-----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, VbvqEH/wFVjV3vkOKNugQle9vVe7uK8NmC3yOF2fuoCpj/rpiyOWPdQmTM+LNzyE uxXiuCeNia6W5Zb2QJnEnw== 0000927016-99-001053.txt : 19990325 0000927016-99-001053.hdr.sgml : 19990325 ACCESSION NUMBER: 0000927016-99-001053 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 3 CONFORMED PERIOD OF REPORT: 19981231 FILED AS OF DATE: 19990323 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: SEC FILE NUMBER: 000-27878 FILM NUMBER: 99570515 BUSINESS ADDRESS: STREET 1: 180 WASHINGTON ST CITY: PROVIDENCE STATE: RI ZIP: 02903 BUSINESS PHONE: 4014213600 10-K 1 FORM 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, 1998 Commission File No. 0-027878 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 March 4, 1999 was $15,852,228 based on the closing sale price of Common Stock as reported on the Nasdaq National Market on such date. At March 4, 1999, there were 1,328,041 shares of the Company's $1.00 par value Common Stock issued, with 1,231,241 shares outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Registrant's Proxy Statement for the Annual Meeting of Stockholders to be held May 12, 1999 are incorporated herein by reference into Part III hereof. - ------------------------------------------------------------------------------- - ------------------------------------------------------------------------------- TABLE OF CONTENTS
Page Reference --------- PART I Item 1. Business................................................ 3 Item 2. Properties.............................................. 14 Item 3. Legal Proceedings....................................... 15 Item 4. Submission of Matters to a Vote of Security Holders..... 15 PART II Item 5. Market for Registrant's Common Equity and Related Stockholder Matters.................................... 16 Item 6. Selected Consolidated Financial Data.................... 17 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............. 35 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.................... 61 PART III Item 10. Directors and Executive Officers of the Registrant...... 61 Item 11. Executive Compensation.................................. 61 Item 12. Security Ownership of Certain Beneficial Owners and Management............................................. 61 Item 13. Certain Relationships and Related Transactions.......... 61 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K............................................... 61 Signatures ........................................................ 63
2 PART I ITEM 1. BUSINESS General First Financial Corp. (Company) is a bank holding company that 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 consumer financial products and services designed to satisfy the deposit and loan needs of its retail customers. The Bank's retail 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, and automated teller machine (ATM) 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 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. 3 1992 Acquisition On May 1, 1992, the Bank acquired certain assets and assumed certain liabilities of Chariho-Exeter Credit Union (Acquisition). On May 4, 1992, the Bank reopened the Chariho-Exeter facility as the third branch of the Bank providing the same service to the local community formerly served by Chariho- Exeter as those provided at the Bank's other two branches. Although the Acquisition was accounted for as a purchase, no goodwill or other intangible asset was recorded because the purchase price did not exceed the fair value of the assets acquired. Through the Acquisition, the Bank acquired $33.4 million in assets, which included $19.5 million in loans and an acquired allowance for loan losses of approximately $3.9 million. Under the Acquisition Agreement, the Bank may, through May 1, 1999, charge-off uncollected acquired loans to this acquired allowance for loan losses. At May 1, 1999, any remaining acquired allowance, less an amount equal to 1% of the remaining acquired loans, must be repaid in the form of cash. In connection with the Acquisition, the Company issued the Senior Debenture to assist in financing the Acquisition. The proceeds of the Senior Debenture were invested as a contribution of capital to the Bank. If, at any time prior to May 1, 1999, net acquired loan losses exceed the acquired allowance for loan losses, such excess may be deducted from the Company's debt obligations under the Senior Debenture. See "Notes to Consolidated Financial Statements," No. (13)--Chariho-Exeter Credit Union Acquisition. Market Area Although its main office is located in downtown Providence, the Bank's Cranston branch is its largest office with deposits of $53.6 million at December 31, 1998. The Providence, Richmond and North Kingstown branches had approximately $26.2 million, $22.0 million and $2.6 million, respectively, in deposits at December 31, 1998. 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 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 portfolio has increased and remains the largest part 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 4 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 1998, 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 30,1998, the Bank ranked fifth (5th) in Rhode Island out of 31 lenders in volume by number of loans approved and sixth (6th) in dollar volume of loans guaranteed by the SBA. 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 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 $50,000, depending on the individual loan officer, and unsecured loans equal to or less than either $25,000 or $10,000, 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 $500,000 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, 1998, the Bank's statutory lending limit to any single borrower approximated $2.1 million, subject to certain exceptions provided under applicable law. The Bank also has a policy of extending loans, under the same 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 capital and otherwise complying with applicable regulatory requirements. At December 31, 1998, the aggregate principal amount of all loans to directors and executive officers and related entities was $1.9 million. 5 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, 1998. Loans having no stated schedule of repayments or no stated maturity (due on demand) are reported as due in one year.
Commercial Home and Equity Residential Lines of Commercial Real Estate Credit Consumer Total ---------- ----------- -------- -------- ------- (In Thousands) Fixed Rate Amounts Due: One year or Less......... $ 1,190 $11,617 $ 44 $ 90 $12,941 After one year through five years.............. 2,941 43,495 263 295 46,994 Beyond five years........ 1,190 11,063 -- 62 12,315 ------- ------- ------ ---- ------- 5,321 66,175 307 447 72,250 ------- ------- ------ ---- ------- Variable Rate Repricing Frequency: Quarterly................ 8,966 560 3,182 534 13,242 Annually or less frequently.............. 476 328 -- -- 804 ------- ------- ------ ---- ------- 9,442 888 3,182 534 14,046 ------- ------- ------ ---- ------- Total.................. $14,763 $67,063 $3,489 $981 $86,296 ======= ======= ====== ==== =======
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 Company 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, 1998, all loans were accruing interest. Commercial 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. Commercial loans do not include business loans primarily secured by real estate. At December 31, 1998, the Bank had outstanding commercial loans totalling $14.8 million which represented 17.1% of total loans. Of the Bank's total commercial loan portfolio, $9.4 million or 64.0% consisted of loans priced on a floating rate basis at a margin over the Bank's base lending rate or Wall Street Prime Rate. At December 31, 1998, the Bank's base rate was 10.25% while the Prime Rate was 7.75%. Commercial and Residential Real Estate Loans. At December 31, 1998, the Bank's outstanding residential first and second mortgage loans and home equity lines of credit of approximately $19.9 million, represented 23.0% of the Bank's total loan portfolio. Of this amount, $17.5 million represented loans originated directly by the Bank, while approximately $2.4 million represents loans acquired in the Acquisition. 6 Most fixed rate conforming loans originated by the Bank are referred to correspondents. The Bank does not fund these loans. 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 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. The Bank has and plans to continue to commit 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, 1998, outstanding commercial real estate loans approximated $50.6 million or 58.7% of total loans outstanding, including total construction and land development loans of approximately $1.8 million. 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 Prime Rate. At December 31, 1998, 83.5% of all residential and commercial real estate loans are subject to repricing within five years. Consumer Loans. At December 31, 1998, the Bank's consumer loan portfolio approximated $1.0 million or 1.2% 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. Allowance for Loan Losses The following table, exclusive of the acquired allowance for loan losses, represents the allocation of the Bank's allowance for loan losses for the periods ending as indicated:
December 31, ---------------------------------------- 1998 1997 1996 ------------ ------------ ------------ (Dollars in Thousands) Loan Category: Commercial....................... $ 160 12.4% $ 75 6.2% $ 90 7.5% Commercial Real Estate........... 840 65.3 848 70.2 718 59.8 Residential Real Estate.......... 219 17.0 266 22.0 317 26.4 Home Equity Lines of Credit...... 54 4.2 7 0.6 55 4.6 Consumer......................... 14 1.1 12 1.0 20 1.7 ------ ----- ------ ----- ------ ----- Total.......................... $1,287 100.0% $1,208 100.0% $1,200 100.0% ====== ===== ====== ===== ====== =====
This allocation 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 allocation should not be considered as an indication of the future amounts or types of loan charge-offs. At December 31, 1998, the Bank classified $1.6 million of loans as substandard based on the rating system adopted by the Bank. Of these amounts, a majority of which are included in the commercial real estate loan portfolio, the Bank estimates a potential loss exposure of $235,000. 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 permissable for banks, which will provide 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. 7 The following table sets forth the amortized cost and fair value of the Bank's investment portfolio at the dates indicated:
December 31, ----------------------------------------------------- 1998 1997 1996 ----------------- ----------------- ----------------- Amortized Fair Amortized Fair Amortized Fair Cost Value Cost Value Cost Value --------- ------- --------- ------- --------- ------- (In thousands) Held-to-Maturity: U.S. Government and agency obligations.... $10,999 $10,947 $11,750 $11,745 $11,400 $11,370 Collateralized mortgage obligations........... 2,734 2,727 718 717 2,381 2,378 ------- ------- ------- ------- ------- ------- $13,733 $13,674 $12,468 $12,462 $13,781 $13,748 ======= ======= ======= ======= ======= ======= Available-for-Sale: U.S. Government and agency obligations.... $24,402 $24,475 $17,528 $17,559 $17,669 $17,696 Mortgage-backed securities............ 7,546 7,662 8,580 8,727 10,684 10,712 Marketable equity securities and other.. 1,022 950 295 313 1 3 ------- ------- ------- ------- ------- ------- $32,970 $33,087 $26,403 $26,599 $28,354 $28,411 ======= ======= ======= ======= ======= =======
The following table sets forth certain information regarding maturity distribution and weighted average yields of the Bank's investment portfolio at December 31, 1998:
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..... $ -- --% $10,999 5.38% $ -- -- % $10,999 5.38% Collateralized mortgage obligations(1)......... 1,640 5.60 1,094 5.55 -- -- 2,734 5.58 ------- ---- ------- ---- ------ ---- ------- ---- 1,640 5.60 12,093 5.40 -- -- 13,733 5.42 ------- ---- ------- ---- ------ ---- ------- ---- Available-for-Sale: U.S. Government and agency obligations..... 17,944 5.34 6,531 5.36 -- -- 24,475 5.35 Mortgage-backed securities(1).......... 1,367 7.21 3,337 7.28 2,958 7.32 7,662 7.28 Marketable equity securities and other... 950 -- -- -- -- -- 950 -- ------- ---- ------- ---- ------ ---- ------- ---- 20,261 5.22 9,868 6.01 2,958 7.32 33,087 5.64 ------- ---- ------- ---- ------ ---- ------- ---- Total................ $21,901 5.25% $21,961 5.67% $2,958 7.32% $46,820 5.58% ======= ==== ======= ==== ====== ==== ======= ====
- -------- (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. 8 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, 1998, the Bank had a total of approximately 3,120 demand deposit, NOW and money market accounts with an average balance of approximately $6,508 each; 3,364 passbook and statement savings accounts with an average balance of approximately $5,143 each; and 3,482 certificates of deposit with an average balance of approximately $19,121 (including 94 certificates of deposit of $100,000 or more totalling $11.8 million). The Bank's office and service hours are supplemented by the Bank's ATM card service which facilitates various deposit and/or withdrawal transactions. The Bank's ATM card may be used in the "PLUS", "CIRRUS", and "NYCE" ATM networks, and the "Maestro" point-of-sale ("POS") network. These networks provide the Bank's ATM cardholders with access to ATMs and POS machines throughout Rhode Island, New England, the United States and more than 34 foreign countries. 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, ------------------------------------------------ 1998 1997 1996 ---------------- --------------- --------------- Average Average Average Average Average Average Balance Rate Balance Rate Balance Rate -------- ------- ------- ------- ------- ------- (In Thousands) Noninterest-bearing deposits.. $ 14,067 $12,124 $10,965 Interest-bearing deposits: NOW and savings accounts.... 20,474 2.51% 21,022 2.52% 21,845 2.58% Money market accounts....... 1,281 2.42 1,499 2.40 1,659 2.41 Certificates of deposit under $100,000............. 54,300 5.34 51,006 5.37 49,955 5.60 Certificates of deposit over $100,000................... 10,909 5.94 9,145 6.38 6,700 5.50 -------- ------- ------- Total..................... $101,031 $94,796 $91,124 ======== ======= =======
Time certificates of deposit in denominations of $100,000 or more, at December 31, 1998, had the following schedule of maturities:
Time Remaining to Maturity Amount -------------------------- -------------- (In Thousands) Less than 3 months............................................ $ 4,026 3 to 6 months................................................. 2,304 6 to 12 months................................................ 3,068 More than 12 months........................................... 2,371 ------- Total....................................................... $11,769 =======
For the past several years the Bank has been active in the securities sold under agreements to repurchase (reverse repo) market as a means of using wholesale funds for capital leverage and interest arbitrage purposes. During 1998 the Bank expanded its use of wholesale funding sources and took down advances for the first time from the Federal Home Loan Bank of Boston. The purpose of these borrowings was to match the funding for selected loans as well as refinance a maturing reverse repo at more favorable terms. For information regarding these borrowing arrangements refer to "Notes to Consolidated Financial Statements." 9 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. 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 contribution 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 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 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. 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, 1998, the Company had 40 full-time and 9 part-time employees. The Company's employees are not represented by any collective bargaining unit, and the Company believes its employee relations are good. The Company maintains a benefit program which includes health insurance, life insurance, a defined benefit pension plan, and a matching savings incentive plan. 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. In addition, legislation such as the Federal Deposit Insurance Corporation Improvement Act (FDICIA) and the Interstate Banking Act have affected the banking industry by, among other 10 things, broadening the regulatory powers of the federal banking agencies in a number of areas and enabling banks and bank holding companies to expand the geographic area in which they may provide banking services. The following summary is qualified in its entirety by the text of the relevant statutes and regulations. The Company General. The Company, as a bank holding company, is subject to regulation and supervision by the Board of Governors of the Federal Reserve System ("Federal Reserve Board") and by the Rhode Island Department of Business Regulation, Division of Banking (the "Banking Division"). The Company is required to file semiannually and annually a report of its operations with, and is subject to examination by, the Federal Reserve Board. BHCA--Activities and Other Limitations. The Bank Holding Company Act ("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. The BHCA also prohibits a bank holding company, with certain exceptions, from acquiring more than 5% of the voting shares of any company that is not a bank and from engaging in any business other than banking or managing or controlling banks. Under the BHCA, the Federal Reserve Board is authorized to approve the ownership of shares by a bank holding company in any company, the activities of which the Federal Reserve Board has determined to be so closely related to banking or to managing or controlling banks as to be a proper incident thereto. In making such determinations, the Federal Reserve Board is required to weigh the expected benefit to the public, including greater convenience, increased competition or gains in efficiency, against the adverse effects, including undue concentration of resources, decreased or unfair competition, conflicts of interest or unsound banking practices. 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. 11 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. 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 (see below) 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 12 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. Recently enacted federal legislation requires federal bank regulators to take "prompt corrective action" with respect to insured depository institutions that fail to satisfy minimum capital requirements and imposes significant restrictions on such institutions. 