----- ------ /s/ PATRICK J. SHANAHAN, JR. Chairman, President and Chief April 12, 2002 - ---------------------------- Executive Officer; Director PATRICK J. SHANAHAN, JR. /s/ GARY R. ALGER Director April 12, 2002 - ------------------------------------ GARY R. ALGER Director April 12, 2002 - ------------------------------------ JOSEPH A. KEOUGH /s/ DR. PETER L. MATHIEU, JR. Director April 12, 2002 - ------------------------------------ Dr. PETER L. MATHIEU, JR. Director April 12, 2002 - ------------------------------------ JOSEPH V. MEGA /s/ JOHN NAZARIAN, PH.D. Director April 12, 2002 - ------------------------------------ JOHN NAZARIAN, PH.D. /s/ FRED J. SIMON Director April 12, 2002 - ------------------------------------ FRED J. SIMON Director April 12, 2002 - ------------------------------------ WILLIAM P. SHIELDS /s/ DONNA DUPUIS Vice President and Treasurer April 12, 2002 - ------------------------------------ DONNA DUPUIS
EX-99.1 3 a2076492zex-99_1.txt EXHIBIT 99.1 Exhibit 99.1 [ANDERSEN LOGO] Arthur Andersen LLP 225 Franklin Street Boston, MA 02110-2812 Tel 617 330 4000 Fax 617 439 9731 www.andersen.com To the Shareholders and Board of Directors of First Financial Corp.: We represent that this audit was subject to our quality control system for the U.S. accounting and auditing practice to provide reasonable assurance that the engagement was conducted in compliance with professional standards, that there was appropriate continuity of Arthur Andersen personnel working on the audit and availability of national office consultation and availability of personnel at foreign affiliates of Arthur Andersen to conduct the relevant portions of the audit. /s/ Arthur Andersen LLP Boston, Massachusetts April 10, 2002 -----END PRIVACY-ENHANCED MESSAGE-----