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New Hampshire Thrift Bancshares 10-K 2005
FORM 10-K
Table of Contents

New Hampshire Thrift Bancshares, Inc. is the parent company of Lake Sunapee Bank, fsb, a federal stock savings bank providing financial services throughout central and western New Hampshire.

 

The Bank encourages and supports the personal and professional development of its employees, dedicates itself to consistent service of the highest level for all customers, and recognizes its responsibility to be an active participant in, and advocate for, community growth and prosperity.


Table of Contents

Table of Contents

 

Selected Financial Highlights

   1

President’s Letter

   2

Management’s Discussion and Analysis of Financial Condition and Results of Operations

   5

Report of Independent Registered Public Accounting Firm

   22

Financial Statements

   76

Notes to Financial Statements

   30

Form 10-K

   54

Board of Directors

   80

Officers and Managers

   80

Board of Advisors

   82

Shareholder Information

   82

Information on Common Stock

   82

 


Table of Contents

Selected Financial Highlights

 

For the Years Ended December 31,


   2004

    2003

    2002

    2001

    2000

 
     (In thousands, except per share data)  

Net Income

   $ 5,098     $ 5,771     $ 4,300     $ 3,100     $ 2,412  

Per Share Data:

                                        

Basic Earnings (1) (3)

     1.23       1.46       1.10       0.80       0.59  

Diluted Earnings (3)

     1.20       1.42       1.09       0.80       0.59  

Dividends Paid (3)

     0.45       0.36       0.32       0.32       0.32  

Dividend Payout Ratio

     36.59       24.66       29.09       40.00       54.24  

Return on Average Assets

     0.87 %     1.15 %     0.88 %     0.65 %     0.52 %

Return on Average Equity

     12.17 %     15.83 %     13.94 %     11.07 %     8.88 %

 

As of December 31,


   2004

    2003

    2002

    2001

    2000

 
     (In thousands, except per share data)  

Total Assets

   $ 595,514     $ 526,246     $ 496,645     $ 493,937     $ 463,397  

Total Deposits

     433,072       428,477       429,328       422,737       394,112  

Total Securities (2)

     123,421       126,179       85,828       56,784       50,724  

Loans, Net

     413,808       344,573       317,144       337,183       348,388  

Federal Home Loan Bank Advances

     75,000       22,000       —         —         10,000  

Shareholders’ Equity

     43,835       39,125       33,766       28,966       26,697  

Book Value of Shares Outstanding

   $ 10.52     $ 19.48     $ 17.24     $ 14.95     $ 13.53  

Average Common Equity to Average Assets

     7.15 %     7.28 %     6.35 %     5.87 %     5.91 %

Shares Outstanding

     4,167,180       2,008,690       1,958,924       1,936,974       1,973,119  

Number of Branch Locations

     15       14       14       14       14  

 

(1) See Note 1 to Consolidated Financial Statements regarding earnings per share.

 

(2) Includes available-for-sale securities shown at fair value, held-to-maturity securities at cost and Federal Home Loan Bank stock at cost.

 

(3) Data presented for years prior to 2004 has been restated for the effect of a two-for-one stock split, in the form of a 100% stock dividend, in February 2005.

 

1


Table of Contents

 

Letter to Shareholders

 

The year 2004 will serve as the beginning of a transitional period for the Company as the enabling economic environment of the last few years draws nearer to a close with each incremental rise in interest rates. The mortgage refinance boom that has served as the primary growth tool for assets and earnings at financial institutions across the country since late in 2000 is all but over and community banks, such as ours, are now turning their attention back to the more traditional models of building upon relationships and advancing into new markets. Lost to the psychology of the mind is the fact that the recent seven-year high in interest rates following a period of forty-year lows still makes for interest rates that are, then, at thirty-three year lows, but the borrowers have now moved on, having refinanced more than once or twice along the way. Fully anticipating these market changes, the Company began, more than a year ago, to develop various strategies to help move us forward…building on opportunities…diversifying products and services…and developing a stronger leadership position in the various markets now being served by both our existing and new branch locations.

 

For the Company, more active balance sheet management strategies have been employed to blend with and address the financial needs of the institution in meeting its longer term goals and objectives. By continuing to develop even closer connections to the communities served, it is most important for the Company to be recognized for an unfailing attention to detail and the delivery of quality services that will add value for both our customers and our shareholders. Operating with a ‘best practices’ mindset from the perspective of good corporate governance, the task ahead, then, is to simply manage the business well, avoid complacency and remain focused on what is important, not just what is expected.

 

COMPANY EARNINGS

 

Due primarily to the Company’s decision to redeem its $16,400,000 Trust Preferred Securities issuance of 1999 and, therefore, to incur the one-time expense of certain unamortized costs, consolidated net earnings for the year ended December 31, 2004 were $5,098,093 or $1.20 per diluted share of common stock. This compares to net income of $5,771,453 or $1.42 per diluted share of common stock that the Company reported for the year ended December 31, 2003. In addition to the expense associated with the trust preferred redemption, earnings were also negatively impacted by an alternative accounting treatment associated with a pre-existing supplemental retirement plan. With the previously mentioned pressures on both interest income and interest expense, much more attention must now be paid to the development and implementation of techniques to further the profitability of the Company through reliable and sustainable resources. Complete financial details for the year ending December 31, 2004 can be found in the Management’s Discussion and Analysis section immediately following this letter.

 

SHAREHOLDER VALUE

 

The underpinnings of growing and developing shareholder value over the longer term are rooted in the fundamentals of consistent asset quality, reliable sources of income and the periodic repositioning of the Company’s broader strategic goals and objectives. The ability of an organization to remain flexible and adaptive as markets change is now seen in the financial services industry as an avenue to better ensure the timely delivery of more refined products and services to meet newly evolving customer expectations. The financial benefits of community banking are sustained by the existence and nurturing of shared values…and the concept that doing what is right is always better than simply doing what is expected.

 

Adjusted for the recent two-for-one stock split, the Company’s stock price ended the year 2004 at $16.50, having ranged from a low of $13.805 to a high of $17.835 over the course of the year. Shareholders’ equity ended the year at $43,835,017 as compared to $39,124,596 at December 31, 2003. The number of common shares outstanding at the end of the year totaled 4,167,180 and the book value per share stood at $10.52 as of December 31, 2004.

 

Additionally, the Company, at the January 2005 board meeting, authorized an increase in the quarterly dividend pay-out from an adjusted $.1125 per share to $.1250 per share, resulting in an annualized dividend of $.50 per share. This change can be seen as representative of a belief that the Company can maintain its well-capitalized position, while at the same time provide sustainable levels of net income in the future.

 

…more active balance sheet management strategies have been employed to blend with and address the financial needs of the institution in meeting its longer term goals and objectives…

 

2


Table of Contents

Letter to Shareholders

 

COMMUNITY BANKING

 

As both the volume and pace of the Company’s mortgage lending activities began to moderate during the third and fourth quarters of 2004, the need to develop and craft a more comprehensive business plan evolved into a general dialogue about the future direction of the community banking industry. Clearly, with the financial benefits of the mortgage refinance boom now having run their course, the business of banking has returned to its most basic tenants…taking in deposits and lending out money. Growth, in all senses of the word, must now come from expanding both the products and services offered, as well as developing new markets.

 

The Company has identified three new branch locations that either expand upon our existing presence in contiguous markets or move us into new areas where the type and style of personal service delivered are seen as being very well received. By mid-year 2005, new ‘full service’ branches will be open and operational in the New Hampshire communities of Peterborough, Enfield and Claremont. The Peterborough office, which is supported by a multi-year mortgage origination effort in that area, opened in January and has more than met our initial expectations. Favorable comments are also being heard in the two other communities and we are anxious to have those offices fully operational in the second quarter.

 

Growing our financial services franchise is an important step toward developing a much broader base of sustainable relationships to carry the institution forward, as well as helping to address the margin compression issue by expanding upon the volume of banking activity that can be handled without corresponding increases in expenses in the future. While the initial costs to open and operate new offices will have a temporary dampening effect on periodic earnings, the longer term prospects for growth-derived net income more than outweigh this initial investment.

 

With the region’s economy remaining strong and healthy, the Company is better able to make strategic decisions that can bring forth more immediate and tangible results. The ‘business of business’ continues to prosper and the Company maintains an ongoing effort to develop and refine a wide variety of offerings to meet the needs of the retail consumer customers and the small business market segment, as well as the more seasoned demand for commercial lending opportunities.

 

BALANCE SHEET FUNDAMENTALS

 

Total assets of the Company stood at $595,514,082 at year end December 31, 2004 as compared to $526,246,231 at year end 2003. This represents a net increase of nearly $70,000,000 over the course of the year and is primarily attributable to a corresponding growth in the loan portfolio that was supported by the leveraged use of advances from the Federal Home Loan Bank that grew from $22,000,000 to $75,000,000 during the year. With total deposits remaining almost flat for the year, it appears that there is now more interest by the investor-depositor in cautiously returning to the stock market as the opportunity (or missed opportunity) for greater returns becomes more financially enticing.

 

The Company’s 10-year fixed-rate portfolio mortgage that was introduced at the end of 2003 has met with great success and, along with the more traditional adjustable rate mortgage programs and the commercial lending activities, helped to significantly increase the outstanding loan portfolio. At December 31, 2004, the loan portfolio stood at $417,827,740 as compared to $348,471,365 at year end 2003. This change represents a net growth of almost 20% and establishes a new baseline from which the Company’s interest income from invested assets will grow in future periods. Additionally, the sold loan portfolio of just under $295,000,000 remained almost flat for the year as a direct result of the increase in interest rates and the corresponding reduction in secondary market loan activity. The Company, as in the past, continues to retain the servicing rights on the majority of these loans in order to maintain a stream of income and to further develop the customer relationships so crucial to the future of community banking.

 

Asset quality remains at historically high levels and the Company uses both internal and external audit functions for thorough review of the loan portfolio, as well as for the periodic review of various other segments of the Company’s operations. The additional burdens placed on financial

 

… by mid-year 2005, new ‘full service’ branches will be open and operational in the New Hampshire communities of Peterborough, Enfield and Claremont…

 

3


Table of Contents

Letter to Shareholders (continued)

 

service providers to monitor and report on suspicious activity as a deterrent to potential terrorist activity remain in place and regulatory compliance with the Bank Secrecy Act is of paramount concern across the industry.

 

LOOKING AHEAD

 

The heightened expectations that accompany today’s daily business climate of operating within a ‘best practices’ environment and the greater demands on corporate governance across the board all lead to the need for more personal accountability throughout an organization. The Company takes these issues quite seriously and works to incorporate a sense of responsibility in all that we do. In a context of a community bank, this means a full recognition of the trust-based relationship that develops between the bank and its customers. While larger banks have the distinct advantage of a greater geographical distribution, community banks focus on the needs of the local families and businesses they serve each and every day. It is the nurturing of this partnership that drives and sustains the community bank.

 

Customer development and retention is a primary key to the Company’s future success and merely satisfying a customer’s needs may just not be enough. There must now be a recognizable value embedded within the relationship that transcends the simple rule of merely meeting a customer’s expectations. The ‘personal banking’ approach that the Company provides its customers is based on a desire to, whenever possible, remove the ‘obstacles’ that may prevent the achievement of their goals. Individual attention, even when the answer may not be what the customer wants to hear, means being willing to take the time to explain why and to identify what may need to be done to help them correct or better an existing situation.

 

We remain committed to growing the Company in a consistent and sustainable manner, setting goals that can be realistically achieved and managing the business in such a way that success comes from quality…not price. It is anticipated that the Company will need to move further in the direction of developing a ‘sales oriented’ culture that bases itself on the principle of whether or not a product or service is of value to the customer, not whether it is just good for the bank. It is this ‘value-added’ philosophy that will be, in the end, the Company’s economic-driver…and by consistently delivering on ‘value’ the Company can expect to see the measured growth necessary to ensure the long-term goals of increased profitability and the building of shareholder value.

 

IN CLOSING

 

The Company continues to seek out and identify ways to further develop the enabling environment that has been created over the last few years in a dedicated effort to sustain a positive and progressive work force. Sharing the vision of where the Company is headed…and why…is an important ingredient in maintaining a motivated team of employees who simply want to do their best.

 

On behalf of those who work so hard to strengthen the role of our banking franchise in all of the communities we serve, I want to again take this opportunity to thank you…our shareholders…for your continuing confidence in, and support of, the Company. As we work to broaden both our product lines and our community presence, we remain steadfast in our desire to provide exceptional banking services for the benefit of all…our customers, our employees and our shareholders.

 

Stephen W. Ensign

Chairman of the Board,

President and Chief Executive Officer

 

… community banks focus on the needs of the local families and businesses they serve each and every day…

 

4


Table of Contents

 

Management’s Discussion and Analysis

 

of Financial Condition and Results of Operations

 

General

 

New Hampshire Thrift Bancshares, Inc.’s (the “Company”) profitability is derived from its subsidiary, Lake Sunapee Bank, fsb (the “Bank”). The Bank’s earnings are primarily generated from the difference between the yield on its loans and investments and the cost of its deposit accounts and borrowings. Loan origination fees, retail-banking service fees, and gains on security and loan transactions supplement these core earnings.

 

Overview

 

    Total assets stood at $595,514,082 at December 31, 2004, an increase of $69,267,851 or 13.16%, from December 31, 2003.

 

    Net loans increased $69,235,575, or 20.09%, to $413,808,290 at December 31, 2004 from $344,572,715 at December 31, 2003.

 

    The Company earned $5,098,093 or $1.20 per common share, assuming dilution, for the year ended December 31, 2004, compared to $5,771,453, or $1.42 per common share, assuming dilution, for the year ended December 31, 2003.

 

    Earnings were negatively impacted by a one-time, non-recurring, pre-tax expense in the amount of $758,408 resulting from the redemption of the Company’s $16,400,000 of Trust Preferred Securities.

 

    During 2004, the Bank sold $67.5 million in loans to the secondary market, realizing gains on those sales of $595,231, as compared to 2003, when the Bank sold $173.0 million in loans to the secondary market, realizing gains on those sales of $3,420,714. A slow-down in mortgage loan refinancings contributed to the decrease.

 

    The Bank’s servicing portfolio increased to $293,569,964 at December 31, 2004 from $289,825,192 at December 31, 2003, an increase of $3,744,772 or 1.29%, due to a slow-down of loan pre-payments.

 

    The Bank’s interest rate spread increased to 3.48% as of December 31, 2004, compared to 3.43%, as of December 31, 2003.

 

    The Company financed two trust preferred securities issuances each in the amount of $10 million, whose proceeds were used to redeem an existing trust preferred security issuance in the amount of $16,400,000.

 

    In 2004, the Bank originated over $282.2 million in loans, compared to over $380.1 million in 2003. The slow-down in refinancings accounted for the decrease.

 

    On February 7, 2005, the Company announced a two-for-one stock split which was effected in the form of a 100% stock dividend.

