-----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, VFq5j98AMIPKHLSO44Usw/t4r5HNfwdzQb++K5CVBw0JavuSgOCpxaoTKPO4WOsq kVnmB5nm5Xkl4C9QQgro9Q== 0001171520-07-000720.txt : 20071105 0001171520-07-000720.hdr.sgml : 20071105 20071105142704 ACCESSION NUMBER: 0001171520-07-000720 CONFORMED SUBMISSION TYPE: 10QSB PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 20070930 FILED AS OF DATE: 20071105 DATE AS OF CHANGE: 20071105 FILER: COMPANY DATA: COMPANY CONFORMED NAME: FIRST IPSWICH BANCORP /MA CENTRAL INDEX KEY: 0000885979 STANDARD INDUSTRIAL CLASSIFICATION: NATIONAL COMMERCIAL BANKS [6021] IRS NUMBER: 223768777 STATE OF INCORPORATION: MA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10QSB SEC ACT: 1934 Act SEC FILE NUMBER: 033-47057 FILM NUMBER: 071213442 BUSINESS ADDRESS: STREET 1: 31 MARKET STREET CITY: IPSWICH STATE: MA ZIP: 01938 BUSINESS PHONE: 9783568257 MAIL ADDRESS: STREET 1: 31 MARKET STREET CITY: IPSWICH STATE: MA ZIP: 01938 10QSB 1 eps2700.txt FIRST IPSWICH BANCORP ================================================================================ UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 ----------------- FORM 10-QSB ----------------- (Mark One) |X| QUARTERLY REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the quarterly period ended September 30, 2007 |_| TRANSITION REPORT UNDER SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ____________ to ____________ Commission File Number 333-114018 ----------------- First Ipswich Bancorp (Exact name of small business issuer as specified in its charter) ----------------- Massachusetts 04-2955061 (State or other jurisdiction of (I.R.S. Employer incorporation or organization) Identification Number) 31 Market Street, Ipswich, Massachusetts 01938 (Address of principal executive offices) (978) 356-3700 (Issuer's telephone number, including area code) Not Applicable (Former name, former address and former fiscal year, if changed since last report) ----------------- Check whether the issuer (1) filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the past 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 whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES |_| NO |X| State the number of shares outstanding of each of the issuer's classes of common equity, as of the latest practical date: At October 31, 2007, there were 2,344,630 shares of common stock issued and outstanding, par value $1.00 per share. Transitional Small Business Disclosure Format (Check one): YES |_| NO |X| ================================================================================ FIRST IPSWICH BANCORP AND SUBSIDIARIES FORM 10-QSB Index Page PART I FINANCIAL INFORMATION ITEM 1. Financial Statements Consolidated Balance Sheets as of September 30, 2007 and December 31, 2006 3 Consolidated Statements of Operations for the quarter and nine months ended September 30, 2007 and 2006 4 Consolidated Statements of Changes in Stockholders' Equity for the nine months ended September 30, 2007 and 2006 5 Consolidated Statements of Cash Flows for the nine months ended September 30, 2007 and 2006 6 Notes to Consolidated Financial Statements 7 Item 2. Management's Discussion and Analysis 10 Item 3. Controls and Procedures 29 PART II OTHER INFORMATION Item 1. Legal Proceedings 30 Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 30 Item 3. Defaults upon Senior Securities 30 Item 4. Submission of Matters to a Vote of Security Holders 30 Item 5. Other Information 30 Item 6. Exhibits 31 Signatures 31 2 PART I--FINANCIAL INFORMATION ITEM 1. Financial Statements FIRST IPSWICH BANCORP AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (unaudited) (In thousands, except share data)
September 30, December 31, 2007 2006 ------------ ------------ ASSETS Cash and due from banks $ 9,398 $ 11,335 Federal funds sold and interest bearing accounts 15,637 2,164 ------------ ------------ Total cash and cash equivalents 25,035 13,499 ------------ ------------ Certificates of deposit 3,440 3,378 Securities available-for-sale, at fair value 39,783 53,962 Federal Home Loan Bank stock, at cost 1,447 3,927 Federal Reserve Bank stock, at cost 774 774 Loans, net of allowance for loan losses of $1,537 and $1,827 198,252 234,890 Real estate held for sale, net 6,281 5,727 Premises and equipment, net 3,675 4,099 Goodwill 3,641 3,641 Other intangible assets 1,184 1,761 Foreclosed real estate 1,484 -- Other assets 6,472 7,117 ------------ ------------ Total assets $ 291,468 $ 332,775 ============ ============ LIABILITIES AND STOCKHOLDERS' EQUITY Deposits $ 225,211 $ 268,868 Short-term borrowings 10,802 13,720 Long-term borrowings 20,831 16,047 Subordinated debentures 13,000 13,000 Other liabilities 2,295 3,269 ------------ ------------ Total liabilities 272,139 314,904 ------------ ------------ Stockholders' equity: Preferred stock, $1.00 par value; 1,000,000 shares authorized, none issued -- -- Common stock, $1.00 par value; 4,000,000 shares authorized, 2,365,120 and 2,240,120 shares issued at September 30, 2007 and December 31, 2006 2,365 2,240 Additional paid-in capital 10,806 9,936 Retained earnings 6,976 6,843 Accumulated other comprehensive loss (707) (1,037) Treasury stock, at cost (20,490 shares) (111) (111) ------------ ------------ Total stockholders' equity 19,329 17,871 ------------ ------------ Total liabilities and stockholders' equity $ 291,468 $ 332,775 ============ ============
See accompanying notes to consolidated financial statements. 3 FIRST IPSWICH BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS (unaudited) (In thousands, except per share data)
Quarter Ended Nine Months Ended September 30, September 30, -------------------- ------------------- 2007 2006 2007 2006 -------- -------- -------- -------- Interest and dividend income: Interest and fees on loans $ 3,701 $ 4,692 $ 11,516 $ 13,054 Interest on debt securities: Taxable 406 1,010 1,302 3,156 Tax-exempt 23 131 68 386 Dividends on equity securities 35 159 167 267 Other interest 227 94 661 211 -------- -------- -------- -------- Total interest and dividend income 4,392 6,086 13,714 17,074 -------- -------- -------- -------- Interest expense: Interest on deposits 1,456 1,829 4,713 4,727 Interest on borrowed funds 401 1,083 1,100 3,365 Interest on subordinated debentures 235 243 706 701 -------- -------- -------- -------- Total interest expense 2,092 3,155 6,519 8,793 -------- -------- -------- -------- Net interest income 2,300 2,931 7,195 8,281 Provision for loan losses 274 66 14 131 -------- -------- -------- -------- Net interest income after provision for loan losses 2,026 2,865 7,181 8,150 Other income: Investment advisory fees 482 453 1,422 1,337 Service charges on deposit accounts 297 296 884 879 Credit card fees 99 219 408 579 Trust fees -- 106 -- 316 Non-deposit investment fees 78 83 212 239 Derivative fair value adjustment (20) 85 147 187 Loss on securities sold or written down, net -- (526) -- (575) Gain on sale of loans, net -- -- 311 -- Rental income 65 99 216 288 Write-down of fixed assets -- (340) -- (340) Valuation reserve for real estate held for sale -- (33) -- (319) Miscellaneous 84 77 211 227 -------- -------- -------- -------- Total other income 1,085 519 3,811 2,818 -------- -------- -------- -------- Operating expenses: Salaries and employee benefits 1,964 2,392 5,635 7,001 Occupancy and equipment 477 702 1,560 2,057 Professional fees 336 332 970 1,211 Credit card interchange 22 140 168 382 Advertising and marketing 97 51 183 384 Data processing 150 199 488 551 ATM processing 99 114 303 328 Telephone 60 93 202 284 FDIC insurance 139 8 425 25 Other general and administrative 227 319 639 1,008 -------- -------- -------- -------- Total operating expenses 3,571 4,350 10,573 13,231 -------- -------- -------- -------- Income (loss) before income taxes (460) (966) 419 (2,263) Provision (benefit) for income taxes (74) (340) 286 (805) -------- -------- -------- -------- Net income (loss) $ (386) $ (626) $ 133 $ (1,458) ======== ======== ======== ======== Weighted average common shares outstanding: Basic 2,345 2,220 2,333 2,220 -------- -------- -------- -------- Diluted 2,348 2,220 2,336 2,220 -------- -------- -------- -------- Earnings (loss) per share: Basic $ (0.16) $ (0.28) $ 0.06 $ (0.66) ======== ======== ======== ======== Diluted $ (0.16) $ (0.28) $ 0.06 $ (0.66) ======== ======== ======== ========
See accompanying notes to consolidated financial statements. 4 FIRST IPSWICH BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (unaudited) NINE MONTHS ENDED SEPTEMBER 30, 2007 AND 2006 (In thousands, except per share data)
Accumulated Additional Other Common Paid-in Retained Comprehensive Treasury Stock Capital Earnings Loss Stock Total ----- ------- -------- ---- ----- ----- Balance at December 31, 2005 $ 2,240 $ 9,936 $ 8,054 $ (1,159) $ (111) $ 18,960 Comprehensive loss: Net loss -- -- (1,458) -- -- (1,458) Unrealized loss on securities available-for-sale, net of reclassification adjustment and tax effect -- -- -- (228) -- (228) -------- Total comprehensive loss -- -- -- -- -- (1,686) -------- Cash dividends declared ($.025 per share) -- -- (55) -- -- (55) -------- -------- -------- -------- -------- -------- Balance at September 30, 2006 $ 2,240 $ 9,936 $ 6,541 $ (1,387) $ (111) $ 17,219 ======== ======== ======== ======== ======== ======== Balance at December 31, 2006 $ 2,240 $ 9,936 $ 6,843 $ (1,037) $ (111) $ 17,871 Comprehensive income: Net income -- -- 133 -- -- 133 Unrealized gain on securities available-for-sale, net of reclassification adjustment and tax effect -- -- -- 330 -- 330 -------- Total comprehensive income -- -- -- -- -- 463 -------- Stock option expense -- 48 -- -- -- 48 Private placement of common stock (125,000 shares) 125 822 -- -- -- 947 -------- -------- -------- -------- -------- -------- Balance at September 30, 2007 $ 2,365 $ 10,806 $ 6,976 $ (707) $ (111) $ 19,329 ======== ======== ======== ======== ======== ========
See accompanying notes to consolidated financial statements. 5 FIRST IPSWICH BANCORP AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (unaudited) (In thousands)
Nine Months Ended September 30, ------------------------------- 2007 2006 ---------- ---------- Cash flows from operating activities: Net income (loss) $ 133 $ (1,458) Adjustments to reconcile net income (loss) to net cash provided (used) by operating activities: Provision for loan losses 14 131 Depreciation and amortization 357 554 Losses on sales and calls of securities, sold or written down, net -- 575 Net amortization of securities, including certificates of deposit 53 92 Valuation reserve for real estate held for sale -- 319 Derivative fair value adjustment (147) (188) Amortization of core deposit intangible 126 121 Write-down of fixed assets 340 Gain on sale of loans, net (311) -- Stock option expense 48 -- Net change in other assets and other liabilities (661) 1,300 ---------- ---------- Net cash provided (used) by operating activities (388) 1,786 ---------- ---------- Cash flows from investing activities: Activity in available-for-sale securities: Purchases -- (2,887) Sales 2,760 101 Maturities, calls and paydowns 11,706 17,656 Activity in held-to-maturity securities: Maturities, calls and paydowns -- 2,094 Redemption of Federal Home Loan Bank stock 2,480 2,507 Additions to premises and equipment, net (602) (675) Deferred payment to the de Burlo Group, Inc. (1,188) -- Proceeds from the sale of loans 15,330 -- Loan originations, net of repayments 9,753 (15,685) ---------- ---------- Net cash provided by investing activities 40,239 3,111 ---------- ---------- Cash flows from financing activities: Net increase (decrease) in deposits (28,388) 17,660 Net increase (decrease) in short-term borrowings (1,615) 359 Proceeds from long-term borrowings 5,000 10,000 Repayment of long-term borrowings (216) (18,695) Proceeds from private placement 947 -- Net cash paid on sale of Cambridge branch (4,043) -- Cash dividends paid -- (55) ---------- ---------- Net cash provided (used) by financing activities (28,315) 9,269 ---------- ---------- Net increase in cash and cash equivalents 11,536 14,166 Cash and cash equivalents at beginning of period 13,499 11,261 ---------- ---------- Cash and cash equivalents at end of period $ 25,035 $ 25,427 ========== ========== Supplemental disclosures: Interest paid $ 6,523 $ 8,609 Income taxes paid, net 138 58 Reclassification of goodwill to fixed assets related to final purchase accounting of Boston branch -- 750 Transfer to securities available-for-sale from held-to-maturity -- 26,566 Transfer from loans to foreclosed real estate 1,484 --