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 ("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, with the categories ranging from 0% (requiring no additional capital), for assets such as cash, to 100% for the bulk of assets which are typically held by a bank holding company, including multi-family residential and commercial real estate loans, commercial business loans and consumer loans. Single-family residential first mortgage loans which are not either 90 days or more past-due or nonperforming and which have been made in accordance with prudent underwriting standards are assigned a 50% level in the risk-weighting system, as are certain privately issued mortgage-backed securities representing indirect ownership of such loans. Off-balance sheet items also are adjusted to take into account certain risk characteristics. Prompt Corrective Action. Under Section 38 of the FDIA, as added by the FDICIA, each federal banking agency is required to implement a system of prompt corrective action for institutions which it regulates. The federal banking agencies have promulgated substantially similar regulations to implement the system of prompt corrective action established by Section 38 of the FDIA, which became effective on December 19, 1992. 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). A "critically undercapitalized institution" is to be placed in conservatorship or receivership within 90 days unless the FDIC formally determines that forbearance from such action would better protect the deposit insurance fund. Unless the FDIC or other appropriate federal banking regulatory agency makes specific further findings and certifies that the institution is viable and is not expected to fail, an institution that remains critically undercapitalized on average during the fourth calendar quarter after the date it becomes critically undercapitalized must be placed in receivership. 13 Immediately upon becoming undercapitalized, an institution shall become subject to the provisions of Section 38 of the FDIA (i) restricting payment of capital distributions and management fees, (ii) requiring that the appropriate federal banking agency monitor the condition of the institution and its efforts to restore its capital, (iii) requiring submission of a capital restoration plan, (iv) restricting the growth of the institution's assets and (v) requiring prior approval of certain expansion proposals. The appropriate federal banking agency for an undercapitalized institution also may take any number of discretionary supervisory actions if the agency determines that any of these actions is necessary to resolve the problems of the institution at the least possible long-term cost to the deposit insurance fund, subject in certain cases to specified procedures. These discretionary supervisory actions include: requiring the institution to raise additional capital; restricting transactions with affiliates; restricting interest rates paid by the institution on deposits; requiring replacement of senior executive officers and directors; restricting the activities of the institution and its affiliates; requiring divestiture of the institution or the sale of the institution to a willing purchaser; and any other supervisory action that the agency deems appropriate. These and additional mandatory and permissive supervisory actions may be taken with respect to significantly undercapitalized and critically undercapitalized institutions. As of December 31, 1998, the Bank was classified as "well capitalized" under these provisions. Interstate Banking Legislation The Riegle-Neal Interstate Banking and Branching Act of 1994 ("Interstate Banking Act"), enacted in 1995, permits adequately capitalized and managed bank holding companies to acquire control of banks in any state. Additionally, as of June 1, 1997, the Interstate Banking Act allows for banks to branch across state lines, provided that individual states did not elect to "opt out" of interstate banking entirely. 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. The foregoing references to laws and regulations which are applicable to the Company and the Bank are brief summaries thereof which do not purport to be complete and which are qualified in their entirety by reference to such laws and regulations. Recent Developments 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. The Company views the repurchase program as an excellent utilization of capital, and consistent with a solid capital management strategy. On January 13, 1999 and February 5, 1999, the Company repurchased a total of 30,000 shares under the repurchase program at prices ranging from $12.75 to $12.875 per share. Total capital used for these repurchases amounted to $384,375. On January 6, 1999, the Company's Board of Directors declared a regular quarterly dividend of $.09 per share to shareholders of record on February 2, 1999. This quarterly dividend represented a 50% increase over the $.06 per share dividend declared in the fourth quarter of 1998. 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 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 14 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 second of the four renewal options which expires in the year 1999. 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. As part of the 1992 Acquisition, the Bank purchased the 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. 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 1998, 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 1998 and 1997 are as follows:
Quarterly Dividends Sales Prices High Low Declared ------------ ------ ------ --------- 1998 1st Quarter.......................................... 17 15 .06 2nd Quarter.......................................... 20 3/8 16 3/4 .06 3rd Quarter.......................................... 17 3/4 11 1/2 .06 4th Quarter.......................................... 13 7/8 12 1/2 .06 1997 1st Quarter.......................................... 13 1/4 11 .05 2nd Quarter.......................................... 12 3/4 11 3/8 .05 3rd Quarter.......................................... 16 12 5/8 .05 4th Quarter.......................................... 16 1/4 15 .05
As of March 4, 1999, there were approximately 172 holders of record of the Company's common stock and approximately 350 shareholders of beneficial ownership who hold their stock in nominee or "street" name through various brokerage firms. 16 ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
Years Ended December 31, -------------------------------------------------- 1998 1997 1996 1995 1994 --------- --------- --------- -------- ------- (Dollars in Thousands, Except Per Share Data) FINANCIAL CONDITION DATA: Total assets.............. $ 141,919 $ 127,310 $ 121,413 $100,304 $92,822 Investments, securities purchased under agreements to resell, federal funds sold and interest bearing deposits................. 49,544 42,944 44,568 30,811 30,327 Total loans............... 86,296 77,680 72,536 64,701 58,569 Allowance for loan losses................... 1,287 1,597 1,942 1,828 2,257 Total deposits............ 104,372 99,290 93,876 89,591 83,184 Securities sold under agreements to repurchase............... 12,256 10,105 10,778 -- -- Federal Home Loan Bank advances................. 6,204 -- -- -- -- Senior debenture.......... 2,971 2,947 2,894 2,845 2,736 Total stockholders' equity................... 14,813 13,713 12,570 7,192 6,559 STATEMENT OF INCOME DATA: Interest income........... 10,564 9,969 8,867 7,732 6,794 Interest expense.......... 5,218 4,803 4,214 3,669 2,629 --------- --------- --------- -------- ------- Net interest income....... 5,346 5,166 4,653 4,063 4,165 Provision for loan losses. 250 250 455 675 555 --------- --------- --------- -------- ------- Net interest income after provision for loan losses................... 5,096 4,916 4,198 3,388 3,610 Noninterest income........ 616 465 536 474 390 Noninterest expense....... 3,468 3,341 3,177 3,093 2,989 Income taxes.............. 794 728 513 251 399 --------- --------- --------- -------- ------- Net income................ $ 1,450 $ 1,312 $ 1,044 $ 518 $ 612 ========= ========= ========= ======== ======= PER SHARE DATA: Net income: Basic................... $ 1.15 $ 1.04 $ 0.99 $ 0.76 $ 0.90 Diluted................. 1.15 1.04 0.98 0.71 0.84 Book value................ 11.75 10.87 9.89 10.35 9.60 Cash dividends declared... 0.24 0.20 0.12 0.11 0.09 Dividend payout ratio..... 20.88% 19.23% 12.83% 14.51% 10.05% Weighted average common shares outstanding....... 1,261,241 1,261,241 1,049,609 683,200 683,200 Weighted average common and common stock equivalent shares outstanding.............. 1,261,241 1,261,241 1,059,963 728,708 727,573 OPERATING RATIO DATA: Return on average total assets................... 1.07% 1.07% 0.96% 0.54% 0.68% Return on average stockholders' equity..... 10.20 10.00 10.02 7.45 9.60 Net interest margin....... 4.12 4.38 4.46 4.43 4.82 Loans to deposits ratio... 82.68 78.24 77.27 72.22 70.41 Leverage capital ratio.... 10.56 10.77 10.32 6.87 7.01 ASSET QUALITY RATIOS: Nonperforming assets to total assets............. 0.36% 0.63% 0.91% 2.00% 1.58% Nonperforming loans to total loans.............. NM 0.02 0.58 0.83 0.89 Net loan charge-offs to average loans(1)......... 0.22 0.34 0.19 1.01 0.97 Allowance for loan losses to total loans(1)........ 1.53 1.64 1.78 1.47 1.50 Allowance for loan losses to nonperforming loans(1)................. NM 7,333.39 280.35 160.63 146.76
- -------- (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. 17 ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Overview The results of operations of First Financial Corp. and its wholly-owned subsidiary, First Bank and Trust Company (collectively, "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, Federal Home Loan Bank advances and the Senior Debenture. 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. The Company reported net income for 1998 of $1,450,048, as compared to $1,311,733 for 1997, or an increase of 10.5%. Diluted earnings per share amounted to $1.15 per share for 1998, based on 1,261,241 weighted average shares outstanding, as compared to $1.04 per share for 1997, also based on 1,261,241 weighted average shares outstanding. Also, in 1998, the Company's return on average equity (ROE) improved to 10.20% from 10.00% in 1997. The Company's return on average assets (ROA) was 1.07% in 1998 and 1997. The improvement in net income is primarily the result of an increase in net interest income and noninterest income, offset somewhat by an increase in noninterest expense and provision for income taxes. In general, the Company's improvement in earnings is attributable to: (i) an increase in average interest-earning assets funded from both retail and wholesale sources; (ii) an increase in SBA lending activities; and (iii) strong asset quality. Results of Operations Net Interest Income Net interest income, the difference between interest income and interest expense, is the single largest contributor to the Company's results of operations. In 1998, net interest income rose $180,461 or 3.5%, to $5,346,267 from $5,165,806 in 1997. The primary reason for this increase was due to an increase in average interest-earning assets of $11.9 million, or 10.1% offset somewhat by a 26 basis point decrease in average net interest spread to 3.20% in 1998, as compared to 3.46% in 1997. The increase in average interest- earning assets was funded largely from deposit growth and other borrowings. Increases in average stockholders' equity and an increase in average noninterest-bearing deposits, accounted for a decrease in average net interest margin of 26 basis points to 4.12% in 1998, the same as the 26 basis point decrease in net interest spread. In 1998 total interest income amounted to $10,564,083 compared to $9,969,127 in 1997, or an increase of $594,956, or 6.0%. This increase was attributable to an $11.9 million increase in average interest-earning assets, offset somewhat by a 31 basis points decline in earning asset yields. The increase in earning assets was funded by an increase of $4.3 million in retail deposits and a $5.2 million increase in wholesale sources. Within earning assets, average loans increased $4.7 million or 6.3%, while average investments increased $6.9 million. During 1998, average loans represented 62.0% of total average interest-earning assets, compared to 64.2% during 1997. This disproportionate growth from higher yielding loans to lower yielding investments, along with a lower interest rate environment, accounted for the decline in average interest-earning asset yield to 8.14% from 8.45%. In terms of rate/volume, the decline in rates reduced interest income by approximately $256,000; but the increase in volume contributed approximately $851,000 in interest income. Total interest expense amounted to $5,217,816 in 1998 compared to $4,803,321 in 1997, or an increase of $414,495, or 8.6%. Average interest-bearing deposits grew $4.3 million, while cost of funds on interest-bearing deposits remained flat at 4.70%. Despite a declining interest rate environment, the Company's cost of funds on retail deposits remained flat due to the predominent growth of retail deposits in high-costing time certificates of 18 deposit. The cost of funds on time deposits dropped to 5.44% from 5.52%. Average wholesale funds (reverse repurchase agreements, FHLB advances, etc.) increased $5.2 million while its cost decreased to 6.01% from 6.77%. The overall cost on interest-bearing liabilities decreased 5 basis points to 4.94% in 1998 compared to 4.99% in 1997. In terms of rate/volume, the decline in rates helped reduce interest expense by approximately $140,000, while the increase in total interest-bearing liabilities of $9.5 million caused an increase of approximately $555,000 in interest expense. Overall, as a result of changes in the mix of interest-earning assets and interest-bearing liabilities as well as a declining interest rate environment, net interest income decreased approximately $116,000. However, due to balance sheet growth (volume) net interest income increased $296,000. This rate/volume activity produced an increase of $180,000 to net interest income. 19 The following table sets forth certain information relating to the Company's average balance sheet 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. AVERAGE BALANCES AND INTEREST RATES (Dollars in Thousands)
Years Ended December 31, -------------------------------------------------------------------------------- 1998 1997 1996 -------------------------- -------------------------- -------------------------- 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................... $ 80,461 $ 7,797 9.69% $ 75,714 $7,401 9.77% $ 68,437 $6,739 9.85% Investment securities taxable--AFS........... 32,357 1,823 5.63 26,608 1,695 6.37 18,180 1,165 6.41 Investment securities taxable--HTM........... 11,748 683 5.81 11,717 672 5.74 13,828 772 5.58 Securities purchased under agreements to resell................. 4,530 221 4.88 3,496 175 5.01 3,456 173 5.01 Federal Home Loan Bank stock and other........ 719 40 5.56 423 26 6.15 348 18 5.17 -------- ------- ---- -------- ------ ---- -------- ------ ---- TOTAL INTEREST-EARNING ASSETS................. 129,815 10,564 8.14 117,958 9,969 8.45 104,249 8,867 8.51 ------- ---- ------ ---- ------ ---- NONINTEREST-EARNING ASSETS: Cash and due from banks. 2,379 2,238 1,886 Premises and equipment.. 2,430 2,141 1,739 Other real estate owned. 605 717 1,077 Allowance for possible loan losses............ (1,412) (1,903) (1,847) Other assets............ 1,396 1,450 1,101 -------- -------- -------- TOTAL NONINTEREST- EARNING ASSETS......... 5,398 4,643 3,956 -------- -------- -------- TOTAL ASSETS............ $135,213 $122,601 $108,205 ======== ======== ======== INTEREST-BEARING LIABILITIES: Deposits: Interest-bearing demand and NOW deposits...... $ 3,479 67 1.93 $ 3,282 64 1.95 $ 2,550 50 1.96 Savings deposits... ... 16,995 446 2.62 17,740 465 2.62 19,295 513 2.66 Money market deposits.. 1,281 31 2.42 1,499 36 2.40 1,659 40 2.41 Time deposits.......... 65,209 3,548 5.44 60,151 3,321 5.52 56,655 3,164 5.59 Securities sold under agreements to repurchase............. 13,059 712 5.45 10,590 647 6.11 3,067 185 6.03 Federal Home Loan Bank advances............... 2,667 161 6.04 -- -- -- -- -- -- Senior debenture........ 2,998 253 8.44 2,946 270 9.16 2,894 262 9.05 -------- ------- ---- -------- ------ ---- -------- ------ ---- TOTAL INTEREST-BEARING LIABILITIES............ 105,688 5,218 4.94 96,208 4,803 4.99 86,120 4,214 4.89 ------- ---- ------ ---- ------ ---- NONINTEREST-BEARING LIABILITIES: Noninterest-bearing deposits............... 14,067 12,124 10,965 Other liabilities....... 1,237 1,158 700 -------- -------- -------- TOTAL NONINTEREST- BEARING LIABILITIES.... 15,304 13,282 11,665 STOCKHOLDERS' EQUITY.... 14,221 13,111 10,420 -------- -------- -------- TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY... $135,213 $122,601 $108,205 ======== ======== ======== NET INTEREST INCOME..... $ 5,346 $5,166 $4,653 ======= ====== ====== NET INTEREST SPREAD..... 3.20% 3.46% 3.62% ==== ==== ==== NET INTEREST MARGIN..... 4.12% 4.38% 4.46% ==== ==== ====
20 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, 1998 December 31, 1997 December 31, 1996 Compared with Compared with Compared with December 31, 1997 December 31, 1996 December 31, 1995 Increase (Decrease) Due To Increase (Decrease) Due To Increase (Decrease) Due To ------------------------------ ----------------------------- ------------------------------ Volume Rate Total Volume Rate Total Volume Rate Total --------- --------- -------- --------- ------- --------- --------- -------- --------- (Dollars in Thousands) INTEREST-EARNING ASSETS: Loans................. $ 457 $ (61) $ 396 $ 717 $ (55) $ 662 $ 727 $ 18 $ 745 Investment securities taxable--AFS......... 325 (197) 128 537 (7) 530 294 113 407 Investment securities taxable--HTM......... 3 8 11 (122) 22 (100) (29) (30) (59) Securities purchased under agreements to resell, and other.... 66 (6) 60 6 4 10 50 (8) 42 -------- --------- -------- --------- ------- --------- --------- -------- --------- TOTAL INTEREST-EARNING ASSETS................. $ 851 $ (256) $ 595 $ 1,138 $ (36) $ 1,102 $ 1,042 $ 93 $ 1,135 ======== ========= ======== ========= ======= ========= ========= ======== ========= INTEREST-BEARING LIABILITIES: Interest-bearing demand and NOW deposits............. $ 4 $ (1) $ 3 $ 14 $ -- $ 14 $ (2) $ (4) $ (6) Savings deposits...... (19) -- (19) (40) (8) (48) (78) 9 (69) Money market deposits. (5) -- (5) (4) -- (4) (12) (3) (15) Time deposits......... 275 (48) 227 197 (40) 157 594 (166) 428 Securities sold under agreements to repurchase........... 135 (70) 65 459 3 462 185 -- 185 Federal Home Loan Bank advances............. 161 -- 161 -- -- -- -- -- -- Senior debenture...... 4 (21) (17) 5 3 8 7 15 22 -------- --------- -------- --------- ------- --------- --------- -------- --------- TOTAL INTEREST-BEARING LIABILITIES............ $ 555 $ (140) $ 415 $ 631 $ (42) $ 589 $ 694 $ (149) $ 545 ======== ========= ======== ========= ======= ========= ========= ======== ========= NET CHANGE IN NET INTEREST INCOME........ $ 296 $ (116) $ 180 $ 507 $ 6 $ 513 $ 348 $ 242 $ 590 ======== ========= ======== ========= ======= ========= ========= ======== =========
Provision for Loan Losses The provision for loan losses was $250,000 in 1998 and 1997. At December 31, 1998 and 1997, the Company's recorded investment in impaired loans was $1,571,661 and $1,394,092, respectively, of which $853,221 and $884,121, respectively, was determined to require a valuation allowance of $235,473 and $237,030. The Company's ratio of net loan charge-offs to average loans decreased to .22% from .34%. At 21 December 31, 1998, there were no nonperforming loans. Loans 30-89 days delinquent decreased to $161,456 from $490,437 at the end of 1998 and 1997, respectively. At December 31, 1998 and 1997, the allowance for loan losses to total loans was 1.53% and 1.64%, respectively. Noninterest Income The following table identifies the major sources of noninterest income.