 

Forward-looking Statements

 

The preceding and following discussion may contain certain forward-looking statements, which are based on management’s current expectations regarding economic, legislative, and regulatory issues that may impact the Company’s earnings in future periods. Factors that could cause future results to vary materially from current management expectations include, but are not limited to: general economic conditions, changes in interest rates, deposit flows, real estate values, and competition; changes in accounting principles, policies, or guidelines; changes in legislation or regulation; and other economic, competitive, governmental, regulatory and technological factors affecting the Company’s operations, pricing, products and services. In particular, these issues may impact management’s estimates used in evaluating market risk and interest rate risk in its gap analysis and Net Portfolio Value (NPV) tables, loan loss provisions, classification of assets, accounting estimates and other estimates used throughout this discussion. The Company disclaims any obligation to subsequently revise any forward-looking statements, or to reflect the occurrence of anticipated or unanticipated events.

 

Critical Accounting Policies

 

The Company considers the following accounting policies to be most critical in their potential effect on its financial position or results of operations:

 

Allowance for Loan Losses

 

The allowance for loan losses is established through a charge to the provision for loan losses. Provisions are made to reserve for estimated losses in outstanding loan balances. The allowance for loan losses is a significant estimate and is regularly reviewed by the Company for adequacy by assessing such factors as changes in the mix and volume of the loan portfolio; trends in portfolio credit quality, including delinquency

 

5


Table of Contents

Management’s Discussion and Analysis (continued)

 

and charge-off rates; and current economic conditions that may affect a borrower’s ability to repay. The Company’s methodology with respect to the assessment of the adequacy of the allowance for loan losses is more fully discussed on pages 15-17 of Management’s Discussion and Analysis.

 

Income Taxes

 

The Company must estimate income tax expense for each period for which a statement of operations is presented. This involves estimating the Company’s actual current tax exposure as well as assessing temporary differences resulting from differing treatment of items, such as timing of the deduction of expenses, for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in the Company’s consolidated balance sheets. The Company must also assess the likelihood that any deferred tax assets will be recovered from future taxable income and to the extent that recovery is not likely, a valuation allowance must be established. Significant management judgment is required in determining income tax expense, and deferred tax assets and liabilities. As of December 31, 2004, there were no valuation allowances set aside against any deferred tax assets.

 

Interest Income Recognition

 

Interest on loans is included in income as earned based upon interest rates applied to unpaid principal. Interest is not accrued on loans 90 days or more past due. Interest is not accrued on other loans when management believes collection is doubtful. All loans considered impaired are nonaccruing. Interest on nonaccruing loans is recognized as payments are received when the ultimate collectibility of interest is no longer considered doubtful. When a loan is placed on nonaccrual status, all interest previously accrued is reversed against current-period interest income.

 

Capital Securities

 

On August 12, 1999, NHTB Capital Trust I (“Trust I”), a Delaware business trust formed by the Company, completed the sale of $16.4 million of 9.25% Capital Securities. Trust I also issued common securities to the Company and used the net proceeds from the offering to purchase a like amount of 9.25% Junior Subordinated Deferrable Interest Debentures (“Debentures I”) of the Company. Debentures I was the sole asset of Trust I and was eliminated, along with the related income statement effects, in the consolidated financial statements. The Company contributed $15.0 million from the sale of Debentures I to the Bank as Tier I Capital to support the acquisition of the three branches of the New London Trust Company (“NLTC”). Total expenses associated with the offering, approximating $900,000, were included in other assets and were amortized on a straight-line basis over the life of Debentures I.

 

The Capital Securities I accrued and paid distributions quarterly at an annual rate of 9.25% of the stated liquidation amount of $10 per Capital Security. The Company had fully and unconditionally guaranteed all of the obligations of Trust I. The guaranty covered the quarterly distributions and payments on liquidation or redemption of Capital Securities I, but only to the extent that Trust I had funds necessary to make these payments.

 

Capital Securities I were mandatorily redeemable upon the maturing of Debentures I on September 30, 2029 or upon earlier redemption as provided in the Indenture. The Company had the right to redeem Debentures I, in whole or in part on or after September 30, 2004 at the liquidation amount plus any accrued but unpaid interest to the redemption date. On September 30, 2004, the Company redeemed Capital Securities I in its entirety and incurred a one-time, non-recurring expense in the amount of $758,408 in unamortized expenses resulting from the origination of Capital Securities I.

 

On March 30, 2004, NHTB Capital Trust II (“Trust II”), a Connecticut statutory trust formed by the Company, completed the sale of $10.0 million of 6.06%, 5 Year Fixed-Floating Capital Securities (“Capital Securities II”). Trust II also issued common securities to the Company and used the net proceeds from the offering to purchase a like amount of 6.06% Junior Subordinated Deferrable Interest Debentures (“Debentures II”) of the Company. Debentures II are the sole assets of Trust II. The Company used the proceeds to redeem the securities issued by Trust I, which were callable on September 30, 2004. Total expenses associated with the offering of $160,402 are included in other assets and are being amortized on a straight-line basis over the life of Debentures II.

 

Capital Securities II accrue and pay distributions quarterly at an annual rate of 6.06% for the first 5 years of the stated liquidation amount of $10 per Capital Security. The Company has fully and unconditionally guaranteed all of the obligations of the Trust. The guaranty covers the quarterly distributions and payments on liquidation or redemption of Capital Securities II, but only to the extent that the Trust has funds necessary to make these payments.

 

6


Table of Contents

Management’s Discussion and Analysis (continued)

 

Capital Securities II are mandatorily redeemable upon the maturing of Debentures II on March 30, 2034 or upon earlier redemption as provided in the Indenture. The Company has the right to redeem Debentures II, in whole or in part on or after March 30, 2009 at the liquidation amount plus any accrued but unpaid interest to the redemption date.

 

On March 30, 2004, NHTB Capital Trust III (“Trust III”), a Connecticut statutory trust formed by the Company, completed the sale of $10.0 million of Floating Capital Securities, adjustable every three months at LIBOR plus 2.79% (“Capital Securities III”). Trust III also issued common securities to the Company and used the net proceeds from the offering to purchase a like amount of Junior Subordinated Deferrable Interest Debentures (“Debentures III”) of the Company. Debentures III are the sole assets of Trust III. The Company used a portion of the proceeds to redeem the balance of securities issued by Trust I, which were callable on September 30, 2004. The balance of the proceeds of Trust III is being used for general corporate purposes. Total expenses associated with the offering of $160,402 are included in other assets and are being amortized on a straight-line basis over the life of Debentures III.

 

Capital Securities III accrue and pay distributions quarterly based on the stated liquidation amount of $10 per Capital Security. The Company has fully and unconditionally guaranteed all of the obligations of Trust III. The guaranty covers the quarterly distributions and payments on liquidation or redemption of Capital Securities III, but only to the extent that Trust III has funds necessary to make these payments.

 

Capital Securities III are mandatorily redeemable upon the maturing of Debentures III on March 30, 2034 or upon earlier redemption as provided in the Indenture. The Company has the right to redeem Debentures III, in whole or in part on or after March 30, 2009 at the liquidation amount plus any accrued but unpaid interest to the redemption date.

 

Charter Holding Corp.

 

On October 2, 2000, the Bank and two other New Hampshire banks acquired Charter Holding Corp. (CHC) and Phoenix New England Trust Company (PNET) from Phoenix Home Life Mutual Insurance Company of Hartford, Connecticut. Contemporaneous with the acquisition, CHC and PNET merged under the continuing name of Charter Holding Corp. with assets of approximately $1.7 billion under management. As a result of the acquisitions and merger, at a cost of $3,003,337 each, the Bank and each of the other two banks own one-third of CHC. Headquartered in Concord, New Hampshire, CHC provides trust and investment services from more than a dozen offices across New Hampshire, as well as one in Norwich, Vermont. The Bank purchased CHC as a means to provide trust and investments services as well as insurance products to the Bank’s customers. By doing so, the Bank anticipates non-interest income to be enhanced. For the years ended December 31, 2004 and December 31, 2003, the Bank realized $155,278 and $81,489, respectively, in a realized gain. The Bank has entered into an agreement with Charter New England Agency (CNEA), a subsidiary of CHC, which enables the Bank to sell brokerage, securities, and insurance products. For the years ended December 31, 2004 and December 31, 2003, the Bank generated commissions in the amount of $192,617 and $108,818, respectively.

 

Comparison of Years Ended December 31, 2004 and 2003

 

Financial Condition

 

Total assets increased by $69,267,851 or 13.16%, from $526,246,231 at December 31, 2003 to $595,514,082 at December 31, 2004. Cash and Federal Home Loan Bank overnight deposit increased $3,017,610. Net loans receivable and loans held-for-sale increased by $69,661,035, or 20.17%, to $415,103,290 at December 31, 2004 from $345,442,255 at December 31, 2003.

 

Total gross loans, excluding loans held-for-sale, increased $68,993,108 or 19.88%, to $416,079,726 at December 31, 2004 from $347,086,618 at December 31, 2003. The increase was attributed to increases of $54,996,866, or 19.17%, in real estate mortgage loans (including conventional and commercial). The Bank’s promotion of a fixed rate, ten year amortizing and a seven year hybrid loans generated the majority of this increase. Consumer loans increased $13,568,600, or 30.92%, to $57,449,583 due to a demand for the Bank’s Home Equity Line of Credit product. The continued low interest rate environment made the above loan offerings very attractive. Sold loans totaled $293,569,964 at year-end 2004, compared to $289,825,192, at year-end 2003. The Bank expects to continue to sell fixed rate loans into the secondary market, retaining the servicing, in order to manage interest rate risk and control growth. Typically, the Bank holds adjustable rate loans in portfolio. Adjustable rate mortgages comprise approximately 82% of the Bank’s real estate mortgage loan portfolio, which is consistent with prior years.

 

7


Table of Contents

Management’s Discussion and Analysis (continued)

 

The amortized cost of investment securities decreased $5,120,621, or 4.13%, from $123,888,403 at December 31, 2003 to $118,767,782 at December 31, 2004. The Bank used the proceeds from maturing investment securities to fund loan demand.

 

The Bank realized gains on the sales and calls of securities in the amount of $392,813 during 2004, compared to $227,687 in 2003. At December 31, 2004, the Bank’s investment portfolio had a net unrealized loss of $226,471, compared to a net unrealized gain of $122,494 at December 31, 2003. As interest rates increased during 2004, the value of the Bank’s investment portfolio decreased. However, since the average life of the investment portfolio is less than five years and the liquidity of the Bank remains strong, the Bank does not anticipate the need to prematurely sell any investments and realize a loss.

 

Real estate owned and property acquired in settlement of loans remained at $0 at December 31, 2004 and 2003.

 

Total deposits increased by $4,595,033 or 1.07%, to $433,071,580 at December 31, 2004, from $428,476,547 at December 31, 2003. Time deposits and money market accounts decreased by $24.1 million, or 13.26%, to $157.3 million as customers sought higher returns in non-bank alternatives and the Bank elected not to match higher-yielding deposit products at other banks. These decreases were offset by increases in the Bank’s core deposits of checking (non-interest-bearing) and savings accounts in the amount of $28.6 million, or 11.59% to $275.8 million. The percentage of the Bank’s core deposits to total deposits increased from 57.68% at December 31, 2003 to 63.69% at December 31, 2004.

 

Advances from the Federal Home Loan Bank (FHLB) increased by $53,000,000, or 240.91%, to $75,000,000 at December 31, 2004 from $22,000,000 at December 31, 2003. The Bank used the proceeds from the advances to fund loan demand. The weighted average interest rate at December 31, 2004 for the outstanding FHLB advances was 2.53%.

 

Liquidity and Capital Resources

 

The Bank is required to maintain sufficient liquidity for safe and sound operations. At year-end 2004 the Bank’s liquidity was sufficient to cover the Bank’s anticipated needs for funding loan commitments of approximately $17.2 million. The Bank’s source of funds comes primarily from net deposit inflows, loan amortizations, principal pay downs from loans, sold loan proceeds, and advances from the FHLB. At December 31, 2004 the Bank had approximately $100,000,000 in additional borrowing capacity from the FHLB.

 

At December 31, 2004, the Company’s shareholders’ equity totaled $43,835,017, compared to $39,124,596 at year-end 2003. The increase of $4,710,421 reflects net income of $5,098,093, the payment of $1,859,333 in common stock dividends, the exercise of 149,800 stock options in the amount of $1,397,998, a tax benefit on the exercise of stock options of $284,403, and a decrease in net unrealized holding gain on securities available-for-sale of $210,740.

 

On February 22, 2001, the Company announced a stock repurchase program. Repurchases will be made from time to time at the discretion of management. The stock repurchase program will continue until the repurchase of 124,000 shares are repurchased. As of December 31, 2004, 59,500 shares of common stock had been repurchased. During 2004, no shares were repurchased. The Board of Directors of the Company has determined that a share buyback is appropriate to enhance shareholder value because such repurchases generally increase earnings per share, return on average assets and on average equity; three performing benchmarks against which bank and thrift holding companies are measured. The Company buys stock in the open market whenever the price of the stock is deemed reasonable and the Company has funds available for the purchase.

 

As of December 31, 2004, the Company had funds in the amount of $5,530,876 available, which it plans to use for stockholder dividend payments and to pay interest on the Company’s capital securities. The Company increased the quarterly dividend by $.0125, or 11.11%, effective with the January 30, 2005 payment. The common stock dividend and capital securities interest payments are approximately $3.1 million per year. The Bank pays dividends to the Company as its sole stockholder, within guidelines set forth by the Office of Thrift Supervision (OTS). Since the Bank is well capitalized and has capital in excess of regulatory requirements, funds will be available to cover the Company’s future dividend, interest, and stock repurchase needs.

 

Net cash provided by operating activities decreased by $692,185 to $9,263,976 in 2004 from $9,956,161 in 2003. A decrease in net income in the amount of $673,360 was offset by the write-off of expenses due to prepayment of debentures held by Trust I in the amount of $758,408. Changes associated in loans-held for-sale, mortgage servicing rights, and

 

8


Table of Contents

Management’s Discussion and Analysis (continued)

 

accrued interest receivable were caused by the slow-down of mortgage loan refinancings.

 

Net cash flows used in investing activities totaled $68,563,105 in 2004 compared to $69,212,941 in 2003, a change of $649,836. During 2004, the Bank utilized proceeds from financing activities to fund loan originations, net, in the amount of $66,031,932.

 

In 2004, net cash flows from financing activities totaled $62,316,739 compared to $24,395,600 in 2003, a change of $37,921,139. The Bank utilized the proceeds from advances provided by the FHLB to fund loan demand.

 

The Bank expects to be able to fund loan demand and other investing activities during 2005 by continuing to use funds provided by customer deposits, as well as the FHLB’s advance program. On December 31, 2004, approximately $17.2 million in commitments to fund loans had been made. Management is not aware of any trends, events, or uncertainties that will have or that are reasonably likely to have a material effect on the Company’s liquidity, capital resources or results of operations.

 

The following table represents the Company’s contractual obligations at December 31, 2004:

 

     Payments Due by Period (in thousands)

     Total

   Less than 1 year

   1-3 years

   3-5 years

   More than 5 years

Long-term Debt Obligation

   $ 40,000    $ —      $ 20,000    $ —      $ 20,000

Operating Lease Obligation

     878      260      378      192      48
    

  

  

  

  

Total

   $ 40,878    $ 260    $ 20,378    $ 192    $ 20,048
    

  

  

  

  

 

The OTS requires that the Bank maintain tangible, core, and total risk-based capital ratios of 1.50%, 4.00%, and 8.00%, respectively. As of December 31, 2004, the Bank’s ratios were 7.87%, 7.87%, and 12.04%, respectively, well in excess of the OTS requirements.

