===============================================================================
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-K
[X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange
Act of 1934. For the fiscal year ended December 31, 2003
[ ] Transition Report Pursuant to Section 13 or 15(d) of the Securities
Exchange Act of 1934
Commission File Number 000-23129
NORTHWAY FINANCIAL, INC.
(Exact name of registrant as specified in its charter)
New Hampshire 04-3368579
------------- ----------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
9 Main Street
Berlin, New Hampshire 03570
--------------------- -----
Address of principal executive offices (Zip Code)
(603) 752-1171 (Registrant's
telephone number, including area code)
Securities Registered Pursuant to Section 12(b) of the Act:
None
Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, Par Value $1.00
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding twelve 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 ninety days. YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to
Item 405 of Regulation S-K is not contained herein, and will not be contained,
to the best of registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Exchange Act Rule 12b-2). YES [ ] NO [X]
The number of shares of voting and nonvoting common stock, par value
$1.00 per share, held by nonaffiliates of the registrant as of June 30, 2003
was 1,291,891 shares with an aggregate market value, computed by reference to
the last reported sales price on the NASDAQ National Market on such date, of
$38,550,027. Although directors and executive officers of the registrant were
assumed to be "affiliates" of the registrant for purposes of this calculation,
this classification is not to be interpreted as an admission of such status.
At March 24, 2004, there were 1,499,574 shares of common stock
outstanding, par value $1.00 per share.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant's proxy statement for its 2004 Annual Meeting of
Stockholders are incorporated by reference in Items 10, 11, 12, 13 and 14 of
Part III.
===============================================================================
NORTHWAY FINANCIAL, INC.
2003 FORM 10-K ANNUAL REPORT
TABLE OF CONTENTS
PART I
ITEM 1 Business ...................................................... 1
ITEM 2 Properties .................................................... 10
ITEM 3 Legal Proceedings ............................................. 11
ITEM 4 Submission of Matters to a Vote of Security Holders ........... 11
PART II
ITEM 5 Market for Registrant's Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities ............. 11
ITEM 6 Selected Financial Data ....................................... 12
ITEM 7 Management's Discussion and Analysis of Financial Condition
and Results of Operations ..................................... 13
ITEM 7A Quantitative and Qualitative Disclosures About Market Risk .... 27
ITEM 8 Financial Statements and Supplementary Data ................... 28
ITEM 9 Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure ...................................... 59
ITEM 9A Controls and Prcedures ........................................ 59
PART III
ITEM 10 Directors and Executive Officers of the Registrant ............ 59
ITEM 11 Executive Compensation ........................................ 59
ITEM 12 Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters .................... 59
ITEM 13 Certain Relationships and Related Transactions ................ 60
ITEM 14 Principal Accountant Fees and Services ........................ 60
ITEM 15 Exhibits, Financial Statement Schedules and Reports on
Form 8-K ...................................................... 60
Signatures ................................................ 61
FORWARD-LOOKING STATEMENTS
Certain statements in this report are "forward-looking statements" within the
meaning of the Private Securities Litigation Reform Act of 1995. Such
forward-looking statements may include, but are not limited to, projections of
revenue, income or loss, plans for future operations and acquisitions,
projections based on assumptions regarding market and liquidity risk, and plans
related to products or services of Northway Financial, Inc. and its
subsidiaries (the "Company", see description of business below). Such
forward-looking statements are subject to known and unknown risks,
uncertainties and contingencies, many of which are beyond the control of the
Company. To the extent any such risks, uncertainties and contingencies are
realized, the Company's actual results, performance or achievements could
differ materially from anticipated results, performance or achievements.
Factors that might affect such forward-looking statements include, among other
factors, the factors described under the caption "Risk Factors" in Item 1 of
this report, overall economic and business conditions, economic and business
conditions in the Company's market areas, interest rate fluctuations, the
demand for the Company's products and services, competitive factors in the
industries in which the Company competes, changes in government regulations,
and the timing, impact and other uncertainties of future acquisitions.
In addition to the factors described above, the following are some additional
factors that could cause our financial performance to differ from any
forward-looking statement contained herein: i) the current economic downturn
nationwide and regionally; ii) changes in interest rates over the past year and
the relative relationship between the various interest rate indices that the
Company uses; iii) a determination in the financial market affecting the
valuation of securities held in the Company's investment portfolio; (iv) a
change in product mix attributable to changing interest rates, customer
preferences or competition; v) a significant portion of the Company's loan
customers are in the hospitality business and therefore could be affected by a
slower economy, adverse weather conditions and/or rising gasoline prices; and
vi) the effectiveness of advertising, marketing and promotional programs.
The words "believe," "expect," "anticipate," "intend," "estimate," "project" or
the negative of such terms and other similar expressions which are predications
of or indicate future events and trends and which do not relate to historical
matters identify forward-looking statements. Reliance should not be placed on
forward-looking statements because they involve known or unknown risks,
uncertainties or other factors, which may cause the actual results, performance
or achievements of the Company to differ materially from anticipated future
results, performance or achievements expressed or implied by such
forward-looking statements. The Company expressly disclaims any obligation to
publicly update or revise any forward-looking statement, whether as a result of
new information, future events or otherwise.
Though the Company has attempted to list comprehensively the factors which
might affect forward-looking statements, the Company wishes to caution you that
other factors may in the future prove to be important in affecting the
Company's results of operations. New factors emerge from time to time and it is
not possible for management to anticipate all of such factors, nor can it
assess the impact of each such factor, or combination of factors, which may
cause actual results to differ materially from forward-looking statements.
PART 1
ITEM 1. BUSINESS
DESCRIPTION OF BUSINESS
Northway Financial, Inc. (the "Company") was incorporated on March 7, 1997,
under the laws of the State of New Hampshire, for the purpose of becoming the
holding company of The Berlin City Bank, a New Hampshire chartered bank
headquartered in Berlin, New Hampshire ("BCB"), pursuant to a reorganization
transaction (the "BCB Reorganization") by and among the Company, BCB, and a
subsidiary of BCB, and, thereafter, effecting the merger (the "Merger") by and
among the Company, BCB, Pemi Bancorp, Inc. ("PEMI"), and PEMI's wholly owned
subsidiary, The Pemigewasset National Bank of Plymouth, New Hampshire, a
national bank headquartered in Plymouth, New Hampshire ("PNB"). The BCB
Reorganization and the Merger became effective on September 30, 1997. As of
such date, BCB and PNB (collectively the "Banks"), became wholly owned
subsidiaries of the Company. Unless the context otherwise requires, references
herein to the "Company" include Northway Financial, Inc. and its consolidated
subsidiaries.
The Company derives substantially all of its revenue and income from the
furnishing of bank and bank-related services, principally to individuals and
small and medium sized companies in New Hampshire. BCB and PNB operate as
typical community banking institutions and do not engage in any specialized
finance or capital market activities. The Company functions primarily as the
holder of stock of its subsidiaries and assists the management of its
subsidiaries as appropriate.
The Company is subject to regulation by the New Hampshire Bank Commissioner
(the "Commissioner"), the Federal Deposit Insurance Corporation (the "FDIC"),
the Comptroller of the Currency of the United States (the "OCC"), and the Board
of Governors of the Federal Reserve System. See "Supervision and Regulation."
BCB, which was first organized in 1891, and PNB, which was first organized in
1881, are engaged in a general commercial banking business and offer commercial
and construction loans, real estate mortgages, consumer loans, including
personal secured and unsecured loans, and lines of credit. During 1998, the
Company, through the BCB subsidiary, established an indirect lending business
unit in Concord, New Hampshire. The unit has substantially increased the volume
of secured consumer installment loans originated for the Banks and for sale to
third parties. The Banks accept savings, time, demand, NOW and money market
deposit accounts, and offer a variety of banking services including safe
deposit boxes, credit card accounts, official checks and money orders,
overdraft lines of credit and wire transfer services.
The Company is a legal entity separate and distinct from its subsidiaries. The
right of the Company to participate in any distribution of assets or earnings
of any subsidiary is subject to the prior claims of creditors of the
subsidiary, except to the extent that claims, if any, of the Company itself as
a creditor may be recognized. See "Supervision and Regulation".
The following information concerning the Company's investment activities,
lending activities, asset quality and allowance for loan losses should be read
in conjunction with "Management's Discussion and Analysis of Financial
Condition and Results of Operations," appearing under Item 7 of this report and
the Company's Consolidated Financial Statements and Notes thereto.
INVESTMENT ACTIVITIES
The following table presents the carrying amount of the Company's securities
available-for-sale as of December 31, 2003, 2002 and 2001 (dollars in
thousands):
2003 2002 2001
------- ------- -------
US Treasury and other
US government agency securities $37,840 $36,188 $10,977
Mortgage-backed securities(1) 2,903 12,646 21,097
Marketable equity securities 2,766 2,377 3,255
Corporate bonds 21,983 33,848 14,230
State and political subdivision bonds
and notes 8,224 6,338 6,005
------- ------- -------
Total securities $73,716 $91,397 $55,564
======= ======= =======
(1) Includes collateralized mortgage obligations
The following table sets forth the amortized cost of the Company's investment
in debt securities maturing within stated periods and their related weighted
average yields, reported on a tax equivalent basis, as of December 31, 2003
(dollars in thousands):
Maturities
-----------------------------------------------------
One to Five to Over Total
Within five ten ten amortized
one year years years years cost
-------- -------- --------- ------- ---------
Available-for-sale:
US Treasury and other
US government agency
securities $ - $25,023 $12,922 $ - $37,945
Mortgage-backed
securities (1) 62 1,090 1,220 446 2,818
Corporate bonds 1,805 14,584 4,468 - 20,857
State and political
subdivision bonds and
notes 196 220 3,274 4,376 8,066
------ ------- ------- ------ -------
Total amortized cost $2,063 $40,917 $21,884 $4,822 $69,686
====== ======= ======= ====== =======
Market value $2,097 $41,828 $22,177 $4,848 $70,950
====== ======= ======= ====== =======
Weighted average yield 5.44% 4.48% 4.96% 7.44% 4.86%
(1) Includes collateralized mortgage obligations
LENDING ACTIVITIES
The following table sets forth information with respect to the composition of
the Company's loan portfolio, excluding loans held for sale, as of December 31,
2003, 2002, 2001, 2000 and 1999 (dollars in thousands):
December 31,
----------------------------------------------------
2003 2002 2001 2000 1999
---- ---- ---- ---- ----
Real estate:
Residential $129,493 $114,526 $109,261 $129,805 $139,389
Commercial 120,366 111,941 111,642 100,608 93,061
Construction 3,851 6,330 1,581 5,752 4,360
Commercial 24,528 23,885 22,727 22,270 28,833
Installment 30,291 40,169 28,210 28,177 24,147
Indirect installment 150,807 139,477 120,761 98,919 75,781
Other 8,896 6,031 6,303 7,881 7,369
-------- -------- -------- -------- --------
Total loans 468,232 442,359 400,485 393,412 372,940
Less:
Unearned income 247 207 169 154 174
Allowance for loan losses 5,036 4,920 4,642 4,354 4,887
-------- -------- -------- -------- --------
Total unearned income
and allowance
for loan losses 5,283 5,127 4,811 4,508 5,061
-------- -------- -------- -------- --------
Net loans $462,949 $437,232 $395,674 $388,904 $367,879
======== ======== ======== ======== ========
The following table presents the maturity distribution of the Company's real
estate construction and commercial loans at December 31, 2003 (dollars in
thousands):
Percent of
Amount Total
Within one year $ 10,917 38.47%
One to five years 8,922 31.44
Over five years 8,540 30.09
------- ------
$28,379 100.00%
======= ======
The Company's real estate construction and commercial loans due after one year
at December 31, 2003 were comprised of the following (dollars in
thousands):
Amount
Fixed interest rate $ 7,311
Adjustable interest rate 10,151
-------
$17,462
ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES
The following table reflects activity in the Company's allowance for loan
losses for the years ended December 31, 2003, 2002, 2001, 2000 and 1999
(dollars in thousands):
Years ended December 31,
----------------------------------------------
2003 2002 2001 2000 1999
------ ------ ------ ------ ------
Balance at the beginning of
period $4,920 $4,642 $4,354 $4,887 $4,404
Charge-offs:
Real estate - 83 110 213 159
Commercial 120 12 95 1,006 25
Installment loans to
individuals 750 729 529 424 120
Credit card - - - - -
Other - - - - -
------ ------ ------ ------ ------
Total 870 824 734 1,643 304
------ ------ ------ ------ ------
Recoveries:
Real estate 25 64 35 32 213
Commercial 11 4 - - 21
Installment loans to
individuals 145 134 87 96 12
Credit card - - - 2 1
Other - - - - -
------ ------ ------ ------ ------
Total 181 202 122 130 247
------ ------ ------ ------ ------
Net charge-offs 689 622 612 1,513 57
Provision charged to expense 805 900 900 980 540
------ ------ ------ ------ ------
Balance at the end of period $5,036 $4,920 $4,642 $4,354 $4,887
====== ====== ====== ====== ======
Ratio of net charge-offs to
average loans 0.15% 0.15% 0.15% 0.39% 0.02%
ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES
The following table sets forth the breakdown of the Company's allowance for
loan losses in the Company's portfolio by category of loan and the percentage
of loans in each category to total loans in the respective portfolios at the
dates indicated (dollars in thousands):
December 31,
---------------------------------------------------------------------------------------------------------------
2003 2002 2001 2000 1999
---------------------- ---------------------- ---------------------- ------------------- ------------------
Percent of Percent of Percent of Percent of Percent of
of loans of loans of loans of loans of loans
in each in each in each in each in each
category category category category category
to total to total to total to total to total
Amount loans Amount loans Amount loans Amount loans Amount loans
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
Commercial $ 155 5.2% $ 216 5.4% $ 208 5.7% $ 719 5.7% $ 530 7.7%
Real estate:
Commercial &
construction 1,724 26.5 2,008 26.7 1,621 28.3 1,009 27.0 1,773 26.1
Residential 624 27.7 598 25.9 585 27.2 1,160 32.9 503 37.3
Installment 2,505 38.7 2,084 40.6 1,719 37.2 1,440 32.4 1,125 26.9
Other 28 1.9 14 1.4 17 1.6 26 2.0 60 2.0
Unallocated - N/A - N/A 492 N/A - N/A 896 N/A
------ ----- ------ ----- ------ ----- ------ ----- ------ -----
$5,036 100.0% $4,920 100.0% $4,642 100.0% $4,354 100.0% $4,887 100.0%
====== ===== ====== ===== ====== ===== ====== ===== ====== =====
DEPOSITS
See "Financial Statements and Supplementary Data" in Item 8 of this report.
SUPERVISION AND REGULATION
The business in which the Company is engaged is subject to extensive
supervision, regulation and examination by various bank regulatory authorities
and other governmental agencies. State and federal banking laws have as their
principal objective either the maintenance of the safety and soundness of
financial institutions and the federal deposit insurance system or the
protection of consumers or classes of consumers, and depositors in particular,
rather than the specific protection of stockholders of a bank or its parent
company.
Set forth below is a brief description of certain laws and regulations that
relate to the regulation of the Company. To the extent the following material
describes statutory or regulatory provisions, it is qualified in its entirety
by reference to the particular statute or regulation.
Regulation of the Company
General. As a registered bank holding company, the Company is subject to
regulation under the Bank Holding Company Act of 1956, as amended, ("BHCA") and
to inspection, examination and supervision by the Board of Governors of the
Federal Reserve System, ("FRB"). The Company is also subject to the laws of the
State of New Hampshire.
The FRB has the authority to issue orders to bank holding companies to cease
and desist from unsound banking practices and violations of conditions imposed
by, or violations of agreements with, the FRB. The FRB is also empowered to
assess civil money penalties against companies or individuals who violate the
BHCA or orders or regulations thereunder, to order termination of non-banking
activities of non-banking subsidiaries of bank holding companies, and to order
termination of ownership and control of a non-banking subsidiary by a bank
holding company. Under the BHCA, the Company may not generally engage in
activities or acquire more than 5% of any class of voting securities of any
company engaged in activities other than banking or activities that are closely
related to banking. However, if the Company elects to be treated as a financial
holding company, the Company may engage in activities that are financial in
nature or incidental or complimentary to such financial activities, as
determined by the FRB and the Secretary of the Department of the Treasury. The
Company has not elected financial holding company status. Under certain
circumstances, the Company may be required to give notice to or seek approval
of the FRB before engaging in activities other than banking.
Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994
("Riegle-Neal"). Riegle-Neal permits adequately capitalized and adequately
managed bank holding companies, as determined by the FRB, to acquire banks in
any state subject to certain concentration limits and other conditions.
Riegle-Neal also generally authorizes the interstate merger of banks. In
addition, among other things, Riegle-Neal permits banks to establish new
branches on an interstate basis provided that the law of the host state
specifically authorizes such action. However, as a bank holding company, we are
required to obtain prior FRB approval before acquiring more than 5% of a class
of voting securities, or substantially all of the assets of a bank holding
company, bank or savings association.
Control Acquisitions. The Change in Bank Control Act prohibits a person or
group of persons from acquiring "control" of a bank holding company, such as
the Company, unless the FRB has been notified and has not objected to the
transaction. Under a rebuttable presumption established by the FRB, the
acquisition of 10% or more of a class of voting securities of a bank holding
company with a class of securities registered under Section 12 of the
Securities Exchange Act of 1934, as amended, would, under the circumstances set
forth in the presumption, constitute acquisition of control of the bank holding
company. In addition, a company is required to obtain the approval of the FRB
under the BHCA before acquiring 25% (5% in the case of an acquirer that is a
bank holding company) or more of any class of outstanding voting securities of
a bank holding company, or otherwise obtaining control or a "controlling
influence" over that bank holding company.
Bank Holding Company Dividends. The FRB has authority to prohibit bank holding
companies from paying dividends if such payment is deemed to be an unsafe or
unsound practice. The FRB has indicated generally that it may be an unsafe or
unsound practice for bank holding companies to pay dividends unless the bank
holding company's net income over the preceding year is sufficient to fund the
dividends and the expected rate of earnings retention is consistent with the
organization's capital needs, asset quality and overall financial condition.
The Company depends in part upon dividends received from its subsidiary banks
to fund its activities, including the payment of dividends. As described below,
the Federal Deposit Insurance Corporation ("FDIC") and the Banks' regulatory
agencies may regulate the amount of dividends payable by the subsidiary banks.
The inability for the bank to pay the dividend may have an adverse effect on
the Company.
Regulation of the Banks
General. PNB is a national banking association, organized under the National
Bank Act. As such, its primary regulatory authority is the OCC. The OCC
regularly examines national banks and their operations. In addition, operations
of national banks are subject to federal statutes and regulations. Such
statutes and regulations relate to required capital and reserves, investments,
loans, mergers, payment of dividends, issuance of securities and many other
aspects of operations. Capital requirements applicable to PNB are substantially
similar to those adopted by the FRB regarding bank holding companies as
described above.
The OCC's approval is required for a national bank to pay dividends if the
total dividends declared by a national bank in any year will exceed the total
of its net profits for that year combined with its retained net profits for the
preceding two years, less any required transfer to surplus. The OCC also has
authority to approve or disapprove mergers, consolidations, the establishment
of branches and similar corporate actions. The OCC also has the power to
prevent a national bank from engaging in unsafe or unsound practices or
violating applicable laws in conducting its business.
Under the Gramm-Leach-Bliley Act (1999) ("GLBA"), the OCC permits national
banks, to the extent permitted under state law, to engage in certain new
activities which are permissible for subsidiaries of a financial holding
company. Further, it expressly preserves the ability of national banks to
retain all existing subsidiaries.
PNB is also subject to applicable provisions of New Hampshire law insofar as
they do not conflict with or are not otherwise preempted by federal banking
law.
BCB is organized under New Hampshire law and is subject to the regulations of
the Commissioner and the FDIC. BCB's operations are subject to various
requirements and restrictions under the laws of the United States and the State
of New Hampshire, including those related to the maintenance of adequate levels
of capital, the payment of dividends, investments, the nature and amount of
loans which can be originated and the rate of interest that can be charged
thereon, and other activities. Capital requirements applicable to BCB are
substantially similar to those adopted by the FRB regarding bank holding
companies as described above.
Insurance of Accounts and FDIC Regulation. The Banks pay deposit insurance
premiums to the FDIC based on an assessment rate established by the FDIC for
Bank Insurance Fund-member institutions. The FDIC has established a risk-based
premium system under which the FDIC classifies institutions based on their
capital ratios and on other relevant factors and generally assesses higher
rates on those institutions that tend to pose greater risks to the federal
deposit insurance funds. The Federal Deposit Insurance Act ("FDIA") does not
require the FDIC to charge all banks deposit insurance premiums when the ratio
of deposit insurance reserves to insured deposits is maintained above specified
levels. However, as a result of general economic conditions and bank failures,
it is possible that the ratio of deposit insurance reserves to insured deposits
could fall below the minimum ratio that FDIA requires, which would result in
the FDIC setting deposit insurance assessment rates sufficient to increase
deposit insurance reserves to the required ratio. We cannot predict whether the
FDIC will be required to increase deposit insurance assessments above their
current levels.
Bank Holding Company Support of Subsidiary Banks. Under FRB policy, a bank
holding company is expected to act as a source of financial and managerial
strength to each of its subsidiary banks and to commit resources to their
support. This support may be required at times when the bank holding company
may not have the resources to provide it. Similarly, under the cross-guarantee
provisions of FDIA, the FDIC can hold any FDIC-insured depository institution
liable for any loss suffered or anticipated by the FDIC in connection with (1)
the "default" of a commonly controlled FDIC-insured depository institution; or
(2) any assistance provided by the FDIC to a commonly controlled FDIC-insured
depository institution "in danger of default." Both BCB and PNB are
FDIC-insured depository institutions.
Regulatory Capital Requirements. The FRB and the FDIC have issued substantially
similar risk-based and leverage capital guidelines applicable to United States
banking organizations. In addition, these regulatory agencies may from time to
time require that a banking organization maintain capital above the minimum
levels, whether because of its financial condition or actual or anticipated
growth.
The FRB risk-based guidelines define a three-tier capital framework. Tier 1
capital includes common stockholders' equity and qualifying preferred stock,
less goodwill and other adjustments. Tier 2 capital consists of preferred stock
not qualifying as Tier 1 capital, mandatory convertible debt, limited amounts
of subordinated debt, other qualifying term debt and the allowance for loan
losses up to 1.25 percent of risk-weighted assets. Tier 3 capital includes
subordinated debt that is unsecured, fully paid, has an original maturity of at
least two years, is not redeemable before maturity without prior approval by
the FRB and includes a lock-in clause precluding payment of either interest or
principal if the payment would cause the issuing bank's risk-based capital
ratio to fall or remain below the required minimum. The sum of Tier 1 and Tier
2 capital less investments in unconsolidated subsidiaries represents qualifying
total capital. Risk-based capital ratios are calculated by dividing Tier 1 and
total capital by risk-weighted assets. Assets and off-balance sheet exposures
are assigned to one of four categories of risk-weights, based primarily on
relative credit risk. The minimum Tier 1 capital ratio is four percent and the
minimum total capital ratio is eight percent. The Company's tier 1 calculation
equals 9.66% and its total capital ratio is 12.81%.
The leverage ratio is determined by dividing Tier 1 capital by adjusted average
total assets. Although the stated minimum ratio is 100 to 200 basis points
above three percent, banking organizations are required to maintain a ratio of
at least five percent to be classified as well capitalized. The Company's
leverage ratio is 7.22%.