Years Ended December 31, ----------------------- 1998 1997 1996 ------- ------- ------- (Dollars in Thousands) Service charges and fees on deposit accounts........ $ 279 $ 317 $ 307 Safe deposit box rental............................. 25 25 26 Other service fees.................................. 35 32 37 Gain on sale of securities.......................... -- -- 56 Gain on sale of loans............................... 166 46 69 Loan servicing fees................................. 41 33 21 ATM surcharge fees.................................. 50 -- -- Other............................................... 20 12 20 ------- ------- ------- $ 616 $ 465 $ 536 ======= ======= =======
Noninterest income increased $150,608 or 32.4% to $616,005 in 1998 from $465,397 in 1997. This increase was the result of the recognition of $165,620 in gains on SBA loan sales, an increase of nearly $120,000 over 1997. During 1998, the Company originated for sale $3,368,807 of guaranteed portion SBA loans at a gain on sale of $261,424 ($95,803 has been deferred into the 1st quarter of 1999). These originations compare to $1,386,340 in 1997. As a result of this SBA activity, the Company's servicing fee income increased $8,301 to $40,805. The other contributor was the result of the imposition of ATM surcharge fees in 1998 which contributed $50,317 to noninterest income. Noninterest Expense The following table identifies the major components of noninterest expense for the respective periods presented:
Years Ended December 31, -------------------------- 1998 1997 1996 -------- -------- -------- (Dollars in Thousands) Salaries and employee benefits................... $ 1,896 $ 1,802 $ 1,654 Occupancy expense................................ 393 375 364 Equipment expense................................ 270 219 200 OREO (gains) losses, write-downs, and carrying costs, net...................................... 42 22 68 Other operating expenses: FDIC insurance premium......................... 12 11 2 Computer service fees.......................... 199 193 162 Regulatory examination fees.................... 5 5 5 Legal and professional fees.................... 136 158 131 Directors' fees................................ 70 60 64 Postage........................................ 47 45 48 Advertising.................................... 75 62 100 Office supplies, forms, stationery, printing, etc........................................... 76 99 103 Miscellaneous.................................. 247 290 276 -------- -------- -------- $ 3,468 $ 3,341 $ 3,177 ======== ======== ========
22 Total overhead spending for the Company increased 3.8% to $3,468,231 in 1998 from $3,341,269 in 1997. During 1998 the Company's efficiency ratio improved to 58.17% from 59.33% in 1997. Essentially, it cost the Company $.5817 to generate $1.00 of revenue. Gross salaries and wages increased $141,597 or 8.9%. This increase was primarily attributable to across the board pay increases and a full year of staffing at the North Kingstown branch. Benefits decreased $13,485 with the greatest savings coming from the fully funded pension plan of $41,160. Health insurance expense increased $12,095 or 18%. As a result of increased loan production, the deferral of salary cost, under SFAS No. 91, increased $34,240 to $196,035 in 1998. This increase in cost deferral helped lower the total increase in salaries and benefits of $93,877 or 5.2% to $1,895,538. Occupancy costs increased $17,895, or 4.8% to $393,189 in 1998. This increase was solely the result of a full year's occupancy at the North Kingstown branch. Specifically, depreciation of leasehold improvements and rent increased $22,242. Equipment expense increased $51,516, or 23.5% to $270,283 during 1998. Equipment maintenance increased $10,661, while equipment depreciation increased $44,767. Both of these increases were the direct result of a full year's cost associated with the technology upgrades of 1997. The cost to carry and dispose of OREO increased $19,465 in 1998 to $41,593. Despite a smaller OREO portfolio, disposal costs increased the Company's loss on OREO sales by $23,683 during the year. Other operating expenses decreased $62,373 during 1998 or 8.7% to $656,527 from $718,900. Advertising and Directors' fees were up $13,181 and $10,241 respectively, while legal and professional, office supplies, printing and forms and the deposit tax were down $21,259, $14,398, $12,008 and $43,497, respectively. Spending control and the elimination of the State deposit tax accounted for these overhead reductions. Income Taxes Income tax expense amounted to $793,993 in 1998, or an effective tax rate of 35.4%. The effective rate in 1997 was 35.7%. The Company's combined federal and state (net of federal benefit) statutory income tax rate was 39.94% in 1998 and 1997. The Company's effective combined federal and state tax rate was lower than the statutory rate primarily due to the exclusion, from state taxable income, interest income on U.S. Treasury obligations and certain government agency debt securities in 1998 and 1997. 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. Financial Condition Total Assets The Company's total assets increased $14.6 million, or 11.5%, from $127.3 million at December 31, 1997, to $141.9 million at December 31, 1998. The increase in total assets primarily occurred within the Company's loan portfolio which increased $8.6 million. The remainder of the increase took place within investment securities which increased $7.8 million. The primary funding sources for the rise in total assets were: (i) $5.1 million increase in total deposits; (ii) nearly $1.1 million in net income, less dividends paid; (iii) $2.2 million increase in securities sold under agreements to repurchase; and (iv) $6.2 million increase in Federal Home Loan Bank advances. Investment Securities The Company's total investment securities portfolio increased $7.8 million to $46.8 million at December 31, 1998, from $39.0 million at December 31, 1997. 23 At December 31, 1998, securities which were classified as held-to-maturity were carried at an amortized cost of $13,733,393, with a fair value of $13,673,673. Securities classified as available-for-sale were carried at a fair value of $33,087,290, with an amortized cost of $32,969,558. At December 31, 1998, 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 discount notes, mortgage-backed securities, 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 of the investment portfolio, the Company views the principal purpose of its investment securities 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. Consequently, the Company's exposure to significant market swings is somewhat controlled. At December 31, 1998, the Company's investment securities had net unrealized gains of $58,012 as compared to net unrealized gains of $189,910 at December 31, 1997. Loans Total loans, net of unearned discount, amounted to $86.3 million at December 31, 1998, up $8.6 million, or 11.1%, from $77.7 million at the end of 1997. The increase in total loans was predominately in the commercial and commercial real estate portfolio, which grew $13.0 million, while residential real estate, home equity lines of credit and consumer loans declined $4.4 million. At December 31, 1998, total loans represented 60.8% of total assets and 82.7% of total deposits compared to 61.0% and 78.2%, respectively, at the end of 1997.
At December 31, ----------------------------------------------- 1998 1997 1996 --------------- --------------- --------------- Amount Percent Amount Percent Amount Percent ------- ------- ------- ------- ------- ------- (Dollars in Thousands) Commercial.............. $14,763 17.1% $ 6,418 8.3% $ 5,075 7.0% Commercial real estate.. 50,646 58.7 45,977 59.2 40,226 55.4 Residential real estate................. 16,417 19.0 21,464 27.6 22,978 31.6 Home equity lines of credit................. 3,489 4.0 2,839 3.7 3,088 4.3 Consumer................ 1,047 1.2 1,057 1.2 1,236 1.7 ------- ----- ------- ----- ------- ----- 86,362 77,755 72,603 Unearned discount....... 66 75 67 ------- ------- ------- 86,296 100.0% 77,680 100.0% 72,536 100.0% ===== ===== ===== Allowance for loan losses................. 1,287 1,597 1,942 ------- ------- ------- Net loans............... $85,009 $76,083 $70,594 ======= ======= =======
In 1998, 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 seek banking relationships with banks which were responsive to their needs, and the success of the Company in meeting those needs. The 24 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, 1998, 1997 and 1996, no troubled debt restructurings were included in the Company's loan portfolio. 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. The amounts and ratios shown are exclusive of the loans and allowance for loan losses acquired in the Chariho- Exeter Credit Union acquisition.
December 31, ------------------------ 1998 1997 1996 ------- ------- -------- (Dollars in Thousands) Loans past due 90 days or more but not included in nonaccrual loans............................. $ -- $ -- $ -- Nonaccrual loans................................. -- 17 428 ------ ------ -------- Total nonperforming loans........................ -- 17 428 Other real estate owned.......................... 513 782 676 ------ ------ -------- Total nonperforming assets....................... $ 513 $ 799 $ 1,104 ====== ====== ======== Delinquent loans 30-89 days past due............. $ 161 $ 490 $ 196 ====== ====== ======== Nonperforming loans as a percent of gross loans.. NM 0.02% 0.64% Nonperforming assets as a percent of total assets.......................................... 0.36% 0.65% 0.95% Delinquent loans 30-89 days past due as a percent of gross loans.................................. 0.19% 0.67% 0.29%
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. 25 The Bank has an informal loan peer review function and a loan loss review committee. The loan peer review committee, which meets monthly, is an informal committee comprised of the Bank's chief executive officer and other loan officers. Every loan of $250,000 or more or a total relationship of $500,000 or more is scheduled to be reviewed annually 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, the loan loss review committee also applies a three year moving weighted average, by category, of net charge-offs to each loan type (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 in determining the historical charge-off 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. 26 The following table is an analysis of the Allowance for Loan Losses over the last three years. This table excludes the acquired loans and related allowance.