See accompanying notes to consolidated financial statements 6 FIRST IPSWICH BANCORP AND SUBSIDIARIES Notes to Consolidated Financial Statements (unaudited) (1) Basis of Presentation and Consolidation The accompanying unaudited consolidated financial statements include the accounts of First Ipswich Bancorp (the "Company"), its wholly owned-subsidiary, The First National Bank of Ipswich (the "Bank"), and the Bank's subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation. These unaudited financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America ("GAAP") for interim financial information and the instructions for Form 10-QSB and Item 310(b) of Regulation S-B. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments necessary for a fair presentation have been included. Interim results are not necessarily indicative of the results that may be expected for the entire year. Certain information and footnote disclosures normally included in the financial statements prepared in accordance with GAAP have been omitted. A summary of significant accounting policies followed by the Company is set forth in the Notes to Consolidated Financial Statements in the Company's Annual Report on Form 10-KSB for the year ended December 31, 2006. In July 2006 the Financial Accounting Standards Board ("FASB") issued Financial Accounting Standards Interpretation No. 48, "Accounting for Uncertainty in Income Taxes" (FIN 48), which clarifies the accounting for uncertainty in income taxes recognized in an entity's financial statements in accordance with FASB Statement No. 109, "Accounting for Income Taxes". FIN 48 prescribes a recognition threshold and measurement attributable for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosures and transitions. FIN 48 is effective for fiscal years beginning after December 15, 2006. The Company has implemented FIN 48 with no resulting impact on the financial statements. In September 2006 FASB issued Statement of Financial Account Standards No. 157, "Fair Value Measurements" (SFAS 157), which defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 is effective for the Company on January 1, 2008 and is not expected to have a significant impact on the Company's financial statements. In February 2007 the FASB issued Statement No. 159, "The Fair Value Option for Financial Assets and Financial Liabilities - including an amendment of FASB Statement No. 115", which provides companies with an option to report selected financial assets and liabilities at fair value. Statement No. 159 also establishes presentation and disclosure requirements designed to facilitate comparisons between companies that choose different measurement attributes for similar types of assets and liabilities. This statement is effective for the Company on January 1, 2008. The Company has not determined the impact of implementing and adopting SFAS No. 159 on its consolidated financial statements. The FASB has ratified EITF 06-4, "Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements," and EITF 06-10, "Accounting for Collateral Assignment Split-Dollar Life Insurance Arrangements," which address accounting for arrangements whereby the employer purchases a policy to insure the life of an employee, and enters into an agreement to split the policy benefits between the employer and the employee. These pronouncements, effective for fiscal years beginning after December 15, 2007, indicate that an obligation arises as a result of a substantive agreement with an employee to provide future postretirement benefits and that a liability should be recognized in accordance with applicable authoritative guidance. Management does not expect that such pronouncements will have a significant impact on the Company's consolidated financial statements. 7 (2) Stockholders' Equity and Earnings per Share Basic earnings per share represents income available to common stockholders divided by the weighted-average number of common shares outstanding for the period. Diluted earnings per share represents income available to common stockholders divided by the sum of the weighted-average number of common shares outstanding and the weighted-average number of common stock equivalents for warrants associated the Company's private placement offering and options associated with its stock option grant. The Company employs the treasury stock method to account for the warrants and options in the diluted earnings per share calculations. (3) Commitments At September 30, 2007, the Company had outstanding commitments to originate loans of $1.5 million. Unused lines of credit and open commitments available to customers at September 30, 2007 amounted to $32.9 million, of which $5.5 million related to construction loans, $10.5 million related to home equity lines of credit, $4.0 million related to credit card loans and $12.9 million related to other open commitments. (4) Segment Reporting Information about reportable segments, and reconciliation of such information to the consolidated financial statements as of and for the nine month periods ended September 30, 2007 and September 30, 2006 is below. Investment Consolidated Banking Advisory Totals ------- -------- ------ (Dollars in thousands) September 30, 2007: - ------------------- Net interest income $ 7,195 -- $ 7,195 Other revenue: external customers 2,389 $ 1,422 3,811 Other expenses: external customers 9,742 831 10,573 Net income (222) 355 133 Total assets $ 287,149 $ 4,319 $ 291,468 September 30, 2006: - ------------------- Net interest income $ 8,281 -- $ 8,281 Other revenue: external customers 1,481 $ 1,337 2,818 Other expenses: external customers 12,387 844 13,231 Net income (loss) (1,785) 327 (1,458) Total assets $ 400,079 $ 2,868 $ 402,947 (5) Divestitures Cambridge, Massachusetts Branch On March 30, 2007 the Company sold its branch located in Cambridge, Massachusetts. Upon consummation of the sale, $16.7 million of deposits and repurchase agreements and $11.9 million of loans were transferred. A loss of $52,000 was recognized on the sale of the branch, which is included in miscellaneous income on the statement of operations. Londonderry, New Hampshire Branch On February 5, 2007 the Company announced that it was closing its branch located in Londonderry, New Hampshire. In conjunction with that closing, in the first quarter of 2007 the Bank sold $15.0 million of commercial real estate loans and commercial loans. A net gain of $311,000 was recognized on the sale of the loans. The branch was closed on May 11, 2007. 8 (6) Private Placement of Common Stock On January 26, 2007 the Company raised $1.0 million of new capital through a private placement of 125,000 shares of common stock. The net proceeds of the private placement totaled $947,000 after costs of $53,000. Net proceeds were invested as additional capital in the Company's primary subsidiary, The First National Bank of Ipswich. Each investor in private placement also received a warrant to purchase a number of shares of common stock equal to 20% of the shares subscribed for in such investor's subscription agreement. The warrants vested immediately, have a strike price of $8.00, and expire on January 26, 2010. (7) Stock Option Grants During 2004, the Board of Directors and stockholders approved two stock option plans, the 2004 Incentive Stock Option Plan for Key Employees and the 2004 Directors Plan. These plans provide for the granting of up to 220,000 options to employees and directors to purchase shares of the Company's common stock. On May 16, 2007 the Board of Directors of First Ipswich Bancorp approved the granting of options to non-employee directors and senior managers. The options have an exercise price equal to fair market value of the Company's stock of $9.50 on the grant date, except for Neil St. John Raymond, Chairman, whose options were granted at an exercise price of $10.45 per share. The non-employee directors include: Messrs. Borden III, Collins, Deery, Raymond Jr., Tinti and Ms. Gaskins. Each of the listed directors received 2,000 options, of which 1,000 vested immediately and the remaining options vest over a four year period. Directors have not received cash fees for their services to the Company since June 30, 2006 when they temporarily waived their right to such fees. The following senior managers received options: Neil St. John Raymond, 7,500, Russell Cole, 10,000, Timothy Felter, 8,000, Jay DiIorio 7,500, Maryjon Brett, 5,500 and Janice Costa 5,500. The options vest over four years, beginning on the first anniversary of the grant date. On July 18, 2007 the Board of Directors of First Ipswich Bancorp approved the granting of options to certain senior managers. The following individuals received options: Maryjon Brett 2,500, Janice Costa 2,500 and John DiIorio 500. The options have an exercise price equal to fair market value of the Company's stock of $9.25 on the grant date. These options vest over four years, beginning on the first anniversary of the grant date. SFAS 123(R) requires the Company to estimate the fair value of stock-based awards on the date of grant. The Company employed the Binomial options pricing model to value the options. Accordingly, the Company recognized $34,000 and $14,000 of employee benefit expense during the second and third quarters of 2007, respectively. (8) Income Taxes Deferred tax assets are evaluated to determine whether it is "more likely than not" that a tax return benefit would be realized when the deferred items reverse. Evaluation considerations include the availability of historical and projected taxable income to offset the deferred items in the periods they are expected to reverse. Management has determined that operational changes which have been made and are being made will generate sufficient income to allow for the recognition of the deferred tax assets. No valuation reserve was recorded as of September 30, 2007 or December 31, 2006. (9) Executive Departure On August 3, 2007, Ipswich Capital Investment Corp. ("ICIC"), a wholly-owned subsidiary of the Bank, notified Peter M. Whitman, Jr., that his employment with ICIC, would terminate on September 3, 2007. Mr. Whitman's Employment Agreement with ICIC, dated as of January 1, 2005, also terminated on September 3, 2007. Mr. Whitman was the President of ICIC. Mr. Whitman's departure is not for "cause" as defined in his Employment Agreement. 