The Federal Deposit Insurance Corporation Improvement Act of 1991 ("FDICIA"),
among other things, identifies five capital categories for insured depository
institutions (well capitalized, adequately capitalized, undercapitalized,
significantly undercapitalized and critically undercapitalized) and requires
the federal bank regulatory agencies to implement systems for "prompt
corrective action" for insured depository institutions that do not meet minimum
capital requirements within such categories. FDICIA imposes progressively more
restrictive constraints on operations, management and capital distributions,
depending on the category in which an institution is classified. Failure to
meet the capital guidelines could also subject a banking institution to capital
raising requirements. An "undercapitalized" bank must develop a capital
restoration plan and its parent holding company must guarantee that bank's
compliance with the plan. The liability of the parent holding company under any
such guarantee is limited to the lesser of five percent of the bank's assets at
the time it became "undercapitalized" or the amount needed to comply with the
plan. Furthermore, in the event of the bankruptcy of the parent holding
company, such guarantee would take priority over the parent's general unsecured
creditors. In addition, FDICIA requires the various regulatory agencies to
prescribe certain non-capital standards for safety and soundness relating
generally to operations and management, asset quality and executive
compensation and permits regulatory action against a financial institution that
does not meet such standards.
The various regulatory agencies have adopted substantially similar regulations
that define the five capital categories identified by FDICIA, using the total
risk-based capital, Tier 1 risk-based capital and leverage capital ratios as
the relevant capital measures. Such regulations establish various degrees of
corrective action to be taken when an institution is considered
undercapitalized. Under the regulations, a "well capitalized" institution must
have a Tier 1 risk-based capital ratio of at least six percent, a total
risk-based capital ratio of at least ten percent and a leverage ratio of at
least five percent and not be subject to a capital directive order. Regulators
also must take into consideration (a) concentrations of credit risk; (b)
interest rate risk (when the interest rate sensitivity of an institution's
assets does not match the sensitivity of its liabilities or its
off-balance-sheet position); and (c) risks from non-traditional activities, as
well as an institution's ability to manage those risks, when determining the
adequacy of an institution's capital. This evaluation will be made as a part of
the institution's regular safety and soundness examination. In addition, the
Company, and any Bank with significant trading activity, must incorporate a
measure for market risk in their regulatory capital calculations. As of
December 31, 2003, the most recent notification from the FDIC categorized both
Banks as well capitalized.
U.S. bank regulatory authorities and international bank supervisory
organizations, principally the Basel Committee on Banking Supervision ("Basel
Committee"), currently are considering changes to the risk-based capital
adequacy framework, which ultimately could affect the appropriate capital
guidelines, including changes (such as those relating to lending to registered
broker-dealers) that are of particular relevance to banks, such as the Banks,
that engage in significant securities activities. Among other things, the Basel
Committee rules, which were proposed formally for public comment in May 2003
and are expected to become effective around early 2007, would add operational
risk as a third component to the denominator of the risk-capital calculation,
which currently includes only credit and market risks.
Limitations on Bank Dividends. The FDIC has the authority to use its
enforcement powers to prohibit a bank from paying dividends if, in its opinion,
the payment of dividends would constitute an unsafe or unsound practice.
Federal law also prohibits the payment of dividends by a bank that will result
in the bank failing to meet its applicable capital requirements on a pro forma
basis.
The Community Reinvestment Act. The Community Reinvestment Act ("CRA") requires
lenders to identify the communities served by the institution's offices and
other deposit taking facilities and to make loans and investments and provide
services that meet the credit needs of these communities. Regulatory agencies
examine each of the banks and rate such institutions' compliance with CRA as
"Outstanding", "Satisfactory", "Needs to Improve" or "Substantial
Noncompliance". Failure of an institution to receive at least a "Satisfactory"
rating could inhibit such institution or its holding company from undertaking
certain activities, including engaging in activities newly permitted as a
financial holding company under the GLBA and acquisitions of other financial
institutions. The FRB must take into account the record of performance of banks
in meeting the credit needs of the entire community served, including low-and
moderate-income neighborhoods. New Hampshire also has enacted substantially
similar community reinvestment requirements. PNB has achieved a rating of
outstanding and BCB a rating of satisfactory on their most recent examinations.
Customer Information Security. The FDIC and other bank regulatory agencies have
adopted guidelines for establishing standards for safeguarding nonpublic
personal information about customers that implement provisions of GLBA, which
establishes a comprehensive framework to permit affiliations among commercial
banks, insurance companies, securities firms, and other financial service
providers by revising and expanding the BHCA framework. Specifically, the
Information Security Guidelines established by the GLBA require each financial
institution, under the supervision and ongoing oversight of its board of
directors or an appropriate committee thereof, to develop, implement and
maintain a comprehensive written information security program designed to
ensure the security and confidentiality of customer information, to protect
against anticipated threats or hazards to the security or integrity of such
information; and to protect against unauthorized access to or use of such
information that could result in substantial harm or inconvenience to any
customer.
Privacy. The GLBA requires financial institutions to implement policies and
procedures regarding the disclosure of nonpublic personal information about
consumers to nonaffiliated third parties. In general, the statute requires
financial institutions to explain to consumers their policies and procedures
regarding the disclosure of such nonpublic personal information, and, unless
otherwise required or permitted by law, financial institutions are prohibited
from disclosing such information except as provided in their policies and
procedures.
USA PATRIOT Act. The USA PATRIOT Act of 2001 (The "USA PATRIOT Act"), designed
to deny terrorists and others the ability to obtain anonymous access to the
U.S. financial system, has significant implications for depository
institutions, broker-dealers and other businesses involved in the transfer of
money. The USA PATRIOT Act, together with the implementing regulations of
various federal regulatory agencies, have caused financial institutions,
including banks, to adopt and implement additional, or amend existing, policies
and procedures with respect to, among other things, anti-money laundering
compliance, suspicious activity and currency transaction reporting, customer
identity verification and customer risk analysis. The statute and its
underlying regulations also permit information sharing for counter-terrorist
purposes between federal law enforcement agencies and financial institutions,
as well as among financial institutions, subject to certain conditions, and
require the FRB (and other federal banking agencies) to evaluate the
effectiveness of an applicant in combating money laundering activities when
considering applications filed under Section 3 of the BHCA or under the Bank
Merger Act. Management believes that the Company is in compliance with all the
requirements prescribed by the USA PATRIOT Act and all applicable final
implementing regulations.
The Sarbanes-Oxley Act. The Sarbanes-Oxley Act of 2002 ("S-O Act") implements a
broad range of corporate governance and accounting measures for public
companies (including publicly-held bank holding companies such as the Company)
designed to promote honesty and transparency in corporate America and better
protect investors from corporate wrongdoings. The S-O Act's principal
provisions, many of which have been interpreted through regulations released in
2003, provide for and include, among other things:
o the creation of an independent accounting oversight board;
o auditor independence provisions which restrict non-audit services that
accountants may provide to their audit clients;
o additional corporate governance and responsibility measures, including the
requirement that the chief executive officer and chief financial officer of a
public company certify financial statements;
o the forfeiture of bonuses or other incentive-based compensation and profits
from the sale of an issuer's securities by directors and senior officers in
the twelve month period following initial publication of any financial
statements that later require restatement;
o an increase in the oversight of, and enhancement of certain requirements
relating to, audit committees of public companies and how they interact with
the company's independent auditors;
o requirements that audit committee members must be independent and are barred
from accepting consulting, advisory or other compensatory fees from the
issuer;
o requirements that companies disclose whether at least one member of the audit
committee is a `financial expert' (as such term is defined by the SEC) and if
not, why not;
o expanded disclosure requirements for corporate insiders, including
accelerated reporting of stock transactions by insiders and a prohibition on
insider trading during pension blackout periods;
o a prohibition on personal loans to directors and officers, except certain
loans made by insured financial institutions, such as the Banks, on
nonpreferential terms and in compliance with other bank regulatory
requirements;
o disclosure of a code of ethics and filing a Form 8-K for a change or waiver
of such code; and
o a range of enhanced penalties for fraud and other violations.
The Company has taken steps to comply with and anticipates that it will incur
additional expenses in continuing to comply with the provisions of the S-O Act
and its underlying regulations. Management believes that such compliance
efforts have strengthened the Company's overall corporate governance structure
and does not expect that such compliance has to date, or will in the future
have a material impact on the Company's results of operations or financial
condition.
COMPETITION
The banking industry in the United States, which includes commercial banks,
savings and loan associations, mutual savings banks, capital stock savings
banks, credit unions, and bank and savings and loan holding companies, is part
of the broader financial services industry which includes insurance companies,
mutual funds, and the brokerage industry, among others. In recent years,
intense market demands and economic pressures have eroded once clearly defined
industry classifications and have forced financial services institutions to
diversify their services, increase returns on deposits, and become more cost
effective as a result of competition with one another and with new types of
financial services companies, including non-bank competitors.
The Company's banking subsidiaries face significant competition in their
respective markets from commercial banks, savings banks, credit unions,
consumer finance companies, insurance companies, "non-bank banks," mutual
funds, government agencies, investment management companies, investment
advisors, brokers and investment bankers. In addition, increasing consolidation
within the banking and financial services industry, as well as increased
competition from larger regional and out-of-state banking organizations and
non-bank providers of various financial services, may adversely affect the
Company's ability to achieve its financial goals. Federal banking laws permit
adequately capitalized bank holding companies to venture across state lines to
offer banking services through bank subsidiaries to a wider geographic market.
Consequently, it is possible for large organizations to enter many new markets
including the markets served by the Company. Certain of these competitors, by
virtue of their size and resources, may enjoy certain efficiencies and
competitive advantages over the Company in pricing, delivery, and marketing of
their products and services. The Company's long-term success depends on the
ability of the Company's banking subsidiaries to compete successfully with
other financial institutions in their service areas. It is not possible to
assess what impact these changes in the regulatory environment will have on the
Company. Many of these large competitors have significantly more financial
resources, larger market share and greater name recognition in the market areas
served by the Company and its banking subsidiaries.
BCB and PNB compete in this environment by providing a broad range of financial
services, competitive interest rates and a personal level of service that,
combined, tend to retain the loyalty of its customers in its market areas
against competitors with far larger resources. To a lesser extent, convenience
of branch locations and hours of operations are also considered competitive
advantages of the Banks.
RISK FACTORS
The discussions set forth below contain certain statements that may be
considered "forward-looking statements." Forward-looking statements involve
unknown risks, uncertainties and other factors that may cause the Company's
actual results to materially differ from those projected in the forward-looking
statements. For further information regarding forward-looking statements, you
should review the discussion under the caption "FORWARD-LOOKING STATEMENTS" on
page 1 of this report.
Recent accounting changes could give rise to adverse changes in the regulatory
capital treatment of junior subordinated debentures, including currently
outstanding junior subordinated debentures of the Company which, in turn, could
adversely affect the Company's regulatory capital position. In January 2003,
the Financial Accounting Standards Board ("FASB") issued FASB Interpretation
No. 46, "Consolidation of Variable Interest Entities" ("FIN 46") that addresses
the consolidation rules to be applied to "variable interest entities" as
defined in FIN 46. FIN 46, which applies to certain variable interest entities
as of February 1, 2003 and to all variable interest entities as of December 14,
2003, provides that certain variable interest entities should not be treated as
consolidates subsidiaries. Northway Capital Trust I and Northway Capital Trust
II, the Company's Delaware statutory business trusts, may constitute variable
interest entities. Historically, issuer trusts, such as Northway Capital Trust
I and Northway Capital Trust II that issued junior subordinated debentures have
been consolidated by their parent companies. In addition, junior subordinated
debentures have been treated as eligible for Tier 1 capital treatment by bank
holding companies under the FRB's rules and regulations relating to minority
interests in equity accounts of consolidated subsidiaries. Accordingly, the
Company has consolidated its existing issuer trusts in preparing its
consolidated financial statements in the past, and the Company's outstanding
junior subordinated debentures have been treated as Tier 1 capital.
On December 24, 2003, FASB issued a revision to FIN 46 ("FIN46R"), to clarify
some of the provisions of FIN 46. Based on FIN46R, the Company deconsolidated
its existing issuer trusts as of December 31, 2003, and restated their
historical financial statements. The adoption of FIN46R results in the
reclassification of the redeemable junior subordinated debentures from
mezzanine capital to other liabilities as well as the reclassification of
interest cost from minority interest to interest expense.
This deconsolidation could result in a change to the regulatory capital
treatment of junior subordinated debentures issued by the Company and other
U.S. bank holding companies. Specifically, it is possible that since its issuer
trust would no longer be consolidated by the Company the junior subordinated
debentures issued by such issuer trust would not be considered a minority
interest in equity accounts of a consolidated subsidiary and therefore not be
accorded Tier 1 capital treatment by the FRB. The FRB has indicated in
supervisory letter SR 03-13, dated July 2, 2003 (the "Supervisory Letter"),
that junior subordinated debentures will be treated as Tier 1 capital until
notice is given to the contrary, but the Supervisory Letter also indicates that
the FRB will review the regulatory implications of any accounting treatment
changes and will provide further guidance if necessary or warranted.
If Tier 1 capital treatment were disallowed by the FRB, the Company would be
able to redeem its owner junior subordinated debentures, thereby causing a
mandatory redemption of capital securities pursuant to the terms and conditions
of the applicable governing documents. As of December 31, 2003, assuming it
were not allowed to include the junior subordinated debentures in Tier 1
Capital, the Company would still exceed the regulatory required minimums for
capital adequacy purposes.
The Company could be adversely impacted by changes in applicable regulations.
The Company is subject to extensive federal and state laws and regulations and
is subject to supervision, regulation and examination by various federal and
state bank regulatory agencies. The restrictions imposed by such laws and
regulations limit the manner in which the Company and its bank subsidiaries may
conduct business and obtain financing. There can be no assurance that any
modification of these laws and regulations, or new legislation that may be
enacted, in the future will not make compliance more difficult or expensive,
restrict the Company's ability to originate, broker or sell loans or otherwise
adversely affect the operations of the Company. See "Supervision and
Regulation" on page 5 of this report.
The Company's business is largely dependent upon the hospitality industry. A
number of the Company's loan customers are in the hospitality industry. The
hospitality industry is dependent on personal discretionary spending levels.
Consequently, the hospitality industry has been adversely impacted by current
negative economic trends, including recession and increased unemployment.
Additionally, unforeseen events including acts of terrorism, war, increases in
fuel prices, travel-related accidents and unusual weather patterns also may
adversely affect the hospitality industry. As a result, the Company's business
also is likely to be adversely affected by those events.
Interest rate volatility may adversely impact the Company's results of
operations. The principal component of the Company's income stream is net
interest and dividend income. Net interest and dividend income is the
difference between interest and fee income on earning assets, such as loans and
investments, and the interest expense paid on interest bearing liabilities,
such as deposits and borrowed funds. The Company's net interest and dividend
income may be significantly affected by changes in market interest rates, which
are currently at historically low levels. A decrease in interest rates could
reduce the Company's net interest and dividend income as the difference between
interest and fee income and interest expense decreases. An increase in interest
rates could also negatively impact the Company's results of operations by
reducing borrowers' ability to repay their current loan obligations, resulting
in increased loan defaults, foreclosures and write-offs and could necessitate
increases to the Company's allowance for loan losses. See "Management's
Discussion and Analysis of Financial Condition and Results of Operations" in
Item 7 of this report.
The Company's allowance for loan losses may not be adequate to cover actual
losses. The Company makes various assumptions and judgments about the
collectibility of its loan portfolio and provides an allowance for potential
loan losses based on several factors. If the Company's assumptions are
incorrect, its allowance for loan losses may be insufficient to cover its
actual losses, which would have an adverse effect on the Company's results of
operations, and may cause the Company to increase the allowance in the future.
See "Management's Discussion and Analysis of Financial Condition and Results of
Operations" in Item 7 of this report.
Changes in the securities market may adversely impact the Company's results of
operations. In recent years the securities market has experienced a significant
downturn and will likely continue to experience volatility as a result of,
among other things, world economic and political conditions. Continued declines
in equity prices, as well as declines in the performance of certain sectors or
specific companies, may result in a corresponding decline in the value of
Company-held securities. The decline in the value of Company-held securities
may decrease the Company's earnings. See "Management's Discussion and Analysis
of Financial Condition and Results of Operations" in Item 7 of this report.
EMPLOYEES
As of December 31, 2003 the Company has 266 full-time equivalent employees. The
Company considers its employee relations to be good.
WEBSITE ACCESS TO COMPANY REPORTS
The Company's annual reports on Form 10-K, quarterly reports on Form 10-Q,
current reports on Form 8-K, and all amendments to those reports are available
free of charge on the Company's website at www.northwayfinancialinc.com as soon
as reasonably practicable after such material is electronically filed with or
furnished to the Securities and Exchange Commission. Also, copies of the
Company's annual report will be made available, free of charge, upon written
request.
ITEM 2. PROPERTIES
The Company operates 21 branch offices and one loan origination facility that
are located in the central and northern New Hampshire communities of Berlin,
Conway (four offices), Gorham (two offices), Groveton, Littleton, West Ossipee,
West Plymouth, Plymouth, Campton, Ashland, North Woodstock, Tilton (two
offices), Franklin, Laconia, Belmont, Pittsfield and Concord. Fourteen of these
offices, including its main offices in Berlin, New Hampshire and Plymouth, New
Hampshire, are located on properties the Company owns. The Company leases seven
of its branches and the loan origination facility under five-year leases
expiring between April 30, 2004 and December 31, 2008. Seventeen of the
Company's branches have drive-up facilities and all are equipped with automated
teller machines.
ITEM 3. LEGAL PROCEEDINGS
The Company is not a party to, nor are any of its subsidiaries the subject of,
any material pending legal proceedings, other than ordinary routine litigation
incidental to the business.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
No matters were submitted to a vote of security holders during the quarter
ended December 31, 2003.
PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND
ISSUER PURCHASES OF EQUITY SECURITIES
The Company's common stock is traded on The Nasdaq Stock Market, Inc.'s
National Market under the symbol "NWFI". The following table sets forth, for
the periods indicated, the high and low closing sale prices for the common
stock, as reported by The Nasdaq National Market, and the dividends paid on the
common stock:
Price Per Share Dividends
Low High Per Share
2003 4th Quarter $29.99 $35.49 $0.17
3rd Quarter 29.10 30.97 0.17
2nd Quarter 28.01 30.65 0.17
1st Quarter 28.81 31.25 0.17
2002 4th Quarter $26.18 $31.50 $0.17
3rd Quarter 27.75 29.90 0.17
2nd Quarter 28.15 30.00 0.17
1st Quarter 27.50 29.40 0.17
The Company intends to continue to pay dividends on a quarterly basis subject
to, among other things, the financial condition and earnings of the Company,
capital requirements, and other factors, including applicable governmental
regulations. No dividends will be payable unless declared by the Board of
Directors and then only to the extent funds are legally available for the
payment of such dividends.
On March 2, 2004, the closing sales price of the common stock on the Nasdaq
National Market was $35.65 per share. As of such date, there were approximately
1,300 holders of record of the Company common stock.
ITEM 6. SELECTED FINANCIAL DATA
The following table sets forth the selected consolidated financial information
of the Company for the five years in the period ended December 31, 2003. This
selected consolidated financial information should be read in conjunction with
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" appearing under Item 7 of this report and "Financial Statements and
Supplementary Data" appearing under Item 8 of this report.
At or for the years ended December 31, 2003 2002 2001 2000 1999
----------------------------------------------------------------------------------------------------------------------------------
(Dollars in thousands, except per share data)
Balance Sheet Data:
Total assets $609,216 $598,945 $513,939 $485,144 $462,552
Securities available-for-sale, at fair value 73,716 91,397 55,564 50,288 51,542
Securities held-to-maturity - - - 2,752 5,151
Loans, net of unearned income 467,985 442,152 400,316 393,258 372,766
Allowance for loan losses 5,036 4,920 4,642 4,354 4,387
Other real estate owned - 175 22 25 115
Unidentifiable intangible assets - - 8,080 5,098 1,271
Goodwill 10,152 10,152 - - -
Core deposit intangible 3,903 4,857 - - -
Deposits 463,307 476,194 412,840 391,772 343,029
Long-term debt 87,620 66,620 48,028 35,528 58,528
Stockholders' equity 47,872 44,266 43,339 41,562 39,286
Income Statement Data:
Net interest and dividend income $ 23,050 $ 21,664 $ 20,721 $ 21,253 $ 19,342
Provision for loan losses 805 900 900 980 540
Noninterest income 5,375 3,396 2,909 2,692 2,718
Noninterest expense 22,136 20,035 17,149 16,699 15,794
Net income 3,617 2,598 3,873 4,159 3,764
Per Common Share Data:
Net income - basic $ 2.40 $ 1.71 $ 2.55 $ 2.61 $ 2.25
Net income - assuming dilution 2.39 1.71 2.54 2.61 2.25
Cash dividends declared 0.68 0.68 0.68 0.60 0.56
Book value 31.92 29.19 28.68 26.74 24.32
Tangible book value 22.30 19.07 23.16 23.41 23.54
Selected Ratios:
Return on average assets 0.59% 0.49% 0.78% 0.86% 0.90%
Return on average equity 7.82 5.86 9.14 10.29 9.37
Dividend payout 28.28 39.65 26.54 22.96 25.03
Average equity to average assets 7.61 8.33 8.58 8.31 9.62
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The purpose of this discussion is to focus on significant changes in the
financial condition and results of operations of the Company. It is intended to
supplement and highlight information contained in the accompanying consolidated
financial statements and the selected financial data presented elsewhere in
this report. The discussion set forth below contains certain statements that
may be considered "forward-looking statements." Forward-looking statements
involve risks, uncertainties and other factors that may cause the Company's
actual results to materially differ from those projected in the
forwarding-looking statements. For further information regarding
forward-looking statements, you should review the discussion under the caption
"FORWARD-LOOKING STATEMENTS" on page 1 of this report.
OVERVIEW OF PERFORMANCE
The Company derives substantially all of its revenue and income from community
bank-related activities. The Banks operate as typical community banking
institutions and do not engage in any specialized finance or capital markets
activities. Northway Financial, Inc. functions primarily as the holder of stock
of its subsidiaries and assists in the management of the operations of its
subsidiaries as appropriate.
The principal components of the Company's income sources are net interest and
dividend income. Net interest and dividend income is the difference between
interest and fee income received on income earning assets, such as loans and
investments, and the interest expense paid on interest bearing liabilities,
such as deposits and borrowed funds. Our other sources of income include
revenues from fee-based services, such as debit card and ATM fees and sales of
securities.
Economic and industry factors that could cause the Company's financial
performance to differ from expected results include changes in applicable
federal and state regulations, changes in the hospitality industry on which the
Company's business is largely dependent, interest rate volatility, significant
changes in loan losses which may affect the Company's allowance for loan losses
and the related provision for loan losses, and changes in the securities market
that would affect the performance of the Company's investment portfolio.
Management evaluates each of these factors on an ongoing basis to determine
their impact and to effect any strategies necessary to mitigate these risks.
The Company reported net income of $3,617,000, or $2.40 per common share, in
2003 compared to net income of $2,598,000, or $1.71 per common share, in 2002
and $3,873,000, or $2.55 per common share, in 2001. Return on average equity
was 7.82% in 2002, compared to 5.86% in 2002 and 9.14% in 2001. Return on
average assets was 0.59% in 2003, compared to 0.49% in 2002 and 0.78% in 2001.
During 2003, the Company took advantage of the improved market conditions for
investment securities and realized securities gains totaling $1,522,000
compared to $151,000 for the prior year. The low interest rate environment
resulted in significant mortgage refinancing activity. The Company decided to
sell a portion of this loan volume in the secondary market based on our
underwriting standards. The result of these sales was an increase in gain on
sale of loans of $163,000 to $422,000 in 2003. The current low interest rate
environment also provided the Company an opportunity to reduce its average cost
of interest bearing liabilities by 0.59%. In addition, this rate environment
allowed the Company to increase its average outstanding borrowings at very
attractive rates and use the proceeds to fund increases in both average loans
and investments.
During the year 2002, the Company continued the implementation of its growth
initiatives with the purchase of three branches located in Laconia, Belmont and
Pittsfield, New Hampshire. Also during 2002 the Company acquired and installed
technology the cost of which was approximately $1,700,000 including a wide-area
network, a voice over internet protocol telephone system, a new on-line teller
system, document imaging and computer upgrades. The Company also made increases
to staff during the year, most notably in the lending area. In addition, the
sustained weakness of the equity market and the impact it had on certain
holdings of the Company's equity securities resulted in net losses on sale of
equity securities of $410,000 and write-downs of equity securities of $910,000.