 

Book value per share was $10.52 at December 31, 2004 versus $19.48 per share at December 31, 2003.

 

Impact of Inflation

 

The financial statements and related data presented elsewhere herein are prepared in accordance with generally accepted accounting principles (GAAP) which require the measurement of the Company’s financial position and operating results generally in terms of historical dollars and current market value, for certain loans and investments, without considering changes in the relative purchasing power of money over time due to inflation. The impact of inflation is reflected in the increased cost of operations.

 

Unlike other companies, nearly all of the assets and liabilities of a bank are monetary in nature. As a result, interest rates have a far greater impact on a bank’s performance than the effects of the general level of inflation. Interest rates do not necessarily move in the same direction or to the same extent as the price of goods and services, since such prices are affected by inflation. In the current interest rate environment, liquidity and the maturity structure of the Bank’s assets and liabilities are important to the maintenance of acceptable performance levels.

 

Interest Rate Sensitivity

 

The principal objective of the Bank’s interest rate management function is to evaluate the interest rate risk inherent in certain balance sheet accounts and determine the appropriate level of risk given the Bank’s business strategies, operating environment, capital and liquidity requirements and performance objectives and to manage the risk consistent with the Board of Director’s approved guidelines. The Bank’s Board of Directors has established an Asset/Liability Committee (ALCO) to review its asset/liability policies and interest rate position monthly. Trends and interest rate positions are reported to the Board of Directors monthly.

 

Gap analysis is used to examine the extent to which assets and liabilities are “rate sensitive”. An asset or liability is said to be interest rate sensitive within a specific time-period if it will mature or reprice within that time. The interest rate sensitivity gap is defined as the difference between the amount of interest-earning assets maturing or repricing within a specified period of time and the amount of

 

9


Table of Contents

Management’s Discussion and Analysis (continued)

 

interest-bearing liabilities maturing or repricing within the same specified period of time. The strategy of matching rate sensitive assets with similar liabilities stabilizes profitability during periods of interest rate fluctuations.

 

The Bank’s one-year gap at December 31, 2004, was –6.10%, compared to the December 31, 2003 gap of –25.59%. During 2004, the Bank removed the decay component from its NOW account deposits because NOW accounts no longer experience rate sensitivity and behave similar to non-interest-bearing checking accounts. This accounts for the difference in the Bank’s one-year gap from 2004 to 2003. If the Bank had removed industry decay formulae for the gap reported as of December 31, 2003, the adjusted gap would have been –4.56%. If interest rates were to rise, the Bank’s spread would be reduced because the cost to re-finance the FHLB advances would increase prior to any asset re-pricing.

 

The Bank continues to offer adjustable rate mortgages, which reprice at one, three, and five-year intervals. In addition, the Bank sells fixed-rate mortgages to the secondary market in order to minimize interest rate risk.

 

The Bank’s one-year gap, of approximately negative 6.10% at December 31, 2004, means net interest income would increase if interest rates trended downward. The opposite would occur if interest rates were to rise.

 

As another part of its interest rate risk analysis, the Bank uses an interest rate sensitivity model, which generates estimates of the change in the Bank’s net portfolio value (NPV) over a range of interest rate scenarios. The Office of Thrift Supervision (OTS) produces the data quarterly using its own model and data submitted by the Bank.

 

NPV is the present value of expected cash flows from assets, liabilities and off-balance sheet contracts. The NPV ratio, under any rate scenario, is defined as the NPV in that scenario divided by the market value of assets in the same scenario. Modeling changes require making certain assumptions, which may or may not reflect the manner in which actual yields and costs respond to the changes in market interest rates. In this regard, the NPV model assumes that the composition of the Bank’s interest sensitive assets and liabilities existing at the beginning of a period remain constant over the period being measured and that a particular change in interest rates is reflected uniformly across the yield curve. Accordingly, although the NPV measurements and net interest income models provide an indication of the Bank’s interest rate risk exposure at a particular point in time, such measurements are not intended to and do not provide a precise forecast of the effect of changes in market rates on the Bank’s net interest income and will likely differ from actual results.

 

10


Table of Contents

Management’s Discussion and Analysis (continued)

 

The following table shows the Bank’s interest rate sensitivity (gap) table at December 31, 2004:

 

     0-3
Months


    3-6
Months


   

6 Months-

1 Year


    1-3
Years


   

Beyond

3 Years


    Total

     ($ in thousands)

Interest-earning assets:

                                              

Loans

   $ 89,502     $ 25,851     $ 55,841     $ 125,664     $ 120,970     $ 417,828

Investments and FHLB overnight deposit

     18,268       4,049       16,697       47,878       39,692       126,584
    


 


 


 


 


 

Total

     107,770       29,900       72,538       173,542       160,662       544,412
    


 


 


 


 


 

Interest-bearing liabilities:

                                              

Deposits

     110,871       29,315       24,568       18,254       220,702       403,710

Repurchase agreements

     13,648       —         —         —         —         13,648

Borrowings

     50,000       15,000       —         20,000       10,000       95,000
    


 


 


 


 


 

Total

     174,519       44,315       24,568       38,254       230,702       512,358
    


 


 


 


 


 

Period sensitivity gap

     (66,749 )     (14,415 )     47,970       135,288       (70,040 )     32,054

Cumulative sensitivity gap

   $ (66,749 )   $ (81,164 )   $ (33,194 )   $ 102,094     $ 32,054        

Cumulative sensitivity gap as a percentage of interest-earning assets

     -12.26 %     -14.91 %     -6.10 %     18.75 %     5.89 %      

 

The following table sets forth the Bank’s NPV as of December 31, 2004, as calculated by the OTS for the December 31, 2004 reporting cycle:

 

Change
in Rates


   Net Portfolio Value

    NPV as % of PV Assets

   $ Amount

   $ Change

   % Change

    NPV Ratio

    Change

+300 bp

   65,771    -14,261    -18 %   11.00 %   -200bp

+200 bp

   72,139    -7,893    -10 %   11.91 %   -108bp

+100 bp

   77,105    -2,927    -4 %   12.61 %   -39bp

      0 bp

   80,032    —      —       13.00 %   —  

- 100 bp

   79,512    -520    -1 %   12.90 %   -10bp

 

11


Table of Contents

Management’s Discussion and Analysis (continued)

 

Results of Operations 2004 versus 2003

 

Net Interest and Dividend Income

 

Net interest income for the year ended December 31, 2004, increased by $3,009,299 or 19.10%, to $18,767,334. The increase was due to the continuing low interest rate environment and the increase in loans outstanding.

 

Total interest and dividend income increased by $3,790,892 or 17.64%. Interest and fees on loans increased $2,293,149, or 12.89%, to $20,087,762 in 2004, due to the increase in loans outstanding.

 

Interest on taxable investments increased by $1,462,875, or 41.28%. Dividends increased by $58,884, or 73.69%, to $138,797. Interest on other investments decreased $24,016, or 31.97%, to $51,100, as the Bank deployed these funds into other investments and loans.

 

Total interest expense increased $781,593, or 13.63%, for the year ended December 31, 2004. Interest on deposits decreased by $844,071, or 20.90% because the Bank’s term deposits matured and re-priced into lower yielding term deposits. In addition, the Bank was able to lag the re-pricing of certain deposit products and delay increases on deposit rates. Interest on FHLB advances increased by $1,147,352, or 2,160.13%, to $1,200,467 for the year ended December 31, 2004 from $53,115 for the year ended December 31, 2003. FHLB advances increased from $22,000,000 at December 31, 2003 to $75,000,000 at December 31, 2004 as the Bank used the proceeds from the advances to fund loan growth.

 

The Bank’s overall cost of funds decreased from 1.35% in 2003 to 1.29% in 2004. The cost of deposits, including repurchase agreements, decreased 20 basis points from 1.02% in 2003 to 0.82% in 2004. The Bank’s time deposits, in particular, rolled into term deposits with lower rates or transferred into more liquid savings or checking accounts.

 

The Bank’s interest rate spread, which represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities, increased to 3.48% at December 31, 2004 from 3.43% at December 31, 2003. The Bank’s net interest margin, representing net interest income as a percentage of average interest-earning assets, increased to 3.54% from 3.50%. Both increases are the result of the Bank’s ability to lag rate increases on certain deposit products.

 

The following table sets forth the average yield on loans and investments, the average interest rate paid on deposits and borrowings, the interest rate spread, and the net interest rate margin:

 

     2004

    2003

    2002

    2001

    2000

 

Yield on loans

   5.13 %   5.33 %   6.27 %   7.25 %   7.77 %

Yield on investment securities

   3.76 %   3.20 %   4.22 %   6.82 %   7.71 %

Combined yield on loans and investments

   4.77 %   4.78 %   5.80 %   7.18 %   7.76 %

Cost of deposits, including repurchase agreements

   0.82 %   1.02 %   2.18 %   3.63 %   3.86 %

Cost of other borrowed funds

   3.37 %   7.64 %   9.43 %   9.12 %   7.56 %

Combined cost of deposits and borrowings

   1.29 %   1.35 %   2.46 %   3.89 %   4.20 %

Interest rate spread

   3.48 %   3.43 %   3.34 %   3.29 %   3.56 %

Net interest margin

   3.54 %   3.50 %   3.42 %   3.33 %   3.64 %

 

12


Table of Contents

Management’s Discussion and Analysis (continued)

 

The following table presents, for the years indicated, the total dollar amount of interest income from interest-earning assets and the resultant yields as well as the interest paid on interest-bearing liabilities, and the resultant costs:

 

Years ended December 31,


   2004

    2003

    2002

 
  

Average (1)

Balance


   Interest

   Yield/
Cost


    Average (1)
Balance


   Interest

   Yield/
Cost


   

Average (1)

Balance


   Interest

   Yield/
Cost


 
     ($ in thousands)  

Assets:

                                                            

Interest-earning assets:

                                                            

Loans (2),

   $ 391,541    $ 20,088    5.13 %   $ 334,041    $ 17,795    5.33 %   $ 333,592    $ 20,910    6.27 %

Investment securities and other

     138,156      5,197    3.76 %     115,608      3,699    3.20 %     100,023      4,223    4.22 %
    

  

        

  

        

  

      

Total interest-earning assets

     529,697      25,285    4.77 %     449,649      21,494    4.78 %     433,615      25,133    5.80 %
    

  

        

  

        

  

      

Noninterest-earning assets:

                                                            

Cash

     16,024                   13,553                   17,378              

Other noninterest-earning assets (3)

     40,317                   37,502                   35,142              
    

               

               

             

Total noninterest-earning assets

     56,341                   51,055                   52,520              
    

               

               

             

Total

   $ 586,038                 $ 500,704                 $ 486,135              
    

               

               

             

Liabilities and Shareholders’ Equity

                                                            

Interest-bearing liabilities:

                                                            

Savings, NOW and MMAs

   $ 292,351    $ 1,183    0.40 %   $ 277,968    $ 1,370    0.49 %   $ 252,719    $ 3,193    1.26 %

Time deposits

     106,027      2,013    1.90 %     116,354      2,669    2.29 %     134,796      5,314    3.94 %

Repurchase agreements

     11,492      154    1.34 %     9,165      96    1.05 %     15,683      269    1.72 %

Capital securities and other borrowed funds

     94,100      3,168    3.37 %     20,942      1,601    7.64 %     16,400      1,547    9.43 %
    

  

        

  

  

 

  

  

Total interest-bearing liabilities

     503,970      6,518    1.29 %     424,429      5,736    1.35 %     419,598      10,323    2.46 %
    

  

        

  

  

 

  

  

Noninterest-bearing liabilities:

                                                            

Demand deposits

     28,161                   30,170                   28,793              

Other

     12,001                   9,647                   6,896              
    

               

               

             

Total noninterest-bearing liabilities

     40,162                   39,817                   35,689              
    

               

               

             

Shareholders’ equity

     41,906                   36,458                   30,848              
    

               

               

             

Total

   $ 586,038                 $ 500,704                 $ 486,135              
    

               

               

             

Net interest rate spread

          $ 18,767    3.48 %          $ 15,758    3.43 %          $ 14,810    3.34 %
           

  

        

  

        

  

Net interest margin

                 3.54 %                 3.50 %                 3.42 %
                  

               

               

Ratio of interest-earning assets to interest-bearing liabilities

                 105.10 %                 105.94 %                 103.34 %
                  

               

               

 

(1) Monthly average balances have been used for all periods. .

 

(2) Loans include 90-day delinquent loans, which have been placed on a non-accruing status. Management does not believe that including the 90-day delinquent loans in loans caused any material difference in the information presented.

 

(3) Other noninterest-earning assets include non-earning assets and other real estate owned.

 

13


Table of Contents

Management’s Discussion and Analysis (continued)

 

The following table sets forth, for the years indicated, a summary of the changes in interest earned and interest paid resulting from changes in volume and rates. The net change attributable to changes in both volume and rate, which cannot be segregated, has been allocated proportionately to the change due to volume and the change due to rate.

 

     Year ended December 31, 2004
vs. 2003 Increase (Decrease) due to


 
     Volume

    Rate

    Total

 
     ($ in thousands)  

Interest income on loans

   $ 2,741     $ (448 )   $ 2,293  

Interest income on investments

     1,317       181       1,498  
    


 


 


Total interest income

     4,058       (267 )     3,791  
    


 


 


Interest expense on savings, NOW and MMAs

     (199 )     12       (187 )

Interest expense on time deposits

     (675 )     19       (656 )

Interest expense on repurchase agreements

     (1 )     59       58  

Interest expense on capital securities and other borrowings

     2,841       (1,274 )     1,567  
    


 


 


Total interest expense

     1,966       (1,184 )     782  
    


 


 


Net interest income

   $ 2,092     $ 917     $ 3,009  
    


 


 


     Year ended December 31, 2003
vs. 2002 Increase (Decrease) due to


 
     Volume

    Rate

    Total

 
     ($ in thousands)  

Interest income on loans

   $ 28     $ (3,143 )   $ (3,115 )

Interest income on investments

     570       (1,094 )     (524 )
    


 


 


Total interest income

     598       (4,237 )     (3,639 )
    


 


 


Interest expense on savings, NOW and MMAs

     1,091       (2,914 )     (1,823 )

Interest expense on time deposits

     (651 )     (1,994 )     (2,645 )

Interest expense on repurchase agreements

     (88 )     (85 )     (173 )

Interest expense on capital securities and other borrowings

     381       (327 )     54  
    


 


 


Total interest expense

     733       (5,320 )     (4,587 )
    


 


 


Net interest income

   $ (135 )   $ 1,083     $ 948  
    


 


 


 

14


Table of Contents

Management’s Discussion and Analysis (continued)

 

Allowance and Provision for Loan Losses

 

Lake Sunapee Bank maintains an allowance for loan losses to absorb losses inherent in the loan portfolio. Adjustments to the allowance for loan losses are charged to income through the provision for loan losses. The Bank tests the adequacy at least quarterly by preparing a worksheet applying loss factors to outstanding loans by type. The worksheet stratifies the loan portfolio by loan type and assigns a loss factor to each type based on an assessment of the inherent risk associated with each type. In determining the loss factors, the Bank considers historical losses and market conditions. Loss factors may be adjusted for qualitative factors that, in management’s judgment, affect the collectibility of the portfolio. No changes were made to the Bank’s procedures with respect to maintaining the loan loss allowances as a result of any regulatory examinations.