9 Under the terms of Mr. Whitman's Employment Agreement, Mr. Whitman will receive as severance (i) continued payment of his current annual base salary and current benefits until September 2, 2008, and (ii) an Additional Compensation Amount (as defined in his Employment Agreement), calculated by reference to the value of ICIC (to be determined by an independent valuation, for which the estimated amount has been accrued at September 30, 2007. The foregoing description of Mr. Whitman's Employment Agreement is qualified in its entirety by reference to the actual terms of the agreement, which was filed as Exhibit 10.12 to the Company's Annual Report on Form 10-KSB for the year ending December 31, 2004 and is incorporated herein by reference. ITEM 2. Management's Discussion and Analysis Forward-looking statements This quarterly report on Form 10-QSB contains and incorporates by reference "forward-looking statements" within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act. All statements, other than statements of historical facts, including statements regarding our strategy, effectiveness of investment programs, evaluations of future interest rate trends and liquidity, expectations as to growth in assets, deposits and results of operations, receipt of regulatory approval for pending acquisitions, success of acquisitions, future operations, market position, financial position, and prospects, plans and objectives of management are forward-looking statements. Words such as "believes", "expects," "may," "will," "should," "contemplates," or "anticipates" may also indicate forward-looking statements. There are a number of important factors that could cause the Company's actual results to differ materially from those contemplated by such forward-looking statements. These important factors include, without limitation, competitive conditions in the Bank's marketplace generally, the Bank's continued ability to originate quality loans, fluctuation in interest rates including fluctuations which may affect the Bank's interest rate spread, real estate conditions in the Bank's lending areas, changes in the securities or financial markets, changes in loan defaults and charge-off rates, a deterioration in general economic conditions on a national basis or in the local markets in which the Company operates, the Bank's continued ability to attract and retain deposits, the risk that difficulties will arise in connection with the integration of the operations of acquired businesses with the operations of the Company's banking or investment management businesses, the Company's ability to control costs, new accounting pronouncements, and the Bank's continued ability to comply with existing and future regulatory requirements. The Company undertakes no obligation to publicly release the results of any revisions to those forward-looking statements, which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Executive Summary First Ipswich Bancorp is a nationally-chartered commercial financial institution that historically has focused on Ipswich, MA and the surrounding communities. Over the past several years, however, the Company expanded beyond the eastern Essex County section of Massachusetts. In 2005 a branch in Boston, MA was purchased, and in 2006 a de novo branch was opened in Portsmouth, NH. In addition, the Company also expanded its product offerings over the past several years. In 2004, The de Burlo Group, a Boston-based investment management business was purchased. The Company's rapid expansion failed to generate revenue streams sufficient to cover increasing levels of overhead costs. Accordingly, the Company reported four consecutive quarterly losses through September 30, 2006. The Bank signed a Formal Agreement with the Office of the Comptroller of the Currency (the "OCC") on June 28, 2006. The Agreement required the Bank to achieve higher capital levels, retain competent management, develop a new strategic plan, adopt a new interest rate risk management plan, and improve liquidity and profitability. Specifically, the Bank was required by December 31, 10 2006, to raise its Tier 1 capital to average assets ratio to a minimum of 8%, the Tier 1 capital to risk-weighted assets ratio to a minimum of 10%, and the total capital to risk-weighted assets ratio to a minimum of 11%. The Bank has exceeded the minimum ratios, required by the Formal Agreement, since February 28, 2007. As required by the Formal Agreement, the Company developed and implemented a strategic plan during the second half of 2006 and first nine months of 2007. A primary goal of the plan was to evaluate operations and identify locations and business lines which were not enhancing the profitability of the Company. So far in 2007, the Company has sold its Cambridge branch, raised $1 million in capital through a private placement offering, sold $15.0 million of loans, and closed its Londonderry branch. The Company recognized a net loss of $386,000 for the quarter ended September 30, 2007 as compared to a net loss of $626,000 for the same period of 2006. Net income for the nine months ended September 30, 2007 was $133,000 as compared to a net loss of $1,458,000 for the same period of 2006. The net loss for the third quarter of 2007 was primarily driven by a provision for loan losses of $274,000 and compensation expense primarily related to the estimated additional compensation amount due to Peter Whitman. The Bank's ability to generate consistent profitability will be a key factor in the OCC's evaluation of the appropriateness of relieving the Bank of the Formal Agreement. A primary objective for the Company going forward is to become a highly profitable community bank. One of the means by which this objective will be accomplished is a focused effort to grow the small business client base which will generate new loans and deposits. In addition, the Company continues to evaluate expenses for additional reductions that can be achieved without unduly impacting the high level of customer service the Company provides through its branches in Beverly, Boston, Essex, Gloucester, Ipswich, Newburyport, and Rowley, Massachusetts and Portsmouth, New Hampshire. The deposit insurance assessment from the FDIC significantly impacted both the third quarter and year-to-date earnings for 2007. The insurance expense related to the FDIC assessment was $139,000 and $425,000 for the third quarter of 2007 and the nine months ended September 30, 2007, respectively. The Company expects that its quarterly FDIC insurance assessment will be reduced to approximately $60,000 starting in the fourth quarter of 2007. Management anticipates that earnings will be weak in the fourth quarter of 2007 even after the reduction of the FDIC insurance assessment. The Company expects to sell the downtown Boston office building that houses the Boston branch which is located at 31-33 State Street, before the end of the fourth quarter. The Bank has retained CB Richard Ellis to sell the building through a "call for offers" process, and plans to retain a long-term lease for the branch as part of the deal. The Company is committed to a focused and disciplined approach to return the Company to consistent profitability. While significant progress has been made to reduce expenses, additional effort is needed to restore net income to an acceptable level. The focus has shifted from right-sizing the Bank (to meet the capital requirements of the Formal Agreement) to implementing a plan to enhance profitability. The Company contemplates calling a special meeting of shareholders later in the fourth quarter to vote on a proposed amendment to the Articles of Organization, which will provide for the reclassification of shares of the Company's common stock held by shareholders who are the record holders of fewer than 200 shares of common stock into shares of Series A Preferred Stock, on the basis of one share of Series A Preferred Stock for each share of common stock held by such shareholders (the "Reclassification"). The Reclassification is designed to allow us to suspend our reporting obligations with the SEC and realize estimated cost savings of approximately $285,000 per year. The Company first filed a Schedule 13E-3 and preliminary proxy statement with the SEC outlining the Reclassification on September 11, 2007. The first amendment to the Schedule 13E-3 and preliminary proxy statement is being filed today. The Company will file another amendment to the Schedule 13E-3 and the definitive proxy statement upon completion of SEC review. All shareholders are advised to read the amended Schedule 13E-3 and definitive proxy statement carefully when these documents are available, as they will contain important information about the Reclassification. Shareholders may obtain free copies of the proxy statement and Schedule 13E-3 when they are available at the SEC's website at http://www.sec.gov. The Company will mail a copy of the definitive proxy statement to all shareholders in advance of the special meeting. 11 Critical Accounting Policies Critical accounting policies are defined as those that reflect significant judgments and uncertainties, and the application of which could potentially result in materially different results under different assumptions and conditions. Accounting policies considered critical to the Company's financial statements include the allowance for loan losses, impairment of investment securities and intangible assets, including goodwill, and valuation of deferred tax assets. The methodology for assessing the appropriateness of the allowance for loan losses is considered a critical accounting policy by management due to the degree of judgment involved, the subjectivity of the assumptions utilized, and the potential for changes in the economic environment that could result in changes to the level of the allowance for loan losses considered necessary. Management considers impairment of investment securities to be critical due to the potential materiality of individual investment security holdings. Management considers impairment of intangible assets to be critical accounting policies because of the intangible assets' materiality to the financial statements and inherent judgment in determining valuation. This valuation involves identification of reporting units and estimation of fair values. The estimation of fair values involves a high degree of judgment and subjectivity in the assumptions utilized. The valuation of deferred tax assets is considered critical because of the degree of judgment required to determine whether it is more likely than not that tax return benefits will be realized when deferred tax items reverse. Comparison of Financial Condition at September 30, 2007 versus December 31, 2006 Total assets were $291.5 million at September 30, 2007 as compared to $332.8 million at December 31, 2006. The decrease of $41.3 million or 12% in total assets was primarily driven by the sale of $15.0 million of loans associated with our Londonderry branch, $11.9 million of loans associated with the sale of our Cambridge branch, and $14.5 million of investment maturities and redemptions. A key element of the Company's strategic plan required shrinking the balance sheet in order to improve capital ratios. Loans Total net loan balances were $198.3 million at September 30, 2007, a decrease of $36.6 million or 16%, from $234.9 million at December 31, 2006. The decrease in total net loans was primarily driven by the aforementioned sales. Commercial real estate loans decreased $21.1 million or 20% to $85.8 million at September 30, 2007 from $107.0 million at December 31, 2006. Commercial loans decreased $14.2 million or 32% to $30.2 million at September 30, 2007 from $44.4 million at December 31, 2006. The decrease of the loan portfolio occurred primarily in the first quarter of the year; net loans were $198.0 million at March 31, 2007 and $198.3 million at September 30, 2007. The Bank's lending activities are focused in northeastern Massachusetts and southern New Hampshire and are diversified by loan types and industries. The Bank continues to focus on originating high quality loans. 12 The following table presents the composition of the Bank's loan portfolio by type of loan at the dates indicated. September 30, 2007 December 31, 2006 ------------------ ----------------- (Dollars in thousands) Real estate mortgage loans: Commercial $ 85,823 $ 106,965 Residential 54,428 54,898 Construction 17,413 19,414 Home equity 9,979 9,520 Commercial loans 30,214 44,442 Consumer loans 2,071 1,599 ------------ ------------ Total loans 198,928 236,838 Net deferred origination fees (139) (121) Allowance for loan losses (1,537) (1,827) ------------ ------------ Loans, net $ 198,252 $ 234,890 ============ ============ Asset Quality and Allowance for Loan Losses The table below summarizes certain key ratios regarding the quality of the Bank's loan portfolio:
September 30, 2007 December 31, 2006 ------------------ ----------------- (Dollars in thousands) Non-accrual loans $ -- $ -- Troubled debt restructurings -- -- Loans past due 90 days or more and still accruing 35 3 Foreclosed real estate 1,484 -- Non-accrual loans to total loans 0.00% 0.00% Non-performing assets to total assets 0.51% 0.00% Allowance for loan losses as a percentage of total loans 0.77% 0.77%
During the second quarter of 2007, the Company placed two related loans totaling $1,748,000 on non-accrual status. During the third quarter of 2007, the Company transferred these non-accrual loans to the in-substance foreclosures category. Upon transfer to the in-substance foreclosures category the Company wrote the property down by $264,000. The property is a residential subdivision. For the nine months ended September 30, 2007, the Company recorded a provision for loan losses of $14,000, charge-offs of $308,000, and recoveries of $4,000. The allowance for loan losses balance stood at $1,537,000 at September 30, 2007, which represents a decrease of $290,000 since December 31, 2006. Management considers the loan loss allowance to be adequate to provide for potential loan losses. The Company assesses the adequacy of the allowance for loan losses each calendar quarter. Although the Company believes that it employs an appropriate approach to downgrading credits that are experiencing slower than projected sales and/or increases in loan to value ratios, subsequent evaluations of the loan portfolio by the Company and its regulators, in light of the factors then prevailing, may require increases in the allowance for loan losses through charges to the provision for loan losses. 13 Over the past several years, the Company has experienced very low levels of loan charge-offs and non-accrual loans. Economic or other external factors, deterioration in credit quality, or appropriate changes in the reserve estimation process as a result of changes in assumptions, as well as other possible factors, may cause the loan loss reserve balance to be increased in the future, perhaps substantially, through charges to current earnings by increasing the loan loss provision. While the real estate market has been under pressure for the last several quarters, to date, the Company has experienced only a small increase in problem loans. Investment Securities Total investments, which includes certificates of deposit, available-for-sale securities and Federal Home Loan Bank and Federal Reserve Bank stock totaled $45.4 million as of September 30, 2007, a decrease of $16.6 million, or 27%, from $62.0 million at December 31, 2006. The Bank has classified all securities as available-for-sale since September 2006. Investment securities may be sold for a variety of reasons, including, but not limited to, swapping into other investment sectors with greater perceived relative value, neutralizing interest rate risk created by loan, deposit, or borrowed funds activity, and managing the level of qualifying collateral for borrowing purposes. The following table presents the composition of the Company's available-for-sale securities portfolio at the dates indicated
September 30, 2007 December 31, 2006 ------------------------ ------------------------ Amortized Fair Amortized Fair Cost Value Cost Value ---------- ---------- ---------- ---------- (Dollars in thousands) Mortgage and asset-backed securities $ 29,433 $ 28,558 $ 39,391 $ 38,307 Government-sponsored enterprise obligations 6,039 5,955 10,550 10,293 Corporate bonds 1,867 1,754 1,845 1,745 Municipal bonds 3,622 3,516 3,756 3,617 ---------- ---------- ---------- ---------- Total securities available-for-sale $ 40,961 $ 39,783 $ 55,542 $ 53,962 ========== ========== ========== ==========
Real Estate Held for Sale Real estate held for sale consists of the land and building acquired in the Boston branch acquisition. The property is being carried at the lower of depreciated cost or the estimated fair value less selling costs. A valuation allowance has been established as appropriate. The Company anticipates that the sale of the Boston building will be consummated before the end of 2007. It is possible that changes to the reserve may occur prior to, and related to, the sale of the real estate. The Company plans to maintain a retail banking branch and loan production office on the Boston property after the sale. Deposits Deposit balances totaled $225.2 million as of September 30, 2007, a decrease of $43.7 million, or 16%, from $268.9 million as of December 31, 2006. The majority of the decrease was driven by a $34.6 million decline in certificates of deposit. The decline in certificates of deposit was the result of promotional certificate of deposit balances running off and the sale of our branch in Cambridge, Massachusetts. The sale of our Cambridge branch resulted in a reduction in total deposits (including certificates of deposit) of $15.4 million. 14 As part of its strategic plan, the Company is pursuing small business owners in its geographic footprint that do not utilize its services. The Company is hopeful that these efforts will result in new relationships that will result in additional core deposits. The following table summarizes the composition of the Bank's deposit balances at the dates indicated. September 30, December 31, 2007 2006 ------------ ------------ (Dollars in thousands) Demand $ 39,148 $ 42,682 NOW 32,805 34,537 Regular savings 27,287 29,837 Money market deposits 47,613 48,868 Certificates of deposit 78,358 112,944 ------------ ------------ $ 225,211 $ 268,868 ============ ============ Borrowings Short-term borrowings were $10.8 million as of September 30, 2007, a decrease of $2.9 million, or 21% from $13.7 million as of December 31, 2006. The contraction related to repurchase agreements which declined $2.9 million or 21% from $13.7 million as of December 31, 2006. The decline in repurchase agreements was driven by lower balances in customer sweep accounts. Long-term borrowings were $20.8 million as of September 30, 2007, an increase of $4.8 million, or 30% from $16.0 million as of December 31, 2006. The increase was driven by a new $5.0 million callable fixed rate advance from the Federal Home Loan Bank of Boston. Stockholder's Equity Total stockholder's equity increased to $19.3 million as of September 30, 2007 from $17.9 million as of December 31, 2006. The increase was primarily driven by: $947,000 of net proceeds from the Company's private placement, year-to-date net income of $133,000 and improvement in the accumulated other comprehensive loss account of $330,000 associated with an unrealized loss, net of tax, on available-for-sale securities. Comparison of Operating Results for the Quarters Ended September 30, 2007 and 2006 General Operating results are largely determined by the net interest spread on the Company's primary assets (loans and investment securities) and its primary liabilities (deposit balances and borrowings). Operating income is also dependent upon revenue from non-interest related sources (such as investment advisory fees and service charges on deposit accounts), the provision for loan losses, and the increase or decrease in operating expenses. Operating results are also significantly impacted by general economic conditions; in particular the general level of interest rates and the resultant impact on asset yields and the cost of funds, as well as the ability and willingness of borrowers to fulfill their debt obligations during various economic cycles. 15 The net loss for the three months ended September 30, 2007 was $386,000 versus a net loss of $626,000 for the three months ended September 30, 2006, an improvement of $240,000. The improvement in earnings is primarily attributable to a $779,000 decrease in non-interest expenses, and a $566,000 improvement in non-interest income. The provision for loan losses was $274,000 for the three months ended September 30, 2007 versus $66,000 for the same period in 2006. Net interest income was $2.3 million for the three months ended September 30, 2007 versus $2.9 million for the same period in 2006. The benefit for taxes was $74,000 for the three months ended September 30, 2007 versus a tax benefit of $340,000 for the same period in 2006. Interest and Dividend Income Total interest and dividend income for the quarter ended September 30, 2007 was $4.4 million, a decrease of $1.7 million from the quarter ended September 30, 2006. The decrease was primarily driven by lower levels of earning assets. For the quarter ended September 30, 2007 average earning assets were $265.0 million versus $364.9 million for the quarter ended September 30, 2006. The lower level of earning assets is a direct result of the implementation of the Company's strategic plan. Average investment securities declined by $65.1 million while average loans declined by $48.6 million The average yield on average earning assets during the third quarter of 2007 was 6.58% as compared to 6.62% for the third quarter of 2006. Interest Expense Interest expense was $2.1 million for the quarter ended September 30, 2007; this represents a $1.1 million decrease from the same quarter of 2006. The majority of the decline was attributable to lower levels of average interest bearing liabilities which decreased by $98.6 million versus the same quarter of 2006. The average rate paid for interest-bearing liabilities was 3.58% for the quarter ended September 30, 2007 versus 3.79% for the quarter ended September 30, 2006. Interest expense on interest-bearing deposits for the quarter ended September 30, 2007 decreased by $373,000 to $1.5 million as compared to the same quarter of 2006. This decrease was primarily due to lower levels of interest-bearing deposits. Average interest-bearing deposit balances for the quarter ended September 30, 2007 totaled $187.0 million, a $51.4 million decrease as compared to the same quarter of 2006. Offsetting the decrease in interest bearing deposit balances was an increase in the average rate paid on the deposits. The average rate paid on deposits increased to 3.09% from 3.04% in the third quarter of 2007 as compared to the same quarter of 2006. Interest expense on borrowed funds, including subordinated debentures, for the quarter-ended September 30, 2007, decreased by $690,000 to $636,000 as compared to the quarter-ended September 30, 2006. The decrease was primarily due to significantly lower average levels of FHLB advances. Net Interest Income Net interest income for the quarter ended September 30, 2007 decreased by $631,000 to $2.3 million as compared to $2.9 million for the quarter ended September 30, 2006. The decline in net interest income was driven by an overall shrinkage of the Company's balance sheet. Average total assets for the quarter ended September 30, 2007 were $293.6 million versus $396.4 million for the same quarter in 2006. While net interest income declined, net interest margin improved. Net interest margin was 3.44% for the quarter ended September 30, 2007 versus 3.19% for the same quarter of 2006, an improvement of 25 basis points. The reduction in investment securities and wholesale funding was a primary factor in the improvement in net interest margin. 16 Average Balances and Yields The following table presents a summary of the Company's interest-earning assets and their average yields, and interest-bearing liabilities and their average rates for the three months ended September 30, 2007 and September 30, 2006. The average balances are derived from average daily balances.