Costs associated with the expansion of the Company's branch network, new
technology and personnel resulted in increased noninterest expense which, when
added to the loss on sale of equity securities and the write-down of equity
securities, caused a decline in 2002 earnings as compared to 2001.
NET INTEREST AND DIVIDEND INCOME ANALYSIS
Fluctuations in interest rates as well as changes in volume and mix of income
earning assets and interest-bearing liabilities can materially impact net
interest and dividend income, the principal source of our income. The
discussion of net interest and dividend income is presented on a taxable
equivalent basis, unless otherwise noted, to facilitate performance comparisons
among various taxable and tax-exempt assets.
The table below under the caption "Consolidated Average Balances, Interest and
Dividend Income/Expense and Average Yields/Rates," presents the average
balances, income earned or interest paid, and average yields earned or rates
paid on our assets and liabilities for the years ended December 31, 2003, 2002,
and 2001.
Net interest and dividend income for 2003 increased $1,466,000, or 7%, over
2002. Interest and dividend income increased $85,000 in 2003 compared to 2002.
This was due to an increase in average earning assets of $66,200,000 which
increase was partially offset by a 0.74% decrease in the yield on average
earning assets. Interest and dividend income on securities increased $423,000
as an increase in average securities of $17,360,000 was partially offset by a
decrease in the average yield on securities of 0.56%. The increase in interest
and dividend income on securities was partially offset by a decrease in
interest income and fees on loans of $185,000 which decrease was primarily due
to a decrease in the average yield of 0.82% and was partially offset by an
increase in the average balance of $52,679,000. In addition, interest income on
federal funds sold decreased $153,000 as the average balance decreased
$3,818,000 and was accompanied by a decrease in the average yield of 0.65%.
Interest expense decreased $1,381,000, or 14%, in 2003 compared to 2002. The
decrease in net interest expense was due primarily to a 0.59% decrease in the
average rate paid on interest bearing liabilities partially offset by an
increase in average interest bearing liability balances of $65,798,000. The
decrease in the rate paid on interest bearing liabilities was a function of
both the acquisition of long-term debt at attractive rates as well as a
decision by management to lower rates on interest bearing deposits. The
increase in the average liability balance is the result of increases in average
FHLB advances of $16,570,000 as the Company took advantage of the current low
rate environment to borrow $28,000,000 in medium-term advances at an average
rate of 2.74%. Further, the average balance in junior subordinated debentures
increased $8,971,000 as a result of the inclusion of this debt, which was
issued during 2002, for the full 2003 fiscal year as compared to six months in
fiscal 2002. . Average interest bearing deposits increased $40,527,000 due
primarily to the fact that deposits acquired in October 2002 were recorded for
the full 2003 fiscal year. Average securities sold under agreements to
repurchase declined $270,000.
Net interest and dividend income for 2002 increased $802,000, or 4%, over 2001.
While net interest and dividend increased, interest and dividend income
decreased $3,653,000, or 10%, in 2002 compared to 2001. The continued decline
in market interest rates during 2002 resulted in a 1.24% decrease in the yield
on average earning assets. A 1.19% decrease in the yield on loans was partially
offset by an increase in average loan balances of $13,829,000. This resulted in
a net decrease of $3,736,000, or 12%, in interest and fees on loans. Federal
funds sold income decreased $157,000 as a decrease in average yield of 1.67%
was partially offset by a $5,175,000 increase in the average balance. The
decrease in interest and fees on loans was partially offset by an increase in
interest and dividend income on securities of $241,000, which was the result of
an increase in average balances of $13,580,000 partially offset by a decrease
in average yield of 0.86%.
Interest expense decreased $4,455,000, or 31%, in 2002 compared to 2001. The
decrease in net interest expense was due primarily to a 1.33% decrease in rates
paid on interest bearing liabilities partially offset by an increase in average
balances of $30,832,000. The increase in average balances is the result of the
issuance of junior subordinated debentures by the Company's Delaware statutory
business trusts, Northway Capital Trust I and Northway Capital Trust II, with
an average balance of $11,649,000 as well as an increase in average interest
bearing deposit balances of $19,539,000 associated primarily with the branches
acquired in the fourth quarter of 2002.
The trend in net interest and dividend income is commonly evaluated in terms of
average rates using net interest margin and interest rate spread. The net
interest margin is computed by dividing fully taxable equivalent net interest
and dividend income by average total earning assets. This ratio represents the
difference between the average yield returned on average earning assets and the
average rate paid for all funds used to support those earning assets, including
both interest bearing and noninterest bearing sources of funds. The net
interest margin decreased 0.26% to 4.16% in 2003 after having decreased 0.14%
to 4.42% in 2002. The decrease in the net interest margin for 2003 was a direct
result of the decrease in the yield on earning assets, which decrease was only
partially offset by the decrease in the cost of funds. The portion of interest
earning assets funded by interest bearing liabilities increased to 87% in 2003
compared to 85% in 2002 and 84% in 2001.
The interest rate spread measures the difference between the average yield on
earning assets and the average rate paid on interest bearing liabilities. The
interest rate spread eliminates the impact of noninterest bearing funds and
gives a direct perspective on the effect of interest rate fluctuations. During
2003, the net interest rate spread decreased 0.15% to 3.92% as the yield on
earning assets declined 0.74% and was only partially offset by a decrease in
the cost of interest bearing liabilities of 0.59%. During 2002, the net
interest rate spread increased 0.09% to 4.07% as the cost of interest bearing
liabilities decreased 1.33% while the yield on earning assets declined 1.24%.
See the tables below under the captions "Consolidated Average Balances,
Interest and Dividend Income/Expense and Average Yields/Rates" and
"Consolidated Rate/Volume Variance Analysis" for more information.
CONSOLIDATED AVERAGE BALANCES, INTEREST INCOME/EXPENSE AND AVERAGE YIELDS/RATES
($000 Omitted)
For the Year Ended December 31,
2003 2002 2001
------------------------------ --------------------------- ---------------------------
Average Average Average
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate Balance Expense Rate
------- ------- ---- ------- ------- ---- ------- ------- ----
Assets
Interest earning assets:
Federal funds sold $ 15,153 $ 118 0.78% $ 18,971 $ 271 1.43% $ 13,796 $ 428 3.10%
Interest bearing deposits 224 2 0.89 225 2 0.89 109 3 2.75
Securities(1)(2) 85,074 3,943 4.64 67,714 3,520 5.20 54,134 3,279 6.06
Loans, net(3)(4) 461,472 27,756 6.01 408,793 27,941 6.83 394,964 31,677 8.02
-------- ------- -------- ------- -------- -------
Total interest earning
assets(5) 561,923 31,819 5.66 495,703 31,734 6.40 463,003 35,387 7.64
------- ------- -------
Cash and due from banks 14,907 14,597 13,529
Allowance for loan losses (4,983) (4,794) (4,481)
Premises and equipment, net 12,447 12,064 11,283
Other assets 23,753 14,960 10,811
-------- -------- --------
Total assets $608,047 $532,530 $494,145
======== ======== ========
Liabilities
Interest bearing liabilities:
Regular savings $ 80,741 338 0.42 $ 70,559 712 1.01 $ 62,596 992 1.58
NOW and super NOW 87,212 285 0.33 66,742 273 0.41 56,326 359 0.64
Money market accounts 66,159 495 0.75 54,676 894 1.64 38,232 1,111 2.91
Certificates of deposit 161,405 3,304 2.05 163,013 4,650 2.85 178,297 8,862 4.97
Securities sold under
agreements to Repurchase 7,895 123 1.56 8,165 136 1.67 10,990 469 4.27
FHLB advances 63,271 2,876 4.55 46,701 2,508 5.37 44,232 2,500 5.65
Junior subordinated debentures 20,620 1,036 5.02 11,649 665 5.71 - - -
-------- ------- ---- -------- ------- ---- -------- ------- ----
Total interest bearing
liabilities 487,303 8,457 1.74 421,505 9,838 2.33 390,673 14,293 3.66
------- ------- -------
Noninterest bearing deposits 71,160 64,513 57,621
Other liabilities 3,307 2,180 3,474
-------- -------- --------
Total liabilities 561,770 488,198 451,768
Stockholders' equity 46,277 44,332 42,377
-------- -------- --------
Total liabilities and
stockholders' Equity $608,047 $532,530 $494,145
======== ======== ========
Net interest and dividend
income (6) $23,362 $21,896 $21,094
======= ======= =======
Interest rate spread(7) 3.92% 4.07% 3.98%
Net interest margin(8) 4.16% 4.42% 4.56%
(1) Reported on a tax equivalent basis. Reported interest on securities of $3,705,000, $3,330,000 and $2,996,000 was adjusted by
$238,000, $190,000 and $283,000, for 2003, 2002 and 2001, respectively, to reflect the tax equivalent adjustment.
(2) Average balances are calculated using the adjusted cost basis.
(3) Reported on a tax equivalent basis. Reported interest and fees on loans of $27,682,000, $27,879,000 and $31,587,000 was
adjusted by $74,000, $62,000 and $90,000 for 2003, 2002 and 2001, respectively, to reflect the tax equivalent adjustment.
(4) Net of unearned income. Includes loans held for sale and nonperforming loans.
(5) Reported on a tax equivalent basis. Reported interest and dividend income of $31,507,000, $31,482,000 and $35,014,000 was
adjusted by $312,000, $252,000 and $373,000 for 2003, 2002 and 2001, respectively, to reflect the tax equivalent adjustment.
(6) Reported on a tax equivalent basis. Reported net interest and dividend income of $23,050,000, $21,644,000 and $20,721,000 was
adjusted by $312,000, $252,000 and $373,000 for 2003, 2002 and 2001, respectively, to reflect the tax equivalent adjustment.
(7) Interest rate spread equals the yield on interest earning assets minus the rate paid on interest bearing liabilities.
(8) The net interest margin equals net interest income divided by total average interest earning assets.
CONSOLIDATED RATE/VOLUME VARIANCE ANALYSIS(1)
2003 Compared to 2002 2002 Compared to 2001
Increase (Decrease) Due to Change In Increase (Decrease) Due to Change In
---------------------------------------- ----------------------------------------
Volume Rate Mix Total Volume Rate Mix Total
------ ---- --- ----- ------ ---- --- -----
Interest and dividend income
Federal funds sold $ (55) $ (123) $ 25 $ (153) $ 161 $ (231) $ (87) $ (157)
Interest bearing deposits -- -- -- -- 3 (2) (2) (1)
Securities 902 (381) (98) 423 823 (465) (117) 241
Loans 3,600 (3,353) (432) (185) 1,109 (4,681) (164) (3,736)
------- ------- ------- ------- ------- ------- ------ -------
Total interest and dividend income 4,447 (3,857) (505) 85 2,096 (5,379) (370) (3,653)
------- ------- ------- ------- ------- ------- ------ -------
Interest expense:
Regular savings 103 (417) (60) (374) 126 (360) (46) (280)
NOW and super NOW 83 (55) 16 12 67 (129) (24) (86)
Money market accounts 188 (485) (102) (399) 478 (486) (209) (217)
Certificates of deposit (46) (1,313) 13 (1,346) (760) (3,776) 324 (4212)
Securities sold under agreements
to repurchase (4) (9) -- (13) (121) (286) 74 (333)
FHLB advances 890 (385) (137) 368 140 (125) (7) 8
Junior subordinated debentures 512 (80) (61) 371 665 -- -- 665
------- ------- ------- ------- ------- ------- ------ -------
Total interest expense 1,726 (2,744) (363) (1,381) 595 (5,162) 112 (4,455)
------- ------- ------- ------- ------- ------- ------ -------
Net interest and dividend income $ 2,721 $(1,113) $ (142) $ 1,466 $ 1,501 $ (217) $ (482) $ 802
======= ======= ======= ======= ======= ======= ====== =======
(1) Reported on a tax equivalent basis.
PROVISION FOR LOAN LOSSES
The provision for loan losses represents the annual cost of providing an
allowance for losses inherent in the loan portfolio. The size of the provision
for each year is determined by management based upon many factors, including
loan growth, net charge-offs, changes in the composition of the loan portfolio,
delinquencies, management's assessment of loan portfolio quality, the value of
collateral and general economic factors.
The provision for loan losses was $805,000 in 2003, a decrease of $95,000 from
the provision recorded in 2002. The 2002 provision of $900,000 was unchanged
from 2001. The provision for each of the three years was based upon a review of
the adequacy of the allowance for loan losses, which review is conducted on a
quarterly basis. This review is based upon many factors including the risk
characteristics of the portfolio, trends in loan delinquencies, and an
assessment of existing economic conditions. In addition, various regulatory
agencies, as part of their examination process, review the banks' allowances
for loan losses and such review may result in changes to the allowance based on
judgments different from those of management.
The decrease in the provision was due in part to the recording of $70,000 to
other expense for a provision for losses related to unfunded loan commitments
such as unused lines of credit and unused portions of home-equity loans. This
provision had previously been calculated as part of the allowance for loan
losses.
Although management utilizes its best judgment in providing for losses, there
can be no assurance that the Company will not have to change its provision for
loan losses in subsequent periods. Management will continue to monitor the
allowance for loan losses and modify the provision to the allowance for loan
losses as appropriate. For additional information regarding estimates in the
assessment of the allowance for loan losses see "Application of Critical
Accounting Policies" below.
NONINTEREST INCOME
Noninterest income consists of revenues generated from a broad range of
financial services and activities, including fee-based services and income
earned through securities sales.
The following table sets forth the components of the Company's noninterest
income:
($000 Omitted)
Years Ended December 31,
---------------------------
2003 2002 2001
---- ---- ----
Service charges and fees on deposit accounts $1,673 $1,473 $1,169
Gain on sales of securities
available-for-sale, net 1,522 151 128
Gain on sales of loans, net 422 259 438
Other 1,758 1,513 1,174
------ ------ ------
Total noninterest income $5,375 $3,396 $2,909
====== ====== ======
Fee income from service charges and fees on deposit accounts increased 14% in
2003, 26% in 2002 and 11% in 2001. The improvement in 2003 is due principally
to increases in overdraft fee income and service charge income resulting from
the full year impact of the branch acquisitions completed in October 2002. The
improvement in 2002 is due principally to the introduction of new overdrawn
account procedures and fee schedules introduced in January 2002 as well as the
impact of the branch purchases during the fourth quarter 2002. The improvements
in 2001 were due to an increased number of deposit accounts as a result of the
Littleton branch purchase in October 2001.
Net gains on sales of securities were $1,522,000 in 2003 compared to $151,000
in 2002 and $128,000 in 2001. Securities gains in 2003 were the result of
improved market conditions for investment securities. Securities gains, net, in
2003 included $175,000 of net losses on sales of equity securities compared to
net losses of $410,000 in 2002 and net gains of $55,000 in 2001. Net gains on
the sales of debt securities totaled $1,669,000 in 2003 compared to $561,000 in
2002 and $73,000 in 2001.
The low interest rate environment resulted in significant mortgage refinancing
activity. The Company decided to sell a portion of this loan volume in the
secondary market based on our underwriting standards. The result of these sales
was an increase in gain on sale of loans of $163,000 to $422,000 in 2003.
During 2002 and 2001, the Company recorded a gain on sale of loans of $259,000
and $438,000, respectively. The gain on sale of loans in 2002 resulted from the
sale of mortgage loans to the secondary market. 2001 gains reflect loans sold
to the secondary market as well as a realized gain of approximately $148,000
from the sale of a pool of nonperforming loans.
Other noninterest income (sources of which include debit card interchange fees,
credit card merchant and fee income, automated teller machine fees, loan fees
and safe deposit fees) increased $245,000, or 16%, to $1,758,000 in 2003
following an increase of $339,000, or 29%, to $1,513,000 in 2002 from
$1,174,000 in 2001. The increase in 2003 was due primarily to the recognition
of approximately $191,000 in other loan fees resulting from transactions with
Federal Home Loan Mortgage Corporation ("FHLMC"). The increase in 2002 compared
to 2001 was the result of increases in several categories including official
check fees, debit card interchange fees, the sale of bank owned real estate,
and the introduction of a loan extension skip-a-payment program for indirect
installment loans.
NONINTEREST EXPENSE
Total noninterest expense increased $2,101,000, or 10%, during 2003 following
an increase of $2,886,000, or 17%, during 2002 and an increase of $450,000, or
3%, during 2001. The increase in expenses during 2003 is due in large part to
the full year impact of the October 2002 branch purchases, which contributed to
the overall in increase in salaries and benefits expense, office occupancy and
equipment expense and increased expenses associated with the amortization of
core deposit intangibles. The increase to expenses during 2002 is due in large
part to the $910,000 write-down of equity securities, expenses related to the
acquisition of three branches during the fourth quarter, staff additions and
technology initiatives. During 2001 expenses increased due to the Company's
initiatives to standardize product offerings at the subsidiary banks, to
increase market share in existing markets and entry into new markets. In 2001
the Company acquired a branch in Littleton, New Hampshire and completed
construction of a new branch location in Tilton, New Hampshire.
The following table sets forth information relating to the Company's
noninterest expense during the periods indicated:
($000 Omitted)
Years Ended December 31,
--------------------------------
2003 2002 2001
------- -------- ------
Salaries and employee benefits $11,426 $ 9,758 $9,014
Office occupancy and equipment 3,753 3,298 2,864
Amortization of unidentifiable intangible
assets - - 625
Amortization of core deposit intangible 954 476 -
Write-down of equity securities
available-for-sale 184 910 -
Professional fees 1,166 1,096 886
Stationery and supplies 556 596 486
Telephone 571 505 283
Postage and shipping 378 378 323
ATM expense 442 366 352
Other 2,706 2,652 2,316
------- ------- -------
Total noninterest expense $22,136 $20,035 $17,149
======= ======= =======
Salaries and employee benefits increased $1,668,000, or 17%, from 2002 to 2003
and $744,000, or 8%, from 2001 to 2002. These increases reflect staff additions
in connection with the expansion of the retail franchise, increased lending
activities and normal salary and wage increases. Also, during 2003, the Company
recorded a liability to deferred compensation related to a Supplemental
Employee Retirement Plan ("SERP"). Refer to Note 15 to the Consolidated
Financial Statements for a further discussion regarding the SERP.
Office occupancy and equipment expense increased $455,000, or 14%, from 2002 to
2003 and $434,000, or 15%, from 2001 to 2002. These increases were due to
increases in depreciation expense associated with technology purchases made in
2002 as well as the expansion of the retail franchise.
The amortization of core deposit intangibles, net, increased $478,000 from 2002
to 2003 due to the full year impact of the October 2002 branch purchases.
Amortization of unidentifiable intangible assets and amortization of core
deposit intangible, net, decreased $149,000 from 2001 to 2002. On October 1,
2002, the Company adopted SFAS 147 which resulted in a decrease of amortization
expense of $281,000 over the prior year which was partially offset by the
recording of $132,000 of amortization of core deposit intangible associated
with the fourth quarter branch acquisitions.
These increases were offset, in part, by a decrease in the write-down on equity
securities of $726,000. During 2003, the Company recorded a write-down of
equity securities of $184,000 compared to $910,000 for the prior year. During
2003, five securities were determined to be other than temporarily impaired due
to sustained weakness in their sector as well as weaknesses related to the
individual companies. During 2002, the sustained overall weakness in the equity
market as well as significant declines in certain sectors and specific
companies within those sectors, resulted in the Company determining that the
market values of certain of its marketable equity securities were other than
temporarily impaired. As a result, during 2002 the Company recorded a
write-down of equity securities of $910,000.
INCOME TAX EXPENSE
The Company recognized $1,867,000, $1,507,000 and $1,708,000 in income tax
expense for the years ended December 31, 2003, 2002 and 2001, respectively. The
effective tax rate was 34.1% for 2003, 36.7% for 2002 and 30.6% for 2001. The
increase in the effective tax rate in 2002 compared to 2001 is due to the fact
that, during 2001, the Company had obtained a number of state tax credits in
New Hampshire related to economic development grants. In addition, the 2001 tax
rate as compared to 2000 was reduced by the increased level of municipal
income. This was partially offset by a 50 basis point increase, or 0.50%, in
the State of New Hampshire Business Profits Tax. For additional information
relating to income taxes, see Note 14 to the Consolidated Financial Statements.
ASSETS
Total assets increased $10,271,000, or 2%, to $609,216,000 at December 31, 2003
compared to $598,945,000 at December 31, 2002. The following is a summary of
significant balance sheet changes.
($000 Omitted)
Years Ended December 31,
--------------------------------------
2003 2002 Change % Change
---- ---- ------ --------
Total assets $609,216 $598,945 $ 10,271 1.7%
Earning assets 562,311 548,980 13,331 2.4
Federal funds sold 16,470 10,170 6,300 61.9
Securities available-for-sale,
at fair value* 78,786 96,109 (17,323) (18.0)
Loans, net of unearned income 467,985 442,152 25,833 5.8
Deposits 463,307 476,194 (12,887) (2.7)
Borrowings 95,021 74,871 20,150 26.9
Stockholders' equity 47,872 44,266 3,606 8.1
* Includes Federal Home Loan Bank stock and Federal Reserve Bank stock.
The increase in earning assets of $13,331,000 was due primarily to an increase
in gross loans partially offset by a decrease in securities available-for-sale.
The increase in earning assets was funded by an increase in borrowings,
specifically FHLB medium-term advances which were acquired at attractive rates
in the current low interest rate environment. This increase in borrowings was
partially offset by a decrease in deposits, primarily time accounts.
SECURITIES AVAILABLE-FOR-SALE
The Company's securities are classified into one of two categories based on
management's intent to hold the securities: (i) "held-to-maturity" securities,
or (ii) securities "available-for-sale." Securities designated to be
held-to-maturity are reported at amortized cost. Securities classified as
available-for-sale are required to be reported at fair value with unrealized
gains and losses, net of taxes, excluded from earnings and shown separately as
a component of stockholders' equity. At December 31, 2003 and 2002 the Company
had no securities designated as held-to-maturity.
The following table summarizes the Company's securities portfolio at December
31, 2003 and 2002, showing amortized cost and fair value for each category:
($000 Omitted)
December 31,
---------------------------------------
2003 2002
------------------ ----------------
Amortized Fair Amortized Fair
Cost Value Cost Value
Securities available-for-sale:
US Treasury and US government
agencies $37,945 $37,840 $36,167 $36,188
Mortgage-backed securities 2,803 2,888 7,286 7,476
Collateralized mortgage obligations 15 15 5,103 5,170
Marketable equity securities 2,589 2,766 3,163 2,377
Corporate bonds 20,857 21,983 33,407 33,848
State and political subdivisions 8,066 8,224 6,154 6,338
------- ------- ------- -------
Total securities
available-for-sale $72,275 $73,716 $91,280 $91,397
======= ======= ======= =======
Total securities decreased $17,861,000 during 2003 to $73,716,000. One of the
primary functions of the investment portfolio is to provide liquidity to the
Company. During 2003, the Company had the ability to increase outstanding
loans, which are a higher yielding asset. As a result of the low interest rate
environment during 2003, the Company sold several corporate bonds at attractive
gains and reinvested these proceeds into the loan portfolio.
The net unrealized gain on securities available-for-sale was $1,441,000 at
December 31, 2003 compared to $117,000 at December 31, 2002. At December 31,
2003, the net unrealized gain on debt securities was $1,264,000 and the net
unrealized gain on marketable equity securities was $177,000. At December 31,
2002, the net unrealized gain on debt securities totaled $903,000, which was
partially offset by a net unrealized loss on marketable equity securities of
$786,000. The net unrealized gain on debt securities for both years is
primarily the result of the low rate environment during 2003 and 2002, which
resulted in an appreciation in value of existing debt holdings. The net
unrealized loss on marketable equity securities for 2002 is primarily the
result of the weak equity market.
Due to the decline in the performance of securities in certain sectors and
specific companies within those sectors, the Company determined, through the
evaluations described in Note 1 to the Consolidated Financial Statements, that
the market values of certain of its marketable equity securities were other
than temporarily impaired. As a result, during 2003 net losses on sales of
marketable equity securities amounted to $147,000 and write-downs of marketable
equity securities amounted to $184,000. During 2002 net losses on sales of
marketable equity securities amounted to $410,000 and write-downs of marketable
equity securities amounted to $910,000.