 

The allowance for loan losses incorporates the results of measuring impairment for specifically identified non-homogenous problem loans in accordance with Statement of Financial Accounting Standards (SFAS) No. 114 “Accounting by creditors for impairment of a loan,” and SFAS No. 118, “Accounting by creditors for impairment of a loan – income recognition and disclosures.” In accordance with SFAS No.’s 114 and 118 the specific allowance reduces the carrying amount of the impaired loans to their estimated fair value. A loan is recognized as impaired when it is probable that principal and/or interest are not collectible in accordance with the contractual terms of the loan. Measurement of impairment can be based on the present value of expected cash flows discounted at the loans effective interest rate, the market price of the loan, or the fair value of the collateral if the loan is collateral dependent.

 

Measurement of impairment does not apply to large groups of smaller balance homogenous loans such as residential mortgage, home equity, or installment loans that are collectively evaluated for impairment. Please refer to Note 4 “Loans Receivable,” in the Consolidated Financial Statements for information regarding SFAS No. 114 and 118.

 

The Bank’s commercial loan officers review the financial condition of commercial loan customers on a regular basis and perform visual inspections of facilities and inventories. The Bank also has loan review, internal audit, and compliance programs. Results are reported directly to the Audit Committee of the Bank’s Board of Directors.

 

At December 31, 2004 the allowance for loan losses was $4,019,450 compared to $3,898,650 at year- end 2003. The increase resulted from the combination of provisions and recoveries during the year. The allowance represented 0.97% of total loans at year-end 2004 compared to 1.12% at year-end 2003. The decline is due to the $69 million increase in the loan portfolio. The Bank charged-off $14,737 in 2004 compared to $86,642 in 2003. The provision for loan losses was $74,997 compared to $99,996 in 2003. Non-performing loans declined $865,000, which resulted in the allowance for loan losses as a percentage of total non-performing loans increasing from 337% at December 31, 2003 to 1,372% at December 31, 2004. The improved loan quality and results of the allowance adequacy tests drove the decision to reduce the provision despite the portfolio growth.

 

Loans classified for regulatory purposes as loss, doubtful, substandard or special mention, do not result from trends or uncertainties that the Bank reasonably expects will materially impact future operating results, liquidity, or capital resources.

 

Total classified assets, excluding special mention loans, as of December 31, 2004 and 2003 were $5,196,123 and $4,046,955, respectively. Total non-performing loans and real estate owned amounted to $293,203 and $1,157,957 for the respective years. Non-performing loans consist of loans 90 days or more past due and non-accrual impaired loans. The decline in non-performing loans came primarily from the liquidation of one residential mortgage loan that was included with loans over 90 days past due at December 31, 2003. Non-accrual impaired loans were $49,394 on December 31, 2004 and $50,934 on December 31, 2003. As of December 31, 2004 the Bank also held $853,064 in restructured loans on accrual status and performing, included in impaired loans; compared to $726,698 at December 31, 2003. Loans 90 days or more past due were $243,809 at the end of 2004 and $1,107,023 at the end of 2003. Loans 30 to 89 days past due were $2,705,154 and $3,397,736, respectively at December 31, 2004 and 2003. If all non-accruing loans had been current in accordance with their terms during the years ended December 31, 2004 and 2003, interest income on such loans would have amounted to approximately $7,000 and $54,000, respectively.

 

As of December 31, 2004 there were no other loans not included in the tables below or discussed above where known information about possible credit problems of the borrowers caused management to have doubts as to the ability of the borrower to comply with present loan repayment terms and which may result in disclosure of such loans in the future.

 

15


Table of Contents

Management’s Discussion and Analysis (continued)

 

The following table sets forth the breakdown of non-performing assets:

 

     2004

   2003

   2002

   2001

   2000

Nonaccrual loans (1)

   $ 293,203    $ 1,157,957    $ 664,092    $ 2,521,424    $ 1,871,442

Real estate owned

     —        —        20,668      100,000      45,000
    

  

  

  

  

Total nonperforming assets

   $ 293,203    $ 1,157,957    $ 684,760    $ 2,621,424    $ 1,916,442
    

  

  

  

  

 

(1) All loans 90 days or more delinquent are placed on a nonaccruing status.

 

The following table sets forth nonaccrual (1) loans by category:

 

     2004

   2003

   2002

   2001

   2000

Real estate loans -

                                  

Conventional

   $ 243,809    $ 1,074,096    $ 499,053    $ 1,048,780    $ 967,663

Construction

     —        —        59,000      101,606      —  

Consumer loans

     —        1,891      —        68,474      38,748

Commercial and municipal loans

     —        31,036      685      35,527      —  

Nonaccrual impaired loans (2)

     49,394      50,934      105,354      1,267,037      865,031
    

  

  

  

  

Total

   $ 293,203    $ 1,157,957    $ 664,092    $ 2,521,424    $ 1,871,442
    

  

  

  

  

 

(1) All loans 90 days or more delinquent are placed on a nonaccruing status.

 

(2) At 12/31/04 $853,064 of impaired loans, not included above, were on accrual status and performing.

 

At 12/31/03 $726,698 of impaired loans, not included above, were on accrual status and performing.

 

The following is a summary of activity in the allowance for loan losses account for the years ended December 31:

 

     2004

   2003

   2002

   2001

   2000

Balance, beginning of year

   $ 3,898,650    $ 3,875,708    $ 4,405,385    $ 4,432,854    $ 4,320,563
    

  

  

  

  

Write-downs of nonperforming loans transferred to loans held-for-sale

     —        —        604,686      —        —  
    

  

  

  

  

Charge-offs:

                                  

Residential real estate

     —        —        15,964      43,358      6,098

Commercial real estate

     —        —        —        88,822      57,385

Construction

     —        —        —        24,642      —  

Consumer loans

     14,737      28,862      48,120      18,866      20,615

Commercial loans

     —        57,780      19,129      25,768      130,752
    

  

  

  

  

Total charged-off loans

     14,737      86,642      83,213      201,456      214,850

Recoveries

     60,540      9,588      38,222      83,987      267,141

Provision charged to income

     74,997      99,996      120,000      90,000      60,000
    

  

  

  

  

Balance, end of year

   $ 4,019,450    $ 3,898,650    $ 3,875,708    $ 4,405,385    $ 4,432,854
    

  

  

  

  

 

16


Table of Contents

Management’s Discussion and Analysis (continued)

 

The following table sets forth the allocation of the loan loss allowance, the percentage of allowance to the total allowance and the percentage of loans in each category to total loans as of December 31 ($ in thousands):

 

     2004

    2003

    2002

 

Real estate loans -

                                                            

Conventional

   $ 2,445     61 %   77 %   $ 2,405     62 %   78 %   $ 2,763     71 %   80 %

Construction

     265     7 %   5 %     251     6 %   4 %     207     5 %   5 %

Collateral and consumer loans

     109     3 %   14 %     114     3 %   13 %     155     4 %   10 %

Commercial and municipal loans

     1,058     26 %   4 %     1,012     26 %   5 %     723     19 %   5 %

Impaired loans

     142     3 %           117     3 %           28     1 %      
    


 

 

 


 

 

 


 

 

Allowance

   $ 4,019     100 %   100 %%   $ 3,899     100 %   100 %%   $ 3,876     100 %   100 %
    


 

 

 


 

 

 


 

 

Allowance as a percentage of total loans

     0.97 %                 1.12 %                 1.21 %            
    


             


             


           

 

     2001

    2000

 

Real estate loans -

                                        

Conventional

   $ 2,421     55 %   82 %   $ 2,457     55 %   80 %

Construction

     176     4 %   5 %     176     4 %   3 %

Collateral and consumer loans

     132     3 %   7 %     139     3 %   10 %

Commercial and municipal loans

     1,273     29 %   6 %     1,446     33 %   7 %

Impaired loans

     293     7 %           130     3 %      

Other

     110     2 %           85     2 %      
    


 

 

 


 

 

Allowance

   $ 4,405     100 %   100 %   $ 4,433     100 %   100 %
    


 

 

 


 

 

Allowance as a percentage of total loans

     1.29 %                 1.26 %            
    


             


           

 

The Bank believes the current allowance for loan losses is at a level sufficient to cover losses in the loan portfolio, given present conditions. At the same time, the Bank recognizes the determination of future loss potential is inherently uncertain. Future adjustments to the allowance may be necessary if economic, real estate, and other conditions differ substantially from the current operating environment resulting in increased levels of non-performing loans and substantial differences between estimated and actual losses.

 

Noninterest Income and Expense

 

Total noninterest income decreased $2,256,010, or 35.64%, to $4,074,567 for 2004. Net gains on sales of loans decreased by $2,825,483, or 82.60%, accounting for 125.24% of the total decrease in noninterest income. As mentioned above, the increase in net interest and dividend income in the amount of $3,009,299 offset the decrease in the net gains on the sales of loans. The Bank sold approximately $67.5 million of loans into the secondary market during 2004. Customer service fees increased by $203,348, or 10.90%, as the Bank was able to reduce waived fees in a more efficient manner, thus increasing the collection of overdraft fees, monthly service charges, and ATM fees. The realized gain in Charter Holding Corp. increased by $73,789, or 90.55%, to $155,278 from $81,489. The gain represents the Bank’s one-third interest in Charter Trust.

 

Total noninterest expenses increased $1,794,660, or 14.12%, to $14,505,301 for 2004.

 

   

Salaries and employee benefits increased by $975,005, or 16.77%, to $6,789,734 for 2004, from $5,814,729 for 2003. Gross salaries and benefits paid increased by $80,544, or 0.98%, to $8,341,404 for 2004, compared to $8,260,860 for 2003. Normal salary and benefit increases were offset by decreased commissions associated with the decrease in the origination of loans. The deferral of expenses in conjunction with the

 

17


Table of Contents

Management’s Discussion and Analysis (continued)

 

 

origination of loans decreased by $894,461, or 36.57%, to $1,551,670 for 2004, from $2,446,131 for 2003. This change was due to the lower volume of loan originations in 2004 as compared to 2003.

 

    Occupancy expenses increased slightly by $59,967, or 2.65%, to $ 2,324,876.

 

    Advertising and promotion increased in the amount of $63,757, or 26.04%, to $308,643, as the Bank took advantage of the low interest rate environment to heavily promote both its fixed-rate mortgage loan products and its low-cost transaction-type deposit offerings. In addition, advertising expenses associated with the opening of a new branch office in Peterborough, NH were also incurred.

 

    Outside services increased by $138,336, or 30.71%, to $588,772, due to expenses incurred for data processing, payroll and employee recruitment, and a conversion to a new brokerage clearing-house provider.

 

    Amortization of mortgage servicing rights (MSR) in excess of mortgage servicing income decreased in the amount of $389,911, or 65.17%, to $208,376 due to the decreased volume of prepayments on mortgage loans serviced for others. The Bank amortizes MSRs collected over a five-year period and because higher than normal prepayments occurred during 2003 due to high refinancings, the unamortized portion of the MSRs was required to be expensed.

 

    Write-off of issuance cost due to prepayment of debentures amounted to $758,408 in 2004 compared to $0 in 2003. As mentioned above, the Company refinanced its Capital Trust Preferred Securities (“Trust I”) in the amount of $16.4 million with an interest rate of 9.25%. Trust I was replaced with similar securities with a weighted average rate of 5.04%. Total expenses associated with the offering of Trust I, approximating $900,000 were being amortized on a straight-line basis over the life of Trust I. The write-off amount of $758,408 represents the remaining amortization of those expenses. The Company expects to save approximately $500,000 in annual, pre-tax interest expense due to the refinance.

 

    Professional services increased in the amount of $22,513, or 4.47%, to $526,055 for 2004, compared to $503,542 for 2003, due to expenses incurred in complying with the provisions of the Sarbanes-Oxley Act regarding the internal documentation and testing of internal controls.

 

    ATM expenses increased in the amount of $122,430, or 36.52%, to $457,700 for 2004, compared to $335,270 for 2003. Increased usage and fees associated with debit card transactions contributed to the increase. These expenses were offset by ATM fees in the amount of $686,155, which are included in customer service fees.

 

    Other expenses increased in the amount of $61,988, or 3.00%, to $2,128,170 for 2004, from $2,066,182 for 2003, due to normal increases in postage and telephone usage.

 

Impact of New Accounting Standards

 

In April 2003, the Financial Accounting Standards Board (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.”

 

In May 2003, the FASB issued SFAS No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity” (“SFAS No. 150”).

 

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)”).

 

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)”).

 

In December 2003, the American Institute of Certified Public Accountants (“AICPA”) issued Statement of Position 03-3 (“SOP 03-3”) “Accounting for Certain Loans or Debt Securities Acquired in a Transfer.”

 

18


Table of Contents

Management’s Discussion and Analysis (continued)

 

In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payments” (“SFAS 123R”).

 

For additional information on the above-referenced new accounting standards, refer to Note 1 of the Consolidated Financial Statements presented on page 30 of this report.

 

Accounting for Income Taxes

 

The provision for income taxes for the years ended December 31, 2004, 2003, and 2002, includes net deferred income tax expense of $378,216, $1,046,854, and $811,907, respectively. These amounts were determined by the deferred method in accordance with generally accepted accounting principles for each year.

 

The Bank has provided deferred income taxes on the difference between the provision for loan losses permitted for income tax purposes and the provision recorded for financial reporting purposes.

 

Comparison of Years Ended December 31, 2003 and 2002

 

In 2003, the Company earned $5,771,453, or $1.42 per common share, assuming dilution, compared to $4,299,988 or $1.09 per common share, assuming dilution, in 2002. The increase in earnings was primarily due to the increase in the net gain on the sale of loans in the amount of $1,217,454. During 2003, the Bank’s loan originations amounted to $380.1 million, compared to $231.5 million in 2002 as refinancings increased. The Bank’s sold loan portfolio increased to $289.8 million at December 31, 2003 from $260.8 million at December 31, 2002.

 

Financial Condition

 

Total assets increased by $29,601,308, or 5.96%, from $496,644,923 at December 31, 2002 to $526,246,231 at December 31, 2003.

 

Total gross loans, excluding loans held-for-sale, increased $27,220,646 or 8.51%, from $319,865,972 at December 31, 2002 to $347,086,618 at December 31, 2003. The increase was attributed to an increase of $18,665,369 or 10.05% conventional real estate mortgage loans. The Bank’s promotion of a fixed rate, ten year amortizing and a seven year hybrid product generated the majority of this increase. Consumer loans increased $11,625,347, or 36.04%, to $43,880,983 due to a demand for the Bank’s Home Line of Credit product. The continued low interest rate environment made the above loan offerings very attractive. Sold loans totaled $289,825,192 at year-end 2003, compared to $260,774,730 for the same period in 2002. Adjustable rate mortgages comprise approximately 79% of the Bank’s real estate mortgage loan portfolio, which is consistent with prior years.

 

The amortized cost of investment securities increased $40,665,238, or 48.86%, from $83,223,165 at December 31, 2002 to $123,888,403 at December 31, 2003. The Bank took the proceeds of the sale of loans, used Federal Funds Sold, and advances in the amount of $22,000,000 from the FHLB and invested these funds into mortgage-backed securities and U.S. Government Agencies. The Bank took advantage of the favorable interest rates on the FHLB advances and invested the proceeds of the advances in higher yielding securities.