Three Months Ended September 30, ----------------------------------------------------------------------------------------- 2007 2006 ----------------------------------------- -------------------------------------------- Interest Interest Income/ Average Average Rate Income/ Average Average Rate Expense Balance Earned/Paid Expense Balance Earned/Paid ----------------------------------------- --------------------------------------------- (Dollars in thousands) Assets: Interest-earning assets: Other short-term investments $ 227 $ 21,098 4.27% $ 94 $ 7,232 5.13% Investment securities: Taxable 441 41,027 4.28% 1,169 95,636 4.85% Tax-exempt 23 3,634 2.47% 131 14,156 3.68% Loans 3,701 199,260 7.37% 4,692 247,872 7.51% ----------------------- ------------------------ Total interest-earning assets 4,392 265,019 6.58% 6,086 364,896 6.62% -------- --------- Non-interest-earning assets 28,578 31,530 ----------- ----------- Total assets $ 293,597 $ 396,426 =========== =========== Liabilities and Stockholders' Equity: Interest-bearing liabilities: Savings 33 26,437 0.49% 39 31,309 0.49% NOW 24 30,850 0.31% 11 35,533 0.12% MMDA 408 46,576 3.48% 486 57,179 3.37% CD's 991 83,173 4.72% 1,293 114,400 4.49% ----------------------- ------------------------ Total interest-bearing deposits 1,456 187,036 3.09% 1,829 238,421 3.04% Federal Home Loan Bank advances 269 19,823 5.38% 890 63,874 5.53% Subordinated debentures 235 13,000 7.18% 243 13,000 7.43% Other borrowed funds 132 11,867 4.41% 193 14,990 5.08% ----------------------- ------------------------ Total interest-bearing liabilities 2,092 231,726 3.58% 3,155 330,285 3.79% -------- --------- Non-interest-bearing deposits 40,011 46,567 Other non-interest-bearing liabilities 2,245 1,701 ----------- ----------- Total liabilities 273,982 378,553 Total stockholders' equity 19,615 17,873 ----------- ----------- Total liabilities and stockholders' equity $ 293,597 $ 396,426 =========== =========== Net interest income $ 2,300 $ 2,931 ======== ========= Interest rate spread 2.99% 2.83% =========== =========== Net interest margin 3.44% 3.19% =========== ===========
17 Non-interest Income Total non-interest income increased $566,000 to $1.1 million for the quarter ended September 30, 2007 as compared to the same quarter of 2006. The improvement in non-interest income was driven by the absence in 2007 of both $526,000 of losses on securities sold or written down and $340,000 of fixed asset write-downs taken during the third quarter of 2006. Partially offsetting the losses were $106,000 of trust fees in the third quarter of 2006 versus none in the third quarter of 2007 because the Company sold the trust department in October of 2006. In addition, the third quarter of 2006 includes $133,000 of merchant credit card processing fees versus $8,000 in the third quarter of 2007 because the Company has outsourced this service. Non-interest Expense Total operating expenses decreased by $779,000 to $3.6 million for the quarter ended September 30, 2007 as compared to the same quarter of 2006. This reduction in expense is a direct result of the implementation of the Company's strategic plan. Salaries and employee benefits decreased by $428,000 to $2.0 million primarily due to a reduction in the number of employees, offset by an increase in severance expense in the third quarter of 2007. Occupancy and equipment expenses decreased by $225,000 to $477,000 for the quarter ended September 30, 2007. The decrease was primarily attributable to lower levels of: utilities expense, maintenance and repair costs, rent expense, and other miscellaneous occupancy expenses. As part of the strategic plan the Company has closed several facilities. In addition, other general and administrative expenses decreased $92,000 to $227,000 for the quarter ended September 30, 2007. Partially offsetting these declines was an increase in FDIC insurance expense in the third quarter of 2007. FDIC insurance expense was $139,000 during the third quarter of 2007 versus $8,000 during the third quarter of 2006. The increase was driven by a revised FDIC insurance assessment process. As a result of tangible improvements stemming from the implementation of the strategic plan, it is anticipated that this expense will decrease by approximately $104,000 per quarter after October 2007. Income Taxes For the quarter ended September 30, 2007 the Company recorded a benefit for income taxes of $74,000 versus a benefit for income taxes of $340,000 for the same quarter of 2006. Deferred tax assets are evaluated to determine whether it is "more likely than not" that a tax return benefit would be realized when the deferred items reverse. Evaluation considerations include the availability of historical and projected taxable income to offset the deferred items in the periods they are expected to reverse. Management has determined that operational changes which have been made and are being made will generate sufficient income to allow for the recognition of the deferred tax assets. No valuation reserve was recorded as of September 30, 2007 or December 31, 2006. The effective tax benefit rate of 16% for the quarter reflects the fact that the costs of implementing the process to reclassify common stockholders are not deductible for income tax purposes. These non-deductible reclassification expenses represent a significant portion of pretax income. Comparison of Operating Results for the Nine Months Ended September 30, 2007 and 2006 General Net income for the nine months ended September 30, 2007 was $133,000 compared with a net loss of $1,458,000 for the nine months ended September 30, 2006. For the nine months ended September 30, 2007, net interest income decreased by $1.1 million, non-interest income increased $993,000, and operating expenses decreased $2.7 million, as compared to the nine months ended September 30, 2006. The provision for loan losses was $14,000 for the nine months ended September 30, 2007 versus $131,000 for the same period in 2006. The provision for taxes was $286,000 for the nine months ended September 30, 2007 versus a benefit for taxes of $805,000 for the same period in 2006. 18 Interest and Dividend Income Total interest and dividend income for the nine months ended September 30, 2007 was $13.7 million, which was $3.4 million lower than the nine months ended September 30, 2006. The decline was primarily resulted from by lower levels of average interest-earning assets. While average balances declined the yield on earning assets increased to 6.63% for the nine months ended September 30, 2007 as compared to 6.25% for the nine months ended September 30, 2006. The improvement in yield was primarily driven by higher yielding loans replacing lower yielding investments. Average interest earning assets of $276.4 million for the period ended September 30, 2007 were $88.7 million lower than average interest-bearing assets of $365.1 million for the period ended September 30, 2006. The increase in average yield was due primarily to a changing mix of assets. While average net loans for the nine months ended September 30, 2007 were $34.5 million lower than the same period of 2006, average investments were $68.8 million lower than the same period of 2006. The changing mix of earning assets reflects the Bank's efforts to increase its core lending efforts and decrease its reliance on the investment portfolio for income. Interest Expense Interest expense on interest-bearing liabilities for the nine months ended September 30, 2007 was $6.5 million, a $2.3 million decrease from the nine months ended September 30, 2006. The decrease was driven by lower levels of interest-bearing liabilities. Average interest-bearing liabilities of $242.9 million for the period ended September 30, 2007 were $88.5 million lower than average interest-bearing liabilities of $331.4 million for the period ended September 30, 2006. The average rate paid for interest bearing liabilities was 3.59% for the nine months ended September 30, 2007 as compared to 3.55% for the same period of 2006. The increase in average rates occurred because of the increase in market short-term rates over the course of the past year. Interest expense on deposits was flat on a comparative basis. The average rate paid for deposit during the first nine months of 2007 was 3.13%, up from 2.76% in the same period of 2006. Average interest-bearing deposit balances during the nine months ended September 30, 2007 were $27.1 million lower than the same period of 2006. Interest expense on borrowed funds, including subordinated debentures, for the nine months ended September 30, 2007 decreased by $2.3 million to $1.8 million as compared to the nine months ended September 30, 2006. The impact of lower average balances of borrowed funds during the nine month period ended September 30, 2007 as compared to the same period of 2006 offset increasing interest rates paid on borrowed funds for the same comparable periods. The average rate paid on borrowed funds increased to 5.84% in the first nine months of 2007 as compared to 5.29% during the first nine months of 2006. The Company relies on dividends from the Bank in order to pay its interest obligations on the subordinated debentures. At present, the Bank is required to obtain OCC approval before it pays dividends because of its level of earnings. The Company can give no assurance that the OCC will grant the Bank approval to pay dividends in the future. At September 30, 2007 the Company had enough cash on hand to pay interest on the subordinated debentures, at current prevailing rates, through October 2007. Interest expense on subordinated debentures and the average balance outstanding in the first nine months of 2007 were relatively level compared to the first nine months of 2006. 19 Net Interest Income Net interest income for the nine months ended September 30, 2007 decreased by $1.1 million, to $7.2 million as compared to the nine months ended September 30, 2006. The decrease in net interest income in the 2007 period was due primarily to the lower levels of average earning assets. Offsetting the lower levels of earning assets was a changing mix of earning assets. The increase of higher yielding loans and corresponding decrease of lower yielding investments as a percentage of average earning assets helped mute the impact of lower levels of earning assets. Average loan balances were 75% of average earning assets for the nine months ended September 30, 2007 versus 66% for nine months ended September 30, 2006. Conversely, investment balances were 18% of average earning assets for the nine months ended September 30, 2007 versus 32% for nine months ended September 30, 2006. Average Balances and Yields The following table presents a summary of the Company's interest-earning assets and their average yields, and interest-bearing liabilities and their average rates for the nine months ended September 30, 2007 and 2006. The average balances are derived from average daily balances.