At December 31, 2003, the Company's investment in equity securities totaled
$2,766,000. This amount is net of a market value adjustment of $177,000, of
which the full amount was reflected in accumulated other comprehensive loss in
stockholders' equity.
The Company has a general policy of purchasing investment grade securities and
U.S. government securities to minimize credit risk. All securities, however,
carry interest rate risk, which affect their market values such that as market
yields increase, the value of the Company's securities decline and vice versa.
Additionally, mortgage-backed securities carry prepayment risk whereby expected
yields may not be achieved due to the inability to reinvest proceeds from
prepayment at comparable yields. Moreover, such mortgage-backed securities may
not benefit from price appreciation in periods of declining rates to the same
extent as the remainder of the portfolio.
A portion of the securities portfolio is pledged to secure public deposits,
short-term securities sold under agreements to repurchase and treasury, tax and
loan accounts. Refer to Note 3 to the Consolidated Financial Statements for a
further discussion of pledging of securities.
LOANS
Loans increased 6% in 2003 with the most significant increases occurring in
residential real estate, commercial real estate and indirect installment loans.
At December 31, 2002 loans increased 10% over the prior year as all categories
of loans, with the exception of other loans, recognized increases, with the
greatest increases occurring in residential real estate, installment loans and
indirect installment loans. The following table presents the composition of the
loan portfolio as of December 31, 2003 and 2002:
($000 Omitted)
Percent Percent
2003 of Total 2002 of Total
-------- -------- -------- --------
Real estate:
Residential $129,493 27.7% $114,526 25.9%
Commercial 120,366 25.7 111,941 25.3
Construction 3,851 0.8 6,330 1.4
Commercial 24,528 5.2 23,885 5.4
Installment 30,291 6.5 40,169 9.1
Indirect installment 150,807 32.2 139,477 31.5
Other 8,896 1.9 6,031 1.4
-------- ----- -------- -----
$468,232 100.0% $442,359 100.0%
======== ===== ======== =====
The loan portfolio mix shifted slightly during the year. Indirect installment
loans, which are fixed-rate loans secured by automobiles originated through
automobile dealers with an average term of 60 months, comprised 32.2% of the
loan portfolio at December 31, 2003 as compared to 31.5% at the end of 2002.
Residential real estate loans increased to account for 27.7% of the portfolio
from 25.9% at December 31, 2002 due in part to the decision to retain high
credit quality fixed rate mortgages in the portfolio rather than sell in the
secondary market. Installment loans, which include consumer loans, fixed rate
equity loans, and home equity lines of credit, comprised 6.5% of the portfolio
at December 31, 2003 compared to 9.1% a year ago due primarily to a decrease in
home equity lines of credit. The Company strives to maintain a balanced
portfolio consisting of approximately 30% residential real estate loans, 33-35%
commercial loans, and 35-37% installment and other loans.
Commercial real estate loans consist of loans secured by income producing
commercial real estate and commercial loans consist of loans that are either
unsecured or are secured by inventories, receivables or other corporate assets,
and many are additionally secured by a guarantee of the federal Small Business
Administration. Commercial real estate and commercial loans increased by
$9,068,000 in 2003 as compared to 2002. The Company continues to emphasize
commercial real estate and commercial loans in order to enhance earnings and
maintain the balance of its portfolio.
Residential real estate loans increased by $14,967,000 in 2003, a 13% increase
from 2002, compared to an increase of $5,265,000, or 5%, in 2002 compared to
2001. The Company originates both fixed-rate and adjustable-rate residential
loans for its portfolio. Some fixed-rate residential loans are originated for
sale to investors in the secondary market. The increase in residential real
estate loans in 2003 resulted primarily from the Company's decision to retain a
greater percentage of fixed-rate residential mortgage loans.
Installment loans consist primarily of loans originated directly by the
Company, however, as part of the Laconia, Belmont and Pittsfield branch
acquisitions, the Company purchased installment loans totaling approximately
$18,102,000 during 2002. During 2003, installment loan balances decreased
$9,878,000 compared to 2002. Indirect installment loans increased by
$13,330,000, or 8%, in 2003.
NONPERFORMING ASSETS
Nonperforming assets were $4,180,000, or 0.69% of total assets, at December 31,
2003 compared to $3,892,000, or 0.65% of total assets, at December 31, 2002, an
increase of $288,000, or 7%. Nonperforming assets are comprised primarily of
nonaccrual loans, other chattels owned and real estate acquired by foreclosure
or a similar conveyance of title. The accrual of interest on a loan is
discontinued when there is reasonable doubt as to its collectibility or
whenever the payment of principal or interest is more than 90 days past due.
However, there are loans within this nonaccrual classification that provide
periodic payments, but which have a weakness with respect to the collateral
securing the loan.
At December 31, 2003, nonaccrual loans totaled $4,089,000, or 0.87% of total
loans, compared to $3,619,000, or 0.82% of total loans, in 2002. There was no
other real estate owned at December 31, 2003 compared to $175,000 of other real
estate owned at December 31, 2002. Other chattels owned decreased $7,000 to
$91,000 at December 31, 2003 compared to $98,000 at December 31, 2002.
ALLOWANCE FOR LOAN LOSSES
The Company maintains an allowance for loan losses to absorb losses inherent in
the existing loan portfolio. When a loan, or portion thereof, is considered
uncollectible, it is charged against the allowance. Recoveries of amounts
previously charged-off are added to the allowance when collected. The adequacy
of the allowance for loan losses is evaluated on a regular basis by management.
Factors considered in evaluating the adequacy of the allowance include previous
loss experience, current economic conditions and their effect on borrowers and
the market area in general, and the performance of individual credits in
relation to the contract terms. In addition various federal and state
regulatory agencies, as an integral part of their examination process,
periodically review the adequacy of the Company's allowance for loan losses.
For additional information regarding estimates in the assessment of the
allowance for loan losses see "Application of Critical Accounting
Policies-Allowance for Loan Losses" below.
The Company's allowance for loan losses increased $116,000 from December 31,
2002 to $5,036,000, or 1.08% of total loans, at December 31, 2003.
The following table sets forth the composition of the allowance for loan losses
for the periods indicated:
($000 Omitted)
Years Ended December 31,
2003 2002 2001
------ ------ ------
Beginning allowance $4,920 $4,642 $4,354
Provision for loan losses 805 900 900
Loans charged-off (870) (824) (734)
Recoveries of loans previously charged-off 181 202 122
------ ------ ------
Net charge-offs (689) (622) (612)
------ ------ ------
Ending allowance $5,036 $4,920 $4,642
====== ====== =======
Allowance as a percentage of loans outstanding 1.08% 1.11% 1.16%
Allowance as a percentage of nonperforming loans 123.2 135.95 333.48
Net charge-offs as a percentage of average loans 0.15 0.15 0.15
DEPOSITS
Total deposits at December 31, 2003 were $463,307,000, a decrease of
$12,887,000, or 3%, compared to $476,194,000 at December 31, 2002. The decrease
in deposits was due primarily to a decrease in time deposits partially offset
by an increase in regular savings, NOW and money market accounts.
The following table sets forth the components of deposits for the periods
indicated:
($000 Omitted)
December 31,
2003 2002
--------- ---------
Demand $ 69,599 $ 71,759
Regular savings, NOW and money market 244,766 232,892
Time 148,942 171,543
-------- --------
Total deposits $463,307 $476,194
======== ========
At December 31, 2003, time deposits of $100,000 or more are scheduled to mature
as follows:
($000 Omitted)
3 months or less $ 6,069
Over 3 to 6 months 4,771
Over 6 to 12 months 7,354
Over 12 months 4,514
-------
$22,708
BORROWINGS
At December 31, 2003 short-term borrowings consisted of securities sold under
agreements to repurchase of $7,401,000 compared to $8,251,000 for 2002.
Long-term debt in 2003 consists of FHLB term advances of $67,000,000 as well as
$20,620,000 of junior subordinated debentures, compared to $46,000,000 of FHLB
term advances and $20,620,000 of junior subordinated debentures in 2002. Many
of the long-term term FHLB advances are callable quarterly with call dates in
January, February and March 2004. The increase in FHLB advances is the result
of twelve new advances, totaling $28,000,000, during the year ranging in term
from two years to seven years with an average interest rate of 2.74% which was
partially offset by the maturity of $7,000,000 in advances.
Junior subordinated debentures consist of two issues of floating rate trust
preferred securities acquired during April and July 2002 in the amount of
$7,217,000 and $13,403,000, respectively, due in 2032. These trust preferred
securities were offered for the purpose of providing capital to the subsidiary
banks to ensure adequate capital following the recent branch acquisitions and
for general corporate purposes. As of December 31, 2003, of the $20,620,000
principal amount outstanding, $10,858,000 qualified as Tier 1 capital and
$9,142,000 was allocated to Tier 2 capital.
See Notes 9 and 10 to the Consolidated Financial Statements for additional
information regarding our borrowings.
The following table sets forth certain information concerning the Company's
borrowings at the dates indicated:
($000 Omitted)
December 31,
2003 2002
------- -------
Short-term borrowings $ 7,401 $ 8,251
Long-term debt 87,620 66,620
------- -------
$95,021 $74,871
======= =======
At December 31, 2003, long-term debt is scheduled to mature as follows:
($000 Omitted)
Less than one year $ 9,000
One to three years 19,000
Three to five years 11,000
Over five years 48,620
-------
$87,620
=======
OFF-BALANCE SHEET ARRANGEMENTS
The Company is party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers and
to reduce its own exposure to fluctuations in interest rates. These financial
instruments include commitments to originate loans and standby letters of
credit. The instruments involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the balance sheet. The
amounts of those instruments reflect the extent of involvement the Company has
in particular classes of financial instruments.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for loan commitments and standby
letters of credit is represented by the contractual amount of those
instruments. The Company uses the same credit policies in making commitments
and conditional obligations as it does for balance sheet instruments.
Financial instruments with off-balance sheet credit risk at December 31, 2003
and 2002 totaled $45,276,000 and $58,229,000, respectively.
See Note 16 to the Consolidated Financial Statements for additional information
regarding off-balance sheet arrangements.
CAPITAL
The Company's stockholders' equity serves to support growth and provide
depositors and other creditors protection against loss. Equity capital
represents the stockholders' investment in the Company. Management strives to
maintain an optimal level of capital on which an attractive return to the
stockholders will be realized over both the short-term and long-term, while
serving depositors' and creditors' needs.
The Company must also observe the minimum requirements enforced by the federal
banking regulators. There are three capital requirements that banks and bank
holding companies must meet: Tier 1 capital, total capital (combination of Tier
1 capital and Tier 2 capital), and leverage (Tier 1 capital to average assets)
ratios. Tier 1 capital consists of stockholders' equity, net of intangible
assets as well as a portion of junior subordinated debentures. Tier 2 capital
consists of a limited amount of allowance for loan losses and the portion of
junior subordinated debentures not allocated to Tier 1 capital. Tier 1 capital,
total capital and leverage ratios do not include any adjustments for unrealized
gains and losses relating to securities available-for-sale except net
unrealized losses relating to marketable equity securities. The minimum
requirements for the leverage ratio, risk-based Tier 1 capital and risk-based
total capital are 4%, 4% and 8%, respectively. As of December 31, 2003 and
2002, Banks were "well capitalized" as defined under FDIC regulations.
The following table sets forth the Company's risk-based capital and
leverage ratios:
($000 Omitted)
December 31,
2003 2002
-------- --------
Risk-adjusted assets $453,272 $445,281
Tier 1 capital (to average assets) 7.22% 6.70%
Tier 1 capital (to risk weighted assets) 9.66 8.57
Total capital (to risk weighted assets) 12.81 12.04
Total stockholders' equity includes a $149,000 adjustment for accumulated other
comprehensive income, net of tax, at December 31, 2003 and a $1,366,000
negative adjustment for accumulated other comprehensive loss, net of tax, at
December 31, 2002. At December 31, 2003, this adjustment was comprised of a net
unrealized gain on securities available-for-sale of $870,000, net of taxes, and
an unfunded pension accumulated benefit obligation of $721,000, net of taxes.
The net unrealized gain on securities available-for-sale is attributable
primarily to the low interest rate environment which results in appreciation of
securities held at higher than market rates. While the Company continues to
contribute the maximum amount permitted by law to its pension plan, the
discount rate used to calculate the future value of such contribution and the
poor asset performance of investment securities has resulted in the unfunded
pension accumulated benefit obligation. For additional information regarding
estimates see "Application of Critical Accounting Policies" below.
The Company intends to continue to pay dividends on a quarterly basis subject
to the financial condition and earnings of the Company, capital requirements,
and other factors, including applicable governmental regulations. No dividends
will be payable unless declared by the Board of Directors and then only to the
extent funds are legally available for the payment of such dividends.
APPLICATION OF CRITICAL ACCOUNTING POLICIES
The Company's accounting policies are more fully described in Note 1 of the
Consolidated Financial Statements. As disclosed in Note 1, the preparation of
financial statements in conformity with generally accepted accounting
principles requires management to make estimates and assumptions about future
events that affect the amounts reported in the financial statements and
accompanying notes. Actual results could differ significantly from those
estimates. The Company believes that the following discussion addresses the
Company's most critical accounting policies, which are those that are most
important to the portrayal of the Company's financial condition and results of
operations and require management's most difficult, subjective and complex
judgments.
Allowance for Loan Losses. Allowance for loan losses are estimated at the
individual Banks based on estimates of losses related to customer loan
balances. In establishing the appropriate provisions for customer loan
balances, the Company makes assumptions with respect to their future
collectibility. The Company's assumptions are based on an individual assessment
of the customer's credit quality as well as subjective factors and trends,
including the credit rating of the loans. Generally, these individual credit
assessments occur prior to the inception of the credit exposure and at regular
reviews during the life of the exposure and consider (a) the customer's ability
to meet and sustain their financial commitments; (b) a customer's current and
projected financial condition; (c) the positive or negative effects of the
current and projected industry outlook; and (d) the economy in general. Once
the Company considers all of these factors, a determination is made as to the
probability of default. An appropriate provision is made, which takes into
account the severity of the likely loss on the outstanding loan balances based
on the Company's experience in collecting these amounts. The Company's level of
allowance for loan losses fluctuates depending upon all of the factors
mentioned above.
Goodwill and Core Deposit Intangible. Effective January 1, 2002, the Company
adopted Statement of Financial Accounting Standards No. 142 ("SFAS No. 142"),
"Goodwill and Other Intangible Assets." Under SFAS No. 142, the Company is
required to perform annual impairment tests of its goodwill and intangible
assets and more frequently in certain circumstances. The Company has elected to
test for goodwill and intangible asset impairment in the fourth quarter of each
year. In that goodwill is carried on the books of the Banks and Northway
Financial, Inc. owns 100% of their outstanding stock, there is no market value
for their common stock. The Company utilizes a multiple of earnings approach in
analyzing the valuation of goodwill. Core deposit intangibles are carried on
the books of the Banks as well. The valuation of core deposit intangibles
incorporate deposits acquired compared with current deposit levels, considers
deposit outflow assumptions made at acquisition as well as other factors.
The most recent impairment test of goodwill and core deposit intangible assets
indicated that no adjustment was required. The Company cannot predict the
occurrence of certain future events that might adversely affect the reported
value of goodwill and core deposit intangible that totaled $10,152,000 and
$3,903,000, respectively, at December 31 2003. Such events include, but are not
limited to, strategic decisions made in response to economic and competitive
conditions, the impact of the economic environment on the Company's customer
base, or the impact of changes in federal and state laws and regulations.
Pension Benefits. The Company maintains a trusteed non-contributory pension
plan (the "Plan") covering substantially all full-time employees. Several
statistical and other factors, which attempt to anticipate future events, are
used in calculating the expense and liability related to the Plan. Key factors
include assumptions about the expected rates of return on plan assets and
discount rates. The Company considers market conditions, including changes in
investment returns and interest rates, in making these assumptions.
The Company determines the expected long-term rate of return on plan assets
based on the building block method, which consists of aggregating the expected
rates of return for each component of the plan's asset mix. Plan assets are
comprised primarily of mutual funds including bond funds, US equity funds,
international equity funds, real estate funds and short-term money market
funds. The Company uses historic plan asset returns combined with current
market conditions to estimate the rate of return. The expected rate of return
on plan assets is a long-term assumption and generally does not change
annually. The discount rate reflects the market rate for high-quality fixed
income debt instruments on the Company's annual measurement date (December 31)
and is subject to change each year.
Unrecognized actuarial gains and losses are being recognized over approximately
a 17-year period, which represents the expected remaining service life of the
employee group. Unrecognized actuarial gains and losses arise from several
factors including experience and assumption changes in the obligations and from
the difference between expected returns and actual returns on plan assets.
These unrecognized losses will be systematically recognized as an increase in
future net periodic pension expense in accordance with FAS 87, "Employers'
Accounting for Pensions."
The actuarial assumptions used by the Company in determining its pension
benefits may differ materially from actual results due to changing market and
economic conditions, higher or lower withdrawal rates or longer or shorter life
spans of the participants. While the Company believes that the assumptions used
are appropriate, differences in actual experience or changes in assumptions may
materially affect the Company's financial position or results of operations.
Mortgage Servicing Rights (MSR or MSRs). Servicing assets are recognized as
separate assets when rights are acquired through purchase or through sale of
financial assets. Capitalized servicing rights are reported in other assets and
are amortized into noninterest income in proportion to, and over the period of,
the estimated future net servicing income of the underlying financial assets.
Servicing assets are evaluated for impairment based upon the fair value of the
rights as compared to amortized cost. Impairment is determined by stratifying
rights by predominant characteristics, such as interest rates and original loan
terms (primarily 15 and 30 year.) Fair value is determined using prices for
similar assets with similar characteristics, when available, or based upon
discounted cash flows using market-based assumptions. In periods of falling
market interest rates, accelerated loan prepayment speeds can adversely impact
the fair value of these mortgage-servicing rights relative to their book value.
In the event that the fair value of these assets were to increase in the
future, the Company can recognize the increased fair value to the extent of the
impairment allowance but cannot recognize an asset in excess of its amortized
book value. When the book value of an individual stratum exceeds its fair
value, an impairment reserve must be recognized. Future changes in management's
assessment of the impairment of these servicing assets, as a result of changes
in observable market data relating to market interest rates, loan prepayment
speeds, and other factors, could impact the Company's financial condition and
results of operations either positively or adversely.
MARKET RISK
Market risk is the risk of loss in a financial instrument arising from adverse
changes in market rates and prices, such as interest rates, foreign currency
exchange rates, commodity prices and equity prices. The Company's primary
market risk exposure is interest rate risk. The ongoing monitoring and
management of this risk is an important component of the Company's
asset/liability management process which is governed by policies established by
the Company's Boards of Directors that are reviewed and approved annually. The
Board of Directors delegates responsibility for carrying out the
asset/liability management policies to the Company's Asset Liability Committee
("ALCO"). In this capacity ALCO develops guidelines and strategies impacting
the Company's asset/liability management-related activities based upon
estimated market risk sensitivity, policy limits and overall market interest
rate levels/trends.
Interest Rate Risk
Interest rate risk represents the sensitivity of earnings to changes in market
interest rates. As interest rates change, the interest income and interest
expenses associated with the Company's financial instruments also change,
thereby impacting net interest income ("NII"), the primary component of the
Company's earnings. ALCO utilizes the results of a detailed and dynamic
simulation model to quantify the estimated exposure of NII to sustained
interest rate changes. While ALCO routinely monitors simulated NII sensitivity
over a rolling 2-year horizon, it also utilizes additional tools to monitor
potential longer-term interest rate risk.
The simulation model captures the impact of changing interest rates on the
interest income received and interest expense paid on all interest-earning
assets and interest-bearing liabilities reflected on the Company's balance
sheet. The Company uses computer simulations to determine the impact on net
interest income of various interest rate scenarios, balance sheet trends and
strategies. These simulations incorporate assumptions about balance sheet
dynamics such as loan and deposit growth, loan and deposit pricing, changes in
funding mix, and asset and liability repricing and maturity characteristics.
Simulations based on numerous assumptions are run under various interest rate
scenarios to determine the impact on net interest income and capital. From
these scenarios, interest rate risk is quantified and appropriate strategies
are developed and implemented.
This sensitivity analysis is compared to ALCO policy limits which specify a
maximum tolerance level for NII exposure over a 1-year horizon given both an
immediate 300 basis point, or 3%, upward and downward shift in interest rates.
Given the current level of interest rates, the Company has modeled an upward
shift in rates of 300 basis points and a downward shift in rates of 100 basis
points. Using an immediate rate shock simulation where interest rates increase
300 basis points, the December 31, 2003 earnings simulation model projects that
net interest income for the twelve months ending December 31, 2004 would
increase by an amount equal to approximately 1.25%. In addition, utilizing an
immediate rate shock simulation where interest rates decrease 100 basis points,
the December 31, 2003 earnings simulation model projects that net interest
income for the twelve months ending December 31, 2004 would decrease by an
amount equal to approximately 2.19%.
Using an immediate rate shock simulation where interest rates increase 300
basis points, the December 31, 2003 earnings simulation model projected that
net interest income for the twelve months ending December 31, 2005 would
increase by an amount equal to approximately 7.30%. In addition, utilizing an
immediate rate shock simulation where interest rates decrease 100 basis points,
the December 31, 2003 earnings simulation model projected that net interest
income for the twelve months ending December 31, 2005 would decrease by an
amount equal to approximately 7.15%. The projected results are within Company
policy limits for both years.
The preceding sensitivity analysis does not represent a Company forecast and
should not be relied upon as being indicative of expected operating results.
These hypothetical estimates are based upon numerous assumptions including,
among others, the nature and timing of interest rate levels, yield curve shape,
prepayments on loans and securities, deposit decay rates, pricing decisions on
loans and deposits, and reinvestment/replacement of asset and liability
cashflows. The assumptions differed in each of the periods included in the
sensitivity analysis above. While assumptions are developed based upon current
economic and local market conditions, the Company cannot make any assurances as
to the predictive nature of these assumptions, including how customer
preferences or competitor influences might change.
The most significant factors affecting the changes in market risk exposure
during 2003 compared to 2002 were the continuation of the low interest rate
environment, changes in the yield curve for investment securities, the increase
in the aggregate principal amount in fixed-rate loans extended by the Banks,
the aggregate decrease in securities available-for-sale, the decrease in total
deposits, as well as the increase in long-term debt.
LIQUIDITY RISK
Liquidity risk management involves the Company's ability to raise funds in
order to meet its existing and anticipated financial obligations. These
obligations are the withdrawal of deposits on demand or at contractual
maturity, the repayment of debt as it matures, the ability to fund new and
existing loan commitments and the ability to take advantage of new business
opportunities. Liquidity may be provided through amortization, maturity or sale
of assets such as loans and securities available-for-sale, liability sources
such as increased deposits, utilization of the FHLB credit facility, purchased
or other borrowed funds, and access to the capital markets. Liquidity targets
are subject to change based on economic and market conditions and are
controlled and monitored by the ALCO. At the bank level, liquidity is managed
by measuring the net amount of marketable assets after deducting pledged
assets, plus lines of credit, primarily with the FHLB, which are available to
fund liquidity requirements. Management then measures the adequacy of that
aggregate amount relative to the aggregate amount of liabilities deemed to be
sensitive or volatile. These include brokered deposits, deposits in excess of
$100,000, term deposits with short maturities, and credit commitments
outstanding.
Additionally, the parent holding company requires cash for various operating
needs including dividends to stockholders, the purchase of treasury stock,
capital injections to the subsidiary banks, and the payment of general
corporate expenses. The primary sources of liquidity for the parent holding
company are dividends from the subsidiary banks and reimbursement for services
performed on behalf of the banks. Additionally, the parent holding company may
utilize outside sources of funding such as the issuance of the trust preferred
securities during 2002.