 

The Bank realized gains on the sales and calls of securities in the amount of $227,687 during 2003, compared to $146,473 in 2002. At December 31, 2003, the Bank’s investment portfolio had an unrealized gain of $122,494, compared to a net unrealized gain of $233,331 at December 31, 2002. The relatively small unrealized gain for 2003 reflects the short-term duration of the Bank’s investment portfolio. The majority of holdings carry final or callable maturities of less than five years, which tends to reduce market price volatility.

 

Real estate owned and property acquired in settlement of loans decreased by a net of $20,668 for the year ended December 31, 2002 to $0 at December 31, 2003.

 

Deposits decreased by $851,873, or 0.20%, to $428,476,547 at December 31, 2003 from $429,328,420 at December 31, 2002. During 2002, customers sought the safety and predictability of insured deposits because of the instability being experienced in the financial markets. Time deposits and money market accounts decreased by $15,323,871, or 7.77%, to $181,836,545 as customers sought higher returns in non-bank alternatives. These decreases were offset by increases in the Bank’s core deposits of checking (non-interest-bearing) and savings accounts in the amount of $14,171,999, or 6.23% to $246,640,003, or 57.56% of total deposits. A marketing campaign conducted by the Bank to attract core accounts contributed in the increase. At December 31, 2003, time deposits comprised 25.39% of total deposits versus 26.59% for the same period in 2002.

 

Advances from the FHLB increased by $22,000,000 for the year ended December 31, 2003 from zero at December 31, 2002. The Bank employed a leverage strategy and took advantage of the favorable interest rates on the FHLB advances by investing the proceeds of the advances in higher yielding securities.

 

19


Table of Contents

Management’s Discussion and Analysis (continued)

 

Net Interest and Dividend Income

 

Net interest and dividend income for the year ended December 31, 2003, increased by $947,718 or 6.40%, to $15,758,035. The increase was primarily due to the continuing low interest rate environment and the Bank’s negative gap position. As interest rates have fallen, more liabilities (deposits) have re-priced into falling rates, thus reducing the Bank’s cost of funds at a faster pace than its income on earning assets. The Bank’s interest rate spread increased by 2.69% to 3.43% and the Bank’s interest margin increased by 2.34%. These increases were driven by a sharp decrease of 53.21% in the Bank’s cost of deposits. The Bank’s overall cost of funds decreased by 45.12% compared to a decrease of 17.59% in the Bank’s yield on loans and investments.

 

Total interest and dividend income decreased by $3,639,644 or 14.48%. Lower interest rates accounted for the majority of the decrease in interest and fees on loans. Interest and fees on loans decreased $3,115,175, or 14.90%, to $17,794,613 in 2003, due to a decrease in yield from 6.27% for the year ended December 31, 2002 to 5.33% for the year ended December 31, 2003.

 

Interest and dividends on investments decreased by $524,469, or 12.42%, due to a drop in yield from 4.22% to 3.20%, or 24.17%. Several higher-yielding callable agency bonds were called and the proceeds were re-invested in lower yielding securities. Also during 2002, the Bank repositioned its investment portfolio in order to shorten maturities and, as a result, higher yielding, long-term bonds were liquidated and replaced by lower yielding, short-term investments.

 

Total interest expense decreased $4,587,362, or 44.44%, for the year ended December 31, 2003. Interest on deposits decreased by $4,467,581, or 52.52% because the Bank’s deposits re-priced into lower rates. Interest on FHLB advances increased by $53,115 for the year ended December 31, 2003 compared to $0 in 2002 as the Bank took advantage of favorable interest rates on the advances and invested the proceeds of the advances in higher yielding securities.

 

The Bank’s overall cost of funds decreased from 2.46% in 2002 to 1.35%, or 45.12%. The cost of deposits, including repurchase agreements, decreased from 2.18% in 2002 to 1.02% in 2003, or 53.21%. The Bank’s certificates of deposit, in particular, rolled into lower rates or transferred into more liquid savings or checking accounts.

 

The Bank’s interest rate spread, which represents the difference between the weighted average yield on interest-earning assets and the weighted average cost of interest-bearing liabilities, increased to 3.43% for the year ended December 31, 2003 from 3.34% for the year ended December 31, 2002. The Bank’s net interest margin, representing net interest income as a percentage of average interest-earning assets, increased to 3.50% from 3.42%. Both increases are the result of falling interest rates.

 

Allowance and Provision for Loan Losses

 

The allowance for loan losses at December 31, 2003 was $3,898,650, compared to $3,875,708 at year-end 2002. During 2003, the Bank had net charge-offs of $77,054 compared to net charge-offs and write-downs of $649,677 in 2002. The lower amount in 2003 is primarily due to $604,686 in write-downs taken prior to the sale of non-performing loans in 2002. The provision for loan losses was $99,996 in 2003 compared to $120,000 in 2002. The allowance represented 1.12% of total loans at year-end 2003 versus 1.21% at year-end 2002. The increase in the allowance resulted from provisions and recoveries exceeding loan charge-offs in 2003.

 

Total classified loans, excluding special mention loans, as of December 31, 2003 and 2002 were $4,046,955 and $3,333,767, respectively. Total non-performing loans amounted to $1,157,957 and $684,760 for the respective years. Non-performing loans include loans 90 days or more past due, which were $1,107,023 at December 31, 2003 and $558,738 at the end of 2002. The increase in non-performing loans was largely due to one residential mortgage loan that was over 90 days past due at year-end 2003. At December 31, 2003 and 2002 the respective amount of impaired loans was $777,632 and $105,354, respectively. At December 31, 2003 the impaired loan amount included $726,698 of performing loans that remained on accrual status. Loans 30 to 89 days delinquent were $3,397,736 at December 31, 2003 compared to $4,542,125 at year-end 2002.

 

Noninterest Income and Expense

 

Total noninterest income increased $1,365,918, or 27.51%, to $6,330,577 for 2003. Net gains on sales of loans increased by $1,217,454, or 55.26%, accounting for 89.13% of the total increase in noninterest income. The Bank sold approximately $173 million of loans into the secondary market during 2003. Customer service fees increased by $146,711, or 8.53%, as the Bank was able to reduce waived fees in a more efficient manner, thus increasing the collection of overdraft fees, monthly service charges, and ATM fees. The realized gain in

 

20


Table of Contents

Management’s Discussion and Analysis (continued)

 

Charter Holding Corp. (CHC) decreased by $31,935, or 28.16%, to $81,489 for the year ended December 31, 2003, from $113,424 for the year ended December 31, 2002. The gain represents the Bank’s one-third interest in Charter Trust.

 

Total noninterest expenses decreased $169,052, or 1.31%, to $12,710,641 for the year ended December 31, 2003, from $12,879,693 for the year ended December 31, 2002.

 

    Salaries and employee benefits decreased $788,253, or 11.94%, to $5,814,729 for the year ended December 31, 2003, compared to $6,602,982 for the year ended December 31, 2002. Gross salaries and benefits paid decreased by $69,162, or 0.83%, to $8,260,860 for the year ended December 31, 2003, compared to $8,330,022 for the year ended December 31, 2002. Normal salary adjustments, commission increases associated with the increased origination of loans, and the costs associated with the Bank’s employee incentive program were mitigated by a one-time insurance re-imbursement generated from the Bank’s self-funded group health insurance program. These increases were offset by the deferral of expenses in the amount of $2,446,131 for the year ended December 31, 2003, compared to $1,727,040 for the year ended December 31, 2002, a change of $719,091.

 

    Occupancy expenses decreased by $102,973, or 4.35%, to $ 2,264,909, due to several pieces of equipment being fully depreciated during 2003.

 

    Advertising and promotion increased in the amount of $19,620, or 8.71%, to $ 244,886, as the Bank took advantage of the low interest rate environment to heavily promote both its fixed-rate mortgage loan products and its low-cost transaction-type deposit offerings.

 

    Professional services increased by $21,925, or 4.55%, to $503,542 for the year ended December 31, 2003.

 

    Outside services increased by $100,476, or 28.71%, to $450,436 for the year ended December 31, 2003, due to expenses paid to several consultants used by the Bank for data processing and accounting services.

 

    ATM expenses increased in the amount of $75,006, or 28.82%, to $335,270 for the year ended December 31, 2003, compared to $260,264 for the year ended December 31, 2002. Increased usage and fees associated with Debit card transactions contributed to the increase. These expenses were offset by fees derived from ATM usage, which are included in customer service fees.

 

    Amortization of mortgage servicing rights (MSR) increased in the amount of $412,806, or 222.56%, to $598,287 for the year ended December 31, 2003, due to the accelerated amortization costs caused by the increased volume of prepayments on mortgage loans. The Bank amortizes MSRs collected over a five-year period. Because higher than normal prepayments occurred during 2003 due to high refinancings, the unamortized portion of the MSRs was required to be expensed.

 

    Other expenses increased in the amount of $34,706, or 1.71%, to $2,066,182 for the year ended December 31, 2003, as compared to $2,031,476 for the year ended December 31, 2002.

 

Off-Balance Sheet Arrangements

 

The Company does not have any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on the Company’s financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors.

 

21


Table of Contents

 

LOGO

 

The Board of Directors

New Hampshire Thrift Bancshares, Inc.

Newport, New Hampshire

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

We have audited the accompanying consolidated balance sheets of New Hampshire Thrift Bancshares, Inc. and Subsidiaries as of December 31, 2004 and 2003 and the related consolidated statements of income, changes in shareholders' equity, cash flows and comprehensive income for each of the years in the three-year period ended December 31, 2004. 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 the standards of the Public Company Accounting Oversight Board (United States). 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 New Hampshire Thrift Bancshares, Inc. and Subsidiaries as of December 31, 2004 and 2003 and the consolidated results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2004, in conformity with accounting principles generally accepted in the United States of America.

 

LOGO

SHATSWELL, MacLEOD & COMPANY, P.C.

 

West Peabody, Massachusetts

January 6, 2005 (except for Note 16, which

    is dated February 14, 2005)

 

LOGO

 

22


Table of Contents

 

New Hampshire Thrift Bancshares, Inc. and Subsidiaries

Consolidated Balance Sheets

 

As of December 31,


   2004

    2003

 

ASSETS

                

Cash and due from banks

   $ 13,243,625     $ 12,107,645  

Federal Home Loan Bank overnight deposit

     8,300,000       6,418,370  
    


 


Total cash and cash equivalents

     21,543,625       18,526,015  

Securities available-for-sale

     118,541,311       121,009,752  

Securities held-to-maturity (fair value of $3,063,200)

     —         3,001,145  

Federal Home Loan Bank stock

     4,879,200       2,167,800  

Loans held-for-sale

     1,295,000       869,540  

Loans receivable, net of the allowance for loan losses of $4,019,450 as of December 31, 2004 and $3,898,650 as of December 31, 2003

     413,808,290       344,572,715  

Accrued interest receivable

     1,938,421       1,941,059  

Premises and equipment, net

     9,700,477       9,305,828  

Investments in real estate

     357,119       524,925  

Goodwill

     12,140,016       12,140,016  

Investment in partially owned Charter Holding Corp., at equity

     3,135,834       3,124,955  

Other assets

     8,174,789       9,062,481  
    


 


Total assets

   $ 595,514,082     $ 526,246,231  
    


 


LIABILITIES AND SHAREHOLDERS’ EQUITY

                

LIABILITIES

                

Deposits:

                

Noninterest-bearing

   $ 29,361,525     $ 31,296,606  

Interest-bearing

     403,710,055       397,179,941  
    


 


Total deposits

     433,071,580       428,476,547  

Federal Home Loan Bank advances

     75,000,000       22,000,000  

Securities sold under agreements to repurchase

     13,647,969       12,364,124  

Guaranteed preferred beneficial interest in junior subordinated debentures

     —         16,400,000  

Subordinated debentures

     20,620,000       —    

Accrued expenses and other liabilities

     9,339,516       7,880,964  
    


 


Total liabilities

     551,679,065       487,121,635  
    


 


SHAREHOLDERS’ EQUITY

                

Preferred stock, $.01 par value, per share: 2,500,000 shares authorized, no shares issued or outstanding

     —         —    

Common stock, $.01 par value, per share: 5,000,000 shares authorized, 4,167,180 shares issued and outstanding as of December 31, 2004 and 2,542,908 shares issued and 2,008,690 shares outstanding as of December 31, 2003

     41,672       25,429  

Paid-in capital

     16,308,031       19,510,646  

Retained earnings

     27,622,080       24,404,156  

Accumulated other comprehensive (loss) income

     (136,766 )     73,974  
    


 


       43,835,017       44,014,205  

Treasury stock, at cost, 534,218 shares as of December 31, 2003

     —         (4,889,609 )
    


 


Total shareholders’ equity

     43,835,017       39,124,596  
    


 


Total liabilities and shareholders’ equity

   $ 595,514,082     $ 526,246,231  
    


 


 

The accompanying notes are an integral part of these consolidated financial statements.

 

23


Table of Contents

 

New Hampshire Thrift Bancshares, Inc. and Subsidiaries

Consolidated Statements of Income

 

For the years ended December 31,


   2004

   2003

   2002

 

INTEREST AND DIVIDEND INCOME

                      

Interest and fees on loans

   $ 20,087,762    $ 17,794,613    $ 20,909,788  

Interest on debt investments Taxable

     5,006,925      3,544,050      3,730,675  

Dividends

     138,797      79,913      104,891  

Other

     51,100      75,116      387,982  
    

  

  


Total interest and dividend income

     25,284,584      21,493,692      25,133,336  
    

  

  


INTEREST EXPENSE

                      

Interest on deposits

     3,195,078      4,039,149      8,506,730  

Interest on advances and other borrowed money

     1,200,467      53,115      —    

Interest on debentures

     1,967,354      1,547,136      1,547,135  

Interest on securities sold under agreements to repurchase

     154,351      96,257      269,154  
    

  

  


Total interest expense

     6,517,250      5,735,657      10,323,019  
    

  

  


Net interest and dividend income

     18,767,334      15,758,035      14,810,317  

PROVISION FOR LOAN LOSSES

     74,997      99,996      120,000  
    

  

  


Net interest and dividend income after provision for loan losses

     18,692,337      15,658,039      14,690,317  
    

  

  


NONINTEREST INCOME

                      

Customer service fees

     2,069,598      1,866,250      1,719,539  

Net gain on sales and calls of securities

     392,813      227,687      146,473  

Net gain on sale of loans

     595,231      3,420,714      2,203,260  

Rental income

     495,319      494,950      483,484  

Realized gain in Charter Holding Corp.