Nine Months Ended September 30, ----------------------------------------------------------------------------------------- 2007 2006 ----------------------------------------- -------------------------------------------- Interest Interest Income/ Average Average Rate Income/ Average Average Rate Expense Balance Earned/Paid Expense Balance Earned/Paid ----------------------------------------- --------------------------------------------- (Dollars in thousands) Assets Interest earning assets: Other short-term investments $ 661 $ 20,034 4.41% $ 211 $ 5,491 5.12% Investment securities: Taxable 1,469 45,777 4.30% 3,423 103,819 4.41% Tax-exempt 68 3,704 2.44% 386 14,477 3.56% Loans 11,516 206,838 7.44% 13,054 241,296 7.23% ----------------------- ------------------------- Total interest-earning assets 13,714 276,353 6.63% 17,074 365,083 6.25% -------- ------------ Non-interest-earning assets 28,899 31,272 ------------- ------------ Total assets 305,252 396,355 ============= ============ Liabilities and Stockholders' Equity: Interest-bearing liabilities: Savings 99 27,484 0.48% 120 32,331 0.49% NOW 82 32,453 0.34% 30 36,138 0.11% MMDA 1,294 49,999 3.46% 1,364 56,929 3.20% CD's 3,238 91,594 4.73% 3,213 103,182 4.16% ----------------------- ------------------------- Total interest-bearing deposits 4,713 201,530 3.13% 4,727 228,580 2.76% Federal Home Loan Bank advances 722 17,267 5.59% 2,854 75,984 5.02% Subordinated debentures 706 13,000 7.26% 701 13,000 7.21% Other borrowed funds 378 11,099 4.55% 511 13,850 4.93% ----------------------- ------------------------- Total interest-bearing liabilities 6,519 242,896 3.59% 8,793 331,414 3.55% -------- ------------ Non-interest-bearing deposits 40,670 45,279 Other non-interest-bearing liabilities 2,323 1,378 ------------- ------------ Total liabilities 285,889 378,071 Total stockholders' equity 19,363 18,284 ------------- ------------ Total liabilities and stockholders' Equity $ 305,252 $ 396,355 ============= ============ Net interest income $ 7,195 $ 8,281 ========= ============ Interest rate spread 3.05% 2.70% ============= ============ Net interest margin 3.48% 3.03% ============= ============
20 Non-interest Income Total non-interest income for the nine months ended September 30, 2007 increased $993,000 as compared to the nine months ended September 30, 2006. The increase was primarily driven by the absence of $575,000 of security write-downs, the absence of $340,000 of fixed asset write-downs, and the absence of a $319,000 valuation reserve for real estate held for sale, because the estimated fair value at that time, less selling costs, of real estate held for sale was less than the book value of the assets. In addition, the Company recognized a $311,000 net gain on the sale of Londonderry loans in 2007. For the nine months ended 2006 the Company recognized $316,000 of trust fees versus $0 for the nine months ended 2007. Non-interest Expense Total operating expenses for the nine months ended September 30, 2007 decreased $2.7 million or 20%, to $10.6 million. The 20% decrease in non-interest expenses was driven by the implementation of the Company's strategic plan. Salaries and employee benefits decreased $1.4 million to $5.6 million. The decrease was driven by a reduction in the number of employees. Occupancy and equipment expenses decreased $497,000 to $1.6 million, advertising and marketing expenses decreased $201,000 to $183,000. Other general and administrative expenses decreased $369,000 to $639,000. Conversely, FDIC insurance expense increased $400,000 to $425,000, due to a revision of the FDIC insurance assessment process. Income Taxes For the nine months ended September 30, 2007 the Company recorded a provision for income taxes of $286,000 versus a benefit for income taxes of $805,000 for the nine months ended 2006. The shift to provision for income taxes from benefit for income taxes was driven by a $2,682,000 improvement in pre-tax income. Deferred tax assets are evaluated to determine whether it is "more likely than not" that a tax return benefit would be realized when the deferred items reverse. Evaluation considerations include the availability of historical and projected taxable income to offset the deferred items in the periods they are expected to reverse. While the recent trend of operating losses increases the likelihood that such taxable income may not occur in the future, management has determined that operational changes which have been made and are being made will generate sufficient income to allow for the recognition of the deferred tax assets. No valuation reserve was recorded as of September 30, 2007 or December 31, 2006. The effective tax rate of 68% for the nine month period reflects the fact that the costs of implementing the process to reclassify common stockholders are not deductible for income tax purposes. These non-deductible reclassification expenses represent a significant portion of pretax income. Asset/Liability Management A principal operating objective of the Bank is to produce stable earnings by achieving a favorable interest rate spread that can be sustained during fluctuations in prevailing interest rates. Since the Bank's principal interest-earning assets generally have longer terms to maturity than its primary source of funds, i.e., deposit liabilities, increases in general interest rates will generally result in an increase in the Bank's cost of funds before the yield on its asset portfolio adjusts upward. A continual trade-off, which is managed and monitored on an ongoing basis, exists between exposure to interest rate risk and current income. In general, during periods with a normalized yield curve, a wider mismatch between the re-pricing periods of interest rate sensitive assets and liabilities can produce higher current net interest income. The management of interest rate risk considers several factors, including, but not limited to, the nature and extent of actual and anticipated embedded options and other attributes of the balance sheet, the perceived direction of market interest rates, and the risk appetite of management and the Asset/Liability Management Committee ("ALCO"). Members of the ALCO consist of the chief 21 executive officer, the chief financial officer, the senior loan officer, the SVP of Operations and IT and the SVP of Retail Banking, one board member and others. The Committee discusses the asset/liability mix on the balance sheet and reviews exposures to changes in interest rates. Certain retail strategies were implemented in 2006 to generate deposit growth, particularly in new markets. As a result of significant new deposit funds, the Bank was able to pay down Federal Home Loan Bank (FHLB) advances and improve the Bank's liquidity position. The principal strategies management utilizes to manage interest rate risk with respect to the loan portfolio is associated with pricing and structure. Although loans originated at relative low points in the interest rate cycle produce lower short-term yields than those originated at higher points in the rate cycle, prepayments into low rates occur more rapidly on higher rate loans as the incentive to refinance is apparent. The Company has not positioned itself as a market leader with respect to pricing long-term fixed-rate residential mortgages in the current environment. However, the Company has and will continue to originate fixed-rate loans for its portfolio in order to serve its customers, preferring ten or fifteen year final maturities. Additional strategies employed to mitigate loan interest rate risk in this environment include targeting shorter amortization periods, increasing the frequency of interest rate resets or shortening the period of time until the first interest rate reset date, and encouraging the origination of floating rate loans. On an ongoing basis, management analyzes the pros and cons of positioning with a narrower or wider interest rate mismatch and whether an asset sensitive or liability sensitive balance sheet is targeted and to what degree. This analysis considers, but is not limited to, originating adjustable- and fixed-rate mortgage loans, managing the cost and structure of deposits, analyzing actual and projected asset cash flow, considering the trade-offs of short versus long-term borrowings, and reviewing the pros and cons of certain investment security sectors. The Company primarily relies upon the investment securities portfolio to balance the interest rate risks produced by retail loan and deposit activity. The interest rate risk of the balance sheet in varying interest rate scenarios has been reduced over the past several quarters as management has positioned the net interest income stream for reduced volatility regardless of the direction of interest rates. On a quarterly basis, an outside advisor performs financial modeling of the balance sheet using certain industry data assumptions. The output from the models, which project the Company's financial performance over certain periods under certain interest rate environments, are reviewed and analyzed as a basis for targeting certain product structures in the future, as well as commenting on pricing decisions in order to encourage or discourage customer choices. While Management is currently pleased with the interest rate sensitivity position of the Bank, there is no guarantee that the Bank will be able to continue to generate low cost deposits and gather high yielding assets. Liquidity and Capital Resources The Bank's primary sources of funds consist of deposits, borrowings, repayment and prepayment of loans and investment securities, sales of securities, maturities and early calls of securities, and funds provided from operations. While scheduled repayments of loans and investment securities are predictable sources of funds, prepayments on loans and investment securities as well as other behavioral variables on certain other balance sheet components are not predictable with certainty. For example, the general level of interest rates, economic conditions, and competition largely influence prepayments on loans and investment securities and the renewal rate on term deposits. The Bank primarily uses its liquidity resources to fund existing and future loan commitments, to fund net deposit outflows, to invest in other interest-earning assets, and to maintain liquidity. . The Bank liquidity contingency plan calls for the Bank to manage loan originations and the level of the investment portfolio as well as Federal Home Loan Bank of Boston (the "FHLBB") advance availability so that deposit flows can be accommodated. 22 The Bank utilizes advances from the "FHLBB" primarily in connection with its management of the interest rate sensitivity of its assets and liabilities, to complement or supplement the volume of retail funding, as well as to selectively capitalize on leverage opportunities. Total advances outstanding at September 30, 2007 amounted to $20.8 million. The Bank's ability to borrow from the FHLBB is dependent upon the amount and type of collateral the Bank has to secure the borrowings. Such collateral consists of, but is not limited to, one-to-four family owner-occupied residential mortgage loans and occupied residential mortgage loans and government-sponsored enterprise obligations. As of September 30, 2007, the Bank's total borrowing capacity through the FHLBB was $33.0 million. The Bank has additional capacity to borrow through such instruments as repurchase agreements utilizing federal agency obligations and mortgage-backed securities as collateral, as well as brokered deposits. The Formal Agreement does require that the Bank get permission of the OCC and FDIC prior to accepting brokered deposits. A major portion of the Bank's liquidity consists of cash and cash equivalents, short-term investments, government-sponsored enterprise and federal agency obligations, mortgage-backed securities, and other debt securities. The level of these assets is dependent upon the Bank's operating, lending, and financing activities during any given period. On a monthly basis, the Bank currently generates an average of approximately $1.4 million in cash flow from the loan and investment securities portfolios. These funds are primarily used to either re-invest in new loans and investment securities or utilized in conjunction with the management of the level of deposit balances or borrowed funds. The Bank signed a Formal Agreement with the Office of the Comptroller of the Currency on June 28, 2006. The Agreement required the Bank to take various actions including raising capital ratios to levels prescribed in the Agreement. Specifically the Bank was required, by December 31, 2006, to raise its Tier 1 capital to average assets ratio to a minimum of 8%, its Tier 1 capital to risk-weighted assets ratio to a minimum of 10%, and its total capital to risk-weighted assets to a minimum of 11%. As of December 31, 2006, the Bank did not attain these ratios. Subsequently, the OCC extended the deadline to achieve the capital ratios until March 31, 2007. The Bank exceeded at February 28, 2007 and continues to exceed the minimum ratios, as listed in the Formal Agreement. At September 30, 2007, Bancorp had $123,000 of cash on hand. Projected interest payments due in October, 2007 on Bancorp's subordinated debentures will deplete its level of cash on hand at September 30, 2007. The Bank intends to get a loan from a third party; the proceeds of the loan will be used to pay the interest on the subordinated debentures. The Bank needs to borrow at least $750,000 to cover interest payments on the subordinated debentures through September 30, 2008. Neither the third party nor the terms of the loan have been finalized. At September 30, 2007, the Bank and the Company exceed all regulatory capital requirements applicable to them. The table below presents the capital ratios at September 30, 2007, for the Bank and Bancorp, as well as the minimum regulatory requirements. 23
Minimum Capital Statutory Minimum Requirements Actual Capital Requirements Per OCC ------------------- --------------------- -------------------- Amount Ratio Amount Ratio Amount Ratio --------- -------- ---------- ------- --------- -------- (Dollars in thousands) Bank: Total capital to risk-weighted assets $ 28,603 13.4% $ 17,059 8.0% $ 23,456 11.0% Tier 1 capital to risk-weighted assets 27,066 12.7 8,530 4.0 21,324 10.0 Tier 1 capital to average assets 27,066 9.4 11,581 4.0 23,162 8.0 Consolidated: Total capital to risk-weighted assets $ 29,748 13.9% $ 17,113 8.0% N/A N/A Tier 1 capital to risk-weighted assets 21,891 10.2 8,557 4.0 N/A N/A Tier 1 capital to average assets 21,891 7.5 11,608 4.0 N/A N/A