Cash and cash equivalents increased by $3,659,000 during 2003. Cash used for
investing activities totaled $8,664,000 with lending activities utilizing
$27,538,000 and investment purchases providing $19,577,000. Cash provided by
financing activities totaled $5,737,000. This cash consisted of $28,000,000
from advances from the FHLB partially offset by the repayment of maturing FHLB
advances in the amount of $7,000,000 as well as a decrease in deposits of
$12,887,000. The net cash provided by operating activities totaled $6,586,000
and consisted primarily of net income of $3,617,000, a decrease in loans held
for-sale and a decrease in other assets and other liabilities, net.
CAPITAL EXPENDITURES AND COMMITMENTS
During 2003, the Company incurred approximately $1,806,000 in capital
expenditures. The expenditures included approximately $846,000 for the purchase
and improvement of a commercial lending and administration facility in North
Conway, New Hampshire. Approximately $307,000 was expended for the
reengineering of the operations department of the Berlin main office facility,
which included both construction and furniture costs. The remaining
expenditures were for normal replacement of, or upgrades in, existing property
and equipment.
During 2002, the Company incurred approximately $2,628,000 in capital
expenditures. These expenditures included approximately $1,700,000 in
technology improvements including installation of a wide-area network, a voice
over internet protocol telephone system, a new on-line teller system, document
imaging and computer upgrades. In addition, $430,000 was recorded for the
purchase of real estate in Laconia, New Hampshire as part of the branch
acquisition. The remaining expenditures were for normal replacement of, or
upgrades in, existing property and equipment.
The Company's estimated capital expenditures for 2004 total $2,067,000. The
Company has budgeted approximately $1,150,000 to complete improvements and
provide equipment and furniture for the commercial lending and administration
facility in North Conway, $276,000 for ATM software and $153,000 for the
replacement of the mainframe computer. The remaining expenditures will be
incurred for normal replacement of, or upgrades to, existing property and
equipment. These expenditures are expected to be funded through normal Company
cash flows.
CONTRACTUAL OBLIGATIONS
The table below contains information on the Company's contractual obligations
as of the fiscal year ended December 31, 2003:
Less Than 1-3 3-5 More than
Contractual Obligations Total One Year Years Years Five Years
---------------------------------------------------------------------------------------------------------------------
FHLB Advances $67,000 $9,000 $19,000 $11,000 28,000
Junior subordinated debentures 20,620 - - - 20,620
-------------------------------------------------------------------------------
Total $87,620 $9,000 $19,000 $11,000 $48,620
==============================================================================
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Information regarding quantitative and qualitative disclosures about market
risk is included in "Management's Discussion and Analysis of Financial
Condition and Results of Operations" appearing under Item 7 of this report and
is hereby incorporated by reference in this Item 7A.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
CONSOLIDATED STATEMENTS OF INCOME
($000 Omitted, Except Per Share Data)
FOR THE YEAR ENDED DECEMBER 31, 2003 2002 2001
------------------------------------------------------------------------------------------------------------------------------
Interest and dividend income
Interest and fees on loans $27,682 $27,879 $31,587
Interest on debt securities available-for-sale:
Taxable 3,075 2,781 2,169
Tax-exempt 393 308 485
Dividends 237 241 342
Interest on federal funds sold 118 271 428
Interest on interest bearing deposits 2 2 3
------------------------------------------------------------------------------------------------------------------------------
Total interest and dividend income 31,507 31,482 35,014
------------------------------------------------------------------------------------------------------------------------------
Interest expense
Interest on deposits:
Regular savings, NOW and money market deposit accounts 1,118 1,878 2,462
Certificates of deposit (in denominations of $100,000 or more) 560 703 1,363
Other time 2,744 3,947 7,499
Interest on short-term borrowings 126 141 513
Interest on long-term debt 3,909 3,169 2,456
------------------------------------------------------------------------------------------------------------------------------
Total interest expense 8,457 9,838 14,293
------------------------------------------------------------------------------------------------------------------------------
Net interest and dividend income 23,050 21,644 20,721
Provision for loan losses 805 900 900
------------------------------------------------------------------------------------------------------------------------------
Net interest and dividend income after provision for loan losses 22,245 20,744 19,821
------------------------------------------------------------------------------------------------------------------------------
Noninterest income
Service charges and fees on deposit accounts 1,673 1,473 1,169
Gain on sales of securities available-for-sale, net 1,522 151 128
Gain on sales of loans, net 422 259 438
Other 1,758 1,513 1,174
------------------------------------------------------------------------------------------------------------------------------
Total noninterest income 5,375 3,396 2,909
------------------------------------------------------------------------------------------------------------------------------
Noninterest expense
Salaries and employee benefits 11,426 9,758 9,014
Office occupancy and equipment 3,753 3,298 2,864
Amortization of core deposit intangible 954 476 -
Amortization of unidentifiable intangible assets - - 625
Write-down of equity securities 184 910 -
Other 5,819 5,593 4,646
------------------------------------------------------------------------------------------------------------------------------
Total noninterest expense 22,136 20,035 17,149
------------------------------------------------------------------------------------------------------------------------------
Income before income tax expense 5,484 4,105 5,581
Income tax expense 1,867 1,507 1,708
------------------------------------------------------------------------------------------------------------------------------
Net income $ 3,617 $ 2,598 $ 3,873
------------------------------------------------------------------------------------------------------------------------------
Basic earnings per common share $ 2.40 $ 1.71 $ 2.55
Earnings per common share assuming dilution $ 2.39 $ 1.71 $ 2.54
------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements
CONSOLIDATED STATEMENTS OF FINANCIAL CONDITION
($000 Omitted)
AS OF DECEMBER 31, 2003 2002
----------------------------------------------------------------------------------------------------------------------------------
Assets Cash and cash equivalents:
Cash and due from banks and interest bearing deposits $14,615 $17,256
Federal funds sold 16,470 10,170
----------------------------------------------------------------------------------------------------------------------------------
Total cash and cash equivalents 31,085 27,426
----------------------------------------------------------------------------------------------------------------------------------
Securities available-for-sale, at fair value 73,716 91,397
Federal Home Loan Bank stock 4,705 4,632
Federal Reserve Bank stock 365 80
Loans held-for-sale 511 669
----------------------------------------------------------------------------------------------------------------------------------
Loans, net before allowance for loan losses 467,985 442,152
Less: allowance for loan losses 5,036 4,920
----------------------------------------------------------------------------------------------------------------------------------
Net loans 462,949 437,232
----------------------------------------------------------------------------------------------------------------------------------
Premises and equipment, net 12,858 12,503
Other real estate owned - 175
Goodwill 10,152 10,152
Core deposit intangible 3,903 4,857
Other assets 8,972 9,822
----------------------------------------------------------------------------------------------------------------------------------
Total assets $609,216 $598,945
----------------------------------------------------------------------------------------------------------------------------------
Liabilities
Deposits:
Demand $69,599 $71,759
Regular savings, NOW and money market deposit accounts 244,766 232,892
Certificates of deposit (in denominations of $100,000 or more) 22,708 25,713
Other time 126,234 145,830
----------------------------------------------------------------------------------------------------------------------------------
Total deposits 463,307 476,194
----------------------------------------------------------------------------------------------------------------------------------
Short-term borrowings 7,401 8,251
Other liabilities 3,016 3,614
Long-term debt 87,620 66,620
----------------------------------------------------------------------------------------------------------------------------------
Total liabilities 561,344 554,679
----------------------------------------------------------------------------------------------------------------------------------
Stockholders' equity
Preferred stock, $1.00 par value; 1,000,000 shares authorized; none issued - -
Common stock, $1.00 par value; 9,000,000 shares authorized; 1,731,969 issued at December 31, 2003
and 2002 and 1,499,574 outstanding in 2003 and 1,516,574 outstanding in 2002 1,732 1,732
Surplus 2,088 2,088
Retained earnings 50,116 47,523
Treasury stock (232,395 shares at December 31, 2003 and 215,395 shares at December 31, 2002) (6,213) (5,711)
Accumulated other comprehensive income (loss), net of tax 149 (1,366)
----------------------------------------------------------------------------------------------------------------------------------
Total stockholders' equity 47,872 44,266
----------------------------------------------------------------------------------------------------------------------------------
Total liabilities and stockholders' equity $609,216 $598,945
----------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY
($000 Omitted)
Accumulated
Other Total
Common Retained Treasury Comprehensive Stockholders'
Stock Surplus Earnings Stock Income (Loss)(1) Equity
------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2000 $1,732 $ 2,101 $43,110 $(4,708) $ (673) $ 41,562
Net income - 2001 - - 3,873 - - 3,873
Net change in unrealized loss on
securities available-for-sale, net of tax - - - - (42) (42)
Net change in unfunded pension accumulated
benefit obligation, net of tax - - - - 130 130
Treasury stock purchased - - - (1,156) - (1,156)
Cash dividends declared ($0.68 per share) - - (1,028) - - (1,028)
------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2001 1,732 2,101 45,955 (5,864) (585) 43,339
Net income - 2002 - - 2,598 - - 2,598
Net change in unrealized loss on
securities available-for-sale, net of tax - - - - 345 345
Net change in unfunded pension - - - - (1,126) (1,126)
accumulated benefit obligation, net of tax
Exercise of stock options - (13) - 153 - 140
Cash dividends declared ($0.68 per share) - - (1,030) - - (1,030)
------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2002 1,732 2,088 47,523 (5,711) (1,366) 44,266
Net income - 2003 - - 3,617 - - 3,617
Net change in unrealized loss on
securities available-for-sale, net of tax - - - - 1,110 1,110
Net change in unfunded pension
accumulated benefit obligation, net of tax - - - - 405 405
Treasury stock purchased - - - (502) - (502)
Cash dividends declared ($0.68 per share) - - (1,024) - - (1,024)
------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31, 2003 $1,732 $ 2,088 $50,116 $(6,213) $ 149 $ 47,872
------------------------------------------------------------------------------------------------------------------------------------
(1) Accumulated other comprehensive income as of December 31, 2003 consists of net unrealized holding gains on
available-for-sale securities of $870, net of tax, and net unrealized holding losses on unfunded pension accumulated benefit
obligation of $721, net of tax. Accumulated other comprehensive loss as of December 31, 2002 consists of net unrealized
holding losses on available-for-sale securities of $240, net of tax, and unfunded pension accumulated benefit obligation of
$1,126, net of tax. Accumulated other comprehensive loss as of December 31, 2001 consists of net unrealized holding losses
on available-for-sale securities, net of tax.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
($000 Omitted)
FOR THE YEAR ENDED DECEMBER 31, 2003 2002 2001
-----------------------------------------------------------------------------------------------------------------------------------
Net income $3,617 $2,598 $3,873
-----------------------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss):
Net unrealized gains on securities available-for-sale 2,662 322 58
Reclassification adjustment for realized (gains) losses in net income (1,338) 759 (128)
-----------------------------------------------------------------------------------------------------------------------------------
Net unrealized gains (losses) on securities 1,324 1,081 (70
Minimum pension liability adjustment 615 (1,707) 197
-----------------------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss) 1,939 (626) 127
Income tax expense 424 155 39
-----------------------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss), net of tax 1,515 (781) 88
-----------------------------------------------------------------------------------------------------------------------------------
Comprehensive income $5,132 $1,817 $3,961
-----------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements
CONSOLIDATED STATEMENTS OF CASH FLOWS
($000 Omitted)
FOR THE YEAR ENDED DECEMBER 31, 2003 2002 2001
-----------------------------------------------------------------------------------------------------------------------------------
Cash flows from operating activities:
Net income $ 3,617 $ 2,598 $3,873
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses 805 900 900
Depreciation and amortization 2,381 1,791 1,704
Deferred income tax (benefit) expense (249) 195 188
Write-down of other real estate owned - - 3
Write-down of equity securities 184 910 -
Gain on sales of securities available-for-sale, net (1,522) (151) (128)
Gain on sale of nonperforming and reperforming loans - - (145)
Loss (gain) on sale, disposal and write-down of premises and equipment 28 (18) 22
Amortization of premiums and accretion of discounts on securities, net 408 246 74
Increase in unearned income, net 40 38 15
Amortization of discount on loans acquired 106 18 -
(Gain) loss on sales of other real estate owned and other personal property, net (58) 5 (22)
Net decrease (increase) in loans held-for-sale 158 1,357 (1,532)
Other liabilities assumed net of (other assets acquired) in branch transactions - (66) 34
Net change in other assets and other liabilities 688 (3,051) (2,900)
-----------------------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 6,586 4,772 2,086
-----------------------------------------------------------------------------------------------------------------------------------
Cash flows from investing activities:
Proceeds from sales of securities available-for-sale 25,191 16,709 3,225
Proceeds from maturities of securities available-for-sale 77,017 30,043 41,930
Purchases of securities available-for-sale (82,273) (82,509) (47,695)
Purchases of Federal Home Loan Bank stock (73) - (500)
Purchases of Federal Reserve Bank stock (285) - -
Redemption of Federal Home Loan Bank stock - - 987
Loan originations and principal collections, net (27,719) (23,526) (6,302)
Recoveries of previously charged-off loans 181 202 122
Loans acquired in branch transactions - (20,192) (2,601)
Purchases of loans - - (297)
Proceeds from sales of nonperforming and reperforming loans - - 675
Proceeds from sales of and payments received on other real estate owned 285 60 50
Proceeds from sales of and payments received on other personal property 822 794 554
Premises and equipment acquired in branch transactions - (519) (6)
Additions to premises and equipment (1,810) (1,796) (1,580)
-----------------------------------------------------------------------------------------------------------------------------------
Net cash used by investing activities (8,664) (80,734) (11,438)
-----------------------------------------------------------------------------------------------------------------------------------
Cash flows from financing activities:
Net (decrease) increase in deposits (12,887) 8,422 (7,592)
Deposits assumed in branch transactions, net of assumption premiums - 47,527 25,053
Advances from FHLB 28,000 1,000 14,000
Repayment of FHLB advances (7,000) (3,028) (1,500)
Net decrease in short-term FHLB advances - - (2,950)
Net (decrease) increase in securities sold under agreements to repurchase (850) 96 (1,235)
Exercise of stock options, net of tax benefit - 140 -
Purchases of treasury stock (502) - (1,156)
Issuance of in junior subordinated
debentures - 20,620 -
Cash dividends paid (1,024) (1,030) (1,028)
-----------------------------------------------------------------------------------------------------------------------------------
Net cash provided by financing activities 5,737 73,747 23,592
-----------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents 3,659 (2,215) 14,240
Cash and cash equivalents at beginning of year 27,426 29,641 15,401
-----------------------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 31,085 $ 27,426 $ 29,641
-----------------------------------------------------------------------------------------------------------------------------------
See Notes to Consolidated Financial Statements
CONSOLIDATED STATEMENTS OF CASH FLOWS (CONTINUED)
($000 Omitted)
FOR THE YEAR ENDED DECEMBER 31, 2003 2002 2001
----------------------------------------------------------------------------------------------------------------------------------
Supplemental disclosure of cash flows:
Interest paid $8,617 $9,876 $16,006
Income taxes paid 1,610 1,743 1,776
Loans transferred to other real estate owned 46 200 33
Loans transferred to other personal property 824 802 565
Loans transferred to held-for-sale - - 265
Carrying amount of securities held-to-maturity transferred to securities
available-for-sale - - 2,752
See Notes to Consolidated Financial Statements
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
NOTE 1 SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
NATURE OF OPERATIONS
The Company is a bank holding company formed in 1997 under the laws of New
Hampshire and is registered under the Bank Holding Company Act of 1956. The
Company's only business activity has been to own all of the shares of, and
provide management, capital and operational support to, The Berlin City Bank
("BCB") and The Pemigewasset National Bank of Plymouth, New Hampshire ("PNB")
and its Delaware statutory business trusts Northway Capital Trust I and
Northway Capital Trust II. The Company's headquarters are in Berlin, New
Hampshire. The banking subsidiaries are engaged principally in the business of
attracting deposits from the general public and investing those deposits in
securities, commercial loans, real estate loans, and consumer loans.
BASIS OF PRESENTATION
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries. All significant intercompany accounts and
transactions have been eliminated in the consolidation.
The accounting and reporting policies of the Company conform to accounting
principles generally accepted in the United States of America and to general
practices within the banking industry.
In preparing the financial statements, management is required to make estimates
and judgments that affect the reported amounts of assets and liabilities as of
the dates of the statements of financial condition, and income and expense for
the periods. Actual results could differ from those estimates. Material
estimates that are particularly susceptible to change in the near-term relate
to the determination of the allowance for loan losses.
RECLASSIFICATIONS
Certain amounts in the prior years' financial statements have been reclassified
to conform with the current year's presentation.
CASH AND CASH EQUIVALENTS
For purposes of the statement of cash flows, cash and cash equivalents include
cash and due from banks, federal funds sold and interest bearing deposits.
SECURITIES
Debt securities that the Company has the positive intent and ability to hold to
maturity are classified as held-to-maturity and reported at amortized cost; if
debt and equity securities are bought and held principally for the purpose of
selling in the near term they would be classified as trading and reported at
fair value, with unrealized gains and losses included in earnings; and debt and
equity securities not classified as either held-to-maturity or trading are
classified as available-for-sale and reported at fair value, with unrealized
gains and losses excluded from earnings and reported as a separate component of
stockholders' equity, net of estimated income taxes. At this time, the Company
has not established a trading account.
Premiums and discounts are amortized and accreted primarily on the level yield
method over the contractual life of the securities adjusted for expected
prepayments.
If a decline in the fair value below the adjusted cost basis of an investment
is judged to be other than temporary, the cost basis of the investment is
written down to fair value as the new cost basis and the amount of the
write-down is included in noninterest expense.
Gains and losses on sales of securities available-for-sale are recognized at
the time of the sale on a specific identification basis.
LOANS HELD-FOR-SALE
Loans held-for-sale are generally identified as such at origination and are
stated at the lower of aggregate cost or market. Market value is based on
outstanding investor commitments. When loans are sold, a gain or loss is
recognized to the extent that the sale proceeds exceed or are less than the
carrying value of the loans. Gains and losses are determined using the specific
identification method. All loans sold are without recourse to the Company.
LOANS
Loans are carried at the principal amounts outstanding, net of any unearned
income, premiums on originated loans and discounts on acquired loans. Unearned
income includes loan origination fees, net of direct loan origination costs.
This income is deferred and recognized as adjustments to loan income over the
contractual life of the related notes using a method the result of which
approximates that of the interest method.
Loans are placed on nonaccrual when payment of principal or interest is
considered to be in doubt or is past due 90 days or more. The Company may
choose to place a loan on nonaccrual status due to payment delinquency or
uncertain collectibility, while not classifying the loan as impaired, if (i) it
is probable that the Company will collect all amounts due in accordance with
the contractual terms of the loan or (ii) the loan is not a commercial,
commercial real estate or an individually significant mortgage or consumer
loan. Previously accrued income on nonaccrual loans that has not been collected
is reversed from current income, and subsequent cash receipts are recorded as
income. Loans are returned to accrual status when collection of all contractual
principal and interest is reasonably assured and there has been sustained
repayment performance.
The Company's loans are primarily secured by real estate in New Hampshire. In
addition, other real estate owned is located in this market. Accordingly, the
ultimate collectibility of a substantial portion of the Company's loan
portfolio and the recovery of other real estate owned are susceptible to
changing conditions in this market.
ALLOWANCE FOR LOAN LOSSES
The allowance for loan losses is maintained at a level considered adequate by
management on the basis of many factors including the risk characteristics of
the portfolio, trends in loan delinquencies and an assessment of existing
economic conditions. Additions to the allowance are charged to earnings;
realized losses, net of recoveries, are charged directly to the allowance.
While management uses available information in establishing the allowance for
loan losses, future additions to the allowance may be necessary if economic
conditions differ substantially from the estimates used in making the
evaluations. In addition, various regulatory agencies, as an integral part of
their examination process, periodically review the Banks' allowances for loan
losses. Such agencies may require the Banks to recognize additions to the
allowance based on judgments different from those of management.
Commercial, commercial real estate and individually significant mortgage and
consumer loans are considered impaired, and are placed on nonaccrual, when it
is probable that the Company will not be able to collect all amounts due
according to the contractual terms of the loan agreement. Mortgage and consumer
loans, which are not individually significant, are measured for impairment
collectively. Loans that experience insignificant payment delays and
insignificant shortfalls in payment amounts generally are not classified as
impaired. The amount of impairment for all impaired loans is determined by the
difference between the present value of the expected cash flows related to the
loan, using the original contractual interest rate, and its recorded value, or,
as a practical expedient in the case of collateralized loans, the difference
between the fair value of the collateral and the recorded amount of the loan.
When foreclosure is probable, impairment is measured based on the fair value of
the collateral.
SERVICING ASSETS
Servicing assets are recognized as separate assets when rights are acquired
through purchase or through sale of financial assets. Capitalized servicing
rights are reported in other assets and are amortized into noninterest income
in proportion to, and over the period of, the estimated future net servicing
income of the underlying financial assets. Servicing assets are evaluated for
impairment based upon the fair value of the rights as compared to amortized
cost. Impairment is determined by stratifying rights by predominant
characteristics, such as interest rates and terms. Fair value is determined
using prices for similar assets with similar characteristics, when available,
or based upon discounted cash flows using market-based assumptions. Impairment
is recognized through a valuation allowance for an individual stratum, to the
extent that fair value is less than the capitalized amount for the stratum.
OTHER REAL ESTATE OWNED
Other real estate owned is comprised of properties acquired either through
foreclosure proceedings or acceptance of a deed in lieu of foreclosure, and for
which the Company has taken physical possession. The Company classifies loans
as repossessed or foreclosed if the Company receives physical possession of the
debtor's assets, regardless of whether or not foreclosure proceedings take
place.
Assets acquired through foreclosure or a similar conveyance of title are
initially recorded at the lower of the carrying value of the loan or the fair
value, less estimated costs to sell, of the property constructively or actually
received. Gains and losses upon disposition are reflected in the statement of
income as realized.
PREMISES AND EQUIPMENT
Premises and equipment are carried at cost less accumulated depreciation.
Depreciation is computed on the straight-line method over the estimated useful
lives of the respective assets. Estimated lives are 39 years for buildings, ten
to fifteen years for building improvements and three to seven years for
furniture and equipment.
Amortization of leasehold improvements is accumulated on a straight-line basis
over the lesser of the term of the respective lease or the asset's useful life,
not to exceed ten years.
ADVERTISING
The Company directly expenses costs associated with advertising as they are
incurred.
INCOME TAXES
The Company uses the asset and liability method of accounting for income taxes.
Under the asset and liability method, deferred tax assets and liabilities are
recognized for the future tax consequences attributable to differences between
the financial statement carrying amounts of existing assets and liabilities and
the respective tax bases and operating loss and tax credit carry forwards.
Deferred tax assets and liabilities are measured using enacted tax rates
expected to apply to taxable income in the years in which those temporary
differences are expected to be recovered or settled. The effect on deferred tax
assets and liabilities of a change in tax rates is recognized in income in the
period that includes the enactment date.
STOCK-BASED COMPENSATION
At December 31, 2003, the Company has a stock-based employee compensation plan
which is described more fully in Note 15. The Company accounts for this plan
under the recognition and measurement principles of APB Opinion No. 25,
Accounting for Stock Issued to Employees, and related Interpretations. No
stock-based employee compensation cost is reflected in net income, as all
options granted under this plan had an exercise price equal to the market value
of the underlying common stock on the date of the grant. The following table
illustrates the effect on net income and earnings per share if the Company had
applied the fair value recognition provisions of SFAS No. 123, Accounting for
Stock-Based Compensation, to stock-based employee compensation.
($000 Omitted, except per share data)
2003 2002 2001
------- ------- -------
Net income As reported $3,617 $2,598 $3,873
Deduct: Total stock-based employee compensation
expense determined under fair value based methods
awards, net of related tax effects 39 39 47
--------- --------- ---------
Pro forma $3,578 $2,559 $3,826
Earnings per common share As reported $ 2.40 $ 1.71 $ 2.55
Pro forma 2.37 1.68 2.52
Earnings per common share As reported $ 2.39 $ 1.71 $ 2.54
(assuming dilution) Pro forma 2.36 1.68 2.51
EARNINGS PER SHARE
Basic earnings per share ("EPS") excludes dilution and is computed by dividing
income available to common stockholders by the weighted-average number of
common shares outstanding for the period. Diluted EPS, if applicable, reflects
the potential dilution that could occur if securities or other contracts to
issue common stock were exercised or converted into common stock or resulted in
the issuance of common stock that then shared in the earnings of the entity.