Years Ended December 31, ------------------------- 1998 1997 1996 ------- ------- ------- (Dollars in Thousands) AVERAGE LOANS OUTSTANDING........................... $77,302 $70,854 $62,846 ======= ======= ======= ALLOWANCE FOR LOAN LOSSES AT BEGINNING OF YEAR...... $ 1,208 $ 1,200 $ 862 CHARGED-OFF LOANS: Commercial........................................ 12 -- 8 Commercial Real Estate: Non-owner occupied 1-4 family................... -- -- 18 Non-owner occupied multi-family................. 128 -- 30 Commercial...................................... 27 25 -- Residential Real Estate: Owner occupied 1-4 family....................... -- 46 22 Non-owner occupied 1-4 family................... 7 111 36 Home Equity Lines of Credit....................... -- 74 -- Consumer.......................................... 10 11 23 ------- ------- ------- Total charged-off loans......................... 184 267 137 ------- ------- ------- RECOVERIES ON LOANS PREVIOUSLY CHARGED-OFF: Commercial........................................ 1 -- 5 Commercial Real Estate: Non-owner occupied 1-4 family................... -- -- -- Non-owner occupied multi-family................. -- -- -- Commercial...................................... -- -- 3 Residential Real Estate: Owner occupied 1-4 family....................... -- 8 -- Non-owner occupied 1-4 family................... -- -- -- Home Equity Lines of Credit....................... -- -- -- Consumer.......................................... 12 17 12 ------- ------- ------- Total recoveries................................ 13 25 20 ------- ------- ------- NET LOANS CHARGED-OFF............................... 171 242 117 PROVISION FOR LOAN LOSSES........................... 250 250 455 ------- ------- ------- ALLOWANCE FOR LOAN LOSSES AT END OF YEAR............ $ 1,287 $ 1,208 $ 1,200 ======= ======= ======= Net loans charged-off to average loans.............. 0.22% 0.34% 0.19% Allowance for loan losses to gross loans at end of year............................................... 1.53 1.64 1.78 Allowance for loan losses to nonperforming loans.... NM 7332.94 280.35 Net loans charged-off to allowance for loan losses at beginning of year............................... 14.16 20.17 13.57 Recoveries to charge-offs........................... 7.07 9.36 14.60
27 The following table summarizes the gross activity in OREO during the periods indicated:
Years Ended December 31, --------------------------- 1998 1997 1996 -------- -------- --------- (Dollars in Thousands) Balance at beginning of year................... $ 782 $ 676 $ 1,470 Property acquired.............................. 245 461 183 Sales and other adjustments.................... (514) (355) (927) Write-downs (charged to operations)............ -- -- (50) ------- ------- --------- Balance at end of year......................... $ 513 $ 782 $ 676 ======= ======= ========= The balance of OREO at December 31, 1998 consisted of: Land development............................. $ 219 1-4 Family residential real estate........... 100 Multi-Family (5 or more) residential properties.................................. -- Commercial real estate....................... 194 ------- $ 513 =======
Deposits and Borrowings The Company devotes considerable time and resources to gathering deposits through its retail branch network system. Total deposits increased $5.1 million, or 5.1%, to $104.4 million at December 31, 1998, from $99.3 million at the end of 1997. Total demand deposits increased $2.5 million, while savings and money market accounts decreased $1.4 million. The preponderance of deposit growth occurred within time deposits which increased $4.0 million. Of this increase, one month to twenty-four month time deposits grew $5.7 million while the Company's eighteen and thirty-six month variable rate certificates of deposit decreased $2.4 million. The Company's depositors, concerned that interest rates would decline in the near-term, shifted their deposits from the longer term variable deposit product to the shorter term fixed rate deposit product. Along with its deposit gathering efforts, the Company relied on borrowing from securities sold under agreements to repurchase (reverse repo) to leverage its capital. At December 31, 1998, securities sold under agreements to repurchase amounted to $12.3 million, compared to $10.1 million at December 31, 1997. During 1998, the Bank expanded its use of wholesale funding sources and took down advances for the first time 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 a maturing reverse repo at more favorable terms. At December 31, 1998, advances from the FHLB amounted to $6.2 million. 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 28 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. 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. 29 The following table presents the repricing schedule for the Company's interest-earning assets and interest-bearing liabilities at December 31, 1998:
Within Over Three Over One Over Five Three to Twelve Year to Years to Over Ten Months Months Five Years Ten Years Years Total ------- ---------- ---------- --------- -------- -------- (Dollars in Thousands) INTEREST-EARNING ASSETS: Securities purchased under agreements to resell, and other.... $ 2,724 $ -- $ -- $ -- $ -- $ 2,724 Investment securities. 11,492 6,942 20,020 8,366 -- 46,820 Loans................. 26,442 11,696 38,989 9,526 -- 86,653 ------- -------- ------- ------- ------- -------- Total interest-earning assets................. 40,658 18,638 59,009 17,892 136,197 INTEREST-BEARING LIABILITIES: Money Market accounts. 249 724 472 -- -- 1,445 Savings deposits and NOW accounts......... 1,687 5,214 13,594 -- -- 20,495 Time deposits......... 27,728 28,785 10,175 -- -- 66,688 Securities sold under agreements to repurchase........... 4,600 2,500 5,156 -- -- 12,256 Federal Home Loan Bank advances............. 100 300 4,102 1,702 -- 6,204 Senior debenture...... -- 2,971 -- -- -- 2,971 ------- -------- ------- ------- ------- -------- Total interest-bearing liabilities............ 34,364 40,494 33,499 1,702 -- 110,059 ------- -------- ------- ------- ------- -------- NET INTEREST SENSITIVITY GAP.................... $ 6,294 $(21,856) $25,510 $16,190 -- $ 26,138 ======= ======== ======= ======= ======= ======== CUMULATIVE GAP.......... $ 6,294 $(15,562) $ 9,948 $26,138 $26,138 $ 26,138 ======= ======== ======= ======= ======= ======== NET INTEREST SENSITIVITY GAP AS A PERCENT OF TOTAL ASSETS........... 4.4% (15.4)% 18.0% 11.4% -- 18.4% ======= ======== ======= ======= ======= ======== CUMULATIVE GAP AS A PERCENT OF TOTAL ASSETS................. 4.4% (11.0)% 7.0% 18.4% 18.4% 18.4% ======= ======== ======= ======= ======= ========
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 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, 1998, the Company's earnings-at-risk under a ^200 basis point interest rate shock test measured a negative 4.3% in a worst case scenario. Under a similar test, the Company's equity-at-risk measured a negative 10.1% of market value of equity at December 31, 1998. At December 31, 1998, 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 30 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, 1998, cash and due from banks, securities purchased under agreements to resell, and short-term investments (unpledged and maturing within one year) amounted to $19.5 million, or 13.8% 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 borrowings of nearly $40.0 million, which could assist the Company in meeting its liquidity needs and funding its asset mix. At December 31, 1998, the Company held state and municipal demand deposits of $1.1 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. The Company is cognizant of the special liquidity demands posed by the Year 2000 issue. Liquidity plans are being developed to ensure adequate liquidity on hand and available should abnormal demands result from the Year 2000 issue. Refer to the discussion below regarding Year 2000 compliance. Capital Resources Total stockholders' equity of the Company at December 31, 1998 was $14.8 million, as compared to $13.7 million at December 31, 1997. The increase of $1.1 million primarily resulted from $1.4 million in net income, less dividends declared. 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, 1998, the Bank's Leverage Capital Ratio was 10.31%, as compared to 10.43% at December 31, 1997. 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 16.61% and a Total Risk- Based Capital Ratio of 17.87% at December 31, 1998, as compared to a Tier I Risk-Based Capital Ratio of 16.52% and a Total Risk-Based Capital Ratio of 17.78% at December 31, 1997. 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 Bank, which happens to be the same requirements which FDIC imposes on the Bank. At December 31, 1998, the Company's Leverage Capital Ratio was 10.56%, as compared to 10.77% at December 31, 1997. The Company's Tier I Risk-Based Capital Ratio was 17.24% and its Total Risk-Based Capital Ratio was 18.49% at December 31, 1998, and 17.50% and 18.76%, respectively, at December 31, 1997. Year 2000 Compliance The efficient operation of the Company's business is highly dependent on its computer software programs and operating systems. Virtually all of these programs and systems are furnished, supported and maintained by correspondent institutions, computer service and system providers, and software vendors. As the year 2000 approaches, a critical business issue has emerged regarding how existing application software programs and operating systems can accommodate this date value. As a result, the year 1999 could be the maximum date value 31 these systems will be able to accurately process. The Company has adopted a Year 2000 Plan which calls for completion of a risk assessment, identification, reprogramming and testing of all programs and systems no later than March 31, 1999. The Company has completed the risk assessment and identification phase of the Year 2000 Plan and is now in the reprogramming and testing phase. The Plan also requires all programs and systems to be fully tested and Year 2000 compliant by June 30, 1999. The Company's Board of Directors plays a very active role in the Year 2000 compliance effort. The Board has approved the Year 2000 Plan and receives monthly status reports from members of the project team. The FDIC has also played a very active role and has visited the Company on two occasions to examine the Company's progress. In confronting the Year 2000 problem, the Company faces potential risks to its and the Bank's operations. As stated above, the Company purchases substantially all of its software from third parties who face the same Year 2000 challenge as the Company. In addition, the Company relies almost exclusively on other companies for the functioning of its automated system. Thus, the Company's operations could be adversely affected if the operations of these third parties are adversely affected by the Year 2000 problem. Most importantly, the Company faces risks that all banking institutions, whether large or small, also face. Included among these risks is the risk that the Year 2000 date change may result in the inability to process and underwrite loan applications, to credit deposits and withdrawals from customer accounts, to credit loan payments or track delinquencies, to properly reconcile and record daily activity or to engage in similar normal banking activities. Additionally, if those commercial loan customers of the Bank whose operations depend heavily on computers and computer software experience Year 2000 compliance problems and suffer adverse effects with respect to their own operations, their ability to meet their obligations to the Bank could be adversely affected. This could force the Bank to increase its provision for loan losses or take more aggressive collection actions, potentially impacting the Company's earnings. Furthermore, the Bank faces the risk that in light of potential uncertainty as to the availability of their funds after the date change and a decrease in interest rates, the Bank's deposit customers could withdraw their funds, causing the Bank to experience deposit run-off prior to the Year 2000 date change. This potential deposit contraction could make it necessary for the Company to change its sources of funding which could materially affect the Company's earnings. Moreover, to the extent that the risks posed by the Year 2000 problem are pervasive in data processing and transmission and communications services worldwide, the Company cannot predict with any certainty that its operations will remain materially unaffected after January 1, 2000, or on dates preceding this date at which time post-January 1, 2000 dates become significant within the Bank's systems. Finally, to the extent that certain utility and communication services utilized by the Company face Year 2000 problems, the Company's operations could be disrupted. The Company is in constant communication with its outside vendors, with whom it is reliant, to ensure that their timetable and progress is consistent with that of the Company. The Company has also communicated with significant borrowers and mission critical vendors to determine the status of their Year 2000 compliance efforts. The Company has also kept the Bank's depositors informed of its efforts. The Company has incorporated a contingency plan into the Year 2000 Plan. The contingency plan calls for a conversion to another core system provider in the event of a system failure during the remediation effort. If the failure occurs on or after January 1, 2000, the Company will convert to a manual system until the computerized system is remedied. The Company believes that a major system failure is highly unlikely, but limited exceptions across its core applications may occur. The Company does not anticipate that the remedial or systems' failure costs incurred in connection with Year 2000 compliance will be material to its financial condition or results of operations. The discussion above contains certain forward-looking statements. The costs of the Year 2000 conversion, the date which the Company has set to complete its Year 2000 project and statements about anticipated compliance are based on the Company's current estimates and are subject to various uncertainties that could cause actual results to differ materially from the Company's expectations. Such uncertainties include, among others, the success of the Company in identifying systems that are not Year 2000 compliant, the nature and 32 amount of programming required to upgrade or replace each of the affected systems, the availability of qualified personnel, consultants and other resources, and the success of the Year 2000 compliance efforts of others. Readers are cautioned not to place undue reliance on these forward looking statements. Comparison of 1997 with 1996 The Company reported net income for 1997 of $1,311,733, as compared to $1,043,677 for 1996, or an increase of 25.7%. Diluted earnings per share amounted to $1.04 per share for 1997, based on 1,261,241 weighted average shares outstanding, as compared to $.98 per share for 1996, based on 1,059,963 weighted average shares outstanding. The improvement in net income is primarily the result of an increase in net interest income and a reduction in the provision for possible loan losses, which were offset somewhat by a decrease in noninterest income, and an increase in noninterest expense and provision for income taxes. In general, the Company's improvement in earnings is attributable to its ability to: (i) increase average interest-earning assets funded from the net proceeds of the 1996 public offering, along with deposits and other borrowings; (ii) increase loan originations; and (iii) improved asset quality. Net Interest Income In 1997, net interest income rose $512,548, or 11.0% to $5,165,806 from $4,653,258 in 1996. The primary reason for this increase was due to an increase in average interest-earning assets of $13.7 million, or 13.2%, offset somewhat by a 16 basis point decrease in average net interest spread to 3.46% in 1997, as compared to 3.62% in 1996. The increase in average interest- earning assets was funded largely from the net proceeds of the public offering, deposit growth and other borrowings. Increases in average stockholders' equity and an increase in average noninterest-bearing deposits, accounted for a decrease in average net interest margin of only 8 basis points to 4.38% in 1997 as compared to the 16 basis point decrease in net interest spread. Interest income totaled $9,969,127 in 1997, an increase of $1,101,644, or 12.4% over the prior year. The $13.7 million increase in average interest- earning assets was primarily responsible for the improvement in interest income. During 1997, loan demand was solid. Nonetheless, the composition of loans to average interest-earning assets decreased to 64.2% during 1997, from 65.6% during 1996. This decrease was primarily the result of the purchase of nearly $10.5 million in mortgage-backed securities in the latter part of 1996. These securities which were placed in the Company's available-for-sale investment portfolio, produced yields which were lower than the blended yield on average interest-earning assets. Consequently, despite a relatively stable interest rate environment, the slight change in the mix of average interest- earning assets accounted for a 6 basis point reduction in average earning asset yield to 8.45% in 1997 from 8.51% in 1996. Interest expense amounted to $4,803,321 in 1997, an increase of $589,096, or 14.0% over the $4,214,225 reported in 1996. This increase was largely attributable to a $10.1 million increase in average interest-bearing liabilities and a 10 basis point increase in cost of funds to 4.99% during 1997, from 4.89% during 1996. Of the increase in average interest-bearing liabilities, average time deposits increased $3.5 million and average securities sold under agreements to repurchase increased $7.5 million. Lower cost NOW, savings and money market deposits decreased $1.0 million. The increase in securities sold under agreements to repurchase was used to fund the purchase of the mortgage-backed securities. Despite the gathering of new deposits and the shifting of existing deposits into higher cost time deposits, the Company's cost of funds would have remained flat at 4.85% in both 1997 and 1996 were it not for the increase in volume and rate of the securities sold under agreements to repurchase. Provision for Loan Losses The provision for loan losses was $250,000 in 1997, compared to $455,000 in 1996. The $205,000 reduction in the provision for loan losses was strictly a function of asset quality. As compared to year-end 1996, the Company's watch list loans decreased to $2.5 million from $3.2 million; impaired loans decreased to $1.4 million 33 from $1.7 million; and impaired loans requiring a specific reserve decreased to $.9 million from $1.4 million with a decrease in the specific reserve for impaired loans to $237,000 from $376,000. The aggressive approach to loan charge-offs during the year drove up the ratio of net loan charge-offs to average loans to .34% from .19%, but also assisted in reducing nonaccrual loans at year end to just $16,477 or 0.02% to total loans. The increase in 30- 89 days delinquent loans to $490,437, from $195,841 at the end of 1996 was more a reflection of an abnormally low level of delinquencies at the end of 1996 than a deterioration of asset quality in 1997. Noninterest Income Noninterest income decreased $70,886 in 1997, to $465,397 from $536,283 in 1996. This decrease was primarily due to a $56,105 gain on sale of securities in 1996 