Off-Balance Sheet Arrangements The Company is a party to financial instruments with off-balance sheet risk in the normal course of business primarily associated with meeting the financing needs of our customers. We may also enter into off-balance sheet strategies to manage the interest rate risk profile of the Company. Loan commitments and all other off-balance sheet instruments involve, to varying degrees, elements of credit, interest rate, and liquidity risk. Lending commitments include commitments to originate loans and to fund unused lines of credit. The Bank evaluates each customer's creditworthiness on a case-by-case basis. At September 30, 2007, the Bank had $1.5 million of outstanding commitments to originate loans and $32.9 million of unused lines of credit. The Bank anticipates that it will have sufficient funds available to meet these commitments, though some commitments may expire and many unused lines are not drawn upon. Business Risks The Bank is subject to a Formal Agreement with the OCC. The Bank is subject to a Formal Agreement dated June 28, 2006 with the OCC. The direct costs of compliance include legal and consulting fees, higher FDIC insurance rates, and staffing costs, which all decrease earnings and reduce the capital base. Other costs include significant dedication of resources that shift the focus of the organization away from growing the customer base to ensuring that heightened regulatory demands are satisfied. The agreement requires the Bank to obtain approval from the OCC prior to paying dividends and restricts the ability of the Bank to pursue certain growth opportunities. In addition, it requires the Bank to maintain higher levels of capital than other financial institutions without similar regulatory issues. The Bank has achieved the initial requirements of the agreement, including achieving higher capital ratios (which were achieved on February 28, 2007). The principal initial requirements were that the Board would achieve higher capital ratios as part of a new three-year capital program, retain competent management, develop a new three-year strategic plan, adopt a new interest rate management plan, improve liquidity, and establish a Compliance Committee. The Board is required to ensure adherence on an ongoing basis to the three-year strategic and capital plans and to perform its other obligations under the agreement. The failure of the Board to ensure such adherence or perform such obligations could result in further regulatory actions by the OCC, which would have a materially adverse financial effect on the Bank and the Company. 24 The value of goodwill and other intangible assets may need to be written down. The Company recorded goodwill and other intangible assets at the time of purchase of The de Burlo Group and the Boston branch. A substantial portion of the purchase price of the investment management company was allocated to goodwill and other intangible assets. If we determine that goodwill or other intangible assets are impaired at a future date, we will have to record a write-down of value through the Company's income statement. Our expansion into the investment management business poses several risks. We may not be able to retain existing investment management clients, nor attract new ones. Lack of new clients or the loss of existing clients could reduce the fee income generated from this business. In addition, the business acquired generates more than 50% of its revenue from five Massachusetts municipal pension funds. The loss of these clients would materially reduce fee income. We may not be able to indefinitely retain existing investment management personnel. Loss of key personnel could negatively impact customer retention or growth due to the high orientation of retention with customer knowledge and customer service in this industry. Our current loan quality and historical loan growth may not continue, particularly in new markets or with the loans acquired with the Boston branch. While the Bank has shown a very low level of loan charge-offs and non-accrual loans in recent years, there can be no assurance that these favorable results will continue in the future. Credit quality standards may change, substantial growth may weaken underwriting or other controls, or new customers or relationships may not perform as expected. Despite our due diligence on the Boston branch portfolio, there is a risk that loan quality may deteriorate as we did not perform the original underwriting. If our allowance for loan losses is not sufficient to cover actual loan losses, our earnings would decrease. In an attempt to mitigate any loan losses we may incur, we maintain an allowance for loan losses based on, among other things, national and regional economic conditions, historical loss experience and delinquency trends among loan types. However, we cannot predict loan losses with certainty and we cannot assure you that charge offs in future periods will not exceed the allowance for loan losses. In addition, regulatory agencies, as an integral part of their examination process, review our allowance for loan losses and may require additions to the allowance based on their judgment about information available to them at the time of their examination. Factors that require an increase in our allowance for loan losses could reduce our earnings. Economic or other external factors, deterioration in credit quality, or appropriate changes in the reserve estimation process as a result of changes in assumptions, as well as other possible factors, may cause the loan loss allowance to be increased through charges to current earnings by increasing the loan loss provision. Despite our due diligence on the Boston branch portfolio, there is a risk that loan quality may deteriorate as these loans are to customers we do not know, nor did we perform the original underwriting. As Bancorp operates in its new geographic loan footprint, including Boston, Massachusetts and Portsmouth, New Hampshire, and hires new commercial lenders, the maintenance of high credit quality and continued growth in loan balances is not assured. We have acquired an investment management business, purchased a new branch in a non-contiguous market, and opened a branch in a non-contiguous market. Revenue growth may not meet our expectations in one or more of these areas, while expenses have already been incurred and expense commitments for the future have been made. Entering into new markets and new lines of businesses with limited or no experience or pre-existing business presence poses an inherent risk. 25 Due to competitive conditions, market conditions, and other factors, growth in deposit balances, loan balances, or investment management revenues may not be in accordance with expectations and thus revenue may not support future growth or an increase in shareholder value. Operating results are also significantly impacted by factors beyond management's control such as interest rate conditions and general economic conditions; in particular the general level of interest rates and the resultant impact on asset yields and the cost of funds, as well as the ability and willingness of borrowers to fulfill their debt obligations during various economic cycles. If we are unable to significantly increase revenue and decrease expenses, our earnings may not improve to the extent necessary to permit access to capital or to avoid increased regulatory scrutiny. The Company initiated a strategic plan in the third quarter of 2006 to address the concerns for poor profitability. Initiatives to improve revenues and/or reduce expenses may not be successful in improving the Company's profitability. Poor profitability may impact the Company's ability to retain or attract customers and key management personnel. Loss of key management personnel may result in the delay or cancellation of plans or strategies under consideration, increased expenses, operational inefficiencies, or lost revenue. We may not be successful in leasing the suburban office space vacated by the Bank as part of the implementation of the strategic plan, on the terms or lease-up ratio we anticipate. Lower than anticipated rental income from these locations may reduce our net income. We may not be able to attract new deposit customers in new markets or retain existing deposit customers. We have opened new branches in non-contiguous markets that are presently served by other financial institutions. We may not be successful in generating revenue by raising deposits and originating loans to offset the initial and ongoing expense of operating these new locations due to lack of recognition of our name, loyalty to existing banks, or other competitive or market factors. Bancorp anticipates, although cannot assure, that a significant portion of new customers obtained from its premium-rate term deposit specials will remain customers for the indefinite future and avail themselves of additional bank products and services. Our business may be negatively impacted if we are unable to retain new customers with market-priced deposit products or cross-sell loan and investment products. Management anticipates, but cannot assure, that continued focus on growth in core deposit categories will generate sufficient growth in targeted deposit categories and continued growth in deposit fee income. Bancorp is hopeful that solid growth will occur in all core deposit categories, particularly in new markets. Growth cannot be assured, however, particularly during a period whereby consumers may perceive more value in other investment options. The inability to grow deposits ultimately limits asset growth. Our capital and expense budgets may limit our ability to compete with larger financial institutions. Our current and future earnings, in addition to our capital, may not allow us to compete with other institutions with regards to pricing deposits, pricing loans, investing in new technologies, or investing in new initiatives. Our growth and future earnings may be limited if we are unable to keep pace with rapid technological innovation or if we are unable to compete with marketing and promotional expense budgets of our larger competitors. 26 Banking is a highly regulated industry and restrictions, limitations, or new laws could impact our business Several non-banking competitors are not subject to strict lending and deposit disclosure laws that impact national banks. Our commitment to compliance with laws and regulations and the cost to do so could impact the decision of customers to seek our banking services or our ability to devote sufficient attention to business development as opposed to consumer compliance. Bancorp is subject to review and oversight of several governmental regulatory agencies. Such agencies impose certain guidelines and restrictions, such as capital requirement and lending limits that may impact our ability to compete with other financial service providers who may not be subject to these restrictions. New laws or changes in existing laws may limit the ability to expand or enter into new businesses that otherwise may be available to other financial service providers. The Bank has entered into an agreement with its primary regulator, the Office of the Comptroller of the Currency. The Bank has achieved all of the major requirements of the Agreement, including capital ratio requirements which were exceeded in February 2007. The agreement calls for on-going compliance with the Agreement terms. While management will diligently attempt to maintain compliance with the terms of the Agreement, it is possible that circumstances might arise which would make the Bank no longer in compliance with the Agreement. Further regulatory action could result in further limitations being imposed upon the Bank. Implementation of Sarbanes-Oxley Section 404 The regulations implementing Section 404 of the Sarbanes-Oxley Act of 2002 (SOX 404) will require us to provide our assessment of the effectiveness of our internal control over financial reporting beginning with our Annual Report on Form 10-KSB for the fiscal year ending December 31, 2007. Our independent auditors will be required to confirm in writing whether our assessment of the effectiveness of our internal control over financial reporting is fairly stated in all material respects, and separately report on whether they believe we maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008. We believe that we currently have adequate controls over financial reporting and that any weakness identified in our internal controls will not be material. We cannot assure you that we will not discover material weaknesses in our internal controls. We also cannot assure you that we will complete the process of our evaluation and the auditors' attestation on time. If a material weakness is discovered, corrective action may be time consuming, costly and further divert the attention of management and its resources. The disclosure of a material weakness, even if quickly remedied, could reduce the market's confidence in our financial statements and lower the stock price, especially if a restatement of financial statements for past periods were to be necessary. The Company has not started to implement SOX 404. The Company anticipates that stockholders will approve a reclassification plan which will allow the Company to suspend its reporting requirements with the Securities and Exchange Commission (the "SEC"). If the reclassification plan is not effective before December 31, 2007, the Company will not be prepared to comply with the requirements of SOX 404. 