     155,278      81,489      113,424  

Brokerage service income

     192,617      108,818      109,398  

Other income

     173,711      130,669      189,081  
    

  

  


Total noninterest income

     4,074,567      6,330,577      4,964,659  
    

  

  


NONINTEREST EXPENSES

                      

Salaries and employee benefits

     6,789,734      5,814,729      6,602,982  

Occupancy expenses

     2,324,876      2,264,909      2,367,882  

Advertising and promotion

     308,643      244,886      225,266  

Depositors’ insurance

     65,254      67,151      72,828  

Professional services

     526,055      503,542      481,617  

Outside services

     588,772      450,436      349,960  

ATM processing fees

     457,700      335,270      260,264  

Amortization of mortgage servicing rights in excess of mortgage servicing income

     208,376      598,287      185,481  

Write-off of issuance cost due to prepayment of debentures

     758,408      —        —    

Supplies

     305,209      364,631      319,562  

Net loss (gain) on sales of premises, equipment, investment in real estate, other real estate owned and other assets

     44,104      618      (17,625 )

Other expenses

     2,128,170      2,066,182      2,031,476  
    

  

  


Total noninterest expenses

     14,505,301      12,710,641      12,879,693  
    

  

  


 

24


Table of Contents

 

New Hampshire Thrift Bancshares, Inc. and Subsidiaries

Consolidated Statements of Income

(continued)

 

For the years ended December 31,


   2004

   2003

   2002

INCOME BEFORE PROVISION FOR INCOME TAXES

     8,261,603      9,277,975      6,775,283

PROVISION FOR INCOME TAXES

     3,163,510      3,506,522      2,475,295
    

  

  

NET INCOME

   $ 5,098,093    $ 5,771,453    $ 4,299,988
    

  

  

Earnings per common share

   $ 1.23    $ 1.46    $ 1.10
    

  

  

Earnings per common share, assuming dilution

   $ 1.20    $ 1.42    $ 1.09
    

  

  

Dividends declared per common share

   $ .45    $ .36    $ .32
    

  

  

 

The accompanying notes are an integral part of these consolidated financial statements.

 

25


Table of Contents

 

New Hampshire Thrift Bancshares, Inc. and Subsidiaries

Consolidated Statements of Changes in Shareholders’ Equity

 

For the years ended December 31,


   2004

    2003

    2002

 

COMMON STOCK

                        

Balance, beginning of year

   $ 25,429     $ 24,899     $ 24,798  

Exercise of stock options (149,800 shares in 2004, 105,900 shares in 2003 and 20,200 shares in 2002)

     749       530       101  

Retirement of treasury stock

     (5,342 )     —         —    

Stock split in form of stock dividend

     20,836       —         —    
    


 


 


Balance, end of year

   $ 41,672     $ 25,429     $ 24,899  
    


 


 


PAID-IN CAPITAL

                        

Balance, beginning of year

   $ 19,510,646     $ 18,402,577     $ 18,110,685  

Increase on issuance of common stock from the exercise of stock options

     1,397,249       968,148       134,365  

Increase on issuance of treasury stock from the exercise of stock options

     —         —         122,400  

Tax benefit for stock options

     284,403       139,921       35,127  

Retirement of treasury stock

     (4,884,267 )     —         —    
    


 


 


Balance, end of year

   $ 16,308,031     $ 19,510,646     $ 18,402,577  
    


 


 


RETAINED EARNINGS

                        

Balance, beginning of year

   $ 24,404,156     $ 20,052,439     $ 16,986,069  

Net income

     5,098,093       5,771,453       4,299,988  

Cash dividends paid

     (1,859,333 )     (1,419,736 )     (1,233,618 )

Stock split in form of stock dividend

     (20,836 )     —         —    
    


 


 


Balance, end of year

   $ 27,622,080     $ 24,404,156     $ 20,052,439  
    


 


 


ACCUMULATED OTHER COMPREHENSIVE (LOSS) INCOME

                        

Balance, beginning of year

   $ 73,974     $ 102,195     $ (1,301,372 )

Net unrealized holding (loss) gain on securities available-for-sale, net of tax effect

     (210,740 )     (28,221 )     981,581  

Minimum pension liability adjustment, net of tax effect

     —         —         421,986  
    


 


 


Balance, end of year

   $ (136,766 )   $ 73,974     $ 102,195  
    


 


 


TREASURY STOCK

                        

Balance, beginning of year

   $ (4,889,609 )   $ (4,816,114 )   $ (4,854,285 )

Shares repurchased, (0 shares in 2004, 6,368 shares in 2003 and 0 shares in 2002 )

     —         (73,495 )     —    

Exercise of stock options, (0 shares in 2004, 0 shares in 2003 and 23,700 shares in 2002)

     —         —         38,171  

Shares retired, (534,218 shares in 2004, 0 shares in 2003 and 0 shares in 2002)

     4,889,609       —         —    
    


 


 


Balance, end of year

   $ —       $ (4,889,609 )   $ (4,816,114 )
    


 


 


 

The accompanying notes are an integral part of these consolidated financial statements.

 

26


Table of Contents

 

New Hampshire Thrift Bancshares, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

 

For the years ended December 31,


   2004

    2003

    2002

 

Net income

   $ 5,098,093     $ 5,771,453     $ 4,299,988  
    


 


 


Other comprehensive (loss) income

                        

Net unrealized holding (loss) gain on securities available-for-sale, net of tax effect

     (210,740 )     (28,221 )     981,581  

Minimum pension liability adjustment

     —         —         421,986  
    


 


 


Total other comprehensive (loss) income

     (210,740 )     (28,221 )     1,403,567  
    


 


 


Comprehensive income

   $ 4,887,353     $ 5,743,232     $ 5,703,555  
    


 


 


Reclassification disclosure for the years ended December 31:

                        
     2004

    2003

    2002

 

Net unrealized gains on available-for-sale securities

   $ 43,848     $ 116,850     $ 1,835,982  

Reclassification adjustment for realized gains in net income

     (392,813 )     (227,687 )     (146,473 )
    


 


 


Other comprehensive (loss) income before income tax effect

     (348,965 )     (110,837 )     1,689,509  

Income tax benefit (expense)

     138,225       82,616       (707,928 )
    


 


 


Other comprehensive (loss) income, net of tax

   $ (210,740 )   $ (28,221 )   $ 981,581  
    


 


 


Minimum pension liability adjustment

   $ —       $ —       $ 692,462  

Income tax expense

     —         —         (270,476 )
    


 


 


     $ —       $ —       $ 421,986  
    


 


 


Accumulated other comprehensive (loss) income consists of the following as of December 31:

 

     2004

    2003

    2002

 

Net unrealized (losses) gains on available-for-sale securities, net of taxes

   $ (136,766 )   $ 73,974     $ 102,195  

Minimum pension liability adjustment, net of taxes

     —         —         —    
    


 


 


Accumulated other comprehensive (loss) income

   $ (136,766 )   $ 73,974     $ 102,195  
    


 


 


 

The accompanying notes are an integral part of these consolidated financial statements.

 

27


Table of Contents

 

New Hampshire Thrift Bancshares, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

 

For the years ended December 31,


   2004

    2003

    2002

 

Cash flows from operating activities:

                        

Net income

   $ 5,098,093     $ 5,771,453     $ 4,299,988  

Adjustments to reconcile net income to net cash provided by operating activities:

                        

Depreciation and amortization

     1,219,145       1,360,447       1,307,149  

Net decrease (increase) in mortgage servicing rights

     53,164       (660,982 )     (270,471 )

Amortization (accretion) of securities, net

     700,566       688,220       (26,923 )

Amortization of deferred expenses relating to issuance of capital securities and subordinated debentures

     27,948       30,136       30,135  

Write-off of issuance cost due to prepayment of debentures

     758,408       —         —    

Amortization of fair value adjustments, net

     12,073       12,073       12,073  

Net (increase) decrease in loans held-for-sale

     (425,460 )     4,686,879       3,079,613  

Writedown of premises and equipment

     —         —         20,912  

Net loss (gain) on sales of premises, equipment, investment in real estate, other real estate owned and other assets

     44,104       618       (17,625 )

Net (gain) loss on sales and calls of debt securities

     (392,813 )     (227,687 )     (146,473 )

Increase in investment in Charter Holding Corp., at equity

     (10,879 )     (81,489 )     (113,424 )

Provision for loan losses

     74,997       99,996       120,000  

Deferred tax expense

     378,216       1,046,854       811,907  

Decrease (increase) in accrued interest receivable and other assets

     871,120       (897,335 )     (273,167 )

Change in deferred loan origination costs, net

     (363,267 )     (231,339 )     (1,109 )

Increase (decrease) in accrued expenses and other liabilities

     1,218,561       (1,641,683 )     1,099,764  
    


 


 


Net cash provided by operating activities

     9,263,976       9,956,161       9,932,349  
    


 


 


Cash flows from investing activities:

                        

Proceeds from sales of other real estate owned

     —         17,050       67,189  

Proceeds from sales of other assets

     —         —         6,570  

Proceeds from sale of equipment

     23,000       3,000       —    

Proceeds from sale of investment in real estate

     377,734       —         —    

Capital expenditures - investment in real estate

     (48,985 )     —         —    

Capital expenditures - software

     —         (71,500 )     (328,894 )

Capital expenditures - premises and equipment

     (1,436,944 )     (929,547 )     (536,466 )

Investment in unconsolidated subsidiaries

     (620,000 )     —         —    

Proceeds from maturities of securities held-to-maturity

     3,000,000       —         1,000,000  

Proceeds from sales of securities available-for-sale

     28,635,547       36,241,623       28,873,099  

Purchases of securities available-for-sale

     (73,050,663 )     (202,664,999 )     (98,152,915 )

Proceeds from maturities of securities available-for-sale

     46,227,984       125,297,605       41,023,582  

Purchase of Federal Home Loan Bank stock

     (2,711,400 )     —         —    

Redemption of Federal Home Loan Bank stock

     —         203,600       75,400  

Loan originations and principal collections, net

     (66,031,932 )     (26,879,732 )     21,187,774  

Purchases of loans

     (2,987,986 )     (439,629 )     (1,294,008 )

Recoveries of loans previously charged off

     60,540       9,588       38,222  
    


 


 


Net cash used in investing activities

     (68,563,105 )     (69,212,941 )     (8,040,447 )
    


 


 


 

28


Table of Contents

New Hampshire Thrift Bancshares, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

(Continued)

 

For the years ended December 31,


   2004

    2003

    2002

 

Cash flows from financing activities:

                        

Net increase in demand deposits, savings and NOW accounts

     14,388,246       4,217,767       45,354,416  

Net decrease in time deposits

     (9,793,213 )     (5,069,640 )     (38,762,990 )

Redemption of capital debentures

     (16,400,000 )     —         —    

Proceeds from issuance of subordinated debentures

     20,299,196       —         —    

(Decrease) increase in short-term advances from Federal Home Loan Bank

     (19,000,000 )     9,000,000       —    

Principal advances from Federal Home Loan Bank

     75,000,000       13,000,000       —    

Repayment of advances from Federal Home Loan Bank

     (3,000,000 )     —         —    

Net increase (decrease) in repurchase agreements

     1,283,845       3,772,026       (10,462,280 )

Repurchase of treasury stock

     —         (73,495 )     —    

Dividends paid

     (1,859,333 )     (1,419,736 )     (1,233,618 )

Proceeds from exercise of stock options

     1,397,998       968,678       295,037  
    


 


 


Net cash provided by (used in) financing activities

     62,316,739       24,395,600       (4,809,435 )
    


 


 


NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS

     3,017,610       (34,861,180 )     (2,917,533 )

CASH AND CASH EQUIVALENTS, beginning of year

     18,526,015       53,387,195       56,304,728  
    


 


 


CASH AND CASH EQUIVALENTS, end of year

   $ 21,543,625     $ 18,526,015     $ 53,387,195  
    


 


 


SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION

                        

Interest paid

   $ 6,450,630     $ 5,729,557     $ 10,699,568  
    


 


 


Income taxes paid

   $ 2,140,386     $ 2,620,972     $ 1,728,728  
    


 


 


SUPPLEMENTAL DISCLOSURES OF NONCASH INVESTING AND FINANCING ACTIVITIES

                        

Transfers from loans to other assets

   $ —       $ —       $ 2,506  
    


 


 


Transfers from loans to real estate acquired through foreclosure

   $ —       $ —       $ 23,796  
    


 


 


Transfers from loans to loans held-for-sale

   $ —       $ —       $ 1,368,835  
    


 


 


Real estate owned transferred to loans

   $ —       $ —       $ 50,000  
    


 


 


Transfer from premises and equipment to investments in real estate

   $ 225,446     $ 159,852     $ —    
    


 


 


Transfer from investments in real estate to premises and equipment

   $ —       $ 100,446     $ —    
    


 


 


 

The accompanying notes are an integral part of these consolidated financial statements.

 

29


Table of Contents

 

Notes to Consolidated Financial Statements

 

NOTE 1. Summary of significant accounting policies:

 

Nature of operations - New Hampshire Thrift Bancshares, Inc. (Company) is a savings association holding company headquartered in Newport, New Hampshire. The Company’s subsidiary, Lake Sunapee Bank, fsb (Bank), a federal stock savings bank operates fourteen branches primarily in Grafton, Sullivan, and Merrimack Counties in west central New Hampshire. Although the Company has a diversified portfolio, a substantial portion of its debtors’ abilities to honor their contracts is dependent on the economic health of the region. Its primary source of revenue is providing loans to customers who are predominately small and middle-market businesses and individuals.

 

Use of estimates in the preparation of financial statements - The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.

 

Principles of consolidation - The consolidated financial statements include the accounts of the Company, the Bank, NHTB Capital Trust I, Lake Sunapee Group, Inc. (LSGI) which owns and maintains all buildings and Lake Sunapee Financial Services Corp. (LSFSC) which was formed to handle the flow of funds from the brokerage services. LSGI and LSFSC are wholly-owned subsidiaries of the Bank. NHTB Capital Trust I, a subsidiary of the Company, was formed to sell capital securities to the public. All significant intercompany accounts and transactions have been eliminated in consolidation.

 

NHTB Capital Trust II and NHTB Capital Trust III, subsidiaries of the Company, were formed to sell capital securities to the public through a third party trust pool. In accordance with FASB Interpretation No. 46, “Consolidation of Variable Interest Entities” (“FIN 46”), the subsidiaries have not been included in the consolidated financial statements.

 

Cash and cash equivalents - For purposes of reporting cash flows, the Company considers cash and due from banks and Federal Home Loan Bank overnight deposit to be cash equivalents. Cash and due from banks as of December 31, 2004 and 2003 includes $4,738,000 and $4,342,000, respectively which is subject to withdrawal and usage restrictions to satisfy the reserve requirements of the Federal Reserve Bank.

 

Securities available-for-sale - Available-for-sale securities consist of bonds, notes, debentures, and certain equity securities. Unrealized holding gains and losses, net of tax, on available-for-sale securities are reported as a net amount in a separate component of shareholders’ equity until realized. Gains and losses on the sale of available-for-sale securities are determined using the specific-identification method. Declines that are other than temporary in the fair value of individual available-for-sale securities below their cost result in write-downs of the individual securities to their fair value. There were no write-downs for the years ended 2004, 2003 and 2002, respectively.

 

Securities held-to-maturity - Bonds, notes and debentures which the Company has the positive intent and ability to hold to maturity are reported at cost, adjusted for premiums and discounts recognized in interest income using the interest method over the period to maturity. Declines that are other than temporary in the fair value of individual held-to-maturity securities below their cost result in write-downs of the individual securities to their fair value. No write-downs have occurred for securities held-to-maturity.