without a similar transaction in 1997. Generally, the Company's intention is not to sell securities prior to maturity. However, in order to utilize a capital loss tax carryforward, which was scheduled to expire at the end of 1996, a security was sold and the tax carryforward was utilized. Service charges and fees on deposit accounts increased $10,000, or 3.4%, to $317,000 primarily as a result of more stringent imposition of fees and growth in the Company's total deposits. The gain on sale of the guaranteed portion of SBA loans decreased $23,000 in 1997 largely due to the increased competition in this business market. Loan servicing fees increased $12,119 or 59.5%, to $32,504 primarily due to growth in the Company's loan servicing portfolio. Noninterest Expense Total noninterest expense in 1997 was $3,341,269 as compared to $3,177,282 in 1996, an increase of $163,987 or 5.2%. The largest expense items accounting for this increase were the $148,000 increase in salaries and employee benefits; the $30,000 increase in occupancy and equipment expense; the $31,000 increase in computer service fees and; the $27,000 increase in legal and professional fees. These increases were offset by a $46,000 decrease in OREO carrying and disposition costs and a $38,000 decrease in advertising. Salaries and benefits increased $148,000, or 8.9% in 1997. This increase reflected an increase in staffing levels associated with the June 1997 opening of the in-store branch in Wal-Mart in North Kingstown, Rhode Island. During 1997, the number of full time equivalent employees reached a high of 46 from 40 at the beginning of the year. Also, effective January 1, 1997, the Company adopted a matching savings incentive plan, also known as a 401(k) plan, which increased benefit costs by $32,000. During 1997, the Company undertook two major projects, namely, the opening of the North Kingstown branch, and an upgrade of its voice and data communications systems. These projects account for the $11,000 increase in occupancy expense through the incurrence of rental expense and the amortization of leasehold improvements. The upgrade in communication systems involved the purchase of state-of-the-art computer hardware and licensing of software applications. Depreciation charges associated with these capital expenditures accounted for the increase of $19,000 in equipment expense. The state-of-the-art processing capabilities and overall enhancement of information systems was primarily responsible for the $31,000 increase in computer service fees. 1997 represented the first full year in which the Company operated in a publicly-held and publicly-traded environment. In connection therewith, the Company incurred typical legal and professional fees related to this public environment. These fees included costs associated with preparation and production of public filings and shareholder reports; listing fees; annual meeting costs; transfer agent costs; and other similar costs. For this reason, legal and professional fees increased $27,000 in 1997. OREO carrying and disposition costs decreased $46,000 primarily due to the elimination of the need to write-down the property's carrying value in 1997, compared to a $50,000 write-down in 1996, along with a decrease in the foreclosed property portfolio from an average of $1,077,000 during 1996 to an average of $717,000 during 1997. Other increases or decreases in general and administrative expenses, including advertising, were largely due to the Company's increased item processing, greater efficiency and productivity, and decisions to increase or curtail discretionary programs, projects and spending. 34 Income Taxes Income tax expense amounted to $728,201 in 1997, or an effective tax rate of 35.7%. The effective rate in 1996 was 33.0%. The Company's combined federal and state (net of federal benefit) statutory income tax rate was 39.94% in 1997 and 1996. The Company's effective combined federal and state tax rate was lower than the statutory rate primarily due to the exclusion from state taxable income interest income on U.S. Treasury obligations and certain government agency debt securities in 1997 and 1996 and, the utilization of a capital loss carryforward in 1996. 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". ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA 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, 1998 and 1997, and the related consolidated statements of income, stockholders' equity and comprehensive income, and cash flows for each of the years in the three year period ended December 31, 1998. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the 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, 1998 and 1997, and the results of their operations and their cash flows for each of the years in the three year period ended December 31, 1998, in conformity with generally accepted accounting principles. Arthur Andersen LLP Boston, Massachusetts January 12, 1999 35 FIRST FINANCIAL CORP. AND SUBSIDIARY CONSOLIDATED BALANCE SHEETS
December 31, ------------------------- 1998 1997 ------------ ------------ ASSETS CASH AND DUE FROM BANKS.............................. $ 2,342,782 $ 2,837,014 ------------ ------------ SECURITIES PURCHASED UNDER AGREEMENTS TO RESELL...... 2,723,488 3,878,000 ------------ ------------ LOANS HELD FOR SALE.................................. 357,493 380,000 ------------ ------------ INVESTMENT SECURITIES (Notes 1 and 3): Held-to-maturity (fair value: $13,673,673 in 1998 and $12,462,016 in 1997).......................... 13,733,393 12,467,740 Available-for-sale (amortized cost: $32,969,558 in 1998 and $26,403,000 in 1997)..................... 33,087,290 26,598,634 ------------ ------------ Total investment securities........................ 46,820,683 39,066,374 ------------ ------------ FEDERAL HOME LOAN BANK STOCK......................... 447,700 447,700 ------------ ------------ LOANS (Notes 1, 8 and 10): Commercial......................................... 14,762,537 6,418,373 Commercial real estate............................. 50,646,390 45,976,986 Residential real estate............................ 16,417,012 21,464,343 Home equity lines of credit........................ 3,489,029 2,838,377 Consumer........................................... 1,047,141 1,056,791 ------------ ------------ 86,362,109 77,754,870 Less--Unearned discount............................ 66,264 75,107 Allowance for loan losses (Notes 4 and 13)......... 1,287,058 1,596,613 ------------ ------------ Net loans.......................................... 85,008,787 76,083,150 ------------ ------------ OTHER REAL ESTATE OWNED (Note 1)..................... 513,127 782,190 ------------ ------------ PREMISES AND EQUIPMENT, net (Notes 5 and 8).......... 2,416,790 2,458,550 ------------ ------------ OTHER ASSETS......................................... 1,288,080 1,376,889 ------------ ------------ TOTAL ASSETS......................................... $141,918,930 $127,309,867 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY DEPOSITS: Demand............................................. $ 15,743,185 $ 13,198,956 Savings and money market accounts.................. 21,940,330 23,371,357 Time deposits (Note 6)............................. 66,688,413 62,719,558 ------------ ------------ Total deposits..................................... 104,371,928 99,289,871 ------------ ------------ SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE (Note 7).................................................. 12,255,880 10,105,000 ------------ ------------ FEDERAL HOME LOAN BANK ADVANCES (Note 7)............. 6,204,077 -- ------------ ------------ ACCRUED EXPENSES AND OTHER LIABILITIES............... 1,302,316 1,255,823 ------------ ------------ SENIOR DEBENTURE, net of unamortized discount of $2,134 in 1998 and $53,460 in 1997 (Note 13)........ 2,971,487 2,946,540 ------------ ------------ COMMITMENTS AND CONTINGENCIES (Note 8) STOCKHOLDERS' EQUITY (Notes 2, 3, 12 and 16): 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.................................. 9,130,143 7,982,792 Accumulated other comprehensive income............. 70,638 117,380 ------------ ------------ 14,960,202 13,859,593 Less--Treasury stock, at cost, 66,800 shares....... 146,960 146,960 ------------ ------------ Total stockholders' equity......................... 14,813,242 13,712,633 ------------ ------------ TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY........... $141,918,930 $127,309,867 ============ ============
The accompanying notes are an integral part of these consolidated financial statements. 36 FIRST FINANCIAL CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF INCOME For the Years Ended December 31, 1998, 1997 and 1996
Years Ended December 31, --------------------------------- 1998 1997 1996 ----------- ---------- ---------- INTEREST INCOME: Interest and fees on loans (Note 1)........ $ 7,796,758 $7,400,873 $6,738,492 Interest and dividends on investment securities-- U.S. Government and agency obligations... 1,882,529 1,532,872 1,558,517 Collateralized mortgage obligations...... 52,398 91,684 134,144 Mortgage-backed securities............... 537,544 727,637 243,994 Marketable equity securities and other... 74,360 40,838 19,503 Interest on cash equivalents (Note 1)...... 220,494 175,223 172,833 ----------- ---------- ---------- Total interest income.................... 10,564,083 9,969,127 8,867,483 INTEREST EXPENSE: Interest on deposits....................... 4,091,958 3,886,454 3,766,620 Interest on reverse repurchase agreements.. 712,217 646,622 185,291 Interest on advances....................... 160,865 -- -- Interest on debenture (Note 13)............ 252,776 270,245 262,314 ----------- ---------- ---------- Total interest expense................... 5,217,816 4,803,321 4,214,225 ----------- ---------- ---------- Net interest income...................... 5,346,267 5,165,806 4,653,258 PROVISION FOR LOAN LOSSES (Note 1)........... 250,000 250,000 455,000 ----------- ---------- ---------- Net interest income after provision for loan losses............................. 5,096,267 4,915,806 4,198,258 ----------- ---------- ---------- NONINTEREST INCOME: Service charges on deposits................ 279,185 317,176 307,060 Gain on sale of securities................. -- -- 56,105 Gain on loan sales......................... 165,620 46,410 69,402 Other...................................... 171,200 101,811 103,716 ----------- ---------- ---------- Total noninterest income................. 616,005 465,397 536,283 ----------- ---------- ---------- NONINTEREST EXPENSE: Salaries and employee benefits (Note 11)... 1,895,538 1,801,661 1,653,929 Occupancy expense.......................... 393,189 375,294 364,414 Equipment expense.......................... 270,283 218,767 200,498 Other real estate owned net losses and expenses.................................. 41,593 22,128 67,658 Computer services.......................... 199,306 193,392 162,470 Deposit insurance assessments.............. 11,795 11,127 1,500 Other operating expenses................... 656,527 718,900 726,813 ----------- ---------- ---------- Total noninterest expense................ 3,468,231 3,341,269 3,177,282 ----------- ---------- ---------- Income before provision for income taxes.................................. 2,244,041 2,039,934 1,557,259 PROVISION FOR INCOME TAXES (Note 9).......... 793,993 728,201 513,582 ----------- ---------- ---------- NET INCOME................................... $ 1,450,048 $1,311,733 $1,043,677 =========== ========== ========== Earnings per share: Basic.................................... $ 1.15 $ 1.04 $ 0.99 =========== ========== ========== Diluted.................................. $ 1.15 $ 1.04 $ 0.98 =========== ========== ========== Weighted average common shares outstanding... 1,261,241 1,261,241 1,049,609 Dilutive effect of common stock equivalents.. -- -- 10,354 ----------- ---------- ---------- Weighted average common and common stock equivalent shares outstanding............... 1,261,241 1,261,241 1,059,963 =========== ========== ==========
The accompanying notes are an integral part of these consolidated financial statements. 37 FIRST FINANCIAL CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY AND COMPREHENSIVE INCOME For the Years Ended December 31, 1998, 1997 and 1996
Accumulated Other Total Common Retained Comprehensive Treasury Stockholders' Comprehensive Stock Surplus Earnings Income Stock Equity Income ---------- ---------- ---------- ------------- --------- ------------- ------------- Balance, December 31, 1995................... $ 750,000 $ 500,000 $6,013,638 $74,911 $(146,960) $ 7,191,589 Net income.............. -- -- 1,043,677 -- -- 1,043,677 $1,043,677 Other comprehensive income,net of tax: Unrealized holding gains................. -- -- -- -- -- -- 15,326 Less: Reclassification adjustment for gains included in net income................ -- -- -- -- -- -- (56,105) ---------- Other comprehensive income................ -- -- -- (40,779) -- (40,779) (40,779) ---------- Comprehensive income.... $1,002,898 ========== Dividends declared ($.12 per share) ............ -- -- (134,007) -- -- (134,007) Exercise of stock options and related tax effect................. 28,041 (41,744) -- -- -- (13,703) Issuance of 550,000 shares of common stock, net of offering costs (Note 2) .............. 550,000 3,973,124 -- -- -- 4,523,124 ---------- ---------- ---------- ------- --------- ----------- Balance, December 31, 1996................... 1,328,041 4,431,380 6,923,308 34,132 (146,960) 12,569,901 Net income.............. -- -- 1,311,733 -- -- 1,311,733 $1,311,733 Other comprehensive income, net of tax: Unrealized holding gains................. -- -- -- 83,248 -- 83,248 83,248 Comprehensive income.... $1,394,981 ========== Dividends declared ($.20 per share) ............ -- -- (252,249) -- -- (252,249) ---------- ---------- ---------- ------- --------- ----------- Balance, December 31, 1997................... 1,328,041 4,431,380 7,982,792 117,380 (146,960) 13,712,633 Net income.............. -- -- 1,450,048 -- -- 1,450,048 $1,450,048 Other comprehensive income, net of tax: Unrealized holding losses....... ........ -- -- -- (46,742) -- (46,742) (46,742) ---------- Comprehensive income.... $1,403,306 ========== Dividends declared ($.24 per share). ........... -- -- (302,697) -- -- (302,697) ---------- ---------- ---------- ------- --------- ----------- Balance, December 31, 1998................... $1,328,041 $4,431,380 $9,130,143 $70,638 $(146,960) $14,813,242 ========== ========== ========== ======= ========= ===========
The accompanying notes are an integral part of these consolidated financial statements. 38 FIRST FINANCIAL CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS For the Years Ended December 31, 1998, 1997 and 1996
Years Ended December 31, ---------------------------------------- 1998 1997 1996 ------------- ----------- ------------ CASH FLOWS FROM OPERATING ACTIVITIES: Net income......................... $ 1,450,048 $ 1,311,733 $ 1,043,677 Adjustments to reconcile net income to net cash provided by operating activities: Provision for loan losses........ 250,000 250,000 455,000 Depreciation and amortization.... 285,721 231,723 185,076 Losses (gains) on other real estate owned.................... 14,162 (9,522) (6,681) Gain on sale of securities....... -- -- (56,105) Gain on sales of loans........... (165,620) (46,410) (69,402) Proceeds from sales of loans..... 3,630,231 1,209,421 890,652 Loans originated for sale........ (3,346,300) (1,386,340) (981,250) Net increase in deferred loan fees............................ 6,226 46,816 30,330 Net accretion on investment securities held-to- maturity.... (5,203) (10,730) (40,619) Net accretion on investment securities available-for-sale... (290,619) (66,649) (103,136) Net (decrease) increase in unearned discount............... (8,843) 8,391 (21,425) Net decrease (increase) in other assets.......................... 88,809 56,596 (314,535) Accretion of discount on debenture....................... 205,983 202,566 199,064 Net (decrease) increase in accrued expenses and other liabilities..................... (136,118) (266,589) 457,584 ------------- ----------- ------------ Net cash provided by operating activities...................... 1,978,477 1,531,006 1,668,230 ------------- ----------- ------------ CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from maturities of investment securities held-to- maturity.......................... 20,472,802 13,573,509 22,766,655 Proceeds from sales and maturities of investment securities available-for-sale................ 150,311,185 30,233,468 21,914,591 Purchase of investment securities held-to-maturity.................. (21,733,252) (12,250,000) (18,865,456) Purchase of investment securities available-for-sale................ (156,587,124) (28,215,380) (38,099,980) Purchase of Federal Home Loan Bank stock............................. -- (99,600) -- Net increase in loans.............. (9,418,020) (6,258,403) (8,368,347) Purchase of premises and equipment......................... (243,961) (1,044,993) (13,463) Sales of other real estate owned... 499,901 366,955 984,416 ------------- ----------- ------------ Net cash used in investing activities........................ (16,698,469) (3,694,444) (19,681,584) ------------- ----------- ------------ CASH FLOWS FROM FINANCING ACTIVITIES: Net increase (decrease) in demand accounts.......................... 2,544,229 1,928,910 (1,213,387) Net (decrease) increase in savings and money market accounts......... (1,431,027) 621,657 (1,442,281) Net increase in time deposits...... 3,968,855 2,863,195 6,941,235 Net increase (decrease) in reverse repurchase agreements............. 2,150,880 (673,000) 10,778,000 Net increase in Federal Home Loan Bank advances..................... 6,204,077 -- -- Net proceeds on issuance of common stock............................. -- -- 4,523,124 Exercise of stock options, net of tax effect........................ -- -- (13,703) Dividends paid..................... (365,762) (227,023) (96,170) ------------- ----------- ------------ Net cash provided by financing activities........................ 13,071,252 4,513,739 19,476,818 ------------- ----------- ------------
39 FIRST FINANCIAL CORP. AND SUBSIDIARY CONSOLIDATED STATEMENTS OF CASH FLOWS--(Continued) For the Years Ended December 31, 1998, 1997 and 1996
Years Ended December 31, ---------------------------------- 1998 1997 1996 ----------- ---------- ---------- NET (DECREASE) INCREASE IN CASH AND CASH EQUIVALENTS................................ $(1,648,744) $2,350,301 $1,463,464 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR....................................... 6,715,014 4,364,713 2,901,249 ----------- ---------- ---------- CASH AND CASH EQUIVALENTS, END OF YEAR...... $ 5,066,270 $6,715,014 $4,364,713 =========== ========== ========== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Interest paid............................. $ 5,211,783 $4,755,368 $3,834,580 =========== ========== ========== Income taxes paid......................... $ 1,083,250 $ 787,242 $ 327,250 =========== ========== ========== SUPPLEMENTAL DISCLOSURE OF NONCASH TRANSACTIONS: Transfer of loans to OREO................... $ 245,000 $ 461,002 $ 183,032 =========== ========== ==========