Earnings per common share have been computed based on the following:
($000 Omitted)
Years Ended December 31,
-----------------------------
2003 2002 2001
------- ------- -------
Net income $3,617 $2,598 $3,873
Less: Preferred stock dividends - - -
------- ------- -------
Net income applicable to common stock $3,617 $2,598 $3,873
======= ======= =======
Average number of common shares outstanding 1,504.4 1,515.1 1,521.6
Effect of dilutive options(1) 7.8 6.0 4.3
------- ------- -------
Average number of common shares outstanding
used to calculate diluted earnings per
common share 1,512.2 1,521.1 1,525.9
======= ======= =======
(1) Approximately 21,000 of the Company's outstanding stock options were not
included in the diluted net earnings per share calculation for 2001 because
to do so would have been antidilutive.
RECENT ACCOUNTING PRONOUNCEMENTS
In June 2002, the FASB issued SFAS No. 146 "Accounting for Costs Associated
with Exit or Disposal Activities" ("SFAS No. 146"). This Statement requires
that a liability for a cost associated with an exit or disposal activity be
recognized and measured initially at fair value only when the liability is
incurred. SFAS No. 146 is effective for exit or disposal activities that are
initiated after December 31, 2002. This Statement did not have a material
impact on the Company's consolidated financial statements.
In October 2002, the FASB issued SFAS No. 147 "Acquisitions of Certain
Financial Institutions" ("SFAS No. 147") an Amendment of SFAS Nos. 72 and 144
and FASB Interpretation No. 9. SFAS No. 72 "Accounting for Certain Acquisitions
of Banking or Thrift Institutions" and FASB Interpretation No. 9 "Applying APB
Opinions No. 16 and 17" When a Savings and Loan Association or a Similar
Institution Is Acquired in a Business Combination Accounted for by the Purchase
Method" provided interpretive guidance on the application of the purchase
method to acquisitions of financial institutions. Except for transactions
between two or more mutual enterprises, SFAS No. 147 removes acquisitions of
financial institutions from the scope of both Statement 72 and Interpretation 9
and requires that those transactions be accounted for in accordance with SFAS
No. 141 "Business Combinations" and SFAS No. 142 "Goodwill and Other Intangible
Assets." Thus, the requirement in paragraph 5 of Statement 72 to recognize (and
subsequently amortize) any excess of the fair value of liabilities assumed over
the fair value of tangible and identifiable intangible assets acquired as an
unidentifiable intangible asset no longer applies to acquisitions within the
scope of SFAS No. 147. In addition, SFAS No. 147 amends SFAS No. 144
"Accounting for the Impairment or Disposal of Long-Lived Assets" to include in
its scope long-term customer-relationship intangible assets of financial
institutions such as depositor- and borrower-relationship intangible assets and
credit cardholder intangible assets. Consequently, those intangible assets are
subject to the same undiscounted cash flow recoverability test and impairment
loss recognition and measurement provisions that SFAS No. 144 requires for
other long-lived assets that are held and used.
Paragraph 5 of SFAS No. 147, which relates to the application of the purchase
method of accounting, was effective for acquisitions for which the date of
acquisition is on or after October 1, 2002. The provisions in paragraph 6
related to accounting for the impairment or disposal of certain long-term
customer-relationship intangible assets were effective on October 1, 2002.
Transition provisions for previously recognized unidentifiable intangible
assets in paragraphs 8-14 were effective on October 1, 2002, with earlier
application permitted. There was no substantial impact on the Company's
consolidated financial statements on adoption of this Statement.
In November 2002, the FASB issued FASB Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 elaborates on the
disclosure to be made by a guarantor in its interim and annual financial
statements about its obligations under certain guarantees that it has issued.
It also clarifies that a guarantor is required to recognize, at the inception
of a guarantee, a liability for the fair value of the obligation undertaken in
issuing the guarantee. FIN 45 clarifies that a guarantor is required to
disclose (a) the nature of the guarantee; (b) the maximum potential amount of
future payments under the guarantee; (c) the carrying amount of the liability;
(d) the nature and extent of any recourse provisions or available collateral
that would enable the guarantor to recover the amounts paid under the
guarantee.
The initial recognition and initial measurement provisions of FIN 45 are
applicable on a prospective basis to guarantees issued or modified after
December 31, 2002. The disclosure requirements in FIN 45 are effective for
financial statements of interim or annual periods ending after December 15,
2002. The Company adopted the initial recognition and initial measurement
provisions of FIN 45 effective as of January 1, 2003 and adopted the disclosure
requirements effective as of December 31, 2002. The adoption of this
interpretation did not have a material effect on the Company's financial
position or results of operations.
In December 2002, the FASB issued SFAS No. 148, "Accounting for Stock-Based
Compensation - Transition and Disclosure, an amendment of SFAS Statement No.
123" ("SFAS No. 148"). SFAS No. 148 provides alternative methods of transition
for a voluntary change to the fair value based method of accounting for
stock-based employee compensation. In addition, SFAS No. 148 amends the
disclosure requirements of SFAS No. 123 to require prominent disclosures in
both annual and interim financial statements about the method of accounting for
stock-based employee compensation and the effect of the method used on reported
results. The transition provisions and disclosure provisions are required for
financial statements for fiscal years ending after December 15, 2002. The
Company adopted the disclosure provisions of SFAS No. 148 as of December 31,
2002 and currently uses the intrinsic value method of accounting for stock
options.
In April 2003, the FASB issued SFAS No. 149, "Amendment of Statement No. 133 on
Derivative Instruments and Hedging Activities" ("SFAS No. 149"), which amends
and clarifies financial accounting and reporting for derivative instruments,
including certain derivative instruments embedded in other contracts and for
hedging activities under SFAS No. 133, "Accounting for Derivative Instruments
and Hedging Activities." This Statement (a) clarifies under what circumstances
a contract with an initial net investment meets the characteristic of a
derivative, (b) clarifies when a derivative contains a financing component, (c)
amends the definition of an underlying to conform to language used in FASB
Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for
Guarantees, Including Indirect Guarantees of Indebtedness of Others," and (d)
amends certain other existing pronouncements. The provisions of SFAS No. 149
are effective for contracts entered into or modified after June 30, 2003. There
was no substantial impact on the Company's consolidated financial statements on
adoption of this Statement.
In May 2003, the FASB issued SFAS No. 150, "Accounting for Certain Financial
Instruments with Characteristics of both Liabilities and Equity" ("SFAS No.
150"). This Statement establishes standards for the classification and
measurement of certain financial instruments with characteristics of both
liabilities and equity. SFAS No. 150 requires that certain financial
instruments that were previously classified as equity must be classified as a
liability. Most of the guidance in SFAS No. 150 is effective for financial
instruments entered into or modified after May 31, 2003, and otherwise is
effective at the beginning of the first interim period beginning after June 15,
2003. This Statement did not have any material effect on the Company's
consolidated financial statements.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities" ("FIN 46"), in an effort to expand upon and
strengthen existing accounting guidance that addresses when a company should
include in its financial statements the assets, liabilities and activities of
another entity. In December 2003, the FASB revised Interpretation No. 46, also
referred to as Interpretation 46 (R) ("FIN 46(R)"). The objective of this
interpretation is not to restrict the use of variable interest entities but to
improve financial reporting by companies involved with variable interest
entities. Until now, one company generally has included another entity in its
consolidated financial statements only if it controlled the entity through
voting interests. This interpretation changes that, by requiring a variable
interest entity to be consolidated by a company only if that company is subject
to a majority of the risk of loss from the variable interest entity's
activities or entitled to receive a majority of the entity's residual returns
or both. The Company is required to apply FIN 46, as revised, to all entities
subject to it no later than the end of the first fiscal year or interim period
ending after March 15, 2004. However, prior to the required application of FIN
46, as revised, the Company shall apply FIN 46 or FIN 46 (R) to those entities
that are considered to be special-purpose entities as of the end of the first
reporting period ending after December 15, 2003. The adoption of this
interpretation has not and is not expected to have a material effect on the
Company's consolidated financial statements.
In December 2003, the FASB issued SFAS No. 132 (revised 2003), "Employers'
Disclosures about Pensions and Other Postretirement Benefits - an amendment of
SFAS No. 87, SFAS No. 88 and SFAS No. 106" ("SFAS No. 132 (revised 2003)").
This Statement revises employers' disclosures about pension plans and other
postretirement benefit plans. It does not change the measurement or recognition
of those plans required by SFAS No. 87, "Employers' Accounting for Pensions,"
SFAS No. 88, "Employers' Accounting for Settlements and Curtailments of Defined
Benefit Pension Plans and for Termination Benefits," and SFAS No. 106,
"Employers' Accounting for Postretirement Benefits Other Than Pensions." This
Statement retains the disclosure requirements contained in SFAS No. 132,
"Employers' Disclosures About Pensions and Other Postretirement Benefits,"
which it replaces. It requires additional disclosures to those in the original
Statement 132 about assets, obligations, cash flows and net periodic benefit
cost of defined benefit pension plans and other defined benefit postretirement
plans. This Statement is effective for financial statements with fiscal years
ending after December 15, 2003 and interim periods beginning after December 15,
2003. Adoption of this Statement did not have a material impact on the
Company's consolidated financial statements.
NOTE 2 CASH AND DUE FROM BANKS
Cash and due from banks at December 31, 2003 and 2002 includes $3,588,000 and
$2,911,000, respectively, which is subject to withdrawals and usage
restrictions to satisfy the reserve requirements of the Federal Reserve Bank.
NOTE 3 SECURITIES AVAILABLE-FOR-SALE
The amortized cost, gains in accumulated other comprehensive income, losses in
accumulated other comprehensive income and fair value of securities at December
31, 2003 and 2002 follows:
($000 Omitted)
Gains in Losses in
Accumulated Accumulated
Other Other
Amortized Comprehensive Comprehensive Fair
Cost Income Income Value
--------- ------------- ------------- ----
December 31, 2003
US Treasury and other US government agency securities $37,945 $ 74 $ 179 $37,840
Marketable equity securities 2,589 251 74 2,766
Mortgage-backed securities 2,803 90 5 2,888
Collateralized mortgage obligations 15 - - 15
Corporate bonds 20,857 1,126 - 21,983
State and political subdivision bonds and notes 8,066 158 - 8,224
--------- -------- ----------- ---------
$72,275 $1,699 $ 258 $73,716
======= ====== ======= =======
December 31, 2002
US Treasury and other US government agency securities $36,167 $ 51 $ 30 $36,188
Marketable equity securities 3,163 45 831 2,377
Mortgage-backed securities 7,286 199 9 7,476
Collateralized mortgage obligations 5,103 67 - 5,170
Corporate bonds 33,407 892 451 33,848
State and political subdivision bonds and notes 6,154 184 - 6,338
--------- -------- ----------- ---------
$91,280 $1,438 $1,321 $91,397
======= ====== ====== =======
The contractual maturity distribution of investments in debt obligations at December 31, 2003 follows:
($000 Omitted)
Within One to Five to Over Total
One Five Ten Ten Amortized
Year Years Years Years Cost
------- -------- ------- ------- ---------
US Treasury and other US government agency securities $ - $25,023 $12,922 $ - $37,945
Mortgage-backed securities 62 1,090 1,220 431 2,803
Collateralized mortgage obligations - - - 15 15
Corporate bonds 1,805 14,584 4,468 - 20,857
State and political subdivision bonds and notes 196 220 3,274 4,376 8,066
------ ------- ------- ------ -------
Total amortized cost $2,063 $40,917 $21,884 $4,822 $69,686
====== ======= ======= ====== =======
Market value $2,097 $41,828 $22,177 $4,848 $70,950
====== ======= ======= ====== =======
Actual maturities of state and political subdivision bonds and notes,
mortgage-backed securities and collateralized mortgage obligations will differ
from the maturities presented because borrowers have the right to prepay
obligations without prepayment penalties.
An analysis of gross realized gains and losses on securities available-for-sale
which have been sold or called during the years ended December 31, follows:
($000 Omitted)
2003 2002 2001
---------------------- --------------------- ----------------------
Realized Realized Realized Realized Realized Realized
Gains Losses Gains Losses Gains Losses
-------- -------- -------- -------- -------- --------
Equity securities $ 97 $ 244 $ 39 $ 449 $ 61 $ 6
US government agency securities 15 - 149 - 91 -
Mortgage-backed securities - - 159 - - 18
Corporate bonds 1,682 28 246 - - -
State and political subdivisions - - 7 - - -
------------------- -------------------- -------------------
$1,794 $ 272 $ 600 $ 449 $ 152 $ 24
=================== ==================== ==================
The tax provision applicable to these net realized gains amounted to $603,000,
$60,000 and $50,000 for 2003, 2002, and 2001, respectively.
Securities with a carrying amount totaling $39,789,000 and $48,433,000 were
pledged to secure public deposits, securities sold under agreements to
repurchase and treasury, tax and loan accounts at December 31, 2003 and 2002,
respectively.
The aggregate fair value and unrealized losses of securities that have been in
a continuous unrealized loss position for less than twelve months and for
twelve months or more, and are not other than temporarily impaired, are as
follows as of December 31, 2003:
($000 Omitted)
Less than 12 Months 12 Months or Longer Total
------------------------- ----------------------- ------------------------
Fair Unrealized Fair Unrealized Fair Unrealized
Value Losses Value Losses Value Losses
------------------------- ---------------------- -----------------------
US government agency securities $16,813 $ 179 $ - $ - $16,813 $ 179
Marketable equity securities 136 6 318 68 454 74
Mortgage-backed securities 168 1 185 4 353 5
---------------------- ----------------------- -----------------------
Total temporarily impaired securities $17,117 $ 186 $ 503 $ 72 $17,620 $ 258
====================== ======================= =======================
At December 31, 2003, securities with a total fair value of $17,620,000 were in
a loss position. These securities were comprised primarily of five US
government agency securities with a fair value of $16,813,000 and an unrealized
loss of $179,000. These securities had an unrealized loss due to the current
interest rate environment. As these securities are guaranteed by US government
agencies such as FHLB or FNMA there is no credit risk associated with them.
These securities are not other-than-temporarily impaired as the Company has the
ability and the intent to hold these securities until maturity.
Mortgage-backed securities with a fair value of $353,000 had an unrealized loss
of $5,000 at December 31, 2003. This total consists of eleven positions with an
average balance of $32,000. As with the US government agency securities, these
securities have an unrealized loss due to the current interest rate
environment. As all of these mortgage-backed securities are guaranteed by US
government agencies such as FHLMC, GNMA or FNMA there is no credit risk
associated with them. These securities have not been classified as
other-than-temporarily impaired as the Company has the ability and intent to
hold these securities until they are paid in full.
Eight marketable equity securities with a fair value of $454,000 had an
unrealized loss of $74,000 at December 31, 2003. Marketable equity securities
are subject to internal testing on a quarterly basis to determine impairment.
Testing includes review of industry analyst reports, credit ratings, sector
analysis and earnings projections. Based upon the December 31, 2003 review,
these securities were not determined to be other-than-temporarily impaired.
NOTE 4 LOANS
Loan balances were comprised of the following:
($000 Omitted)
December 31, 2003 2002
------------------------------ -------- --------
Real estate:
Residential $129,493 $114,526
Commercial 120,366 111,941
Construction 3,851 6,330
Commercial 24,528 23,885
Installment 30,291 40,169
Indirect installment 150,807 139,477
Other 8,896 6,031
-------- --------
Total loans 468,232 442,359
Less:
Unearned income 247 207
Allowance for loan losses 5,036 4,920
-------- --------
Total unearned income and allowance for loan losses 5,283 5,127
-------- --------
Net loans $462,949 $437,232
======== ========
Total loans above are net of unearned discount on loans acquired in the amount
of $575,000 and $681,000 at December 31, 2003 and 2002, respectively. In
addition, total loans above are net of unamortized premium on indirect
installment loans originated in the amount of $3,392,000 and $3,684,000 at
December 31, 2003 and 2002, respectively.
Loans are made in the ordinary course of business to directors, executive
officers, and their immediate families and to organizations in which such
persons have more than a 10% ownership interest. These loans are made on
substantially the same terms, including interest rate and collateral, as those
prevailing at the same time for comparable transactions with unrelated persons
and did not involve more than the normal risk of collectibility or present
other unfavorable features. Total loans to such persons and their companies
amounted to $364,000 as of December 31, 2003. During 2003, principal payments
were $533,000 and principal advances amounted to $58,000.
The Company's lending activities are conducted principally in New Hampshire.
Although the loan portfolio is diversified, a portion of its debtors' ability
to repay is dependent upon the economic conditions prevailing in New Hampshire.
The Company maintains significant credit relationships with borrowers in the
hotel and motel industry. The aggregate loan balances to these industries
totaled $56,200,000 at December 31, 2003 and $56,470,000 at December 31, 2002.
Loans serviced for others are not included in the accompanying statements of
financial condition. The unpaid principal balances of these loans total
$45,967,000 and $49,908,000 at December 31, 2003 and 2002, respectively. The
Company sold $22,483,000 of mortgage loans and $1,482,000 of indirect
installment loans in 2003 and $20,694,000 of mortgage loans and $1,472,000 of
indirect installment loans in 2002.
The Company capitalized $187,000 and $177,000 of servicing rights and amortized
$137,000 and $97,000 of those rights in 2003 and 2002, respectively. Impairment
of mortgage servicing rights of $5,000 and $0 was recognized in 2003 and 2002,
respectively. Impairment of mortgage servicing rights is assessed based on the
fair value of those rights. Fair values are estimated using discounted cash
flows based on a current market interest rate. The amount of the impairment
recognized is the amount by which the capitalized mortgage servicing rights
exceed their fair value. At December 31, 2003 and 2002, respectively, the
carrying amount of servicing rights was $384,000 and $339,000, and is included
in other assets.
Restructured, accruing loans entered into prior to the adoption of SFAS No. 114
and 118 are not required to be reported as impaired loans unless such loans are
not performing in accordance with the restructured terms at adoption of SFAS
No. 114. Restructured, accruing loans entered into subsequent to the adoption
of these statements are reported as impaired loans. In the year subsequent to
restructure these loans may be removed from the impaired loan disclosure
provided that the loan bears a market rate of interest at the time of
restructure and is performing under the restructured terms.
At December 31, 2003 and 2002, loans restructured in a troubled debt
restructuring before January 1, 1995, the effective date of SFAS No. 114, that
are not impaired based on the terms specified by the restructuring agreement
totaled $897,000 and $945,000, respectively. The gross interest income that
would have been recorded in the years ended December 31, 2003 and 2002 if such
restructured loans had been current in accordance with their original terms was
$65,000 and $76,000, respectively. The amount of interest income recognized on
such restructured loans for the years ended December 31, 2003 and 2002 was
$44,000 and $54,000, respectively.
At December 31, 2003 and 2002, nonperforming loans totaled $4,089,000 and
$3,619,000, respectively. Of this total, $0 and $3,000, for December 31, 2003
and 2002, respectively, were past due 90 days or more and still accruing
interest.
The recorded investment in loans that are considered to be impaired under SFAS
No. 114 was $3,014,000 and $2,775,000 at December 31, 2003 and 2002,
respectively, for which the related allowance for loan losses is $485,000 and
$459,000 as of December 31, 2003 and 2002, respectively. All of the Company's
impaired loans are collateralized and therefore all impaired loans are measured
by the difference between the fair value of the collateral and the recorded
amount of the loan. All of the Company's impaired loans had a related allowance
for loan losses at December 31, 2003 and 2002. The average recorded investment
in impaired loans during the twelve months ended December 31, 2003 and 2002 was
approximately $3,001,000 and $854,000, respectively. For the twelve months
ended December 31, 2003 and 2002 the Company recognized interest income on
impaired loans of $217,000 and $94,000, respectively, which included $168,000
and $67,000 of interest income recognized using the cash-basis method of income
recognition, respectively.
NOTE 5 ALLOWANCE FOR LOAN LOSSES
Changes in the allowance for loan losses for the years ended December 31,
follows:
($000 Omitted)
2003 2002 2001
------- ------- -------
Balance at beginning of year $4,920 $4,642 $4,354
Provision for loan losses 805 900 900
Recoveries on loans previously charged-off 181 202 122
Loans charged-off (870) (824) (734)
------ ------ ------
Balance at end of year $5,036 $4,920 $4,642
====== ====== ======
NOTE 6 OTHER REAL ESTATE OWNED
Other real estate owned consists of real estate acquired by foreclosure or a
similar conveyance of title. At December 31, 2003 the Company had no other real
estate owned. At December 31, 2002 other real estate owned was comprised of
commercial real estate of $175,000.
Sales of other real estate owned by the Company resulted in gains of $65,000,
$13,000 and $17,000 for the years ended December 31, 2003, 2002 and 2001,
respectively.
There were no write-downs on other real estate owned for the years ended
December 31, 2003 and 2002; and write-downs on other real estate owned totaled
$3,000 for the year ended December 31, 2001.
NOTE 7 PREMISES AND EQUIPMENT
A summary of premises and equipment follows:
($000 Omitted)
December 31,
2003 2002
------- -------
Land $ 2,445 $ 2,418
Buildings 9,644 9,437
Leasehold improvements 508 481
Construction in progress 958 228
Equipment 7,855 7,162
------- -------
21,410 19,726
Less accumulated depreciation and amortization 8,552 7,223
------- -------
$12,858 $12,503
======= =======
Depreciation expense for the years ended December 31, 2003, 2002 and 2001
amounted to $1,427,000, $1,315,000 and $1,079,000, respectively.
The Company leases seven of its locations under non-cancellable operating
leases and one location under a tenant at will agreement. In addition, the
Company leases a storage facility under a non-cancellable lease. Minimum lease
payments in future periods under non-cancellable operating leases at December
31, 2003 are as follows:
($000 Omitted)
2004 $ 338
2005 157
2006 156
2007 123
2008 25
Thereafter -
-----
$ 799
The terms of two of the leases provide that the Company can, at the end of the
initial five-year term, renew the lease under two five-year options. The terms
of two of the leases provided that the Company can, at the end of the current
five year term, renew the lease under one five-year option. All leases contain
a provision that the Company shall pay its pro-rata share of operating costs.
Additionally, two of the leases require that the Company pay all real estate
taxes.
Rent expense for the years ended December 31, 2003, 2002, and 2001 amounted to
$421,000, $369,000 and $287,000, respectively.
NOTE 8 DEPOSITS
The aggregate amount of maturities for time deposits as of December 31, 2003,
for each of the following five years ended December 31 and thereafter, are as
follows:
($000 Omitted)
2004 $120,373
2005 21,395
2006 5,968
2007 853
2008 333
Thereafter 20
--------
$148,942
Deposits from related parties held by the Banks at December 31, 2003 and 2002
amounted to $3,081,000 and $2,315,000, respectively.
NOTE 9 SHORT-TERM BORROWINGS
Short-term borrowings consist of securities sold under agreements to
repurchase. Amounts outstanding and the related average interest rates for the
years ended December 31, 2003, 2002 and 2001 are as follows:
($000 Omitted)
Amount outstanding at December 31,
-----------------------------------------------------------------
2003 2002 2001
------------------- ---------------- -----------------
Avg. Avg. Avg.
Int. Int. Int.
Amount Rate Amount Rate Amount Rate
------ ----- ------ ----- ------ -----
Short-term borrowings $ 7,401 1.43% $ 8,251 1.54% $ 8,155 1.97%
Maximum amount outstanding at any month end 8,646 12,834 19,080
Average amount outstanding during the year 8,029 1.57% 8,454 1.67% 11,725 4.38%
The underlying securities associated with securities sold under agreements to
repurchase are under the control of the Company.