 

30


Table of Contents

Notes to Consolidated Financial Statements

 

NOTE 1. Summary of significant accounting policies: (continued)

 

Investment in Charter Holding Corp. - As of December 31, 1999, the Company had an investment of $79,999 in the common stock of Charter Holding Corp. (CHC). This investment was included in other investments on the consolidated balance sheet and was accounted for under the cost method of accounting for investments. On October 2, 2000, the Bank and two other New Hampshire banks acquired CHC and Phoenix New England Trust Company (PNET) from the Phoenix Home Life Mutual Insurance Company of Hartford, Connecticut. Contemporaneous with the acquisition, CHC and PNET merged under the continuing name of Charter Holding Corp. with assets of approximately $1.7 billion under management. As a result of the acquisitions and merger, at an additional cost of $3,033,337 each, the Bank and each of the other two banks own one-third of CHC. Headquartered in Concord, New Hampshire, CHC provides trust and investment services from more than a dozen offices across New Hampshire, as well as one in Norwich, Vermont. Charter New England Agency, a subsidiary of CHC, provides life insurance, fixed and variable annuities and mutual fund products, in addition to full brokerage services through a broker/dealer affiliation with W.S. Griffith Inc., a wholly owned subsidiary of PM Holdings.

 

Goodwill resulting from the acquisition was “pushed down” to the financial statements of CHC.

 

The Bank uses the equity method of accounting to account for its investment in CHC. An investor using the equity method initially records an investment at cost. Subsequently, the carrying amount of the investment is increased to reflect the investor’s share of income of the investee and is reduced to reflect the investor’s share of losses of the investee or dividends received from the investee. The investor’s share of the income or losses of the investee is included in the investor’s net income as the investee reports them. Adjustments similar to those made in preparing consolidated financial statements, such as elimination of intercompany gains and losses, also are applicable to the equity method.

 

At December 31, 2004 and 2003 the carrying amount of the Company’s investment in CHC equalled the amount of the Bank’s underlying equity in the net assets of CHC.

 

Loans held-for-sale - Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated market value in the aggregate. Net unrealized losses are recognized through a valuation allowance by charges to income. No losses have been recorded.

 

Nonaccrual loans - Residential real estate loans and consumer loans are placed on nonaccrual status when they become 90 days past due. Commercial loans are placed on nonaccrual status when they become 90 days past due or when it becomes probable that the Bank will be unable to collect all amounts due pursuant to the terms of the loan agreement. When a loan has been placed on nonaccrual status, previously accrued interest is reversed with a charge against interest income on loans. Interest received on nonaccrual loans is generally booked to interest income on a cash basis. Residential real estate loans and consumer loans generally are returned to accrual status when they are no longer over 90 days past due. Commercial loans are generally returned to accrual status when the collectibility of principal and interest is reasonably assured.

 

Allowance for loan losses - The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance.

 

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

 

31


Table of Contents

Notes to Consolidated Financial Statements

 

NOTE 1. Summary of significant accounting policies: (continued)

 

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.

 

Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify individual consumer and residential loans for impairment disclosures.

 

Deferred loan origination fees - Loan origination, commitment fees and certain direct origination costs are deferred, and the net amount is being amortized as an adjustment of the related loan’s yield. The Company is amortizing these amounts over the contractual life of the related loans.

 

Loan servicing - For loans sold after December 31, 1995 with servicing retained, the Company recognizes as separate assets from their related loans the rights to service mortgage loans for others, either through acquisition of those rights or from the sale or securitization of loans with the servicing rights retained on those loans, based on their relative fair values. To determine the fair value of the servicing rights created, the Company uses the market prices under comparable servicing sale contracts, when available, or alternatively uses a valuation model that calculates the present value of future cash flows to determine the fair value of the servicing rights. In using this valuation method, the Company incorporates assumptions that market participants would use in estimating future net servicing income, which includes estimates of the cost of servicing loans, the discount rate, ancillary income, prepayment speeds and default rates.

 

The cost of mortgage servicing rights is amortized in proportion to, and over the period of, estimated net servicing revenues. Refinance activities are considered in estimating the period of net servicing revenues. 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. For purposes of measuring impairment, the rights are stratified based on the interest rate risk characteristics of the underlying loans. The amount of impairment recognized is the amount by which the capitalized mortgage servicing rights for a stratum exceed their fair value.

 

Concentration of credit risk - Most of the Company’s business activity is with customers located within the state. There are no concentrations of credit to borrowers that have similar economic characteristics. The majority of the Company’s loan portfolio is comprised of loans collateralized by real estate located in the state of New Hampshire.

 

Premises and equipment - Company premises and equipment are stated at cost, less accumulated depreciation. Depreciation is computed using straight-line and accelerated methods over the estimated useful lives of the assets. Estimated lives are 5 to 40 years for buildings and premises and 3 to 15 years for furniture, fixtures and equipment. Expenditures for replacements or major improvements are capitalized; expenditures for normal maintenance and repairs are charged to expense as incurred. Upon the sale or retirement of company premises and equipment, the cost and accumulated depreciation are removed from the respective accounts and any gain or loss is included in income.

 

Investment in real estate - Investment in real estate is carried at the lower of cost or estimated fair value. The buildings are being depreciated over their useful lives. The properties consist of two buildings that the Company rents for commercial purposes. Rental income is recorded in income when received and expenses for maintaining these assets are charged to expense as incurred.

 

32


Table of Contents

Notes to Consolidated Financial Statements

 

NOTE 1. Summary of significant accounting policies: (continued)

 

Real estate owned and property acquired in settlement of loans - The Company classifies loans as in-substance, repossessed or foreclosed if the Company receives physical possession of the debtor’s assets regardless of whether formal foreclosure proceedings take place. At the time of foreclosure or possession, the Company records the property at the lower of fair value minus estimated costs to sell or the outstanding balance of the loan. All properties are periodically reviewed and declines in the value of the property are charged against income.

 

Earnings per share - Basic earnings per share 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 earnings per share, 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.

 

Advertising - The Company directly expenses costs associated with advertising as they are incurred.

 

Income taxes - The Company recognizes income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are established for the temporary differences between the accounting basis and the tax basis of the Company’s assets and liabilities at enacted tax rates expected to be in effect when the amounts related to such temporary differences are realized or settled.

 

Fair value of financial instruments - The following methods and assumptions were used by the Company in estimating fair values of financial instruments as disclosed herein:

 

Cash and cash equivalents - The carrying amounts of cash and cash equivalents approximate their fair value.

 

Available-for-sale and held-to-maturity securities - Fair values for available-for-sale and held-to-maturity securities are based on quoted market prices.

 

Other investments - The carrying amounts of other investments approximate their fair values.

 

Loans held-for-sale - Fair values of loans held-for-sale are based on estimated market values.

 

Loans receivable - For variable-rate loans that reprice frequently and have no significant change in credit risk, fair values are based on carrying values. Fair values for all 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. Fair values for impaired loans are estimated using discounted cash flow analyses or underlying collateral values, where applicable.

 

Accrued interest receivable - The carrying amounts of accrued interest receivable approximate their fair values.

 

Deposit liabilities - The fair values disclosed for demand deposits are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). The carrying amounts of variable-rate, fixed term money-market accounts and certificates of deposits (CD’s) approximate their fair values at the reporting date. Fair values for fixed-rate CD’s are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.

 

Federal Home Loan Bank advances - Fair values for Federal Home Loan Bank advances are estimated using a discounted cash flow technique that applies interest rates currently being offered on advances to a schedule of aggregated expected monthly maturities on Federal Home Loan Bank advances.

 

Securities sold under agreements to repurchase - The carrying amounts of securities sold under agreements to repurchase approximate their fair values.

 

Junior subordinated debentures and subordinated debentures - Fair values of the guaranteed preferred beneficial interests in junior subordinated debentures are based on the quoted market prices of the NHTB Capital Trust I Capital Securities. Fair values of subordinated debentures are estimated using discounted cash flow analyses, using interest rates currently being offered for debentures with similar terms.

 

Off-balance sheet instruments - Fair values for loan commitments have not been presented as the future revenue derived from such financial instruments is not significant.

 

33


Table of Contents

Notes to Consolidated Financial Statements

 

NOTE 1. Summary of significant accounting policies: (continued)

 

Stock based compensation - At December 31, 2004, the Company has four fixed stock-based employee compensation plans which are described more fully in Note 10. The Company accounts for those plans 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 has been recognized for its fixed stock option plans. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value recognition provisions of Statement of Financial Accounting Standards (SFAS) No. 123 (revised 2004), Stock-Based Payments, to stock-based employee compensation.

 

For the years ended December 31,


   2004

   2003

   2002

Net income, as reported

   $ 5,098,093    $ 5,771,453    $ 4,299,988

Deduct: Total stock-based employee compensation expense determined under fair value based method for all awards, net of related tax effects

     —        652,078      324,178
    

  

  

Pro forma net income

   $ 5,098,093    $ 5,119,375    $ 3,975,810
    

  

  

Earnings per share:

                    

Basic - as reported

   $ 1.23    $ 1.46    $ 1.10

Basic - pro forma

   $ 1.23    $ 1.29    $ 1.02

Diluted - as reported

   $ 1.20    $ 1.42    $ 1.09

Diluted - pro forma

   $ 1.20    $ 1.26    $ 1.01

 

Recent Accounting Pronouncements - In April 2003, the Financial Accounting Standards Board (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.

 

34


Table of Contents

Notes to Consolidated Financial Statements

 

NOTE 1. Summary of significant accounting policies: (continued)

 

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 reporting 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 fiscal year or interim period ending after December 15, 2003. The adoption of this interpretation did not 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. The adoption of this Statement did not have a material impact on the Company’s consolidated financial statements.

 

In December 2003, the American Institute of Certified Public Accountants (“AICPA”) issued Statement of Position 03-3 (“SOP 03-3”) “Accounting for Certain Loans or Debt Securities Acquired in a Transfer.” SOP 03-3 requires loans acquired through a transfer, such as a business combination, where there are differences in expected cash flows and contractual cash flows due in part to credit quality be recognized at their fair value. The excess of contractual cash flows over expected cash flows is not to be recognized as an adjustment of yield, loss accrual, or valuation allowance. Valuation allowances cannot be created nor “carried over” in the initial accounting for loans acquired in a transfer on loans subject to SFAS 114, “Accounting by Creditors for Impairment of a Loan.” This SOP is effective for loans acquired in fiscal years beginning after December 15, 2004, with early adoption encouraged. The Company does not believe the adoption of SOP 03-3 will have a material impact on the Company’s financial position or results of operations.

 

In December 2004, the FASB issued SFAS No. 123 (revised 2004), “Share-Based Payments” (“SFAS 123R”). This Statement revises FASB Statement No. 123, “Accounting for Stock Based Compensation” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and its related implementation guidance. SFAS 123R requires that the cost resulting from all share-based payment transactions be recognized in the consolidated financial statements. It establishes fair value as the measurement objective in accounting for share-based payment arrangements and requires all entities to apply a fair-value based measurement method in accounting for share-based payment transactions with employees except for equity instruments held by employee share ownership plans. This Statement is effective for the Company as of the beginning of the first interim or annual reporting period that begins after June 15, 2005. The Company does not believe the adoption of this Statement will have a material impact on the Company’s financial position or results of operations.

 

35


Table of Contents

Notes to Consolidated Financial Statements

 

Reclassifications - Certain amounts in the 2003 and 2002 consolidated financial statements have been reclassified to conform to the current year’s presentation.

 

36


Table of Contents

Notes to Consolidated Financial Statements

 

NOTE 2. Issuance of Capital Securities:

 

In August, 1999, NHTB Capital Trust I (“Trust I”), a wholly owned subsidiary of the Company, sold capital securities to the public. The capital securities sold consisted of 1,640,000 9.25% Capital Securities I with a $10.00 liquidation amount for each capital security, for a total of $16,400,000. The capital securities were fully guaranteed by the Company. Each capital security paid a cumulative quarterly distribution at the annual rate of 9.25% of the liquidation amounts. Each capital security represented an undivided preferred beneficial interest in the assets of Trust I. Trust I used the proceeds of the above sale and the proceeds of the sale of its common securities to the Company to buy $16,907,300 of 9.25% subordinated debentures (“Debentures I”) issued by the Company. These Debentures I were due to mature on September 20, 2029. The Debentures I had the same financial terms as the capital securities. The Company made interest payments and other payments under Debentures I to Trust I. The Company’s obligations under the Debentures I were unsecured and ranked junior to all of the Company’s other borrowings, except borrowings that by their terms ranked equal or junior to the subordinated debentures. The Company guaranteed the payment by Trust I of the amounts that were required to be paid on the capital securities, to the extent that Trust I had funds available for such payments.

 

Trust I were mandatorily redeemable upon the maturing of Debentures I on September 30, 2029 or upon earlier redemption as provided in the Indenture. The Company had the right to redeem Debentures I, in whole or in part on or after September 30, 2004 at the liquidation amount plus any accrued but unpaid interest to the redemption date. On September 30, 2004, the Company redeemed Capital Securities I in its entirety and recognized $758,408 in unamortized offering expenses resulting from the issuance of Capital Securities I.

 

On March 30, 2004, NHTB Capital Trust II (“Trust II”), a Connecticut statutory trust formed by the Company, completed the sale of $10.0 million of 6.06%, 5 Year Fixed-Floating Capital Securities (“Capital Securities II”). Trust II also issued common securities to the Company and used the net proceeds from the offering to purchase a like amount of 6.06% Junior Subordinated Deferrable Interest Debentures (“Debentures II”) of the Company. Debentures II are the sole assets of Trust II. The Company used the proceeds to redeem the securities issued by Trust I, which were callable on September 30, 2004. Total expenses associated with the offering of $160,402 are included in other assets and are being amortized on a straight-line basis over the life of Debentures II.

 

Capital Securities II accrue and pay distributions quarterly at an annual rate of 6.06% for the first 5 years of the stated liquidation amount of $10 per Capital Security. The Company has fully and unconditionally guaranteed all of the obligations of the Trust. The guaranty covers the quarterly distributions and payments on liquidation or redemption of Capital Securities II, but only to the extent that the Trust has funds necessary to make these payments.

 

Capital Securities II are mandatorily redeemable upon the maturing of Debentures II on March 30, 2034 or upon earlier redemption as provided in the Indenture. The Company has the right to redeem Debentures II, in whole or in part on or after March 30, 2009 at the liquidation amount plus any accrued but unpaid interest to the redemption date.

 

On March 30, 2004, NHTB Capital Trust III (“Trust III”), a Connecticut statutory trust formed by the Company, completed the sale of $10.0 million of Floating Capital Securities, adjustable every three months at LIBOR plus 2.79% (“Capital Securities III”). Trust III also issued common securities to the Company and used the net proceeds from the offering to purchase a like amount of Junior Subordinated Deferrable Interest Debentures (“Debentures III”) of the Company. Debentures III are the sole assets of Trust III. The Company used a portion of the proceeds to redeem the balance of securities issued by Trust I, which were callable on September 30, 2004. The balance of the proceeds of Trust III are being used for general corporate purposes. Total expenses associated with the offering of $160,402 are included in other assets and are being amortized on a straight-line basis over the life of Debentures III.

 

37


Table of Contents

Notes to Consolidated Financial Statements

 

NOTE 2. Issuance of Capital Securities: (continued)

 

Capital Securities III accrue and pay distributions quarterly based on the stated liquidation amount of $10 per Capital Security. The Company has fully and unconditionally guaranteed all of the obligations of Trust III. The guaranty covers the quarterly distributions and payments on liquidation or redemption of Capital Securities III, but only to the extent that Trust III has funds necessary to make these payments.