The accompanying notes are an integral part of these consolidated financial statements. 40 FIRST FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Years Ended December 31, 1998, 1997 and 1996 (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 (collectively, "Company"), after elimination of all intercompany transactions and balances. Certain reclassifications have been made to prior year balances to conform with the current year presentation. 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. Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and 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. 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 fair 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, 1998 and 1997 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. 41 FIRST FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 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 past loan loss experience, changes in the character and size of the loan portfolio, current and expected economic conditions, 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 management to be adequate in relation to the estimate of loss exposure in the loan portfolio. Losses are charged against the allowance for loan losses when management believes that the collectibility of principal is unlikely. Investment Securities Investments in equity securities that have readily determinable fair values and all investments in debt securities are classified as either held-to- maturity, available-for-sale or trading. 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, 1998 and 1997, the Company had no securities classified as trading. Debt and equity securities not classified as either held-to-maturity or trading 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. 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. 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: Buildings 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. 42 FIRST FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 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 (gains) losses and expenses. 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, the Company would reduce the carrying value of such assets. To date the Company has not had any such impairments. Earnings Per Share The Company has implemented Statement of Financial Accounting Standards (SFAS) No. 128, "Earnings per Share," which is effective for fiscal periods ending after December 15, 1997. This standard requires presentation of both basic and diluted earnings per share on the face of the consolidated statements of income. 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. Common stock equivalent shares represent the assumed exercise of outstanding stock options during 1996, net of shares assumed to be repurchased using the treasury stock method, if dilutive. Prior period amounts have been restated to conform to current year presentation. Comprehensive Income In June 1997, the Financial Accounting Standards Board (FASB) issued SFAS No. 130, "Reporting Comprehensive Income" which established standards for reporting and display of comprehensive income and its components in a full set of general purpose financial statements displayed with the same prominence as other financial statements. SFAS No. 130 became effective for both interim and annual periods beginning after December 15, 1997, with retroactive application to prior periods presented. 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. Employee Benefit Plans In February 1998, the FASB issued SFAS No. 132 "Employer's Disclosure about Pensions and Other Postretirement Benefits"--an amendment to FASB Statements Nos. 87, 88 and 106. This statement revises 43 FIRST FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 employer's disclosures about pension and other postretirement benefit plans. It does not change the measurement or recognition of those plans but standardizes the disclosure requirement. This statement suggests combined formats for presentation of pension and other postretirement benefit disclosure and requires restatement of disclosures for earlier periods. The adoption of SFAS No. 132 did not have a material effect on the Company's financial statements, but did affect the disclosure of employee benefits contained elsewhere herein (Note 11). Recent Pronouncements In March 1998, the American Institute of Certified Public Accountants (AICPA) issued Statement of Position (SOP) 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use". SOP 98-1 requires computer software costs associated with internal-use software to be expensed as incurred until certain capitalization criteria are met. The Company will adopt SOP 98-1 on January 1, 1999 and does not believe that the adoption will have a material impact on its financial statements. In April 1998, AICPA issued SOP 98-5, "Reporting on the Cost of Start-up Activities." SOP 98-5 requires all costs associated with pre-opening and organization activities to be expensed as incurred. The Company will adopt SOP 98-5 beginning January 1, 1999. The Company believes that the adoption of SOP 98-5 will have no material impact on its financial statements. In June 1998, the FASB issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This statement establishes accounting and reporting standards requiring that every derivative instrument (including certain derivative instruments embedded in other contracts) be recorded in the balance sheet as either an asset or liability measured at its fair value. The statement requires that changes in the derivative's fair value be recognized currently in income 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 statement of income and requires that a company must formally document, designate and assess the effectiveness of transactions that receive hedge accounting. SFAS No. 133 is effective for fiscal years beginning after June 15, 1999. A company may also implement the statement as of the beginning of any fiscal quarter after issuance (that is, financial quarters beginning June 16, 1998 and thereafter). SFAS No. 133 cannot be applied retroactively. SFAS No. 133 must be applied to (a) derivative instruments and (b) certain derivative instruments embedded in hybrid contracts that were issued, acquired or substantively modified after December 31, 1997 (and, at the Company's election, before January 1, 1998). The Company has not yet quantified the impact of adopting SFAS No. 133 on its consolidated financial statements and has not determined the timing or method of its adoption of the statement. However, the Company does not expect that the adoption of this statement will have a material impact on its financial position or results of operations. In October 1998, the FASB issued SFAS No. 134, "Accounting for Mortgage- Backed Securities Retained After the Securitization of Mortgage Loans Held for Sale by a Mortgage Banking Enterprise." This statement requires that after the securitization of mortgage loans held for sale, an entity engaged in mortgage banking activities classify the resulting mortgage-backed securities or other retained interests based on its ability and intent to sell or hold those investments. This statement shall be effective for the first fiscal quarter beginning after December 15, 1998, and has no applicability to the Company's financial position or results of operations at this time. (2) Public Offering On May 13, 1996, the Securities and Exchange Commission simultaneously declared effective the Company's Registration Statement on Form S-1 filed under the Securities Act of 1933, as amended, and its 44 FIRST FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 Registration Statement on Form 8-A filed under the Securities Exchange Act of 1934, as amended. The Registration Statement related to the public offering of 550,000 shares of common stock. On May 13, 1996 the Company entered into an agreement with an underwriter to purchase from the Company the shares of the common stock at the public offering price of $9.75 per share, less an underwriting discount of $.58 per share. On May 17, 1996, the Company received from the underwriter the net proceeds of the public offering in the amount of $5,043,500 exclusive of $520,376 in expenses incurred in connection with the offering. (3) Investment Securities The fair value and amortized cost at December 31, 1998 and 1997 are as follows:
December 31, 1998 --------------------------------------------- Gross Gross Amortized Unrealized Unrealized Cost Gains Losses Fair Value ----------- ---------- ---------- ----------- Held-to-maturity-- U.S. Government & agency obligations................... $10,999,326 $ 831 $53,573 $10,946,584 Collateralized mortgage obligations................... 2,734,067 1,194 8,172 2,727,089 ----------- -------- ------- ----------- $13,733,393 $ 2,025 $61,745 $13,673,673 =========== ======== ======= =========== Available-for-sale-- U.S. Government & agency obligations................... $24,402,016 $ 78,580 $ 5,361 $24,475,235 Mortgage-backed securities..... 7,545,496 123,203 6,890 7,661,809 Marketable equity securities and other..................... 1,022,046 4,016 75,816 950,246 ----------- -------- ------- ----------- $32,969,558 $205,799 $88,067 $33,087,290 =========== ======== ======= ===========
December 31, 1997 --------------------------------------------- Gross Gross Amortized Unrealized Unrealized Cost Gains Losses Fair Value ----------- ---------- ---------- ----------- Held-to-maturity-- U.S. Government & agency obligations................... $11,750,000 $ 5,411 $10,311 $11,745,100 Collateralized mortgage obligations................... 717,740 1,012 1,836 716,916 ----------- -------- ------- ----------- $12,467,740 $ 6,423 $12,147 $12,462,016 =========== ======== ======= =========== Available-for-sale-- U.S. Government & agency obligations................... $17,527,771 $ 36,039 $ 4,478 $17,559,332 Mortgage-backed securities..... 8,580,132 146,750 221 8,726,661 Marketable equity security and other......................... 295,097 17,544 -- 312,641 ----------- -------- ------- ----------- $26,403,000 $200,333 $ 4,699 $26,598,634 =========== ======== ======= ===========
During 1996, the Company sold 2,150 shares of a marketable equity security with a cost basis of $11,250 at a gain of $56,105 in order to utilize a capital loss tax carryforward which was scheduled to expire at the end of 1996. There were no sales of securities during the years ended December 31, 1998 and 1997. 45 FIRST FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 A schedule of the maturity distribution of U.S. Government and agency obligations is as follows:
December 31, 1998 ----------------------------------------------- Held-to-Maturity Available-for-Sale ----------------------- ----------------------- Amortized Amortized Cost Fair Value Cost Fair Value ----------- ----------- ----------- ----------- Within one year................. $ -- $ -- $17,905,038 $17,944,010 Over one year to five years..... 10,999,326 10,946,584 6,496,978 6,531,225 ----------- ----------- ----------- ----------- $10,999,326 $10,946,584 $24,402,016 $24,475,235 =========== =========== =========== ===========
At December 31, 1998, $10,000,000 of debt securities maturing in the one-to- five-year period are subject to call provisions within one year. At December 31, 1998, the collateralized mortgage obligations have principal payment windows which extend through February 2001. Investment securities with a carrying value of $14,848,939 and $11,985,298, at December 31, 1998 and 1997, respectively, were pledged as collateral for repurchase agreements, public deposits and other purposes, as required by law. (4) 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 is available only for loans of Chariho existing as of the acquisition date. The following analysis summarizes activity for both the acquired allowance and the Company's allowance for loan losses.
December 31, ---------------------------------- 1998 1997 1996 ---------- ---------- ---------- Company Allowance: Balance at beginning of year............. $1,208,322 $1,199,617 $ 861,693 Provision.............................. 250,000 250,000 455,000 Loan charge-offs....................... (184,278) (267,012) (136,899) Recoveries............................. 13,014 25,717 19,823 ---------- ---------- ---------- Balance at end of year................... 1,287,058 1,208,322 1,199,617 ---------- ---------- ---------- Acquired Allowance: Balance at beginning of year............. 388,291 742,840 966,347 Loan charge-offs....................... (402,404) (341,118) (230,016) Recoveries (costs)..................... (12,266) (13,431) 6,509 Reclassification to senior debenture (Note 13)............................. 26,379 -- -- ---------- ---------- ---------- Balance at end of year................... -- 388,291 742,840 ---------- ---------- ---------- Total Allowance............................ $1,287,058 $1,596,613 $1,942,457 ========== ========== ==========
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. 46 FIRST FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 Conversely, in the event the allowance is inadequate, additional loan charge- offs will reduce the amount owed on the debenture (Note 13) issued to DEPCO in connection with the acquisition. At December 31, 1998, the remaining balance of acquired loans was $2,387,021. At December 31, 1998 and 1997, the Company's recorded investment in impaired loans was $1,571,661 and $1,394,092, respectively, of which $853,221 and $884,121, respectively, was determined to require a valuation allowance of $235,473 and $237,030. The average recorded investment in impaired loans during 1998 and 1997 was $1,454,652 and $1,760,040, respectively. For the years ended December 31, 1998 and 1997, interest income on impaired loans totaled $225,730 and $167,818, respectively. At December 31, 1998 and 1997, nonaccrual loans totaled $0 and $16,477, respectively. Had nonaccrual loans been accruing, interest income would have increased by $248 and $10,195 for the years ended December 31, 1997 and 1996, respectively. During 1996, the Company satisfactorily resolved a loan which was on nonaccrual status at December 31, 1995, and recorded approximately $47,000 in cash basis interest income. (5) Premises and Equipment Premises and equipment are summarized as follows:
December 31, --------------------- 1998 1997 ---------- ---------- Land and improvements................................. $ 676,294 $ 676,294 Buildings and improvements............................ 1,240,851 1,263,718 Leasehold improvements................................ 407,186 413,096 Furniture, fixtures and equipment..................... 1,558,622 1,430,662 ---------- ---------- 3,882,953 3,783,770 Less--Accumulated depreciation........................ 1,466,163 1,325,220 ---------- ---------- $2,416,790 $2,458,550 ========== ==========
(6) Time Deposits At December 31, 1998, scheduled maturities of time deposits are as follows:
$100,000 Maturity Or More Other Total -------- -------- ------- ------- (In Thousands) 1999............................................... $ 9,398 $36,951 $46,349 2000............................................... 1,344 12,684 14,028 2001............................................... 410 2,605 3,015 2002............................................... 300 856 1,156 2003 and thereafter................................ 317 1,823 2,140 ------- ------- ------- $11,769 $54,919 $66,688 ======= ======= =======
Included in total time deposits are $13,029,000 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, $3,024,000 have remaining maturities of one year or less. 47 FIRST FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 (7) Federal Home Loan Bank Advances and Other Borrowings At December 31, 1998, advances from the Federal Home Loan Bank of Boston ("FHLB") have scheduled repayments as follows: 1999.............................................................. $ 104,121 2000.............................................................. 112,008 2001.............................................................. 118,564 2002.............................................................. 127,817 2003 and thereafter............................................... 5,741,567 ---------- $6,204,077 ==========
Of the total FHLB advances, $3,704,077 represents amortizing notes with final maturities of 10-15 years and amortization periods of 15-20 years. The remaining $2,500,000 matures at September 17, 2003 with a one time put option exercisable by the FHLB on September 17, 2001. Information relative to the Company's advances from the FHLB during 1998 is as follows: Balance, December 31, 1998....................................... $6,204,077 Average amount outstanding during the year....................... $2,667,000 Maximum amount outstanding at any month end...................... $6,204,077 Weighted average interest rate at December 31, 1998.............. 5.61% Weighted average interest rate during the year................... 6.04%
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, 1997, the Company had no outstanding FHLB advances. At December 31, 1998 and 1997, the Company had an unused borrowing capacity of $2,750,000 and $8,954,000, respectively, which includes an unused overnight line of credit of $2,599,000 and $2,352,000 respectively. The Company also had $12,255,880 and $10,105,000 of other borrowings at December 31, 1998 and 1997, respectively. These borrowings consist of reverse 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, 1998:
Weighted Maturity Average Rate Amount -------- ------------ ----------- January 1999........................................ 3.50% $ 4,655,880 September 1999...................................... 6.47 2,500,000 February 2001....................................... 5.67 5,100,000 ---- ----------- 5.29% $12,255,880 ==== ===========
At December 31, 1998, the Company's risk with counterparties to securities sold under repurchase agreements was approximately $371,000. The amount at risk with counterparties represents the excess of the greater of the carrying value or fair value of underlying collateral plus related accrued interest receivable over the total repurchase borrowing and related accrued interest payable. 48 FIRST FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 Securities sold under repurchase agreements averaged $13,059,000 and $10,590,000 during 1998 and 1997, respectively. The maximum amounts outstanding at any month end were $15,108,000 during 1998 and $10,778,000 during 1997. The weighted average interest rate was 5.45% during 1998 and 6.11% during 1997. (8) 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 remaining annual rental expense under these leases is as follows:
Amount ------- 1999................................................................. $32,708 2000................................................................. 25,000 2001................................................................. 25,000 2002................................................................. 10,416 2003 and thereafter.................................................. --
The leases contain renewal options commencing in May 1999 and extending to May 2012. Under the terms of the renewal options, the annual rental expense for both leases will not exceed $63,563. Litigation As of December 31, 1998, 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. Employment Contract In February 1996, the Company amended the employment agreement with its chief executive officer. This agreement provides for, among other things, a lump sum severance payment equal to 2.99 times annual base salary (as defined) in the event of a "change-in-control" (as defined) and upon either elective or involuntary termination thereafter. This agreement, which has an indefinite term, provides for an annual increase in salary of not less than 5%. 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 $363,000 and $342,000 as of December 31, 1998 and 1997, 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 49 FIRST FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 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, --------------------- 1998 1997 ---------- ---------- Unused portion of existing lines of credit............ $9,939,000 $7,837,000 Unadvanced construction loans......................... 604,000 856,000 Firm commitments to extend credit..................... 8,572,000 2,277,000