NOTE 10 LONG-TERM DEBT
Long-term debt at December 31, 2003 and 2002 consisted of FHLB advances of
$67,000,000 and $46,000,000, respectively, as well as $20,620,000 of junior
subordinated debentures, for each year.
As of December 31, 2003, contractual principal payments due under long-term
debt, which consists of FHLB advances and junior subordinated debentures, are
as follows:
($000 Omitted)
2004 $ 9,000
2005 2,000
2006 17,000
2007 7,000
2008 4,000
2009 and years thereafter 48,620
-------
$87,620
=======
The FHLB long-term debt consisted of twenty two separate advances with the
following terms:
($000 Omitted)
Amount Rate Maturity Date Call Date
------- ----- ------------- ---------
$ 1,000 3.49 05/14/04 N/A
3,000 4.78 06/25/04 N/A
5,000 5.79 08/30/04 03/01/04
2,000 2.06 02/07/05 N/A
3,000 2.58 01/24/06 N/A
5,000 2.68 03/20/06 N/A
3,000 2.50 04/03/06 N/A
2,000 2.63 04/24/06 N/A
4,000 2.62 04/24/06 N/A
5,000 6.11 03/28/07 03/29/04
2,000 2.35 06/04/07 N/A
2,000 3.14 05/09/08 N/A
2,000 2.84 05/20/08 N/A
7,000 5.54 11/02/09 02/02/04
7,000 5.57 11/09/09 02/09/04
5,000 5.91 12/17/09 03/17/04
1,000 3.76 04/12/10 N/A
1,000 3.84 04/14/10 N/A
1,000 3.84 04/23/10 N/A
2,000 4.80 12/27/10 03/26/04
3,000 4.50 01/24/11 01/22/04
1,000 4.58 02/07/11 02/05/04
-------
$67,000
=======
The $20,620,000 of junior subordinated debentures consists of the following two
issues:
On April 10, 2002, the Company completed the private placement of $7,217,000
aggregate liquidation amount of floating rate trust preferred securities (the
"Trust I Capital Securities") issued by its Delaware statutory business trust,
Northway Capital Trust I ("Capital Trust I"). The Trust I Capital Securities
were sold to a pooled investment vehicle. The proceeds from the sale of the
Trust I Capital Securities, which included the proceeds from the sale by
Capital Trust I of its common securities to the Company, were invested in
Floating Rate Junior Subordinated Debt Securities of the Company due 2032 (the
"Trust I Junior Subordinated Debt"), which were issued pursuant to an
Indenture, dated April 10, 2002, between the Company and Wilmington Trust
Company, as Trustee. Both the Trust I Capital Securities and the Trust I Junior
Subordinated Debt have a floating rate, which resets semi-annually, equal to
six-month LIBOR plus 3.70%, with a ceiling of 11.00% for the first five years.
Currently, the interest rate on these securities is 4.92%. Payments of
distributions and other amounts due on the Trust I Capital Securities are
irrevocably guaranteed by the Company, to the extent that Capital Trust I has
funds available for the payments of such distributions, pursuant to a Guarantee
Agreement, dated April 10, 2002, between the Company and Wilmington Trust
Company, as Guarantee Trustee. The Trust I Junior Subordinated Debt and the
Trust I Capital Securities may be redeemed at the option of the Company on
fixed semi-annual dates beginning on April 22, 2007.
On July 11, 2002, the Company completed the private placement of $13,403,000
aggregate liquidation amount of floating rate trust preferred securities (the
"Trust II Capital Securities") issued by its Delaware statutory business trust,
Northway Capital Trust II (the "Capital Trust II"). The Trust II Capital
Securities were sold to a pooled investment vehicle. The proceeds from the sale
of the Trust II Capital Securities, which include the proceeds from the sale by
Capital Trust II of its common securities to the Company, were invested in
Floating Rate Junior Subordinated Debt Securities of the Company due 2032 (the
"Trust II Junior Subordinated Debt"), which were issued pursuant to an
Indenture, dated July 11, 2002, between the Company and Wilmington Trust
Company, as Trustee. Both the Trust II Capital Securities and the Trust II
Junior Subordinated Debt have a floating rate, which resets quarterly, equal to
three-month LIBOR plus 3.65%, with a ceiling of 12.50% for the first five
years. Currently, the interest rate on these securities is 4.80%. Payments of
distributions and other amounts due on the Trust II Capital Securities are
irrevocably guaranteed by the Company, to the extent that Capital Trust II has
funds available for the payments of such distributions, pursuant to a Guarantee
Agreement, dated July 11, 2002, between the Company and Wilmington Trust
Company, as Guarantee Trustee. The Trust II Junior Subordinated Debt and the
Trust II Capital Securities may be redeemed at the option of the Company on
fixed quarterly dates beginning on July 7, 2007.
NOTE 11 ACQUISITIONS
On October 18, 2002, the Company acquired certain assets and assumed the
deposits of three branches offices of Fleet National Bank located in Laconia,
Belmont and Pittsfield, New Hampshire. This acquisition has allowed the Company
to expand its market area further into Belknap and Merrimack Counties. Deposits
assumed totaled $54,932,000 for which the Company paid a deposit purchase
premium of 11.25%. In addition, the Company acquired certain loans associated
with the branches totaling $20,192,000. As a result of this purchase the
Company made the following entries to record this transaction:
($000 Omitted)
Cash $26,738
Loans 20,192
Goodwill 4,766
Core deposit intangible 2,639
Land and buildings 430
Furniture and fixtures 13
Leasehold improvements 76
Other assets 83
Building lease and equipment expense 12
Salary expense 7
Deposits 54,932
Other liabilities 17
Other income 7
This transaction was accounted for using the purchase method of accounting. The
results of operations of the acquired branches are included in the 2002
consolidated statements of income of the Company from the date of the
transaction.
The cost of the acquired branch offices exceeded the fair values of the assets
acquired and liabilities assumed by $7,405,000. Of this amount, $2,639,000 was
assigned to core deposit intangible and $4,766,000 was recorded as goodwill.
All of the goodwill was deductible for tax purposes. The core deposit
intangible of $2,639,000 is being amortized to noninterest expense over fifty
months using the straight line method.
On October 26, 2001, the Company acquired certain assets and assumed the
deposits of a branch office of The Bank of New Hampshire located in Littleton,
New Hampshire. As a result of this purchase the Company made the following
entries to record this transaction:
($000 Omitted)
Cash $22,481
Loans 2,601
Deposit assumption premium 3,607
Equipment 6
Other assets 14
Miscellaneous expense 1
Deposits 28,660
Other liabilities 48
Other income 2
This transaction was accounted for using the purchase method of accounting. The
results of operations of the acquired branch are included in the 2001
consolidated statements of income of the Company from the date of the
transaction.
The deposit assumption premium of $3,607,000 was amortized, through December
31, 2001, to noninterest expense over fifteen years using the straight line
method. For 2002 accounting, see Note 1, Recent Accounting Pronouncements, SFAS
No. 147.
On August 25, 2000, the Company acquired certain assets and assumed the
deposits of a branch office of The Bank of New Hampshire located in West
Ossipee, New Hampshire. As a result of this purchase the Company made the
following entries to record this transaction:
($000 Omitted)
Cash $16,952
Loans 6,197
Deposit assumption premium 4,340
Premises and equipment 301
Other assets 38
Miscellaneous expense 8
Deposits 27,782
Other liabilities 50
Other income 4
This transaction was accounted for using the purchase method of accounting. The
results of operations of the acquired branch are included in the consolidated
statements of income of the Company from the date of the transaction.
The deposit assumption premium of $4,340,000 was amortized, through December
31, 2001, to noninterest expense over fifteen years using the straight line
method. For 2002 accounting, see Note 1, Recent Accounting Pronouncements, SFAS
No. 147.
On July 9, 1999, the Company acquired certain assets and assumed the deposits
from branch offices of Vermont National Bank located in Tilton and Franklin,
New Hampshire. As a result of this purchase, the Company made the following
entries to record this transaction:
($000 Omitted)
Cash $16,931
Deposit assumption premium 789
Premises and equipment 292
Other assets 5
Interest expense 3
Deposits 18,011
Other liabilities 3
Other income 6
This transaction was accounted for using the purchase method of accounting. The
results of operations of the acquired branches are included in the consolidated
statements of income of the Company from the date of the transaction.
The deposit assumption premium of $789,000 was amortized, through December 31,
2001, to noninterest expense over seven years using the straight line method.
For 2002 accounting, see Note 1, Recent Accounting Pronouncements, SFAS No.
147.
Management reviews the carrying amount of intangible assets resulting from
these transactions on an ongoing basis, taking into consideration any events
and circumstances that might have diminished such amount. During 2003 and 2002,
the Company reviewed the carrying amount of intangible assets and determined
that no impairment was required.
NOTE 12 REGULATORY MATTERS
The Company and the Banks are subject to various regulatory capital
requirements administered by the federal banking agencies. Failure to meet
minimum capital requirements can initiate certain mandatory, and possibly
additional discretionary actions by regulators that, if undertaken, could have
a direct material effect on the Banks' financial statements. Under capital
adequacy guidelines and the regulatory framework for prompt corrective action,
the Banks must meet specific capital guidelines that involve quantitative
measures of the Banks' assets, liabilities and certain off-balance sheet items
as calculated under regulatory accounting practices. The Banks' capital amounts
and classifications are also subject to qualitative judgments by the regulators
about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy
require the Company and the Banks to maintain minimum amounts and ratios (set
forth in the table below) of total and Tier 1 capital (as defined in the
regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as
defined) to average assets (as defined). As of December 31, 2003, the most
recent notification from the FDIC categorized both banks as well-capitalized
under the regulatory framework for prompt corrective action. To be categorized
as well-capitalized the Banks must maintain minimum total risk-based, Tier 1
risk-based and Tier 1 leverage ratios. There are no conditions or events since
that notification that management believes have changed the Company's and
Banks' categories. Management believes, as of December 31, 2003 and 2002, that
the Company and the Banks met all capital adequacy requirements to which they
are subject.
These minimum capital amounts and ratios, as well as the Company's and Banks'
actual capital amounts and ratios, are presented in the following table:
($000 Omitted)
To Be Well
Capitalized
Under Prompt
For Capital Corrective
Adequacy Action
Actual Purposes Provisions
--------------- --------------- --------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
As of December 31, 2003
------------------------------------------------
Tier 1 capital (to average assets)
Consolidated $43,769 7.22% $24,256 =>4.00% N/A
The Berlin City Bank 28,732 7.09 16,220 =>4.00 $20,276 =>5.00%
The Pemigewasset National Bank of Plymouth, New Hampshire 16,572 7.55 8,774 =>4.00 10,968 =>5.00
Total capital (to risk weighted assets)
Consolidated 58,020 12.81 36,244 =>8.00 N/A
The Berlin City Bank 32,231 10.51 24,526 =>8.00 30,657 =>10.00
The Pemigewasset National Bank of Plymouth, New Hampshire 18,184 12.50 11,642 =>8.00 14,533 =>10.00
Tier 1 capital (to risk weighted assets)
Consolidated 43,769 9.66 18,122 =>4.00 N/A
The Berlin City Bank 28,732 9.37 12,263 =>4.00 18,394 =>6.00
The Pemigewasset National Bank of Plymouth, New Hampshire 16,572 11.39 5,821 =>4.00 8,732 =>6.00
To Be Well
Capitalized
Under Prompt
For Capital Corrective
Adequacy Action
Actual Purposes Provisions
--------------- --------------- --------------
Amount Ratio Amount Ratio Amount Ratio
------ ----- ------ ----- ------ -----
As of December 31, 2002
------------------------------------------------
Tier 1 capital (to average assets)
Consolidated $38,140 6.70% $22,766 =>4.00% N/A
The Berlin City Bank 24,743 6.82 14,513 =>4.00 $18,141 =>5.00%
The Pemigewasset National Bank of Plymouth, New Hampshire 15,416 7.05 8,749 =>4.00 10,936 =>5.00
Total capital (to risk weighted assets)
Consolidated 53,597 12.04 35,622 =>8.00 N/A
The Berlin City Bank 28,121 10.30 21,850 =>8.00 27,312 =>10.00
The Pemigewasset National Bank of Plymouth, New Hampshire 16,958 10.02 13,540 =>8.00 16,925 =>10.00
Tier 1 capital (to risk weighted assets)
Consolidated 38,140 8.57 17,811 =>4.00 N/A
The Berlin City Bank 24,743 9.06 10,925 =>4.00 16,387 =>6.00
The Pemigewasset National Bank of Plymouth, New Hampshire 15,416 9.11 6,770 =>4.00 10,155 =>6.00
Federal regulations prohibit banking companies from paying dividends on their
stock if the effect would cause stockholders' equity to be reduced below
applicable regulatory capital requirements or if such declaration and payment
would otherwise violate regulatory requirements.
Under the National Bank Act, the approval of the OCC is required if dividends
declared by PNB to the Company in any year exceed the net profits of that year,
as defined, combined with the retained net profit for the two preceding years.
At December 31, 2003 PNB could, without approval of the OCC, declare dividends
aggregating $424,000.
As of December 31, 2003, BCB is restricted from declaring dividends to the
Company in an amount greater than approximately $7,651,000, as such declaration
would decrease capital below BCB's required minimum level of regulatory
capital.
NOTE 13 OTHER NONINTEREST EXPENSE
The major components of other noninterest expense for the years ended December
31, are as follows:
($000 Omitted)
2003 2002 2001
------- ------- -------
Professional fees $1,166 $1,096 $ 886
Stationery and supplies 556 596 486
Telecommunications 571 505 283
Postage and shipping 378 378 323
ATM expense 442 366 352
Other 2,706 2,652 2,316
------ ------ -------
$5,819 $5,593 $ 4,646
====== ====== ========
NOTE 14 FEDERAL AND STATE TAXES
The components of federal and state tax expense (benefit) for the years ended
December 31, are as follows:
($000 Omitted)
2003 2002 2001
------- ------ ------
Current
Federal $1,713 $ 985 $1,319
State 403 327 201
------ ------
2,116 1,312 1,520
------ ------ ------
Deferred
Federal (181) 176 223
State (37) (12) (35)
------ ------ ------
(218) 164 188
------ ------ ------
Change in valuation allowance (31) 31 -
------ ------ ------
(249) 195 188
------ ------ ------
Total $1,867 $1,507 $1,708
====== ====== ======
The temporary differences (the differences between the financial statement
carrying amounts of existing assets and liabilities and their respective tax
bases) that give rise to significant portions of the deferred income tax asset
and deferred income tax liability at December 31, are as follows:
($000 Omitted)
2003 2002
------- -------
Deferred income tax asset
Allowance for loan losses $ 1,836 $ 1,706
Other 10 8
Interest on nonaccrual loans 27 22
Loan origination costs, net 23 8
Unrealized holding loss on equities
available-for-sale - 285
Securities writedown 9 38
Capital loss carryforward 162 -
Minimum pension liability adjustment 371 581
Amortization of goodwill and core deposit intangible 257 384
Supplemental pension 136 48
------- -------
2,831 3,080
Valuation allowance - (316)
------- -------
2,831 2,764
------- -------
Deferred income liabilities
Depreciation (751) (728)
Unrealized holding gain on securities
available-for-sale (571) (357)
Prepaid pension (208) (221)
Mortgage and consumer servicing rights (152) (134)
------- -------
(1,682) (1,440)
------- -------
Deferred income tax asset, net $ 1,149 $ 1,324
======= =======
The primary sources of recovery of the deferred income tax asset are taxes paid
that are available for carryback and the expectation that the deductible
temporary differences will reverse during periods in which the Company
generates taxable income.
Total income tax expense for the years ended December 31, 2003, 2002 and 2001
differs from the "expected" federal income tax expense at the 34% statutory
rate for the following reasons:
2003 2002 2001
---- ---- ----
Expected federal income taxes 34.0% 34.0% 34.0%
Interest on municipal securities
available-for-sale and municipal loans (3.3) (3.8) (4.2)
State tax expense, net of federal benefit 4.4 5.1 2.0
Valuation allowance for securities (0.6) - -
Other (0.4) 1.4 (1.2)
---- ---- ----
Effective tax rates 34.1% 36.7% 30.6%
==== ==== ====
NOTE 15 EMPLOYEE BENEFITS
Pension Plan
The Company maintains a trusteed non-contributory pension plan (the "Plan")
covering substantially all full-time employees. Assuming retirement at age 65
after 30 years or more of service, the benefits are computed as the sum of one
percent of final average earnings up to a covered compensation limit, plus 0.65
percent of final average earnings in excess of covered compensation, times
years of service, up to 30. Final average earnings are defined as the five
consecutive years out of the employee's last ten years of employment during
which compensation is highest. The amounts contributed to the Plan are
determined annually on the basis of (a) the maximum amount that can be deducted
for federal income tax purposes or (b) the amount certified by a consulting
actuary as necessary to avoid an accumulated funding deficiency as defined by
the Employee Retirement Income Security Act of 1974. Contributions are intended
to provide not only benefits attributed to service to date but also for those
expected to be earned in the future.
The following table sets forth information about the Plan as of December 31,
and for the years then ended:
($000 Omitted)
2003 2002
-------- --------
Change in benefit obligation
Benefit obligation at beginning of year $ 4,356 $ 3,305
Service cost 444 356
Interest cost 266 246
Actuarial (gain) loss (46) 747
Benefits paid (119) (298)
------- -------
Benefit obligation at end of year 4,901 4,356
------- -------
Change in plan assets
Fair value of plan assets at beginning of year 2,685 2,918
Actual return on plan assets 540 (248)
Employer contributions 546 313
Benefits paid (119) (298)
------- -------
Fair value of plan assets at end of year 3,652 2,685
------- ------
Funded status at end of year (1,249) (1,671)
Unrecognized transition asset (1) (5)
Unrecognized net actuarial loss 2,824 3,371
Unrecognized prior service cost (961) (1,046)
------- -------
Net amount recognized $ 613 $ 649
======= =======
Amounts recognized in the consolidated statements of
financial condition consist of:
Accrued benefit liability $(1,092) $(1,707)
Accumulated other comprehensive loss, before income
tax benefit 1,092 1,707
Prepaid benefit cost 613 649
------- -------
Net amount recognized $ 613 $ 649
======= =======
The accumulated benefit obligation for the plan was $4,131,000 and $3,743,000
at December 31, 2003 and 2002, respectively.
The expected long-term rate of return for the plan's total assets is based on
the expected return of asset categories identified below, weighted based on the
target allocations for each class. Equity funds are expected to return 8% to
10% over the long-term and bond funds and short-term money markets are expected
to return between 4% and 6%.
($000 omitted)
Components of net periodic benefit cost 2003 2002 2001
--------------------------------------- ----- ----- -----
Service cost $ 444 $ 356 $ 309
Interest cost 266 246 254
Expected return on plan assets (211) (244) (271)
Amortization of prior service cost (84) (84) (85)
Amortization of net actuarial loss 172 122 85
Recognized transition amount (5) (5) (4)
----- ----- -----
Net periodic benefit cost $ 582 $ 391 $ 288
===== ===== ====
Assumptions used to determine benefit
obligations and benefit cost
as of and for the years ending December 31, 2003 2002
------------------------------------------- ---- ----
Discount rate 6.25% 6.25%
Long-term rate of return on plan assets 8.00 8.50
Rate of compensation increase 4.00 4.00
At December 31, 2003 and 2002, the comprehensive loss for the unfunded pension
accumulated benefit obligation was $721,000 and $1,126,000, net of taxes,
respectively. While the Company continues to contribute the maximum amount
permitted by law to its pension plan, the discount rate used to calculate the
future value of such contribution and the poor asset performance of the munutal
funds has resulted in the unfunded pension accumulated benefit obligation.
The Company's pension plan actual asset allocations by asset category are as
follows:
Plan Assets at December 31,
2003 2002
------ ------
Asset Category
Mutual funds:
Bond funds 32.3% 45.1%
U. S. common stock funds 36.8 43.6
International equity funds 7.1 7.2
Real estate funds 8.8 -
Short-term money market 15.0 4.1
----- -----
Total 100.0% 100.0%
===== =====
The investment policy, as established by the Company, is to provide for a
moderate growth of capital with a moderate level of volatility by investing
assets per the target allocations as follows:
2003 2002
------ ------
Asset Category
Mutual funds:
Bond funds 40.0% 45.0%
U.S. common stock funds 42.0 46.0
International equity funds 8.0 9.0
Real estate funds 10.0 -
----- -----
Total 100.0% 100.0%
===== =====
The assets will be re-allocated quarterly to meet the above target allocations.
The investment policy is reviewed on an annual basis, under the advisement of
our certified investment advisor, to determine if the policy should be changed.
The plan assets do not include any Company common stock at December 31, 2003
and 2002.
The Company expects to contribute $430,000 to its pension plan in 2004.
401(k) Plan
The Company offers a contributory 401(k) Plan. Under the Northway Financial,
Inc. 401(k) and Profit Sharing Plan (the "401K Plan") employees must have
attained age 21, completed six months of service and be credited with 1,000
hours of service in order to participate. Employees of the Company, PNB and BCB
are eligible to participate. Under the 401K Plan, employers match 50 percent of
the first 4 percent of employee contributions. Total 401(k) matching expense in
2003, 2002 and 2001 amounted to $130,000, $120,000 and $113,000, respectively,
and there was no Profit Sharing contribution expense for 2003 and 2002, and in
2001 it was $64,000.
Supplemental Executive Retirement Plan
Effective May 29, 2003, the existing Executive Life program sponsored by the
Company was terminated and replaced with a SERP. The existing Split Dollar Life
Insurance policy designed to support the Executive Life program is now fully
owned by Northway. This policy will be maintained by Northway and is used as
the benchmark for the newly established SERP.
This SERP is an "account balance" type plan designed to provide retirement
income to Mr. Woodward. Pre-retirement, Northway credits the participant's
account with a contribution at the end of each calendar year. Contributions to
the account are equal to the excess (if any) of the gain in the associated life
insurance contract over the cost of the funds expense as defined in the SERP.
Contributions are not guaranteed by the Company.
The total retirement SERP benefit is as follows: Upon Mr. Woodward's
termination of employment for reasons other than death or for cause, the
account balance is paid out to him in ten (10) equal annual installments on the
first day of the month following the month in which employment is terminated.
Upon death after retirement, the unpaid account balance, if any, is paid out in
a lump sum to the named beneficiary. During retirement, an additional
retirement payment, based on the policy gains associated with the prior
calendar year, will also be paid on an annual basis until the executive's
death. In the event of Mr. Woodward's death while employed by the Company, the
SERP permits a death benefit of $2,000,000 be paid to his beneficiary.
Stock-Based Compensation
The Board of Directors (the "Committee") administers the 1999 Stock Option and
Grant Plan (the "1999 Plan") which is described below.
Under the 1999 Plan, the Committee may select the individuals to whom awards
may from time to time be granted; determine the time or times of grant; and
determines the extent, if any, of incentive stock options, non-qualified stock
options, restricted stock awards, unrestricted stock awards, performance share
awards, or any combination of the foregoing.
The 1999 Plan expires in February 2009. The aggregate number of shares of the
Company's common stock which may be issued upon the exercise of options granted
under the 1999 Plan is 175,000. The option price is fixed by the Committee at
the time of the grant and may not be less than 100 percent of the fair market
value of the stock, as determined by the Committee, in good faith as of the
grant date. Each option may be exercised at such times as shall be determined
by the Committee at or after the grant date; provided, however, that no option
may be exercised ten years after the date of grant.
The fair value of each option granted is estimated on grant date using the
Black-Scholes option pricing model. In 2000 the weighted average dividend yield
was 2.5%, the weighted average risk-free interest rate was 6.01%, the expected
volatility was 23% and the expected life was 8 years.