27 The Bancorp is dependent upon the Bank for cash to pay interest on subordinated debentures. The Bancorp raised capital by issuing trust preferred stock which is supported by subordinated debentures. The Bancorp's primary source of cash to pay the interest on the subordinated debentures is dividends from the Bank. The Agreement with the OCC requires that the OCC grant approval prior to the Bank declaring dividends to its parent, Bancorp. The OCC currently withholds permission from the Bank to pay a dividend. If the OCC does not permit the Bank to make a dividend payment aggregating approximately $250,000, Bancorp may be forced to elect to defer interest payments on the subordinated debentures during December 2007 and January 2008 unless an alternative source of cash is identified. Currently, management is evaluating several options to help address the projected short-fall of cash at the Bancorp. No assurance can be given that the OCC will approve future dividends to the Bancorp. The Bancorp had $123,000 of cash on hand at September 30, 2007. This amount is sufficient to make interest payments on subordinated debentures, at current prevailing rates, through October 31, 2007. The Bank intends to get a loan from a third party; the proceeds of the loan will be used to pay the interest on the subordinated debentures. The Bank will need to borrow at least $750,000 to cover interest payments on the subordinated debentures through September 30, 2008. Neither the third party nor the terms of the loan have been finalized. The interest rate environment may reduce our earnings or liquidity or Bancorp may not respond sufficiently to changes in interest rates or other factors impacting the business Changes in the interest rate environment may have a significant impact on the future earnings and liquidity of Bancorp. If interest rates rise or the yield curve remains flat, net interest income may narrow further. Liquidity could be reduced in the future if customers choose other investment options in an improving economy. Liquidity could also be negatively impacted if current strategies to increase deposit balances in several new locations do not occur as planned due to competitive or other factors. Although we may be successful raising deposits in certain markets, we may have to pay higher than planned rates on these deposits to do so. An increase in market interest rates, continued competition from several local and national financial institutions, and increased reliance on higher cost funding sources could also cause higher rates paid on deposits without an equal or greater increase on yield on new loans. Bancorp assesses its interest rate risk and liquidity needs frequently, however, there is no assurance that its assessments result in appropriate actions on a timely basis or that interest rates do not change rapidly without corrective actions. Bancorp maintains its entire portfolio of long-term fixed rate loans on its books and is thus susceptible to interest rate risk in the event of a higher rate environment to the extent the prepayment activity on these loans falls, while the cost of funds increases. To the extent longer-term fixed rate loans are being held on the books at historic lows in a protracted low interest rate environment, it is important that growth in longer-term checking and savings balances occurs in several markets. Bancorp has had some success in increasing the level of adjustable rate loans and loans with shorter amortization periods or maturity dates, but has had little success in extending the terms of it deposits. These trends may reduce net interest income in the future. Given the strong emphasis on generating new loans, the risk exists that loan demand could place a strain on liquidity. Bancorp may have to slow its pace of new loan approvals and thus may generate less interest income. The Company's information systems may experience an interruption or breach in security. We rely heavily on technology and information systems to conduct our business. Any failure, interruption or breach in security of these systems could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems. While we have policies and 28 procedures designed to prevent or limit the effect of the failure, interruption or security breach of our systems, there can be no assurance that any such failures, interruptions or security breaches will not occur. The occurrence of any failures, interruptions or security breaches could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, any of which could have a material adverse effect on our financial condition and results of operations. The Bancorp may require additional capital in the future, but that capital may not be available when it is needed. Bancorp and the Bank are required by Federal regulatory authorities to maintain adequate levels of capital to support their operations. The Company may at some point want or need to raise additional capital to comply with regulatory requirements, including requirements under the Bank's agreement with the OCC, or to support growth. Bancorp's ability to raise additional capital, if needed, will depend on conditions in the capital markets at that time, which are outside Bancorp's control, and on its financial performance. Accordingly, Bancorp cannot assure an investor of its ability to raise additional capital if needed or on terms acceptable to Bancorp. The Bancorp's inability to file audited financial statements for the Boston branch of Atlantic Bank may impair the Company's ability to raise capital. Typical of the banking industry, Bancorp is unable to obtain audited financial statements of a retail branch. Under SEC rules, Bancorp may be unable, until early 2008, to raise capital through a public offering or a private offering to unaccredited investors without having filed audited financial statements for the Boston branch. The Company may raise capital through a private offering of its securities to accredited investors. Stockholders' ability to sell your shares of common stock at the times and in the amounts they desire may be limited. Although our common stock is listed for trading on the Over-the-Counter Bulletin Board, the trading volume in our common stock is thin and average daily volumes are much lower than those of other larger financial services companies. We are not listed on the NASDAQ or any other securities exchange. While there are investment securities brokers/dealers who make a market in our common stock, there is no active trading market for our common stock and thus stockholders may not be able to sell the shares of common stock that they own at the times and in the amounts they would otherwise like to. Our directors and executive officers beneficially own a significant portion of our common stock. At September 30, 2007 our directors and executive officers beneficially owned 48.1% of our common stock. As a result, such stockholders would most likely control the outcome of corporate actions requiring shareholder approval, including the election of directors and the approval of significant corporate transactions, such as a merger or sale of all or substantially all of our assets. We can provide no assurance that the investment objectives of such stockholders will be the same as our other stockholders. ITEM 3. Controls and Procedures (a) Evaluation of disclosure controls and procedures. As required by Rule 15d-15 under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), the Company's management conducted an evaluation with the participation of the Company's Chief Executive Officer and Chief Financial Officer, regarding the effectiveness of the Company's disclosure controls and procedures, as of the end of the last fiscal quarter. In designing and evaluating the Company's disclosure controls and procedures, the Company and 29 its management recognize that any controls and procedures, no matter how well designed and operated, can provide only a reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating and implementing possible controls and procedures. Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that they believe the Company's disclosure controls and procedures are reasonably effective to ensure that information required to be disclosed by the Company in the reports it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC rules and forms. We intend to continue to review and document our disclosure controls and procedures, including our internal controls and procedures for financial reporting, and we may from time to time make changes to the disclosure controls and procedures to enhance their effectiveness and to ensure that our systems evolve with our business. (b) Changes in internal controls over financial reporting. There were no changes in the Company's internal controls over financial reporting identified in connection with the Company's evaluation of its disclosure controls and procedures that occurred during the Company's last fiscal quarter that have materially affected, or are reasonably likely to materially affect the Company's internal control over financial reporting. PART II -- OTHER INFORMATION ITEM 1. Legal Proceedings There have been no material changes in legal proceedings from the information provided in Item 3, "Legal Proceedings" of the Company's Annual Report on Form 10-KSB for the year ended December 31, 2006. ITEM 2. Unregistered Sales of Equity Securities and Use of Proceeds Not applicable. ITEM 3. Defaults Upon Senior Securities Not applicable. ITEM 4. Submission of Matters to a Vote of Security Holders Not applicable ITEM 5. Other Information Not applicable. 30 ITEM 6. Exhibits (a) Exhibits 20.1 Letter to Shareholders from Russell G. Cole, President and Chief Executive Officer, incorporated by reference to Exhibit 20.1 to the Company's Form 8-K filed with the SEC on September 11, 2007. 31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934. 31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934. 32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. 32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. SIGNATURES In accordance with the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized. FIRST IPSWICH BANCORP Date: November 2, 2007 By: /s/ Russell G. Cole ---------------------- Russell G. Cole President and Chief Executive Officer Date: November 2, 2007 By: /s/ Timothy L. Felter ---------------------- Timothy L. Felter Senior Vice President, Chief Financial Officer, and Treasurer 31 EX-31.1 2 ex31-1.txt Exhibit 31.1 CERTIFICATIONS I, Russell G. Cole, hereby certify that: (1) I have reviewed this quarterly report on Form 10-QSB of First Ipswich Bancorp; (2) Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; (3) Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the small business issuer as of, and for, the periods presented in this quarterly report; (4) The small business issuer's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the small business issuer and we have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the small business issuer, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) Evaluated the effectiveness of the small business issuer's disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this quarterly report based on such evaluation; and c) Disclosed in this quarterly report any change in the small business issuer's internal control over financial reporting that occurred during the small business issuer's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the small business issuer's internal control over financial reporting; and (5) The small business issuer's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the small business issuer's auditors and the audit committee of the small business issuer's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the small business issuer's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the small business issuer's internal control over financial reporting. /s/ Russell G. Cole - ------------------- Russell G. Cole Chief Executive Officer November 2, 2007 EX-31.2 3 ex31-2.txt Exhibit 31.2 CERTIFICATIONS I, Timothy L. Felter, hereby certify that: (1) I have reviewed this quarterly report on Form 10-QSB of First Ipswich Bancorp; (2) Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report; (3) Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the small business issuer as of, and for, the periods presented in this quarterly report; (4) The small business issuer's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the small business issuer and we have: a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the small business issuer, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared; b) Evaluated the effectiveness of the small business issuer's disclosure controls and procedures and presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this quarterly report based on such evaluation; and c) Disclosed in this quarterly report any change in the small business issuer's internal control over financial reporting that occurred during the small business issuer's most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the small business issuer's internal control over financial reporting; and (5) The small business issuer's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the small business issuer's auditors and the audit committee of the small business issuer's board of directors (or persons performing the equivalent functions): a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the small business issuer's ability to record, process, summarize and report financial information; and b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the small business issuer's internal control over financial reporting. /s/ Timothy L. Felter - --------------------- Timothy L. Felter Chief Financial Officer November 2, 2007 EX-32.1 4 ex32-1.txt Exhibit 32.1 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of First Ipswich Bancorp (the "Company") on Form 10-QSB for the quarter ended September 30, 2007 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Russell G. Cole, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. This certification is provided solely pursuant to 18 U.S.C. Section 1350 and Item 601(b)(32) of Regulation S-B ("Item 601(b)(32)") promulgated under the Securities Act of 1933 (the "Securities Act") and the Securities Exchange Act of 1934 (the "Exchange Act"). In accordance with clause (ii) of Item 601(b)(32), this certification (A) shall not be deemed "filed" for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, and (B) shall not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the Company specifically incorporates it by reference. /s/ Russell G. Cole - ------------------- Russell G. Cole Chief Executive Officer November 2, 2007 EX-32.2 5 ex32-2.txt Exhibit 32.2 CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 In connection with the Quarterly Report of First Ipswich Bancorp (the "Company") on Form 10-QSB for the quarter ended September 30, 2007 as filed with the Securities and Exchange Commission on the date hereof (the "Report"), I, Timothy L. Felter, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that: (1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. This certification is provided solely pursuant to 18 U.S.C. Section 1350 and Item 601(b)(32) of Regulation S-B ("Item 601(b)(32)") promulgated under the Securities Act of 1933 (the "Securities Act") and the Securities Exchange Act of 1934 (the "Exchange Act"). In accordance with clause (ii) of Item 601(b)(32), this certification (A) shall not be deemed "filed" for purposes of Section 18 of the Exchange Act, or otherwise subject to the liability of that section, and (B) shall not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the Company specifically incorporates it by reference. /s/ Timothy L. Felter - --------------------- Timothy L. Felter Chief Financial Officer November 2, 2007 -----END PRIVACY-ENHANCED MESSAGE-----