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. (9) Income Taxes The provision for income taxes consists of the following components:
December 31, ------------------------------ 1998 1997 1996 --------- -------- --------- Federal-- Current.................................... $ 832,993 $665,201 $ 677,832 Prepaid.................................... (114,000) (3,250) (185,050) State........................................ 75,000 66,250 20,800 --------- -------- --------- $ 793,993 $728,201 $ 513,582 ========= ======== =========
50 FIRST FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 The provision for income taxes differs from the amount computed by applying the statutory rate of 34%, as summarized below:
December 31, ---------------------------- 1998 1997 1996 -------- -------- -------- Provision for income taxes at statutory rate................... $762,974 $693,578 $529,468 State taxes, net of federal benefit........ 49,500 43,725 13,728 Utilization of capital loss carryforward...... -- -- (19,075) Other................... (18,481) (9,102) (10,539) -------- -------- -------- $793,993 $728,201 $513,582 ======== ======== ========
The approximate tax effects of temporary differences that give rise to gross deferred tax assets and gross deferred tax liabilities at December 31, 1998 and 1997 are as follows:
December 31, ----------------- 1998 1997 -------- -------- Gross deferred tax assets: Allowance for loan losses.................................. $329,005 $256,612 Deferred loan origination fees............................. 58,998 56,508 OREO writedown............................................. 5,200 5,200 Supplemental executive pension plan........................ 110,840 78,661 Accrued expenses........................................... 73,316 55,987 -------- -------- Gross deferred tax assets.................................... 577,359 452,968 -------- -------- Gross deferred tax liabilities: Depreciation............................................... 180,269 161,200 Installment sales.......................................... 19,090 27,768 -------- -------- Gross deferred tax liabilities............................... 199,359 188,968 -------- -------- Net deferred tax asset....................................... $378,000 $264,000 ======== ========
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, 1998 or 1997. (10) 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:
1998 1997 ---------- ---------- Balance at beginning of year......................... $ 905,052 $1,384,981 Originations....................................... 238,363 97,278 Payments........................................... (237,707) (74,705) Other.............................................. 1,000,571 (502,502) ---------- ---------- Balance at end of year............................... $1,906,279 $ 905,052 ========== ==========
51 FIRST FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 (11) 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. For the year ended December 31, 1998, the plan reached a fully funded status and the Company was not required to make a contribution. Consequently, no pension expense was recorded during 1998. The Company's pension expense was $55,413 and $78,671 for the years ended December 31, 1997 and 1996, respectively. 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. A liability and transition asset of $121,707 were recorded, as of the effective date, in accordance with SFAS No. 87, "Employer's Accounting for Pensions." 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, 1998, 1997 and 1996:
1998 1997 1996 -------- -------- --------- Change in benefit obligation: Benefit obligation at beginning of year....... $365,941 $329,525 $ 322,747 Service cost.................................. 19,177 14,650 14,163 Interest cost................................. 32,715 23,948 22,002 Actuarial loss (gain)......................... 70,260 (2,182) (29,387) -------- -------- --------- Benefit obligation at end of year............. 488,093 365,941 329,525 -------- -------- --------- Change in plan assets: Fair value of plan assets at beginning of year......................................... 310,091 -- -- Actual return on plan assets.................. 21,779 22,115 -- Employer contributions........................ 80,448 287,976 -- -------- -------- --------- Fair value of plan assets at end of year...... 412,318 310,091 -- -------- -------- --------- Funded status................................. (75,775) (55,850) (329,525) Unrecognized net actuarial loss (gain)........ 39,657 (30,603) (29,380) Unrecognized prior service cost............... 171,335 199,891 228,447 Unrecognized net asset being recognized over 10 years..................................... (31,638) (66,580) (91,323) -------- -------- --------- Prepaid (accrued) benefit cost................ $103,579 $ 46,858 $(221,781) ======== ======== ========= Components of net period benefit cost Service cost.................................. $ 19,177 $ 14,650 $ 14,163 Interest cost.......... ...................... 32,715 23,948 22,002 Amortization of prior service cost............ 28,556 28,556 28,556 Amortization of unrecognized net gain......... -- (959) (7) -------- -------- --------- Net periodic benefit cost..................... $ 80,448 $ 66,195 $ 64,714 ======== ======== =========
52 FIRST FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 For calculating 1998, 1997 and 1996 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
During 1996, the Company adopted the Financial Institutions Thrift Plan for the benefit of its employees. The 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 $32,848 and $32,009 for the years ended December 31, 1998 and 1997. (12) Stockholders' Equity In November 1986, the Company granted a non-statutory option ("Stock Option Agreement") to purchase 60,000 shares of common stock to its chief executive officer at an exercise price of $2.50 per share, the estimated market value of the Company's stock at that time. These options were exercisable for a period of 10 years from the date of grant. In February 1996, the Company amended the Stock Option Agreement to allow the offset of the shares otherwise issuable under the Stock Option Agreement by the number of shares required to exercise the options and pay the minimum withholding tax requirement. In May 1996, the options were exercised in connection with the public offering, under the amended Stock Option Agreement. As a result of the exercise of the options, 28,041 shares of the Company's Common Stock were issued. In connection with the cashless exercise of these options, the Company paid the minimum withholding tax requirement of $161,603 and recognized a tax benefit of $147,900 on the deemed compensation to the recipient. (13) 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 is payable semiannually thereafter. The Senior Debenture bears 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 is being amortized over the initial term of the Senior Debenture on the level yield method. The discount amortization for the years ended December 31, 1998, 1997 and 1996 amounted to $205,983, $202,566 and $199,064, respectively, and is classified as interest expense in the accompanying consolidated statements of income. The Senior Debenture is scheduled to mature on May 31, 1999; however, the Company may, at its option, extend the maturity date to May 1, 2002 for up to one half of the then outstanding principal balance. As discussed in Note 4, the Company may, through May 1, 1999, charge net acquired loan losses in excess of the acquired loan loss reserve of $3,850,000 against the outstanding Senior Debenture to the extent of 53 FIRST FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 $3,000,000. At December 31, 1998, the Company had charged-off $26,379 of acquired loans against the outstanding Senior Debenture. (14) 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 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 sheet 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. 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. 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. Senior Debenture. The face value of the senior debenture 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. 54 FIRST FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 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, 1998 and 1997, the fair value of the Company's financial instruments are as follows:
December 31, ------------------------------------------------- 1998 1997 ------------------------- ----------------------- Carrying Carrying Amount Fair Value Amount Fair Value ------------ ------------ ----------- ----------- ASSETS ------ Cash and due from banks and securities purchased under agreement to resell......... $ 5,066,270 $ 5,066,270 $ 6,715,014 $ 6,715,014 Loans held for sale.......... 357,493 392,141 380,000 416,298 Investment securities: Held-to-maturity........... 13,733,393 13,673,673 12,467,740 12,462,016 Available-for-sale......... 33,087,290 33,087,290 26,598,634 26,598,634 Federal Home Loan Bank stock...................... 447,700 447,700 447,700 447,700 Loans--net................... 85,008,787 89,227,000 76,083,150 77,583,000 LIABILITIES Deposits..................... $104,371,928 $105,090,000 $99,289,871 $99,412,000 Securities sold under agreements to repurchase.... 12,255,880 12,377,000 10,105,000 10,105,000 Federal Home Loan Bank advances.................... 6,204,077 6,415,000 -- -- Senior debenture............. 2,971,487 2,973,621 2,946,540 3,000,000
55 FIRST FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 (15) The Company (Parent Company Only) The condensed separate financial statements of the Parent Company are presented below. CONDENSED BALANCE SHEETS
December 31, ----------------------- 1998 1997 ----------- ----------- ASSETS Cash and due from banks................................ $ 102,773 $ 97,957 Investment securities: Available-for-sale (amortized cost: $3,545,200 in 1998 and $3,578,030 in 1997)........................ 3,469,998 3,577,365 Investment in subsidiary bank.......................... 14,128,694 12,884,343 Other assets........................................... 114,715 102,256 ----------- ----------- Total assets....................................... $17,816,180 $16,661,921 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Senior debenture, net of unamortized discount.......... $ 2,971,487 $ 2,946,540 Other liabilities...................................... 31,451 2,748 ----------- ----------- 3,002,938 2,949,288 ----------- ----------- Stockholders' Equity: Common stock......................................... 1,328,041 1,328,041 Surplus.............................................. 4,431,380 4,431,380 Retained earnings.................................... 9,130,143 7,982,792 Accumulated other comprehensive income............... 70,638 117,380 ----------- ----------- 14,960,202 13,859,593 Less--Treasury stock................................. 146,960 146,960 ----------- ----------- Total stockholders' equity......................... 14,813,242 13,712,633 ----------- ----------- Total liabilities and stockholders' equity......... $17,816,180 $16,661,921 =========== ===========
56 FIRST FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 CONDENSED STATEMENTS OF INCOME
Years Ended December 31, ---------------------------------- 1998 1997 1996 ---------- ---------- ---------- Interest and dividend income............... $ 491,446 $ 461,850 $ 252,993 Interest and other expense................. 338,776 380,180 287,348 ---------- ---------- ---------- Income (loss) before income taxes and equity in undistributed earnings of subsidiary................................ 152,670 81,670 (34,355) Applicable income tax benefit.............. (51,007) (58,799) (56,418) ---------- ---------- ---------- Income before equity in undistributed earnings of subsidiary.................... 203,677 140,469 22,063 Equity in undistributed earnings of subsidiary................................ 1,246,371 1,171,264 1,021,614 ---------- ---------- ---------- Net income................................. $1,450,048 $1,311,733 $1,043,677 ========== ========== ==========
CONDENSED STATEMENTS OF CASH FLOWS
Years Ended December 31, ---------------------------------- 1998 1997 1996 ---------- ---------- ---------- CASH FLOWS FROM OPERATING ACTIVITIES: Net income................................ $1,450,048 $1,311,733 $1,043,677 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Equity in undistributed earnings of subsidiary............................. (1,246,371) (1,171,264) (1,021,614) Accretion of discount on debenture...... 205,983 202,566 199,064 Net accretion on investment securities.. (44,134) (98,254) (59,483) Net decrease in accrued expenses and other liabilities...................... (59,453) (210,471) (761,675) Net (increase) decrease in other assets................................. (12,459) 39,164 (141,420) ---------- ---------- ---------- Net cash provided by (used in) operating activities................. 293,614 73,474 (741,451) ---------- ---------- ---------- CASH FLOWS FROM INVESTING ACTIVITIES: Proceeds from maturities of investment securities available-for-sale............ 3,600,000 7,700,000 2,700,000 Purchase of investment securities available-for-sale....................... (3,523,036) (7,503,613) (6,316,681) ---------- ---------- ---------- Net cash provided by (used in) investing activities................. 76,964 196,387 (3,616,681) ---------- ---------- ---------- CASH FLOWS FROM FINANCING ACTIVITIES: Net proceeds on issuance of common stock.. -- -- 4,523,124 Exercise of stock options, net of tax effect................................... -- -- (13,703) Dividends paid............................ (365,762) (227,023) (96,170) ---------- ---------- ---------- Net cash (used in) provided by financing activities................. (365,762) (227,023) 4,413,251 ---------- ---------- ---------- NET INCREASE IN CASH AND CASH EQUIVALENTS... 4,816 42,838 55,119 CASH AND CASH EQUIVALENTS, BEGINNING OF YEAR....................................... 97,957 55,119 -- ---------- ---------- ---------- CASH AND CASH EQUIVALENTS, END OF YEAR...... $ 102,773 $ 97,957 $ 55,119 ========== ========== ========== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Interest paid............................. $ 201,450 $ 218,100 $ 212,550 ========== ========== ==========
57 FIRST FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 (16) 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 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, 1998, 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 December 31, 1997 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 Under Prompt For Capital Corrective Action Actual Adequacy Purposes Provisions ----------------- ---------------------------------------- Amount Ratio Amount Ratio Amount Ratio ----------- ----- ----------- ------------------- -------- As of December 31, 1998 The Company: Total capital (to risk weighted assets)............ $15,814,000 18.49% $ 6,842,320 8.00% -- -- Tier I capital (to risk weighted assets)............ 14,742,000 17.24 3,421,160 4.00 -- -- Tier I capital (to average assets).... 14,742,000 10.56 4,189,170 3.00 -- -- The Bank: Total capital (to risk weighted assets)............ $15,070,000 17.87% $ 6,748,240 8.00% $ 8,435,300 10.00% Tier I capital (to risk weighted assets)............ 14,013,000 16.61 3,374,120 4.00 5,061,180 6.00 Tier I capital (to average assets).... 14,013,000 10.31 4,078,020 3.00 6,796,700 5.00 As of December 31, 1997: The Company: Total capital (to risk weighted assets)............ $14,574,000 18.76% $ 6,214,240 8.00% -- -- Tier I capital (to risk weighted assets)............ 13,595,000 17.50 3,107,120 4.00 -- -- Tier I capital (to average assets).... 13,595,000 10.77 3,788,520 3.00 -- -- The Bank: Total capital (to risk weighted assets)............ $13,741,000 17.78% $ 6,185,200 8.00% $ 7,731,500 10.00% Tier I capital (to risk weighted assets)............ 12,767,000 16.52 3,092,000 4.00 4,638,900 6.00 Tier I capital (to average assets).... 12,767,000 10.43 3,674,700 3.00 6,124,500 5.00
(17) Business Segments On January 1, 1998, the Company adopted SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information," which establishes standards for reporting operating segments of a business enterprise. The new rules establish revised standards for public companies relating to the reporting of financial and descriptive information about their operating segments in financial statements. Operating segments are components of an enterprise which 58 FIRST FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996 are evaluated regularly by the chief operating decision maker in deciding how to allocate resources and in assessing performance. The Company's chief operating decision maker is the Chairman, President and Chief Executive Officer of the Company. The adoption of SFAS No. 131 did not have a material effect on the Company's primary financial statements, but did result in the disclosure of segment information contained herein. 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). 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 15). The accounting policies used in the disclosure of business segments are the same as those described in the summary of significant account 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:
Community Other Adjustments Banking Other and Eliminations Consolidated ------------ ----------- ----------------- ------------ December 31, 1998 Investment Securities........... $ 43,350,685 $17,598,692 $(14,128,694) $ 46,820,683 Net Loans............. 85,008,787 -- -- 85,008,787 Total Assets.......... 138,314,148 17,816,180 (14,211,398) 141,918,930 Total Deposits........ 104,454,631 -- (82,703) 104,371,928 Total Liabilities..... 124,185,453 3,002,938 (82,703) 127,105,688 Net Interest Income... 5,410,294 238,670 (302,697) 5,346,267 Provision for Loan Losses............... 250,000 -- -- 250,000 Total Noninterest Income............... 616,005 1,246,371 (1,246,371) 616,005 Total Noninterest Expense.............. 3,382,231 86,000 -- 3,468,231 Net Income............ 1,549,068 1,450,048 (1,549,068) 1,450,048 December 31, 1997 Investment Securities........... $ 35,489,009 $16,461,708 $(12,884,343) $ 39,066,374 Net Loans............. 76,083,150 -- -- 76,083,150 Total Assets.......... 123,658,196 16,661,921 (13,010,250) 127,309,867 Total Deposits........ 99,352,715 -- (62,844) 99,289,871 Total Liabilities..... 110,773,853 2,949,288 (125,907) 113,597,234 Net Interest Income... 5,226,449 191,606 (252,249) 5,165,806 Provision for Loan Losses............... 250,000 -- -- 250,000 Total Noninterest Income............... 465,397 1,171,264 (1,171,264) 465,397 Total Noninterest Expense.............. 3,231,333 109,936 -- 3,341,269 Net Income............ 1,423,513 1,311,733 (1,423,513) 1,311,733
59 FIRST FINANCIAL CORP. AND SUBSIDIARY NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(Continued) Years Ended December 31, 1998, 1997 and 1996