A summary of the status of the Company's 1999 Plan as of December 31, 2003,
2002 and 2001 and changes during the years then ended is presented below:
2003 2002 2001
-------------------- ------------------ --------------------
Weighted Weighted Weighted
Average Average Average
Exercise Exercise Exercise
Shares Price Shares Price Shares Price
------ --------- ------ -------- ------ ---------
Outstanding, beginning of year 42,000 $24.93 49,500 $24.91 49,500 $24.91
Granted - - - - - -
Exercised - - (5,250) 25.70 - -
Forfeited - (2,250) 22.63 - -
------ ------ ------
Outstanding, end of year 42,000 $24.93 42,000 $24.93 49,500 $24.91
====== ====== ======
Options exercisable at year-end 42,000 36,000 35,250
Per share weighted-average fair value
of options granted during the year $ - $ - $ -
The following table summarizes information about fixed stock options outstanding as of December 31, 2003:
Options Outstanding Options Exercisable
Weighted
Number Average Number Weighted
Outstanding Remaining Exercisable Average
Exercise as of Contractual as of Exercise
Price 12/31/03 Life 12/31/03 Price
-------- ----------- ----------- ----------- ---------
$28.00 18,000 5.50 years 18,000 $28.00
22.63 24,000 6.63 years 24,000 22.63
------ ------
$24.93 42,000 6.15 years 42,000 $24.93
====== ======
Change in Control
The Company and its subsidiaries have entered into Key Employee agreements with
the Named Executive Officers as well as other Senior Officers of the Company.
These agreements provide for payments, under certain circumstances, to the
officer upon the officer's termination after a change in control. Payments will
be made under these agreements upon the officer's termination or resignation in
connection with certain specified actions adverse to the officer's employment
status after a change in control. The amount of such payments ranges from 1.0
to 1.5 times such officer's annual compensation.
NOTE 16 FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Company is party to financial instruments with off-balance sheet risk in
the normal course of business to meet the financing needs of its customers and
to reduce its own exposure to fluctuations in interest rates. These financial
instruments include commitments to originate loans and standby letters of
credit. The instruments involve, to varying degrees, elements of credit and
interest rate risk in excess of the amount recognized in the balance sheet. The
amounts of those instruments reflect the extent of involvement the Company has
in particular classes of financial instruments.
The Company's exposure to credit loss in the event of nonperformance by the
other party to the financial instrument for loan commitments and standby
letters of credit is represented by the contractual amount of those
instruments. The Company uses the same credit policies in making commitments
and conditional obligations as it does for on-balance sheet instruments.
Financial instruments with off-balance sheet credit risk at December 31, are as
follows:
($000 Omitted)
2003 2002
------- -------
Financial instrument whose contract amounts
represent credit risk:
Unadvanced portions of home equity loans $13,798 $14,414
Unadvanced portions of lines of credit 10,535 10,761
Unadvanced portions of commercial real estate loans 2,202 2,410
Commitments to originate all other loans 18,391 29,608
Commitments to originate municipal notes - 1,000
Standby letters of credit 350 36
Commitments to originate loans and municipal notes, unadvanced portions of home
equity loans, lines of credit and commercial real estate loans are agreements
to lend to a customer provided there is no violation of any condition
established in the contract. Commitments generally have fixed expiration dates
or other termination clauses and may require payment of a fee. Since many of
the commitments are expected to expire without having been drawn upon, the
total commitment amounts do not necessarily represent future cash requirements.
The Company evaluates each customer's creditworthiness on a case-by-case basis.
The amount of collateral obtained, if deemed necessary by the Company upon
extension of credit, is based on management's credit evaluation of the
borrower.
Standby letters of credit are conditional commitments issued by the Company to
guarantee the performance by a customer to a third party. The credit risk
involved in issuing letters of credit is essentially the same as that involved
in extending loan commitments to customers. As of December 31, 2003 and 2002,
the maximum potential amount of the Company's obligation was $350,000 and
$36,000, respectively, for financial and standby letters of credit. The
Company's outstanding letters of credit generally have a term of less than one
year. If a letter of credit is drawn upon, the Company may seek recourse
through the customer's underlying line of credit. If the customer's line of
credit is also in default, the Company may take possession of the collateral,
if any, securing the line of credit.
NOTE 17 FAIR VALUE OF FINANCIAL INSTRUMENTS
The following methods and assumptions were used by the Company in estimating
its fair value disclosures for financial instruments:
Cash and cash equivalents: The carrying amounts reported in the statements of
financial condition for cash and cash equivalents approximates the fair value
of those assets.
Securities: Fair values for securities are based on quoted market prices, where
available. If quoted market prices are not available, fair values are based on
quoted market prices of comparable instruments.
FHLB and Federal Reserve Bank ("FRB") Stock: The carrying amount reported in
the statements of financial condition for FHLB and FRB Stock approximates their
fair value. If redeemed, the Company will receive an amount equal to the par
value of the stocks.
Loans held-for-sale: Fair values for loans held-for-sale are estimated based on
outstanding investor commitments, or in the absence of such commitments, are
based on current investor yield requirements.
Loans: For variable-rate loans that reprice frequently and with no significant
change in credit risk, fair values are based on carrying values. The fair value
for other loans are estimated using discounted cash flow analyses, using
interest rates currently being offered for loans with similar terms to
borrowers of similar credit quality. The fair value of nonaccrual loans was
estimated using the estimated fair value of the underlying collateral. The fair
value of commitments to originate loans and outstanding letters of credit were
considered in estimating the fair value of loans. As the undisbursed lines of
credit are at floating rates, there is no fair value adjustment.
Accrued interest receivable: The carrying value of accrued interest receivable
approximates its fair value because of the short-term nature of this financial
instrument.
Deposits: The fair value of demand deposits (e.g. NOW and super NOW checking,
noninterest bearing checking, regular savings, money market accounts and
mortgagors' escrow accounts) are, by definition, equal to the amount payable on
demand at the reporting date (i.e. their carrying amounts). Fair values for
certificates of deposit are estimated using a discounted cash flow technique
that applies interest rates currently being offered on certificates to a
schedule of aggregated expected monthly maturities of time deposits.
Short-term borrowings: The carrying value of short-term borrowings approximates
its fair value because of the short-term nature of these financial instruments.
Long-term debt: The fair values of long-term debt are determined by discounting
the anticipated future cash payments by using the rates currently available to
the Company for debt with similar terms and remaining maturities.
Junior subordinated debentures: The fair values of junior subordinated
debentures are based on quoted market prices, where available. If quoted market
prices are not available, fair values are based on quoted market prices of
comparable instruments.
The estimated fair values of the Company's financial instruments are as
follows:
($000 Omitted)
December 31,
2003 2002
------------------------ -------------------------
Estimated Estimated
Carrying Fair Carrying Fair
Amount Value Amount Value
------- --------- ------- --------
Financial assets:
Cash and cash equivalents $ 31,085 $ 31,085 $ 27,426 $ 27,426
Securities available-for-sale 73,716 73,716 91,397 91,397
FHLB stock 4,705 4,705 4,632 4,632
FRB stock 365 365 80 80
Loans held-for-sale 511 519 669 669
Loans, net 462,949 466,706 437,232 440,639
Accrued interest receivable 2,590 2,590 2,680 2,680
Financial liabilities:
Deposits 463,307 464,605 476,194 477,907
Short-term borrowings 7,401 7,401 8,251 8,251
Long-term debt 67,000 68,961 46,000 49,067
Junior subordinated debentures 20,620 21,083 20,620 20,759
The carrying amounts of financial instruments shown in the above table are
included in the consolidated statements of financial condition under the
indicated captions except that accrued interest receivable is included with
other assets in the statements and in junior subordinated debentures is
included with long-term debt in the statements.
At December 31, 2003 and 2002, all the Company's financial instruments were
held for purposes other than trading.
Limitations
Fair value estimates are made at a specific point in time, based on relevant
market information and information about the financial instrument. These
estimates do not reflect any premium or discount that could result from
offering for sale at one time the Company's entire holdings of a particular
financial instrument. Because no market exists for some of the Company's
financial instruments, fair value estimates are based on judgments regarding
future expected loss experience, cash flows, current economic conditions, risk
characteristics, and other factors. These estimates are subjective in nature
and involve uncertainties and matters of significant judgment and therefore
cannot be determined with precision. Changes in assumptions and changes in the
loan, debt and interest rate markets could significantly affect the estimates.
Further, the income tax ramifications related to the realization of the
unrealized gains and losses can have a significant effect on the fair value
estimates and have not been considered. The fair value amounts presented do not
represent the underlying value of the Company because fair values of certain
other financial instruments, assets and liabilities have not been determined.
NOTE 18 CONDENSED PARENT ONLY FINANCIAL STATEMENTS
Condensed financial statements of Northway Financial, Inc. (Parent Company
only) as of December 31, 2003 and 2002 and for the three years ended December
31, 2003 follow:
STATEMENTS OF FINANCIAL CONDITION
($000 Omitted)
2003 2002
--------- ----------
Assets
Cash and cash equivalents $ 3,525 $ 6,688
Investment in subsidiary, The Berlin City Bank 35,991 32,114
Investment in subsidiary, The Pemigewasset National Bank of Plymouth, New Hampshire 24,277 23,634
Investment in unconsolidated subsidiary, Northway Capital Trust I
Investment in unconsolidated subsidiary, Northway Capital Trust II 620 620
Equipment, net 1,792 1,820
Due from subsidiaries 978 515
Other assets 3,400 1,905
------- -------
Total assets $70,583 $67,296
======= =======
Liabilities and stockholders' equity
Accrued expenses $ 480 $ 568
Other liabilities 1,611 1,842
Junior subordinated debentures 20,620 20,620
------- -------
Total liabilities 22,711 23,030
------- -------
Stockholders' equity:
Common stock 1,732 1,732
Additional paid-in-capital 2,088 2,088
Retained earnings 50,116 47,523
Treasury stock (6,213) (5,711)
Accumulated other comprehensive income (loss) 149 (1,366)
------- -------
Total stockholders' equity 47,872 44,266
------- -------
Total liabilities and stockholders' equity $70,583 $67,296
======= =======
STATEMENTS OF INCOME
($000 Omitted)
2003 2002 2001
------ ------ ------
Income:
Dividends from subsidiaries $ 1,820 $ 1,520 $ 3,925
Interest income 54 104 24
Management fee income from subsidiaries 9,112 6,710 5,337
Other 57 20 --
------- -------- -------
11,043 8,354 9,286
------- -------- -------
Expense:
Interest expense 1,036 665 10
Salaries and employee benefits 5,130 3,848 3,430
Office occupancy and equipment expense 1,223 905 664
Professional fees 933 683 587
Other 1,830 1,415 755
------- -------- -------
10,152 7,516 5,446
------- -------- -------
Income before income tax benefit and
equity in undistributed net income of subsidiaries 891 838 3,840
Income tax benefit (316) (232) (29)
------- -------- -------
Income before equity in undistributed net
income of subsidiaries 1,207 1,070 3,869
Equity in undistributed net income of subsidiaries 2,410 1,528 4
------- -------- -------
Net income $ 3,617 $ 2,598 $ 3,873
======= ======== =======
STATEMENTS OF CASH FLOWS
($000 Omitted)
2003 2002 2001
------- -------- -------
Cash flows from operating activities:
Net income $ 3,617 $ 2,598 $ 3,873
Adjustments to reconcile net income to net
cash (used in) provided by operating activities:
Depreciation and amortization 467 289 132
(Increase) decrease in amount due from subsidiaries (463) (73) 6
Increase in other assets (2,071) (493) (400)
Increase (decrease) in accrued expenses and other liabilities 662 314 (195)
Loss on disposal of assets 27 -- --
Undistributed net income of subsidiaries (2,410) (1,528) (4)
------- -------- -------
Net cash (used in) provided by operating activities (171) 1,107 3,412
------- -------- -------
Cash flows from investing activities: Capital contributions to subsidiaries:
The Berlin City Bank (1,000) (3,000) --
Pemigewasset National Bank -- (9,500) --
Additions to premises and equipment (466) (1,362) (447)
------- -------- -------
Net cash used in investing activities (1,466) (13,862) (447)
------- -------- -------
Cash flows from financing activities:
Proceeds from issuance of junior
subordinated debentures by subsidiaries -- 20,000 1,855
Repayments of advances from subsidiaries -- -- (2,535)
Exercise of stock options -- 140 --
Purchases of treasury stock (502) -- (1,156)
Dividends paid (1,024) (1,030) (1,028)
------- -------- -------
Net cash (used in) provided by financing activities (1,526) 19,110 (2,864)
------- -------- -------
Net (decrease) increase in cash and cash equivalents (3,163) 6,355 101
Cash and cash equivalents at beginning of year 6,688 333 232
------- -------- -------
Cash and cash equivalents at end of year $ 3,525 $ 6,688 $ 333
======= ======== =======
QUARTERLY RESULTS OF OPERATIONS (UNAUDITED)
Summarized quarterly financial data for 2003 and 2002 follows:
($000 Omitted, except earnings per share)
2003 Quarters Ended
------------------------------------------
Mar 31 Jun 30 Sep 30 Dec 31
------ ------ ------ ------
Interest and dividend income $7,999 $8,203 $7,713 $7,592
Interest expense 2,199 2,218 2,084 1,956
------- ------- ------- -------
Net interest and dividend income 5,800 5,985 5,629 5,636
Provision for loan losses 225 220 210 150
Noninterest income 1,050 987 1,724 1,614
Noninterest expense 5,347 5,464 5,607 5,718
------- ------- ------- -------
Income before taxes 1,278 1,288 1,536 1,382
Income tax expense 467 464 558 378
-------- -------- -------- --------
Net income $ 811 $ 824 $ 978 $1,004
====== ======= ======= ======
Basic earnings per common share $ 0.54 $ 0.55 $ 0.65 $ 0.66
======= ======= ======= =======
Earnings per common share assuming dilution $ 0.54 $ 0.54 $ 0.65 $ 0.66
======= ======= ======= =======
2002 Quarters Ended
------------------------------------------
Mar 31 Jun 30 Sep 30 Dec 31
------ ------ ------ ------
Interest and dividend income $7,854 $7,752 $7,778 $8,098
Interest expense 2,535 2,321 2,482 2,500
------- ------- ------- -------
Net interest and dividend income 5,319 5,431 5,296 5,598
Provision for loan losses 225 225 225 225
Noninterest income 952 755 875 814
Noninterest expense 4,329 4,560 5,662 5,484
------- ------- ------- -------
Income before taxes 1,717 1,401 284 703
Income tax expense 598 479 109 321
-------- -------- -------- --------
Net income $1,119 $ 922 $ 175 $ 382
====== ======= ======= =======
Basic earnings per common share $ 0.74 $ 0.60 $ 0.12 $ 0.25
======= ======= ======= =======
Earnings per common share assuming dilution $ 0.74 $ 0.60 $ 0.12 $ 0.25
======= ======= ======= =======
INDEPENDENT AUDITORS' REPORT
Shatswell, MacLeod & Company, P.C.
Certified Public Accountants
83 Pine Street
West Peabody, Massachusetts 01960
The Board of Directors and Stockholders
Northway Financial, Inc.
Berlin, New Hampshire
We have audited the accompanying consolidated statements of financial condition
of Northway Financial, Inc. and Subsidiaries as of December 31, 2003 and 2002
and the related consolidated statements of income, comprehensive income,
changes in stockholders' equity and cash flows for each of the years in the
three-year period ended December 31, 2003. These consolidated financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these consolidated financial
statements based on our audits.
We conducted our audits in accordance with auditing standards generally
accepted in the United States of America. Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the
consolidated financial statements are free of material misstatement. An audit
includes examining, on a test basis, evidence supporting the amounts and
disclosures in the consolidated financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall consolidated financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of
Northway Financial, Inc. and Subsidiaries as of December 31, 2003 and 2002 and
the results of their operations and their cash flows for each of the years in
the three-year period ended December 31, 2003, in conformity with accounting
principles generally accepted in the United States of America.
/s/ SHATSWELL, MacLEOD & COMPANY, P.C.
SHATSWELL, MacLEOD & COMPANY, P.C.
West Peabody, Massachusetts
January 16, 2004
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
The Company's management, with the participation of the Company's Chief
Executive Officer and Chief Financial Officer, has evaluated the effectiveness
of the company's disclosure controls and procedures as of December 31, 2003.
Based on that evaluation, the Company's Chief Executive Officer and Chief
Financial Officer concluded that the Company's disclosure controls and
procedures were effective as of December 31, 2003. There were no material
changes in the Company's internal control over financial reporting during the
fourth quarter 2003.
PART III
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
Information required by this item is incorporated by reference to the
information set forth under the captions "Information Concerning Directors and
Nominees," "Executive Officers" and "Audit and Compliance Committee" in the
Company's definitive proxy statement to be delivered in connection with its
2004 Annual Meeting of Stockholders.
Further, the Company has adopted a code of ethics that applies to all of its
directors, officers and employees. The Company has filed a copy of this Code of
Ethics as Exhibit 14 to this Form 10-K. The Company has also made the Code of
Ethics available on its website at www.northwayfinancialinc.com.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item is incorporated by reference to the
information set forth under the caption "Executive Compensation" in the
Company's definitive proxy statement to be delivered in connection with its
2004 Annual Meeting of Stockholders, provided however, that the "Report of the
Human Resources, Compensation and Nominating Committee on Executive
Compensation" and the "Stock Price Performance Graph" contained in such proxy
statement are not incorporated by reference herein.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
RELATED STOCKHOLDER MATTERS
The information required by this item is incorporated by reference to the
information set forth under the caption "Security Ownership of Management" in
the Company's definitive proxy statement to be delivered in connection with its
2004 Annual Meeting of Stockholders.
The following table sets forth information regarding securities authorized for
issuance under the Company's equity compensation plans as of December 31, 2003:
EQUITY COMPENSATION PLAN INFORMATION
Number of securities
Number of securities remaining available
to be issued Weighted-average for future issuance under
upon exercise of exercise price of equity compensation plans
outstanding options, outstanding options, (excluding securities
Plan category warrants and rights warrants and rights reflected in column (a))
------------- --------------------- -------------------- -------------------------
(a) (b) (c)
Equity compensation
plans approved by
security holders 42,000 $ 24.93 127,750
Equity compensation
plans not approved
by security holders - - -
----------- --------- -----------
Total 42,000 $ 24.93 127,750
=========== ========= ===========
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS
The information required by this item is incorporated by reference to the
information set forth under the caption "Certain Relationships and Related
Transactions" in the Company's definitive proxy statement to be delivered in
connection with its 2004 Annual Meeting of Stockholders.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this item is incorporated by reference to the
information set forth under the caption "Fees Paid to Independent Auditors" in
the Company's definitive proxy statement to be delivered in connection with its
2004 Annual Meeting of Stockholders.
ITEM 15 EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K
(a)(1) The following financial statements are incorporated by reference from
Item 8 hereof:
Auditor's Independent Report
Consolidated Statements of Financial Condition as of December
31, 2003 and 2002
Consolidated Statements of Income for the years ended December
31, 2003 and 2002
Consolidated Statements of Changes in Stockholders Equity for
the years ended December 31, 2003, 2002, 2001 and 2000
Consolidated Statements of Comprehensive Income for the years
ended December 31, 2003, 2002 and 2001
Consolidated Statements of Cash Flows for the years ended
December 31, 2003, 2002 and 2001
Notes to Consolidated Financial Statements
(2) Financial Statement Schedules:
None
(3) The Exhibits which are filed with this report or which are incorporated
herein by reference are set forth in the Exhibit Index. The Exhibit
Index is incorporated herein by reference.
(b) Current Report on Form 8-K filed on October 28, 2003.
Item reported: Earnings announcement for third quarter ending
September 30, 2003.
(c) See Item 15(a)(3) above
(d) See Item 8 of this Annual Report on Form 10-K
SIGNATURES
Pursuant to requirements of Section 13 or 15(d) 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.
NORTHWAY FINANCIAL, INC.
March 23, 2004 BY: /S/ William J. Woodward
-------------------------------
William J. Woodward
Chairman of the Board, President &
Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
Signature Title Date
Chairman of the Board, March 23, 2004
President and CEO (Principal
/S/ William J. Woodward Executive Officer)
------------------------------
William J. Woodward
Senior Vice President and March 23, 2004
Chief Financial Officer
(Principal Financial
/S/ Richard P. Orsillo and Accounting Officer)
------------------------------
Richard P. Orsillo
/S/ Fletcher W. Adams Vice Chairman of the Board March 26, 2004
------------------------------
Fletcher W. Adams
/S/ John D. Morris Director March 26, 2004
------------------------------
John D. Morris
/S/ John H. Noyes Director March 24, 2004
------------------------------
John H. Noyes
/S/ Barry J. Kelley Director March 23, 2004
------------------------------
Barry J. Kelley
/S/ Randall G. Labnon Director March 25, 2004
------------------------------
Randall G. Labnon
/S/ Stephen G. Boucher Director March 26, 2004
------------------------------
Stephen G. Boucher
/S/ Brien L. Ward Director March 26, 2004
-----------------------------
Brien L. Ward
/S/ Charles H. Clifford, Jr. Director March 26, 2004
-----------------------------
Charles H. Clifford, Jr.
/S/ Arnold P. Hanson, Jr. Director March 23, 2004
-----------------------------
Arnold P. Hanson, Jr.
/S/ Frederick C. Anderson Director March 26, 2004
-----------------------------
Frederick C. Anderson
INDEX OF EXHIBITS
Exhibit Number Description of Exhibit
2.1 Agreement and Plan of Merger, dated as of March 14, 1997, by
and among Northway Financial, Inc., The Berlin City Bank,
Pemi Bancorp, Inc. and Pemigewasset National Bank (the
"Merger Agreement") (incorporated by reference to Exhibit
2.1 to Registration Statement No. 333-33033).
3.1 Amended and Restated Articles of Incorporation of Northway
Financial, Inc. (incorporated by reference to Exhibit 3.1
to Registration Statement No. 333-33033).
3.2 By-laws of Northway Financial, Inc (incorporated by
reference to Exhibit 3.2 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1997).
4 Form of Certificate representing the Company Common Stock
(reference is also made to Exhibits 3.1 and 3.2)
(incorporated by reference to Exhibit 4 to Registration
Statement No. 333-33033).
10.1 Employment Agreement for William J. Woodward (incorporated
by reference to Exhibit 10.1 to the Company's Annual Report
on Form 10-K for the year ended December 31, 1997).
10.2 Employment Agreement for Fletcher W. Adams (incorporated by
reference to Exhibit 10.2 to the Company's Annual Report on
Form 10-K for the year ended December 31, 1997).
10.3 Amendment to the Employment Agreement for William J.
Woodward. (incorporated by reference to Exhibit 10.3 to the
Company's Annual Report on Form 10-K for the year ended
December 31, 1998).(2)
10.4 Amendment to the Employment Agreement for Fletcher W. Adams.
(incorporated by reference to Exhibit 10.4 to the Company's
Annual Report on Form 10-K for the year ended December 31,
1998). (2)
10.5 Northway Financial, Inc. 1999 Stock Option and Grant Plan
(incorporated by reference to Exhibit 4.1 to Registration
Statement No. 333-83571 dated July 23,1999). (2)
10.7 Form of Key Employee Agreement (incorporated by reference to
Exhibit 10.8 to the Company's Annual Report on Form 10-K
for the year ended 1999). (2)
10.8 Supplemental Executive Retirement Plan.(1)
11 Statement re: Computation of Per Share Earnings(1)
14 Code of Ethics(1)
21 List of Subsidiaries(1)
23 Consent of Shatswell, MacLeod & Company, P.C. (1)
31.1 Certification of President of Northway Financial, Inc.,
pursuant to rules 13(a)-15(e) and 15d-15(e), as adopted
pursuant to Section 302 of the Sarbanes-Oxley Act of
2002.(1)
31.2 Certification of Chief Financial Officer of Northway
Financial, Inc., pursuant to rules 13(a)-15(e) and
5d-15(e), as adopted pursuant to Section 302 of the
Sarbanes-Oxley Act of 2002.(1)
32.1 Certification of President of Northway Financial, Inc.,
pursuant to 18 U.S.C. Section 1350, as adopted pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002.(1)
32.2 Certification of Chief Financial Officer of Northway
Financial, Inc., pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act
of 2002.(1)
(1) Filed herewith.
(2) Management contract or compensatory plan required to be filed as an
exhibit to this form pursuant to Item 14(c) of this report.