 

Capital Securities III are mandatorily redeemable upon the maturing of Debentures III on March 30, 2034 or upon earlier redemption as provided in the Indenture. The Company has the right to redeem Debentures III, in whole or in part on or after March 30, 2009 at the liquidation amount plus any accrued but unpaid interest to the redemption date.

 

NOTE 3. Securities:

 

Debt and equity securities have been classified in the consolidated balance sheets according to management’s intent.

 

The amortized cost of securities and their approximate fair values are summarized as follows:

 

    

Amortized

Cost


  

Gross

Unrealized
Gains


  

Gross

Unrealized
Losses


  

Fair

Value


Available-for-sale:

                           

December 31, 2004:

                           

Bonds and notes -

                           

U. S. Government, including agencies

   $ 30,079,787    $ 3,697    $ 214,421    $ 29,869,063

Mortgage-backed securities

     72,065,872      335,994      509,496      71,892,370

Other bonds and debentures

     16,137,737      112,229      55,288      16,194,678

Equity securities

     484,386      100,814      —        585,200
    

  

  

  

Total available-for-sale

   $ 118,767,782    $ 552,734    $ 779,205    $ 118,541,311
    

  

  

  

December 31, 2003:

                           

Bonds and notes -

                           

U. S. Government, including agencies

   $ 39,059,281    $ 291,004    $ 63,344    $ 39,286,941

Mortgage-backed securities

     58,009,781      151,236      540,819      57,620,198

Other bonds and debentures

     23,333,810      290,200      43,897      23,580,113

Equity securities

     484,386      38,114      —        522,500
    

  

  

  

Total available-for-sale

   $ 120,887,258    $ 770,554    $ 648,060    $ 121,009,752
    

  

  

  

Held-to-maturity:

                           

December 31, 2003:

                           

Bonds and notes -

                           

Other bonds and debentures

   $ 3,001,145    $ 73,200    $ 11,145    $ 3,063,200
    

  

  

  

Total held-to-maturity

   $ 3,001,145    $ 73,200    $ 11,145    $ 3,063,200
    

  

  

  

 

For the years ended December 31, 2004, 2003 and 2002, proceeds from sales of debt securities available-for-sale amounted to $28,635,547, $36,241,623 and $28,873,099, respectively. Gross gains of $369,494, $265,794 and $1,075,473, and gross losses of $8,757, $55 and $929,000, were realized during 2004, 2003 and 2002, respectively, on sales of available-for-sale debt securities. The tax provision applicable to these net realized gains amounted to $142,888, $105,259 and $58,018, respectively. There were no sales of available-for-sale equity securities during 2004, 2003 and 2002.

 

38


Table of Contents

Notes to Consolidated Financial Statements

 

NOTE 3. Securities: (continued)

 

Maturities of debt securities, excluding mortgage-backed securities, classified as available-for-sale are as follows as of December 31, 2004:

 

     Fair Value

U.S. Government, including agencies

   $ 5,493,907
    

Total due in less than one year

   $ 5,493,907
    

U.S. Government, including agencies

   $ 24,375,156

Other bonds and debentures

     12,774,604
    

Total due after one year through five years

   $ 37,149,760
    

Other bonds and debentures

   $ 1,542,774
    

Total due after five years through ten years

   $ 1,542,774
    

Other bonds and debentures

   $ 1,877,300
    

Total due after ten years

   $ 1,877,300
    

 

There were no securities of issuers which exceeded 10% of shareholders’ equity as of December 31, 2004.

 

Securities, carried at $99,226,273 and $94,395,722 were pledged to secure public deposits, the treasury, tax and loan account and securities sold under agreements to repurchase as of December 31, 2004 and 2003, 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, 2004:

 

     Less than 12 Months

   12 Months or Longer

   Total

    

Fair

Value


   Unrealized
Losses


  

Fair

Value


   Unrealized
Losses


  

Fair

Value


   Unrealized
Losses


Bonds and notes -

                                         

U.S. Government, including agencies

   $ 23,836,563    $ 214,421    $ —      $ —      $ 23,836,563    $ 214,421

Mortgage-backed securities

     16,190,946      105,811      22,226,361      403,685      38,417,307      509,496

Other bonds and debentures

     9,307,476      55,288      —        —        9,307,476      55,288
    

  

  

  

  

  

Total temporarily impaired securities

   $ 49,334,985    $ 375,520    $ 22,226,361    $ 403,685    $ 71,561,346    $ 779,205
    

  

  

  

  

  

 

The investments in the Company’s investment portfolio that are temporarily impaired as of December 31, 2004 consist of debt securities issued by U.S. government corporations and agencies and corporate debt with strong credit ratings. The unrealized losses in the above table are attributable to changes in market interest rates. Company management does not intend to sell these securities in the near term, and due to the securities’ relative short duration, anticipates that the unrealized losses that currently exist will be reduced going forward.

 

39


Table of Contents

Notes to Consolidated Financial Statements

 

NOTE 4. Loans receivable:

 

Loans receivable consisted of the following as of December 31:

 

     2004

    2003

 

Real estate loans

                

Conventional

   $ 233,429,745     $ 204,282,408  

Construction

     21,756,712       15,241,362  

Commercial

     86,660,465       67,326,286  
    


 


       341,846,922       286,850,056  

Consumer loans

     57,449,583       43,880,983  

Commercial and municipal loans

     16,722,853       16,283,138  

Unamortized adjustment to fair value

     60,368       72,441  
    


 


Total loans

     416,079,726       347,086,618  

Allowance for loan losses

     (4,019,450 )     (3,898,650 )

Deferred loan origination costs, net

     1,748,014       1,384,747  
    


 


Loans receivable, net

   $ 413,808,290     $ 344,572,715  
    


 


 

The following is a summary of activity in the allowance for loan losses account for the years ended December 31:

 

     2004

    2003

    2002

 

BALANCE, beginning of year

   $ 3,898,650     $ 3,875,708     $ 4,405,385  

Charged-off loans

     (14,737 )     (86,642 )     (83,213 )

Writedowns of nonperforming loans transferred to loans held-for-sale

     —         —         (604,686 )

Recoveries

     60,540       9,588       38,222  

Provision for loan losses charged to income

     74,997       99,996       120,000  
    


 


 


BALANCE, end of year

   $ 4,019,450     $ 3,898,650     $ 3,875,708  
    


 


 


 

Certain directors and executive officers of the Company and companies in which they have significant ownership interest were customers of the Bank during 2004. Total loans to such persons and their companies amounted to $1,666,128 as of December 31, 2004. During 2004 principal advances of $899,028 were made and principal payments totaled $360,981.

 

The following is a summary of information regarding impaired loans, nonaccrual loans and accruing loans 90 days or more overdue:

 

     December 31,

     2004

   2003

Nonaccrual loans

   $ 293,203    $ 1,157,957
    

  

Accruing loans which are 90 days or more overdue

   $ —      $ —  
    

  

Impaired loans as of December 31,


   2004

   2003

Recorded investment in impaired loans at December 31

   $ 902,458    $ 777,632

Portion of allowance for loan losses allocated to impaired loans

   $ 141,666    $ 116,645

Net balance of impaired loans

   $ 760,792    $ 660,987

Recorded investment in impaired loans with a related allowance for credit losses

   $ 902,458    $ 777,632

 

Years Ended December 31,


   2004

   2003

   2002

Average recorded investment in impaired loans

   $ 479,096    $ 425,009    $ 770,979

Interest income recognized on impaired loans

   $ 50,701    $ 22,770    $ 68,916

Interest income on impaired loans on a cash basis

   $ 2,748    $ 8,945    $ 68,916

 

40


Table of Contents

Notes to Consolidated Financial Statements

 

NOTE 4. Loans receivable: (continued)

 

In addition to total loans previously shown, the Company services loans for other financial institutions. Participation loans are loans originated by the Company for a group of banks. Sold loans are loans originated by the Company and sold to the secondary market. The Company services these loans and remits the payments received to the buyer. The Company specifically originates long-term, fixed-rate loans to sell. The amount of loans sold and participated out which are serviced by the Company are as follows as of December 31:

 

     2004

   2003

Sold loans

   $ 293,569,964    $ 289,825,192
    

  

Participation loans

   $ 12,782,673    $ 7,672,024
    

  

 

The balance of capitalized servicing rights, net of valuation allowances, included in other assets at December 31, 2004 and 2003 was $2,281,309 and $2,334,473, respectively.

 

Servicing assets of $859,564, $1,837,297 and $1,141,341 were capitalized in 2004, 2003 and 2002, respectively. Amortization of servicing assets was $944,959 in 2004, $1,293,748 in 2003 and $802,540 in 2002.

 

The fair value of servicing assets was $3,021,319 and $2,945,009 as of December 31, 2004 and 2003, respectively. Following is an analysis of the aggregate changes in the valuation allowances for servicing assets:

 

     2004

    2003

 

Balance, beginning of year

   $ 61,115     $ 178,548  

Decrease

     (32,231 )     (117,433 )
    


 


Balance, end of year

   $ 28,884     $ 61,115  
    


 


 

NOTE 5. Premises and equipment:

 

Premises and equipment are shown on the consolidated balance sheets at cost, net of accumulated depreciation, as follows as of December 31:

 

     2004

   2003

Land

   $ 1,128,768    $ 1,221,249

Buildings and premises

     10,329,871      9,702,994

Furniture, fixtures and equipment

     5,334,432      4,709,441
    

  

       16,793,071      15,633,684

Less - Accumulated depreciation

     7,092,594      6,327,856
    

  

     $ 9,700,477    $ 9,305,828
    

  

 

Depreciation expense amounted to $797,630, $949,931 and $976,746 for the years ending December 31, 2004, 2003 and 2002, respectively.

 

NOTE 6. Deposits:

 

The following is a summary of maturities of time deposits as of December 31, 2004:

 

2005

   $ 80,295,399

2006

     16,589,390

2007

     2,332,673

2008

     1,077,851

2009

     1,289,401
    

     $ 101,584,714
    

 

41


Table of Contents

Notes to Consolidated Financial Statements

 

NOTE 6. Deposits: (continued)

 

Deposits from related parties held by the Bank as of December 31, 2004 and 2003 amounted to $5,495,567 and $3,786,673, respectively.

 

As of December 31, 2004 and 2003, time deposits include $28,654,490 and $29,813,003, respectively of certificates of deposit with a minimum balance of $100,000.

 

NOTE 7. Federal Home Loan Bank Advances:

 

Advances consist of funds borrowed from the Federal Home Loan Bank of Boston (FHLB).

 

As of December 31, 2004, FHLB advances totaled $75,000,000 with $55,000,000 maturing in 2005 and $20,000,000 maturing in May 2006. At December 31, 2004 the interest rates on FHLB advances ranged from 2.05% to 3.09%. The weighted average interest rate at December 31, 2004 is 2.53%.

 

Advances are secured by the Company’s stock in that institution, its residential real estate mortgage portfolio and the remaining U.S. government and agency securities not otherwise pledged.

 

NOTE 8. Securities sold under agreements to repurchase:

 

The securities sold under agreements to repurchase as of December 31, 2004 are securities sold on a short-term basis by the Bank that have been accounted for not as sales but as borrowings. The securities consisted of U.S. Agencies. The securities were held in the Bank’s safekeeping account at Bank of America under the control of the Bank and pledged to the purchasers of the securities. The purchasers have agreed to sell to the Bank substantially identical securities at the maturity of the agreements.

 

NOTE 9. Income taxes:

 

The components of income tax expense are as follows for the years ended December 31:

 

     2004

   2003

   2002

Current tax expense

   $ 2,785,294    $ 2,459,668    $ 1,663,388

Deferred tax expense

     378,216      1,046,854      811,907
    

  

  

Total income tax expense

   $ 3,163,510    $ 3,506,522    $ 2,475,295
    

  

  

 

The reasons for the difference between the tax at the statutory federal income tax rate and the effective tax rates are summarized as follows for the years ended December 31:

 

     2004

    2003

    2002

 

Federal income tax at statutory rate

   34.0 %   34.0 %   34.0 %

Increase (decrease) in tax resulting from:

                  

Tax-exempt income

   (.3 )   (.1 )   (.1 )

Dividends received deduction

   (1.2 )   (.9 )   (1.1 )

Other, net

   5.7     4.8     3.7  
    

 

 

Effective tax rates

   38.2 %   37.8 %   36.5 %
    

 

 

 

42


Table of Contents

Notes to Consolidated Financial Statements

 

NOTE 9. Income taxes: (continued)

 

The Company had gross deferred tax assets and gross deferred tax liabilities as follows as of December 31:

 

     2004

    2003

 

Deferred tax assets:

                

Interest on non-performing loans

   $ 2,052     $ 21,255  

Allowance for loan losses

     1,238,003       1,148,977  

Deferred compensation

     115,128       47,686  

Deferred retirement expense

     167,660       147,975  

Accrued directors fees

     56,175       55,021  

Net unrealized holding loss on securities available-for-sale

     89,705       —    

Other

     13,128       10,103  
    


 


Gross deferred tax assets

     1,681,851       1,431,017  
    


 


Deferred tax liabilities:

                

Deferred loan costs, net of fees

     692,011       524,996  

Prepaid pension

     954,206       986,839  

Accelerated depreciation

     819,319       688,181  

Net unrealized holding gain on securities available-for-sale

     —         48,520  

Purchased goodwill

     888,216       592,144  

Mortgage servicing rights

     903,626       925,873  
    


 


Gross deferred tax liabilities

     4,257,378       3,766,553  
    


 


Net deferred tax liabilities

   $ (2,575,527 )   $ (2,335,536 )
    


 


 

As of December 31, 2004, the Company had no operating loss and tax credit carryovers for tax purposes.

 

NOTE 10. Stock compensation plans:

 

At December 31, 2004, the Company has four fixed stock-based employee compensation plans. Under the plans, amounts equal to 10% of the issued and outstanding common stock of the Company were reserved for future issuance. As of December 31, 2004 all such options had been granted. Under the plans, the exercise price of each option equals the market price of the Company’s stock on the date of grant and an option’s maximum term is 10 years. Options are exercisable immediately.

 

There were no options granted in 2004. The fair value of each option granted in 2003 and 2002 was estimated on the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:

 

     2003

    2002

 

Weighted risk-free interest rate

   4.36 %   5.13 %

Weighted expected life

   10 years     10 years  

Weighted expected volatility

   22.3 %   19.3 %

Weighted expected dividend yield

   2.78% per year     3.5% per year  

 

No modifications have been made to the terms of the option agreements.

 

43


Table of Contents

Notes to Consolidated Financial Statements

 

NOTE 10. Stock compensation plans: (continued)

 

A summary of the status of the Company’s fixed stock option plans as of December 31, 2004, 2003 and 2002 and changes during the years ending on those dates is presented below:

 

     2004

   2003

   2002

     Shares

    Weighted
Average
Exercise
Price


   Shares

    Weighted
Average
Exercise
Price


   Shares

    Weighted
Average
Exercise
Price


Outstanding at beginning of year

   522,800     $ 10.45      410,700     $ 8.74      281,600     $ 8.21

Granted

   —         —        218,000       13.05      200,000       9.13

Exercised

   (149,800 )     9.33      (105,900 )     9.15      (43,900 )     6.72

Forfeited

   —       <