Community Other Adjustments Banking Other and Eliminations Consolidated ------------ ----------- ----------------- ------------ December 31, 1996 Investment Securities........... $ 38,515,147 $15,305,809 $(11,629,111) $ 42,191,845 Net Loans............. 70,593,970 -- -- 70,593,970 Total Assets.......... 117,632,933 15,502,348 (11,722,281) 121,413,000 Total Deposits........ 93,931,228 -- (55,119) 93,876,109 Total Liabilities..... 106,003,822 2,932,447 (93,170) 108,843,099 Net Interest Income (Loss)............... 4,796,586 (9,321) (134,007) 4,653,258 Provision for Loan Losses............... 455,000 -- -- 455,000 Total Noninterest Income............... 536,283 1,021,614 (1,021,614) 536,283 Total Noninterest Expense.............. 3,152,248 25,034 -- 3,177,282 Net Income............ 1,155,621 1,043,677 (1,155,621) 1,043,677
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 ITEM 11. EXECUTIVE COMPENSATION ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS Items 10 through 13 are incorporated herein by reference to the Company's definitive proxy statement to be filed with the Securities and Exchange Commission. 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 II of this report: Report of Independent Public Accountants Consolidated Balance Sheets as of December 31, 1998 and 1997 Consolidated Statements of Income for the years ended December 31, 1998, 1997 and 1996 Consolidated Statements of Stockholders' Equity and Comprehensive Income for the years ended December 31, 1998, 1997 and 1996 Consolidated Statements of Cash Flows for the years ended December 31, 1998, 1997 and 1996 Notes to Consolidated Financial Statements (3) Financial Statement Schedules The Financial Data Schedule is included as Exhibit 27.1 to this Form 10-K and certain other 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 No reports on Form 8-K were filed during the quarter ended December 31, 1998. 61 EXHIBIT INDEX
Exhibit Reference Number Description --------- ------- ----------- 3.1 --Amended and Restated Articles of Incorporation of the (1) Registrant. (1) 3.2 --By-Laws of Registrant. 4.1 --Specimen Certificate for Shares of the Registrant's Common (1) 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. (1) 10.6 --Supplemental Executive Retirement Plan. (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. (4) 27.1 --Financial Data Schedule
- -------- (1) Incorporated by reference to the Registrant's Registration Statement of 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) Filed herewith. 62 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. /s/ Patrick J. Shanahan, Jr. By: _________________________________ Patrick J. Shanahan, Jr Chairman, President and Chief Executive Officer Date: March 8, 1999 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 March 8, 1999 ______________________________________ Chief Executive Officer; Patrick J. Shanahan, Jr. Director /s/ Gary R. Alger Director March 8, 1999 ______________________________________ Gary R. Alger Director ______________________________________ Raymond F. Bernardo /s/ Artin H. Coloian Director March 8, 1999 ______________________________________ Artin H. Coloian /s/ Joseph A. Keough Director March 8, 1999 ______________________________________ Joseph A. Keough /s/ Peter L. Mathieu, Jr., M.D. Director March 8, 1999 ______________________________________ Peter L. Mathieu, Jr., M.D. /s/ Joseph V. Mega Director March 8, 1999 ______________________________________ Joseph V. Mega /s/ John Nazarian Director March 8, 1999 ______________________________________ John Nazarian /s/ William P. Shields Director March 8, 1999 ______________________________________ William P. Shields /s/ Fred J. Simon Director March 8, 1999 ______________________________________ Fred J. Simon /s/ John A. Macomber Vice President, Treasurer March 8, 1999 *By: _________________________________ and Chief Financial John A. Macomber Officer
63 EX-10.4 2 SECOND AMENDED AND RESTATED EMPLOYMENT AGREEMENT SECOND AMENDED AND RESTATED EMPLOYMENT AGREEMENT ------------------------------------------------ THIS SECOND AMENDED AND RESTATED EMPLOYMENT AGREEMENT, is made and entered into on the 8th day of February, 1999, by and among: FIRST FINANCIAL CORP., a Rhode Island bank holding company, and FIRST BANK AND TRUST COMPANY, a Rhode Island bank, each with its principal place of business at 180 Washington Street, Providence, Rhode Island (together the "Employer"); and -------- PATRICK J. SHANAHAN, JR., of 10 Celestia Court, North Kingstown, Rhode Island ("Employee"). -------- WHEREAS, the Employer and the Employee entered into an Amended and Restated Employment Agreement dated as of February 6, 1996 (the "Original -------- Employment Agreement"), pursuant to which the Employee agreed to perform - ---------- --------- services to the Employer upon the terms set forth therein; WHEREAS, the Employer and Employee desire to amend and restate the Original Employment Agreement; NOW, THEREFORE, in consideration of the mutual covenants and agreements herein set forth, the parties agree to amend and restate the Original Employment Agreement as follows: 1. Employment. Employer hereby employs Employee as Chairman, President ---------- and Chief Executive Officer and Employee accepts such employment on the terms and conditions herein set forth. 2. Term. The term of employment pursuant to this Agreement shall ---- commence on the date hereof and end on the election of either party with ninety (90) days notification of such termination. In the event Employer shall exercise the right of termination pursuant to this Agreement, Employer shall pay Employee his usual and customary compensation for twenty-four (24) months commencing upon said termination and said salary shall consist of his wages prevailing at the time of termination, together with all existing benefits and accruements that Employee is entitled to at the time of termination for said twenty-four (24) month period, except in the event that Employee is terminated for Cause in which case Employee may be terminated without further compensation. "Cause" for purposes of this Agreement shall mean Employee's criminal conduct attributable to his employment. -2- 3. Duties. Employee shall perform the duties of Chairman, President and ------ Chief Executive Officer pursuant to the direction and under the general supervision of the Board of Directors of Employer, and also shall be a member of the Board of Directors of Employer. Employee shall devote his full time and attention to his employment aforesaid, shall use his best efforts, skills and abilities in the performance of his duties and shall at all times promote the best interests and success of Employer's business. It is further understood that Employee as a member of the Board of Directors shall be compensated by a monthly fee for attendance at such monthly meetings by receipt of the same fees for such attendance as all other members of the Board of Directors. Any annual retainer fee paid to the members of the Board of Directors or other compensation paid to the Board of Directors not considered monthly attendance fees, will also be paid to Employee. 4. Base Salary. Employee shall receive an annual base salary of ----------- Two-Hundred and Sixty-Five Thousand ($265,000) Dollars payable in equal consecutive weekly installments, less the standard payroll deductions for federal and state tax withholdings ("Base Salary"), effective as of the date ---- ------ hereof. The salary shall be reviewed on December 1st of each year and the annual increase shall not be less than five (5%) percent per year. 5. Benefits. In addition to the Base Salary, Employer shall continue to -------- provide Employee with the benefits presently in place (i.e., company automobile, Defined Pension Plan, life insurance, disability insurance, health insurance and major medical family coverage, annual dues and related business expenses at Quidnessett Country Club and Squantum Association), along with any other present and future employee benefit programs that may be generally available to senior management of Employer, including without limitation benefits under the Employer's Supplemental Executive Retirement Plan. 6. Death During Employment. If Employee dies during the existence of ----------------------- this Agreement, Employer shall continue to pay to the estate of Employee seventy-five (75%) percent of his Base Salary. Payments are to be payable to Employee's estate for a period of six (6) months. 7. Vacations. Employee shall be entitled to an aggregate of thirty (30) --------- days of paid vacation during each year at such times and for such periods as shall reasonably be determined by Employer and Employee; provided that such aggregate number of days shall be adjusted from time to time to equal the aggregate weeks paid vacation offered by Employer to its senior management. 8. Termination. Pursuant to paragraph 2 of this Agreement, Employer, ----------- may at any time, upon giving said ninety (90) day notice, at its sole option, terminate this Agreement. If Employer so terminates the Agreement, other than for Cause, Employer shall continue to pay Employee his annual base -3- salary plus existing benefits at the time of termination for a period of twenty- four (24) months following such termination. If Employee voluntarily terminates this Agreement other than pursuant to paragraph 9(a) of this Agreement, and gives ninety (90) days notice of termination, he shall receive the salary and benefits set forth in paragraph 2 of this Agreement for a period of one (1) month following the expiration of the required ninety (90) day notice period. 9. Change of Control. In the event that, during the term of this ----------------- Agreement, there shall have occurred a "Change of Control" (as defined in Section 9(d) of this Agreement) in the ownership of Employer, the person(s), corporation(s) or other entity or entities so acquiring control of Employer shall assume Employer's obligations under this Agreement. (a) Elective Termination: -------------------- In addition, upon such a Change of Control, the Employee shall be entitled to terminate the Agreement by a written notice to Employer or its successor, and in such event (in addition to whatever other entitlements the Employee shall then have under this Agreement for any benefit that would continue upon the termination of the Employee other than for Cause pursuant to paragraph 2 hereof and which would not be deemed a "parachute payment" under Section 280G(b)(2) of the Internal Revenue Code of 1986, as amended (the "IRC"), --- excluding the annual base salary), the Employee shall be entitled to receive a cash severance payment equal to 2.99 times the sum of (i) the average Base Salary (which shall include W-2 earnings resulting from the exercise of stock options) of the Employee for the immediately preceding five (5) years prior to the Change of Control, plus, (ii) the amount of the bonus paid to the Employee ---- by the Employer, if any, during the immediately preceding year prior to the Change of Control, payable in one lump sum on the date of termination, provided, -------- however, that if Employee elects to terminate the Agreement pursuant to this - ------- paragraph 9(a), the Employee may elect to receive either the severance payment and benefits provided under this paragraph 9(a), or such termination benefits that would continue upon the Termination of the Employee other than for Cause pursuant to paragraph 2 hereof, but may not elect to receive both. (b) Involuntary Termination: ----------------------- In addition, in the event that, subsequent to such a Change of Control, Employer or its successor (i) terminates the Employee's employment other than for Cause, (ii) Employer or its successor otherwise breaches this Agreement, or (iii) the successor to Employer does not expressly assume Employer's obligations under this Agreement, then this Agreement may, at the Employee's option, be deemed to be involuntarily terminated by Employer and, if so, the Employee shall be entitled to receive a severance payment as set forth in paragraph 9(a) above (in addition to whatever other entitlements the Employee shall then have -4- under this Agreement for any benefit that would continue upon the termination of the Employee other than for Cause pursuant to paragraph 2 hereof and which would not be deemed a "parachute payment" under Section 280G(b)(2) of the IRC, excluding the annual base salary), provided, however, that if this Agreement is -------- ------- deemed terminated pursuant to this paragraph 9(b), the Employee may elect to receive either the severance payment and benefits provided under this paragraph 9(b), or such termination benefits that would continue upon the Termination of the Employee other than for Cause pursuant to paragraph 2 hereof, but may not elect to receive both. For these purposes, any diminution in the rights, benefits or entitlements of the Employee or positions or authorities occupied by the Employee prior to the Change of Control shall be conclusively deemed to be a breach of this Agreement. (c) Reductions: ---------- Notwithstanding anything to the contrary contained in this Agreement, the payments and benefits to which the Employee would be entitled pursuant to this Section 9 or otherwise as a result of a Change of Control shall be reduced (i) by any severance pay or comparable payments to which the Employee is entitled under applicable law as a result of the termination of his employment and (ii) to the maximum amount for which the Employer will not be limited in its deduction pursuant to Section 280G of the Internal Revenue Code of 1986, as amended, or any successor provision or pursuant to any other provision of applicable law. Any such reduction shall be applied to the amounts due to the Employee in such manner as the Employee may reasonably specify within thirty (30) days following notice from Employer of the need for such reduction or, if the Employee fails to so specify timely, as determined by Employer. (d) Change of Control: ----------------- For purposes of this Section 9, a "Change of Control" shall be deemed to have occurred in either of the following events: (i) when any "person" (as such term is used in Sections 13(d) and 14(d)(2) of the Securities Exchange Act of 1934, as amended (the "1934 Act")) becomes a "beneficial owner" (as such term is defined in Rule 13d-3 promulgated under the 1934 Act), directly or indirectly, of securities of the Employer representing twenty-five percent (25%) or more of the total number of votes that may be cast for the election of directors of Employer; or (ii) if, as a result of, or in connection with, any tender or exchange offer, merger or other business combination, sale of assets or contested election, or any combination of the foregoing transactions, the persons who were directors of Employer immediately before such transaction shall cease to constitute a majority of the Board of Directors of Employer or of any successor institution. -5- (e) Dispute Under Section 9: ----------------------- If any dispute between the Employer and the Employee as to any of the amounts to be determined under this Section 9, or the method of calculating such amounts, cannot be resolved by the Employer and the Employee, either party after giving three (3) days written notice to the other, may refer the dispute to a partner in the Boston office of a firm of independent certified public accountants ("Partner") selected jointly by the Employer and the Employee. The ------- determination of such Partner as to the amount to be determined under this Section 9 and the method of calculating such amounts shall be final and binding on both the Employer and the Employee. The Employer shall bear the costs of any such determination. 10. Disclosure of Information. It is understood that the ------------------------- business of Employer is of a confidential nature. During the existence of this Agreement, Employer may reveal to Employee confidential information concerning Employer (the term "Employer" shall be deemed to include all affiliates, subsidiaries, customers and participants of Employer), which, if known to competitors thereof, would damage Employer. Employee agrees that during and after the existence of this Agreement, he will not divulge or appropriate to his own use, or to the use of any third party, any secret or confidential information or knowledge obtained by him during the term concerning Employer. At the expiration of this Agreement, Employee shall promptly deliver to Employer all materials of a secret or confidential nature relating to the business of Employer together with any other property of Employer which may have been delivered to Employee or which Employee may have procured during the existence of this Agreement. 11. Adequacy of Remedy. Employee acknowledges that the remedy at law for ------------------ breach by him of any of the provisions of paragraph 9 hereof will be inadequate and that Employer shall be entitled to injunctive relief, in addition to any other remedies that it may have. 12. Waiver. Failure of either party hereto to insist upon strict ------ compliance with any of the terms, covenants and conditions hereof shall not be deemed a waiver or relinquishment of any similar right or power hereunder at any subsequent time. This Agreement shall be binding upon and inure to the benefit of the parties hereto, the successors and assigns of Employer and to the heirs, executors, administrators and assigns of Employee. This Agreement may not be assigned by Employee without the prior written consent of Employer. 13. Notice. All notices hereunder shall be in writing and shall be made ------ by Certified Mail, Return Receipt Requested, to the party to whom notice is to be given at the address set forth below or to such other address as either party shall designate by notice: -6- If to Employer: First Financial Corp. Attn: Joseph V. Mega, Chairman/Compensation Committee 180 Washington Street Providence, Rhode Island 02903 If to Employee: Patrick J. Shanahan, Jr. 10 Celestia Court North Kingstown, Rhode Island 02852 14. Governing Law. This Agreement shall be deemed to be a contract made ------------- in and shall be governed by the laws (including the conflicts of law provisions) and decisions of the State of Rhode Island. 15. Successors In Interest. This Agreement shall be binding on the ---------------------- parties to this Agreement as successors, assigns, heirs at law and in any change in position of the Employee directed by the Employer. Such change in position shall be deemed a termination of this Agreement by the Employer pursuant to paragraph 8 herein. 16. Entire Agreement. This Agreement contains all the terms agreed upon ---------------- between the parties with respect to the subject matter hereof and supersedes all previous written or oral negotiations, commitments and writings, including those set forth in the Original Employment Agreement. -7- IN WITNESS WHEREOF, this Agreement has been executed in duplicate the day and year first above written. FIRST FINANCIAL CORP. By: /s/Joseph V. Mega ---------------------------------------- Chairman, Compensation Committee FIRST BANK AND TRUST COMPANY By: /s/Joseph V. Mega ---------------------------------------- Chairman, Compensation Committee /s/Patrick J. Shanahan ------------------------------------------- PATRICK J. SHANAHAN, JR. EX-27 3 FINANCIAL DATA SCHEDULE
9 YEAR DEC-31-1998 JAN-01-1998 DEC-31-1998 2,342,782 0 2,723,488 0 33,087,290 13,733,393 13,673,673 86,295,845 1,287,058 141,918,930 104,371,928 12,255,880 1,302,316 9,175,564 0 0 1,328,041 13,485,201 141,918,930 7,796,758 2,767,325 0 10,564,083 4,091,958 5,217,816 5,346,267 250,000 0 3,468,231 2,244,041 2,244,041 0 0 1,450,048 1.15 1.15 4.12 0 0 0 1,571,661 1,596,613 572,569 13,014 1,287,058 1,287,058 0 0
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